Date: 10 June 2004

Speakers:
Orsalia Kalantzopoulos, Country Director, World Bank
Satu Kristiina Kahkonen, Lead Economist and author of the report, World Bank

 
CEPS hosted a presentation of the World Bank’s Economic Memorandum on Kosovo. This report delivers an assessment of Kosovo’s economic performance by identifying its strengths and opportunities as well as the prevailing impediments to growth, and formulates policy recommendations on that basis. The topic was introduced by the World Bank’s Country Director for Kosovo, Orsalia Kalatzopoulos, and presented by Satu Kristiina Kahkonen, a Lead Economist at the World Bank.
 
In 1999, Kosovo’s economy emerged badly damaged from the ethnic conflict and was characterised by fractured external commercial and financial links, international sanctions, a lack of investment and bad economic policies. After an initial increase in international aid following the conflict, donor flows receded by 70% between 2000 and 2003. Over that period, economic growth fell from 21% to a modest 4.7%. The current situation furthermore is characterized by a negative trade balance, high poverty and high unemployment. The principal policy challenges for Kosovo are thus to achieve sustainable growth and job creation, while maintaining macroeconomic stability – all against a background of peace and security. As a small land-locked economy, the country’s growth strategies need to be export oriented and regional integration fostered.
 
Kosovo has a stable macroeconomic environment, which indeed is a laudable achievement, as - lacking an independent monetary policy - it only has the fiscal policy instrument at its disposal. Local SMEs face favourable investment conditions and Kosovo benefits from both a liberal trading regime and flexible labour markets. Finally, it can draw on a stock of natural resources such mineral deposits and fertile agricultural land, which represent a potential economic opportunity for the future.
 
However, legal and political risks as well as ethnic tensions have a restricting impact on FDI flows and adversely affect both the savings base (short-term deposits in particular) and access to external finance. The fiscal policy instrument is furthermore exposed to certain risks, such as debt servicing obligations and wage pressure. A badly functioning power sector represents an additional, cost-entailing strain on the public and the private sector. Finally informal competition and corruption are widespread and result in a substantial grey economy.
 
Mrs Kahkonen listed a few policy recommendations in different domains. Regarding macroeconomic policy, the World Bank advocates a cautious fiscal expansion to complete the reconstruction of the infrastructure, but warns that fiscal risks should be taken on board and that the cash reserve should not be exhausted on recurrent spending, such as public sector wages. The tax administration has also to be improved by strengthening the tax base.
 
Regarding trade policy, the current liberal environment should be maintained and protectionism averted. Tariffs should be cut even further, while considering the revenue implications. Kosovo should also try to enhance membership in free trade areas – mainly at the regional level. Policy measures to boost export performance (e.g. duty drawback, export processing zones) should also be undertaken.
 
Better implementation and enforcement of the regulatory regime could improve the business environment and thus trigger investment. The VAT administration should be improved and the VAT rate possibly increased – in part to compensate for revenue shortfalls resulting from tariff cuts. Privatisation, both of socially owned enterprises (SOEs) as well as of land, should be promoted, while publicly owned enterprises (POEs) should be restructured. Since the development of the financial sector in 1999, lending rose substantially, but financial intermediation remains low. This situation could be improved by strengthening the capacity of courts to enforce creditors’ rights and contracts, and accounting and financial reporting.
 
Currently the power sector and its unreliable supply are one of the biggest obstacles to business operations and growth. Power theft and financial problems of Kosovo’s Power Corporation, which are a strain on public resources, exacerbate this bad situation. The mining sector however represents a potential source of growth, due to the relative abundance of certain minerals (e.g. lignite, ferronickel) and the proximity to European markets. To develop efficiently, considerable FDI inflows and technical know-how are needed, and some environmental and social legacies have to be resolved. Privatisation and sound regulation would also enhance activity in that sector. Kosovo also has a comparative advantage in certain agricultural sub-sectors (e.g. vegetables, dairy products), but needs to foster agro-processing and improve food safety and phyto-sanitary standards.
 
The labour market is characterised by high unemployment, in particular youth unemployment, and high flexibility. Unemployment indeed varies between 23-33% (World Bank estimates) and 50% (official figures). The prevailing flexibility needs to be maintained rather than impeded by payroll taxes and unemployment insurance. At the same time social programmes need to be developed that are targeted at poverty reduction.
 
To conclude, the key issues highlighted by the World Bank’s “Develop Kosovo Economic Strategy” are the following: Fiscal policy has to address sustainability and risks, prioritise expenditures and improve budget management. Privatisation of SOEs and restructuring of POEs should advance, mainly in the energy and mining sectors in order to attract FDI. The business and trading environment for SMEs has to be improved. But above all, security and stability has to be warranted.
 
See the slides of the presentation.