Ian Bancroft in Belgrade -

At the height of the global economic crisis, the outlook for the Western Balkans was gloomy. Recent positive signs, however, suggest that some - Bosnia-Herzegovina and Serbia, in particular - are weathering the storm better than expected, whilst others are beginning to regret the courses of action that they took.

One of those with cause to regret is Croatia. Having suffered an economic contraction of 5.8% last year and facing a further decline of 1.9% in 2010, the governor of Croatia's central bank, Zeljko Rohatinski, recently conceded that it was a mistake not to seek assistance from the International Monetary Fund (IMF) at the height of the crisis. Facing elections in 2011, Croatia's prime minister, Jadranka Kosor, who recently survived a vote of no-confidence, has avoided making politically contentious spending cuts. Though the ahead-of-schedule abolishment of the 4% crisis tax on higher incomes (which affects about 350,000 people) is expected to boost domestic consumption in the near term, growth is likely to remain below pre-crisis levels in the coming years.

By contrast, Bosnia - whose economy declined 3.1% in 2009 - has been praised for the steps taken in the face of stark economic realities, even though it was facing important elections of its own in October. As Damir Cosic, an economist for the World Bank in Bosnia, tells bne, "the authorities undertook to introduce important reforms aimed at making public spending sustainable under the fiscal framework programme agreed with the IMF and with the budget support provided by the World Bank and the European Union. The performance under these programmes has been broadly on-track as evidenced by approval of the second and third reviews by the IMF's executive board in October."

Though 0.5% growth is forecast for this year and 3% for 2011, Cosic cautions that the economic recovery remains fragile and dependent on external conditions. "Bosnia's exports have picked up this year, supported by the external commodity demand. Drops in domestic demand have levelled off from 2009, in part supported by the improving credit conditions."

One beneficiary of the improved export environment is Birac, an alumina manufacturer based in the eastern town of Zvornik, which posted net profits of €1.185m in the third quarter of 2010, compared to a loss of almost €3.5m in the same period last year. Continued expansions in output are expected to drive further improvements in efficiency and profits - a story that Bosnia hopes will be repeated across its manufacturing sector.

Serbian plaudits

With the modest recovery seen in 2010 expected to continue into 2011, Serbia has received similar plaudits for its response to the crisis. Dusko Vasiljevic, an economist for the World Bank in Serbia, explains that the authorities in Serbia reacted quickly to deteriorating external conditions by initiating a programme with the IMF and undertaking a significant fiscal adjustment. "The government put in place expenditure controls and spending was contained by a range of expenditure measures, including most potently a nominal wage and pension freeze. Prudent monetary policy in the pre-crisis period and [the Vienna Initiative] agreement with foreign banks in the early stages of the crisis assured that the banking system has weathered well the external shocks; banks in Serbia remain highly liquid and well-capitalized."

As in Bosnia, Vasiljevic notes a "welcomed re-balancing of growth sources," adding that "exports are recovering vigorously indicating that the economy may be moving away from consumption-driven growth. Going forward, growth will have to rely much more on exports and investments, as opposed to consumption financed by foreign capital inflows, as in the pre-crisis period."

To capitalise on this momentum, Vasiljevic calls for structural reforms, "including expenditure reprioritization and a reduction of current expenditures over the medium term...[plus] reforms to facilitate the growth of Serbia's private and financial sectors, including through enhancing the business environment, improving competition on the domestic markets, strengthening financial discipline and building a more efficient and stable financial sector."

Despite such positive assessments, however, an IMF mission recently concluded a visit to Serbia without reaching an agreement on the latest instalment of the country's €2.9bn stand-by agreement, in part due to concerns about higher inflation and the measures in-place to ensure Serbia's 2011 budget deficit does not exceed the agreed 4% target.

One potential sticking point is mounting union opposition to legislation lowering pensions and raising the retirement age. Amidst threats of strikes and petitions seeking a vote of no-confidence in the government, there are fears that Serbia's economic restraint may begin to fray in the face of such pressures, particularly with parliamentary elections ahead in 2012. However, the planned sale of a 51% stake in Telekom Srbija, the national telephone company, in the first quarter of 2011 - which is expected to raise around €1.4bn - may provide the government with an opportunity to solve the deficit problem without political confrontation, though at the expense of much-needed capital investment.

Challenges lie ahead

Other challenges remain on the horizon. For Serbia, this includes getting the growth to translate into more jobs, as over 10% of jobs were lost since the crisis started, while in the case of Bosnia private investment is still declining amidst weak foreign direct investment flows and there is scant evidence of job creation.

With respect to Bosnia, Cosic also warns that public spending reforms are "going slower than anticipated as they coincided with the October general elections. Delays with the formation of new governments could risk delays in implementation of reforms as well, which would have a negative effect on the economic outlook and public budgets."

Though much criticised for its role in previous global financial crises, the IMF's medicine has helped treat many of the underlying problems that left all countries in the region vulnerable to contagion. Whilst many of the symptoms remain - particularly poor rates of job creation - both Serbia and Bosnia continue to see positive improvements in export-led growth that will help offset the weakening in domestic consumer demand. If the governments of the region can resist growing political pressure to ease controls on public spending, then the economic prospects for the Western Balkans will remain better than many had expected only two years ago.