IMPORTANT NOTICE:

The information in this PDF file is subject to Business Monitor Internationals full copyright and entitlements as defined and protected by international law. The contents of the file are for the sole use of the addressee. All content in this file is owned and operated by Business Monitor International, and the copying or distribution of this file, internally or externally, is strictly prohibited without the prior written permission and consent of Business Monitor International Ltd. If you wish to distribute the file, please email the Subscriptions Department at subs@businessmonitor.com, providing details of your subscription and the number of recipients you wish to forward or distribute this information to.

DISCLAIMER All information contained in this publication has been researched and compiled from sources believed to be accurate and reliable at the time of publishing. However, in view of the natural scope for human and/or mechanical error, either at source or during production, Business Monitor International accepts no liability whatsoever for any loss or damage resulting from errors, inaccuracies or omissions affecting any part of the publication. All information is provided without warranty, and Business Monitor International makes no representation of warranty of any kind as to the accuracy or completeness of any information hereto contained.

ISSN 1474-5615

www.emergingeuropemonitor.com

Emerging Europe Monitor

South East Europe
Vol 20 Issue 10 October 2013 Business Monitor Internationals monthly regional report on political risk and macroeconomic prospects

TURKEY

This months top stories

More Bearish On Growth

BMI View: A challenging external financing environment will result in deteriorating credit conditions in Turkey, weighing on private consumption and fixed investment. More aggressive monetary tightening will be necessary to prevent sustained capital outflows and to restore investor sentiment, damaged by domestic protests, widening external deficits and questions over central bank credibility. We have revised down our already below-consensus real GDP growth forecast.
Our real GDP growth forecasts for Turkey in 2013-2015 were already below consensus, but we see mounting headwinds and now forecast full-year real GDP growth of just 2.8%. In 2014 and 2015 we have revised down our forecasts from 4.2% and 4.8% to 3.1% and 3.4%. With a current account deficit likely to reach 6.7% of GDP in 2013, a lack of foreign direct investment (FDI) and a large stock of short-term external debt, Turkey depends on sustained portfolio and other investment inflows to avoid a balance of payments crisis. The only way to avoid this in a context of rising developed state yields, depressed demand for risky emerging market assets and deteriorating investor sentiment willbe more aggressive monetary tightening in the rest of 2013 and 2014. Our revisions are based on our core view that a more challenging external financing environment will prompt a steady deterioration of credit conditions in Turkey, eliminating a key driver of growth and leading to stresses on corporate and household balance sheets. Market interest rates have spiked since May, when speculation regarding eventual tapering of quantitative easing by the US Federal Reserve combined with mass domestic protests to spur substantial capital outflows. Turkey's
...continued on page 2

Romania: Rate Cutting To Continue

Inflation will fall within the NBRs 2.5% 1.0% target range by end-2013, as easing agricultural prices and a VAT rate cut filter into the economy. We forecast inflation to average 4.6% in 2013 and 3.2% in 2014, and expect the interest rate cutting cycle to continue, with 50bps more cuts likely.
page 4

Bulgaria: Uninspiring Banking Outlook Ahead

While the sector benefits from a robust funding structure and strong capital buffers, the outlook is relatively uninspiring. NPLs are likely to edge higher and the weak macroeconomic outlook will weigh on loan growth and profitability.
page 6

Slovenia: Long Road To Fiscal Stability

page 7

Macedonia: BMI Stays Below Consensus On Economic Recovery

page 8

Serbia: Continuity Despite Reshuffle

page 9

Albania: 25bps More Cuts In 2013

page 10

Croatia: Bank Lending To Contract

ROMANIA
page 11

Pace Of Consolidation Slowing, But Limited Risks

BMI View: Although Romania's fiscal deficit will narrow to 2.5% of GDP in 2013 and 2.4% in 2014, the pace of fiscal consolidation in is slowing. Steady revenue growth will be offset by a modest recovery in government spending, as the country's exit from the EU Excessive Deficit Procedure (EDP) allows the government slightly to relax its fiscal consolidation programme.
Following Romania's staff-level agreement of a new EUR4.0bn precautionary loan agreement with the EU/IMF (its third such deal in five years), we reiterate our view that the fiscal position will remain reasonably healthy. We believe stability provided by the new agreement will help keep government borrowing costs down and support the leu, despite
...continued on page 5

Bosnia: Well Placed For Growth

page 12

Regional Indicators
South Eastern Europe Indicators
Nominal GDP, US$bn Population, mn GDP per capita, US$ Real GDP growth, % Inflation, % Goods exports, US$bn Goods imports, US$bn

2011 2012e

2013f

2014f

1,216.4 1,197.6 1,275.4 1,316.0 129.7 6.2 5.9 300.5 437.7 130.5 1.4 7.0 307.7 417.7 131.3 2.1 5.6 326.9 449.6 132.1 2.8 4.6 341.3 468.4 9,376.5 9,176.0 9,713.1 9,965.2

e/f = estimate/forecast. South East Europe = Turkey, Romania, Bulgaria, Slovenia, Macedonia, Serbia, Montenegro, Albania, Croatia, Bosnia. Source: BMI

Visit www.emergingeuropemonitor.com for the following subscriber benefits:  Instant access to the latest issue on the day of publication via
pdf download, as well as access to pdfs of back issues. online 24 hours a day, from any location.

ISSN: 1469-5286
Editorial/Subscriptions Office: Senator House, 85 Queen Victoria Street, London EC4V 4AB, UK Tel: +44 (0)20 7246 5162 Fax: +44 (0)20 7248 0467 email: subs@businessmonitor.com www.businessmonitor.com www.latinamericamonitor.com

 Access to the latest stories, analysis, charts, graphs and data  Search across a 3-year archive of stories by keyword, sector or
country. Find what you want when you want.

Dont know your password? Contact subs@businessmonitor.com or call +44 (0)20 7246 5162 today. Not a subscriber? Go to www.emergingeuropemonitor.com today, register your details and get instant trial access.

TURKEY
...continued from top of front page

RISK SUMMARY
POLITICAL RISK

PKK Deal Under Pressure

The government has begun debating the democratisation package, a set of reforms aimed at expanding Kurdish rights, a prerequisite for a peace deal with the Kurdistan Workers Party (PKK). With a ceasefire largely holding in previous months, PKK spokesmen have threatened renewed conflict if progress is delayed, prompting Prime Minister Recep Tayyip Erdogan to suggest parliament may be called back to pass the package. A war of words erupted in mid-August, with both sides accusing the other of not fulfilling promises.
Turkey scores 59.2 out of 100 in our Short-Term Political Risk Ratings.

sovereign yield curve, which has flattened considerably since, reflects an uncertain macroeconomic outlook and investor doubts over the sustainability of Turkey's growth model.
Short-Term Debt Raises Sovereign Risk
Net International Investment Position And Short-Term External Debt
-100,000 -150,000 -200,000 -250,000 -300,000 -350,000 -400,000 -450,000 -500,000 60,000 40,000 20,000 0 140,000 120,000 100,000 80,000

private investment to pick up substantially. With a net short FX liability position of some 18% of GDP, the non-financial corporate sector will face rising debt servicing costs due to lira weakness. Mass protests against Prime Minister Recep Tayyip Erdogan have damaged Turkey's stable, investment friendly image. Erdogan's hostile rhetoric towards the international financial community, perceived targeting of domestic private firms seen as sympathetic to the protesters, and souring relations with neighbours and the EU will likely weigh on private investment decisions and FDI inflows. Government Spending To Prop Up Growth Public GFCF has helped fill the void left by scant private fixed investment, and we see this continuing. Government spending, including consumption and public fixed investment, has been a main contributor to growth. However, this highlights underlying weakness in the economy, which in the absence of private sector investment demand and slowing exports depends on state spending to spur growth. With elections in 2014 and 2015, the state will move ahead with infrastructure and development goals. It has relatively healthy public finances, with low deficits and debt, allowing it to enact counter-cyclical spending as growth slows. However, as revenues slow and borrowing costs rise, a rapid deterioration of public finances could damage the sovereign risk profile and long-term growth potential. A decline in imports would mitigate the overall impact on GDP through a higher contribution of net exports,aided by a relatively stable export outlook. Turkey has a diversified basket of export goods and exposure to markets in which we expect to see stronger growth, including Germany, the UK and the US. A falling real effective exchange rate would bolster export demand. Risks To Outlook Should the US Federal Reserve send a clear signal that its quantitative easing programme will continue at its present pace for longer than the market expects, this could give the central bank room to hold off on further monetary tightening, supporting the expansion of credit while keeping interest rates from rising further. Various factors could damage the outlook, including regional instability, domestic protests and faster-than-expected normalisation of monetary policy in developed states. With net international reserves low and appetite for Turkish assets not yet recovered, any run on the lira would necessitate more aggressive monetary tightening than envisioned.

Q107

Q307

Q108

Q308

Q109

Q309

Q110

Q310

Q111

Q311

Q112

Q312

Short-Term External Debt, US$mn (RHS) Net International Investment Position, US$mn (LHS)

Source: Central Bank of the Republic of Turkey (CBRT), BMI

ECONOMIC RISK

Lira Depreciation
The lira fell against the euro and US dollar in August, as a combined 125 basis point increase to the upper bound of the central bank's interest rate corridor in the previous two months was insufficient to curb capital outflows and depreciatory pressure. Given the large current account deficit, demand for Turkish assets will suffer as the US Federal Reserve begins to taper off its quantitative easing programme in H213. More central bank tightening will be needed to prevent a disorderly lira sell off and a potential external financing crisis. By the end of 2013 we expect a hike to the interest rate corridor, bringing the main policy rate to 5.0%.
Our Short-Term Economic Risk Rating is 55.2.

The central bank has begun to hike interest rates, but policy rates have to rise as depreciatory pressure on the lira and weak foreign demand for Turkish assets will threaten financial stability. The bank has damaged its credibility by showing a clear preference for supporting growth even as inflation remains well above target and capital outflows accelerate. Robust financial inflows in H212-H113 combined with aggressive monetary easing to flood the banking sector with liquidity, bringing domestic interest rates to historic lows. This propelled an expansion of consumer credit and recovery of private consumption, which grew 3.0% year-on-year (y-o-y) in Q113 and was a main driver of GDP growth. As we expect the credit cycle to have peaked in Q213, private consumption will be unable to maintain this momentum.
Flattened Yield Curve, Uncertain Outlook
TRY Government Yield Curve, %
500 9 450 8 400 350 300 250 200 3M 6M 1Y 2Y 3Y 4Y 5Y 7Y 8Y 9Y 10Y 1-Apr-13 Change (bps) (RHS) 29-Jul-13

BUSINESS ENVIRONMENT

Expanding In Kurdistan
According to Reuters, a state-backed Turkish firm was set up in Q213 to explore for oil and gas in the semi-autonomous Kurdistan region of Northern Iraq. Partly state-owned oil firm TPIC and pipeline operator Botas are said to have stakes in the venture, which has teamed up with Exxon in several exploration projects. Baghdad says management of Iraqi oil must run through the central government. But with increased energy independence one of Ankara's key policyies, Turkey is willing to take the risk. Plans are moving forward for construction of a pipeline linking the Taq Taq oil fields in Kurdistan to the Kirkuk-Ceyhan pipeline in Turkey.
Our Business Environment Rating is 54.4.

Source: Bloomberg, BMI

Despite optimal domestic financing conditions in Q113, private sector gross fixed capital formation (GFCF) fell 9.1% y-o-y, a fourth straight quarter of contraction. With capacity utilisation levels well below pre-crisis levels and export growth faltering, we do not expect

SOUTH EAST EUROPE OCTOBER 2013

Q113

www.emergingeuropemonitor.com

TURKEY
ECONOMIC OUTLOOK

Financing Risks Remain

BMI View: Turkey's current account deficit will widen to 6.7% of GDP in 2013, before moderating domestic demand and waning financial account inflows contribute to a gradual external rebalancing, bringing the deficit to 5.9% by 2015. In the context of a long-term decline in demand for emerging market assets, heightened investor perceptions of sovereign risk in Turkey and a loss of monetary policy credibility create a risk of a financing crisis.
Capital outflows suggest the possibility of a more severe and short-term correction in the current account deficit, but we believe the Central Bank of Turkey (CBRT) will be forced into more aggressive rate hikesto prop up demand for assets and stabilise the financial account. Domestic demand will stagnate in 2013 and 2014. This may be already visible in balance of payments dynamics. The current account will widen in 2013, and external rebalancing will remain gradual.
Energy Deficit Drives External Imbalances
Current Account Deficit, US$mn (12-month rolling average)
Non-Energy Current Account Deficit Current Account Deficit 40,000 20,000 0 -20,000 -40,000 -60,000 -80,000 -100,000

Source: Turkish Statistical Institute, CBRT, BMI

Energy needs account for 66.7% of the current account deficit thus far in 2013, averaging 78.7% since 2010, meaning only a recessionary environment will lead to a rapid
DATA & FORECASTS
BMI View:Underpinning our forecast for easing inflation in the rest of 2013 is our expectation that monetary tightening and higher foreign borrowing costs will slow economic growth momentum,
Population, mn [3] Nominal GDP, TRYbn [4] GDP per capita, US$ [5] Real GDP growth, % change y-o-y [4] Budget balance, % of GDP [1,6] Consumer price index, % y-o-y, eop [4] Exchange rate TRY/US$, eop[ 7] Goods imports, US$bn [8] Goods exports, US$bn [8] Current account balance, % of GDP [9] Foreign reserves, excl gold, US$bn [2,8] Total external debt stock, % of GDP [9]

rebalancing of external deficits. Major investments will diversify the energy mix and boost energy independence, but will take years. In Q213 the current account deficit was US$35.9bn. Import growth slowed to 2.7% y-o-y in June after 17.0% in April, but collapsing export growth contributed to a 17.0% widening of the trade deficit. While external demand has been slow to recover, much of this deterioration can be attributed to gold. Turkey won investors' favour with impressive current account rebalancing in 2012. As much as 20% of this can be attributed to the 'gas for gold' trade, whereby Iranian energy imports were paid for with Turkish gold earmarked as exports in the balance of payments. With US sanctions ending this and Turkey's high demand for gold surging, the gold balance swung to a deficit of US$7.0bn in H113 after a US$5.7bn surplus in 2012. We forecast export growth of 4.0% in 2013, as base effects from the gold trade weigh on trade figures. We are more optimistic beyond 2013. Accelerating economic activity in Turkey's main trading partners, export partner diversification and a depreciated lira will see export growth of 8.5% and 11.0% in 2014 and 2015. We expect credit growth to slow in H213 and 2014 as interest rates rise. Given a
easing demand-pull price pressures. However, a sharp devaluation of the lira in recent months will slowly feed through to the consumer price index, especially as energy prices push modestly higher.
2011 73.1e 1,298.1 10,575 8.8 -1.4 10.5 1.89 233.5 143.4 -9.8 78.5 39.4 2012 74.0e 1,416.8 10,637 2.2 -2.1 6.2 1.78 229.6 163.2 -6.2 99.9 42.8 357.9 3.0 8.9 1.99 20.3 13.3 105.6 -

correlation between import and credit growth, this will cap non-energy imports. With large external imbalances weighing on the sovereign risk profile, the outbreak of protests damaged investor sentiment. Amid speculation the US Federal Reserve would taper off its asset purchase programme, Turkey saw a slowdown in financial account inflows. Although the financial account remained in surplus, June saw the first net portfolio investment outflow since September 2011. With net FDI flows falling to just 7.3% of the financial account thus far in 2013, Turkey will remain reliant on volatile and predominantly short-term financing. As outlined in the previous story, FDI will remain subdued. We believe the CBRT has damaged its credibility by a lack of action to counter the effects of capital outflows and sharp lira depreciation, even as inflation and credit growth remain well above target. The CBRT has resorted to daily liquidity tightening measures and FX reserve sales, bringing import cover precariously low. With neither action preventing depreciatory pressure or stemming net portfolio investment outflows, risks to current account financing will remain until there is more aggressive monetary tightening. Risks To Outlook The risks to a gradual external rebalancing are to the downside, given the volatility in international investment flows and investor sentiment that threaten a disorderly lira sell off and accelerating withdrawal of capital. If the CBRT acts too late, it would result in a more severe shock to domestic demand and more rapid external rebalancing.

Apr-09

Oct-09

Apr-10

Oct-10

Apr-11

Oct-11

Apr-12

Oct-12

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Apr-13

Jul-09

Jul-10

Jul-11

Jul-12

Jul-13

We forecast the consumer price index to average 6.5% growth and fall to 5.5% by the end of 2013, but will consider revising upward if August and September inflation does not drop off.
Latest period Jan-Mar Jan-Mar Jul Aug-22 Jun Jun Jun 2013f 74.9 1,550.8 11,067 2.8 -1.9 5.5 1.91 246.8 169.7 -6.7 108.9 46.6 2014f 75.8 1,686.9 11,436 3.1 -1.8 5.5 1.98 264.0 184.2 -6.3 115.4 50.5

e/f = BMI estimate/forecast; eop = end of period. 1 Central/consolidated budget; 2 Central bank foreign exchange reserves. Source: 3 World Bank, UN, BMI; 4 Turkish Statistical Institute; 5 Turkish Statistical Institute, BMI; 6 Turkish Treasury, BMI; 7 BMI; 8 CBRT; 9 CBRT, BMI

www.emergingeuropemonitor.com

OCTOBER 2013 SOUTH EAST EUROPE

 ROMANIA
RISK SUMMARY
POLITICAL RISK ECONOMIC OUTLOOK

Romania Condemns Irredentist Hungarian Statements

Romania has condemned a recent statement by the leader of the Hungarian radical nationalist party, Jobbik, who claimed that Hungary should seek autonomy for the Hungarian-populated Szekly Land in Romania. In response, the Romanian president, Traian Basescu, has declared that his government would rein in Budapest from interfering with national government policies throughout the region. Although the Hungarian foreign affairs ministry emphasised its commitment to the Hungarian-Romanian strategic partnership, we believe the recent events will modestly sour relations between the two countries.
Romania's Short-Term Political Risk Rating is 64.5 out of 100.

Rate Cutting Cycle To Continue

BMI View: Inflation will fall within the National Bank of Romania (NBR)'s 2.5% 1.0% target range by end-2013, as easing agricultural prices and a VAT rate cut in September filter into the economy. We forecast inflation to average 4.6% in 2013 and 3.2% in 2014, and expect the banks interest rate cutting cycle to continue, with 50bps more cuts likely before the end of the year.
On August 5 the NBR cut the benchmark interest rate by 50 basis points (bps) to a low of 4.50%, surprising analysts who had been pricing in just 25bps cuts. We have now downgraded our forecast for the policy rate to 4.00% by the end of the year, in line with increasingly dovish statements by NBR governor Mugur Isarescu and easing inflation, which we long expected to fall in H213. In the NBR's August Inflation Report, Isarescu argued further rate cuts would be based on anticipation of faster disinflation in the period ahead, and we see lower price growth enabling the NBR to accelerate monetary easing. Rate markets have begun to price in further cuts, with the one-year interest rate swap market trading at 4.2% (10 day moving average), down from 5.1% earlier in July.
Inflation To Ease
Consumer Price Index, % change y-o-y
10 8 6 4 2 0

our forecast for inflation to average 4.6% in 2013 and 3.2% in 2014, from 4.8% and 3.4% previously. The adjusted CORE 2 inflation rate (which strips out volatile prices from the consumer price basket) saw a consolidation of its downward path in July, at 2.8% y-o-y, from 3.0% in March, due to easing non-food prices and service prices.
Supply-Side Food Price Pressures Easing
Consumer Price Index, % change
m-o-m y-o-y 7 6 5 4 3 2 1 0 -1 Poor Higher Eletricity -2 -3

ECONOMIC RISK

Economy Up 1.3% In Q213

Romania's economy grew less than expected in the second quarter of 2013, with real GDP expanding by 1.3% y-o-y, according to preliminary estimates from the National Statistics Institute (INE). The median figure for the 10 economists surveyed by Bloomberg was for 1.4% growth. Despite the below expectation GDP growth figures, we hold to our view that the country's economic recovery is picking up steam, with Q213 figures hindered by base effects from the same period a year earlier. We are forecasting real GDP to expand by 1.7% in 2013 and 2.8% in 2014.
The Short-Term Economic Risk Rating is 67.5.

Apr-12

Oct-12

Nov-12

Aug-12

Sep-12

Dec-12

Jan-12

Jun-12

Jan-13

Apr-13

Jun-13

Jul-12

May-12

Source: INE, BMI

NBR Target 1.0%

CPI, % chg y-o-y

Source: INE, BMI

BUSINESS ENVIRONMENT

FDI Down
Foreign direct investment (FDI) in Romania was EUR666.0mn in H113, down from EUR826.1mn in H112, according to the National Bank of Romania (NBR). The figures reflect our expectations for regional uncertainty to undermine investor risk sentiment in the country, predicating a shift towards different investment streams, notably portfolio investment. Nevertheless, we believe domestic political stability and the country's improving economy could see FDI recover modestly in 2014.
Romania's Business Environment Rating is 54.6 out of 100.

Cnsumer price index (CPI) growth slowed to 4.4% y-o-y in July, from 5.4% in June, in line with our view that easing agricultural prices would send prices lower in H213. Food prices (which make up 37.7% of the consumer price basket) fell from 5.8% y-o-y in June to 3.4% in July, as a bumper agricultural crop eased supply-side food pressures stemming from a drought-induced poor harvest in 2012. We see food prices falling further, as base effects from 2012's food price rally filter into the economy, contributing towards inflation coming within the upper band of the NBR's target range of 2.5% 1.0% in Q413. A VAT cut on September 1 will lower VAT on bread from 24.0% to 9.0%, which will aid disinflationary pressure, and we have revised

We believe scope for continued aggressive monetary loosening will be more limited in 2014, due to high foreign debt. High FX exposure will make the NBR wary of allowing excessive leu depreciation, which would be more likely if demand for local debt was un dercut by lower interest rates. We expect the recovery to pick up in 2014 (we forecast 2.8% real GDP growth), supported by strong net exports and improving private consumption. As well as providing impetus for a stabilisation in demand-pull inflationary pressures, growth will reduce the NBRs desire to use monetary policy to promote increased lending in 2014. We forecast 25bps of cuts to the policy rate in 2014. Risks To Outlook While we do not expect prices to edge higher, another supply-side food price shock or a further significant leu sell off would slow disinflation. The NBR could delay its rate cutting cycle, prompting a revision to our forecast of 50bps of cuts in 2013. With the NBR having accepted above-target inflation in the past few years, we believe inflation would have to edge significantly higher for this to play out.

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jul-07

Jul-09

Jul-11

SOUTH EAST EUROPE OCTOBER 2013

Jul-13

Jul-08

Jul-10

Jul-12

www.emergingeuropemonitor.com

May-13

Mar-12

Feb-12

Feb-13

Mar-13

Jul-13

 ROMANIA
...continued from bottom of front page

Prime Minister Victor Ponta stressing that the country was unlikely to draw-down any of the funds from the upgraded precautionary deal. The new agreement follows the countrys successful exit from the EDP in June, predicated on the belief that the fiscal deficit is unlikely to rise above the 3.0% of GDP target, having narrowed to 2.9% in 2012. We believe IMF supervision and the ruling Social-Liberal Union (USL)'s commitment to fiscal prudence will reduce the likelihood of any significant fiscal slippage over the next few years, ensuring that the deficit remains below 3.0% of GDP for the foreseeable future.
Pace Of Correction Slowing
Fiscal Deficit, % GDP
0 -1 -2 -3 -4 -5 -6 -7 Fiscal Deficit EU Target -8 -9 -10

f = BMI forecast. Source: Eurostat, BMI

Romania's fiscal deficit fell to EUR6.6bn in H113 (1.1% of GDP), down 2.4% y-o-y, and we expect the shortfall to continue narrowing. In light of better-than-expected government revenues in the first few months of 2013, we revise our forecast for Romania's fiscal deficit to come in at 2.5% of GDP in 2013 and 2.3% in 2014, from 2.6% and 2.4% previously. One of the main drivers of the shrinking
DATA & FORECASTS
BMI View: The current account deficit will narrow to 3.6% of GDP in 2013, before widening to 3.7% in 2014, as a modest pickup in domestic demand and

deficit, which fell from a peak of 9.0% of GDP in 2009 to just 2.9% in 2012, has been falling government expenditures. We believe a faster correction in the fiscal accounts will be prevented by a modest growth in expenditures over the next few quarters. In H113 government spending increased 4.4% y-o-y, against a backdrop of the EU-approved 2013 budget including a 4.0% increase in pensions and a minimum wage increase from RON700 to RON750 in February. Social security spending increased 2.8% y-o-y in H113, a product of high unemployment and low wage growth, which we see remaining an issue. A further public sector minimum wage increase to RON800 a month was implemented on July 1, which should boost expenditures through H213, while budget minister Liviu Voinea recently suggested that future annual budgets would be more growth-orientated than those developed under the EDP. We forecast government expenditures to grow by 4.2% in 2013 and by 4.3% in 2014, as the EDP exit and the country's low public debt (just 39.1% of GDP in 2012) allows the government to slow the pace of fiscal consolidation modestly. We believe steady revenue growth will ensure the modest rise in government spending does not translate into an expanding deficit. Revenues grew 4.8% y-o-y in H113, and Romania's improving economic outlook should ensure revenue growth remains steady, with unemployment likely to stabilise and disposable incomes showing signs of recovery. New taxes on gas, oil and mining companies are expected to bring in EUR3.1bn for the government this year, while an increase in the number of individual farm owners who pay tax

is expected to boost agricultural tax revenue from an estimated RON200mn in 2012 to RON600mn in 2013. We forecast government revenues to increase 4.8% y-o-y in 2013.
Government Spending Restrained
Central Government Budget, % change y-o-y
Expenditure Revenue 120 100 80 60 40 20 0 -20

Source: Eurostat, BMI

We believe more significant growth in revenues will be restricted by poor tax collection, and the informal economy. The World Banks' tax efficiency index gave the country 54.0 (out of 100) for VAT collection and 61.0 for social contribution collection in 2012, one of the worst performances in the EU. While improving these figures is a key aim of the administration, we believe tax collection will remain below potential until the country can reduce the size of the informal economy, which accounted for 32.6% of GDP in 2012. Plans to lower VAT on bread to 9.0% in September are also likely to keep a lid on revenue growth. Risks To Outlook The main short-term risk to our fiscal deficit forecast is a slower economic recovery. Weaker GDP growth would weigh on income tax revenues and government revenues.

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013f

2014f

2015f

weak remittance inflows begin widening the shortfall beyond H213. Subdued domestic demand in the eurozone will keep a lid on export growth, while an increas2011 2012 21.8e 168.8e 587.5e 7,940e 0.7e 5.6e -2.9e 5.0 5.25 3.37 66.6e 57.2e -9.4e -3.9e 31.2e 74.6e 1.3 7.6 4.4 4.5 3.34 18.1 17.6 0.1 0.1 -

Latest Period Q213 Jun July Aug 13-Aug Jan-Mar Jan-Mar Jan-Mar Jun -

Population, mn [2] Nominal GDP, US$bn [3] Nominal GDP, RONbn [3] GDP per capita, US$ [3] Real GDP growth, % change y-o-y [3] Unemployment, % of labour force, eop [4] Budget balance, % of GDP [5] Consumer price index, % y-o-y, eop [4] Central bank policy rate, % eop [5] Exchange rate RON/US$, eop [1,6] Goods imports, US$bn [5] Goods exports, US$bn [5] Balance of trade in goods, US$bn [5] Current account balance, % of GDP [5] Foreign reserves ex gold, US$bn [7] Total external debt stock, % of GDP [5]

21.8e 182.6 556.7 8,549 2.2 5.1 -5.6 3.1 6.0 3.34 73.2 62.9 -10.3 -4.5 33.7 75.1

e/f = BMI estimate/forecast; eop = end of period. 1 Redenomination of currency at ROL10,000=RON1 on July 1 2005. Source: 2 World Bank, UN, BMI; 3 Eurostat, BMI; 4 National Institute of Statistics, BMI; 5 NBR, BMI; 6 BMI; 7 IMF IFS, BMI

www.emergingeuropemonitor.com

OCTOBER 2013 SOUTH EAST EUROPE

Q198 Q498 Q399 Q200 Q101 Q401 Q302 Q203 Q104 Q404 Q305 Q206 Q107 Q407 Q308 Q209 Q110 Q410 Q311 Q212 Q113

ingly volatile local currency bond market will prevent portfolio investments from remaining as robust, ensuring Romania's FX reserves erode further in 2013.
2013f 21.7 188.9 653.2 8,922 1.7 5.5 -2.6 4.3 4.5 3.35 70.6 61.1 -9.4 -3.6 29.3 72.4 2014f 21.6 193.5 708.6 9,182 2.8 4.5 -2.4 3.5 4.25 3.62 69.5 59.8 -9.7 -3.6 29.6 74.3

BULGARIA
RISK SUMMARY
POLITICAL RISK ECONOMIC OUTLOOK

President Vetoes Revised Budget

On August 7 the Bulgarian president, Rosen Plevneliev, vetoed a revised budget, which had been aimed at increasing the 2013 budget deficit to 2% of GDP from 1.3% in an attempt to help the country's economic growth. The president claimed that the revised budget was vetoed as there was not enough transparency in the government's use of public money. The parliament speaker, Mihail Mihov, has said that lawmakers would hold an extraordinary session on August 30 in order to assess Plevneliev's decision.
Bulgaria's Short-Term Political Risk Rating is 49.4 out of 100.

Uninspiring Banking Outlook Ahead

BMI View: While the Bulgarian banking sector benefits from a robust funding structure and strong capital buffers, the outlook is relatively uninspiring. Non-performing loans are likely to edge higher and the weak macroeconomic outlook will weigh on loan growth and profitability over the coming quarters.
While Bulgarian banks weathered the financial crisis period better than some of their regional counterparts, the sector is coming under increasing pressure from rising non-performing loans (NPLs) and weak economic growth, which is capping loan growth prospects. We are below-consensus on Bulgarian growth for 2013, forecasting real GDP to expand by just 0.5% following a slowdown across virtually every sector of the economy. Accordingly, the operating environment for Bulgarian banks will remain unfavourable, and asset quality deterioration is likely to remain a problem over coming quarters. Robust deposit growth will see assets continue to grow as a percentage of GDP but tighter lending standards and household deleveraging means loans will grow at a slightly slower pace of 3.0% y-o-y . Aggregate loans grew by 5.9% y-o-y in May 2013, the same as average loan growth over the first five months of the year, and we expect to see a slight deceleration in the second half of 2013, bringing full-year loan growth to 4.5 % y-o-y. Deposits have grown at roughly the same pace, leading to a stabilisation of the loan-to-deposit ratio (L/D ratio).
DATA & FORECASTS
BMI View: Industrial production contracted sharply in May, by 6.0% y-o-y, from 1.3% in April. The contraction adds weight to our below-consensus forecast for real GDP growth in 2013, which we expect to arrive at just 0.5%, against the government's original expectations of 1.2%. We forecast most GDP by expenditure segments to remain relatively stagnant, with net exports posting a slight drag on growth in 2013.
Population, mn [2] Nominal GDP, BGNbn [1,3] GDP per capita, US$[ 3] Real GDP growth, % change y-o-y [3] Budget balance, % of GDP [4] Consumer price index, % y-o-y, eop [3] Exchange rate BGN/US$, eop [5] Goods imports, US$bn [6] Goods exports, US$bn [6] Current account balance, % of GDP [6] Foreign reserves, excl. gold, US$bn [6] Total external debt stock, % of GDP [6] 2011 7.3e 75.3 7,302 1.8 -2.1 2.0 1.51 31.2 28.2 0.1 14.3 85.5 2012 7.3e 77.6 7,007 0.8 -0.5 2.8 1.48 31.0 26.4 -1.3 18.4 87.9e Latest period 2.6 1.47 28.5 Jun Aug Jun 2013f 7.2 80.6 7,576 0.5 -1.8 2.6 1.47 34.6 29.9 -0.3 18.0 92.9 2014f 7.2 84.1 7,600 1.5 -0.8 2.5 1.57 35.3 30.1 -1.2 19.0 92.0

ECONOMIC RISK

Raiffeisenbank Bulgaria Downgraded

Global ratings agency Moody's has downgraded the long-term local and foreign-currency deposit ratings of Raiffeisenbank Bulgaria to Ba2, from Ba1. Its standalone bank financial strength rating was downgraded to E+, mapping to a baseline credit assessment of b1, from D-/ba3. The outlook on long-term deposit ratings was changed from stable to negative. According to Moody's, the ratings change was mainly driven by the bank's weakening asset quality and rising delinquencies in the broader loan portfolio. Offsetting factors are Raiffeisenbank's comfortable capital and liquidity buffers.
The countys Short-Term Economic Risk Rating is 52.9.

We expect to see only a minor improvement on these growth rates in 2014, forecasting aggregate loans to grow by 4.8 %, and deposits to increase by 7.0%, implying a further drop in the L/D ratio. While there were concerns that foreign parent banks would create liquidity risks by pulling capital out of domestic subsidiaries, this has not been the case most likely because these banks are too small to provide substantial support to parent banks. However, the asset side of the balance sheet generates considerably more red flags. Asset quality remains a substantial problem in Bulgarian banks, with NPLs rising to 16.6% by end-2012 (up 14% y-o-y). NPLs have been increasing as a percentage of the total loan book for five consecutive years, and we expect NPLs to edge slightly higher this year too. Overall, the outlook for the Bulgarian banking sector is relatively uninspiring. Profitability remains low and declined further in 2013 , with banks aggregate return on equity at just 6.4% and return on assets of just 0.8% in Q113, and is unlikely to rebound substantially in light of the countrys weak economic outlook.

BUSINESS ENVIRONMENT

Additional Metro Line To Cost EUR680mn

The construction of Sofia Metro's third line will include an investment of nearly EUR680mn (US$909.64mn), according to the CEO of Sofia Metropolitan, Stoyan Bratoev. The 16km-long third line is to be constructed between the districts of Ovcha Kupel and Levski. It will include 19 metro stations and some 53% of the stretch will be underground, mainly in downtown Sofia. The construction is expected to start in 2014, with completion due in 2017 or 2018.
Bulgaria's Business Environment Rating is 54.5 out of 100.

e/f = BMI estimate/forecast. 1 In 1999 the lev was redenominated at 1000:1. Data are for the new Bulgarian lev. Source: 2 World Bank, UN, BMI; 3 National Statistical Institute, BMI; 4 Finance ministry, BMI; 5 BMI; 6 Bulgarian National Bank, BMI

SOUTH EAST EUROPE OCTOBER 2013

www.emergingeuropemonitor.com

SLOVENIA
ECONOMIC OUTLOOK

RISK SUMMARY
POLITICAL RISK

Long Road To Fiscal Stability

BMI View: The budget deficit is set to balloon in 2013, largely due to the state rescue and reform of the banking sector. Though the government has developed a comprehensive fiscal consolidation plan that received initial approval from Brussels, we do not believe it will successfully reduce the budget deficit to the Maastricht ceiling of 3% of GDP until 2016. Political instability will continue to generate uncertainty, presenting a key risk to our fiscal forecasts.
The budget deficit for 2012 came in lower than expected, at 4% of GDP, as the previous administration implemented additional spending cuts including in public sector wages to compensate for a 0.6% fall in revenues amid a worsening recession. However, while this was a considerable trimming of the 6.4% of GDP budget deficit in 2011, it was considerably short of the objective to reduce the shortfall below 3%, as required by the European Commissions Excessive Deficit Procedure (EDP). We forecast a shortfall of 7.7%, though excluding the bank rescue costs, the deficit should remain broadly similar to the 2012 outturn of -4%, as the government introduces new austerity measures in H213. Among the policies in the revised stability programme are a 0.5%-5% cut in public sector wages, a 2% increase in VAT (from 20% to 22%), and a 3% reduction in unemployment benefits. Further fiscal consolidation is planned for
DATA & FORECASTS
BMI View: The unemployment rate has been falling, reaching 12.8% in June from 13.3% in April 2013. While this is below our estimate for the year, short-term improvements in the labour market are mostly driven by the seasonal effect of the summer months. Year-on-year, unemployment remains on an upward trend as the economy adjusts to slower growth and the government continues to implement austerity measures. We continue to expect unemployment to increase up to 15% in 2015, with a fall afterwards as wages progressively adjust to improving economic conditions.
Population, mn [3] Nominal GDP, US$bn [4] Nominal GDP, EURbn[ 5] GDP per capita, US$ [5] Real GDP growth, % change y-o-y [5] Unemployment, % of labour force, eop [1,4] Budget balance, % of GDP [2,6] Consumer price index, % y-o-y, eop [4] Central bank policy rate, % eop [7] Exchange rate EUR/US$, eop [8] Goods imports, EURbn [9] Goods exports, EURbn [9] Current account balance, EURbn [9] Current account balance, % of GDP [9] Foreign reserves,excl. gold, US$bn [10] Total external debt stock, % of GDP [9] 2011 2.1e 50.3 36.2 24,396 0.6 11.8 -6.4 2.0 1.00 0.77 22.3 21.3 0.0 0.0 0.8 107.1 2012 2.1e 45.6 35.5 22,049 -2.3 12.4 -4.0 2.7 0.50 0.76 21.7 21.5 0.9 2.5 0.8 117.6 Latest period -4.8 2.6 11.1 10.8 0.2 Jan-Mar July Jan-June Jan-June Jan-Mar 2013f 2.1 47.2 35.5 22,788 -2.3 13.9 -7.8 2.3 0.50 0.75 21.8 22.0 0.9 2.5 0.8 118.4 2014f 2.1 45.8 36.1 22,071 -0.2 15.0 -3.8 1.6 1.25 0.80 22.8 23.0 0.8 2.2 0.9 119.8

Regional Leadership
The Slovenian president, Borut Pahor, confirmed his country will look to provide support for the Balkan state to move progressively toward EU integration. This move is critical in illustrating the fact that Slovenia is gaining political influence in the region despite its economic woes. We have already outlined the attempt of the country's political leadership to improve its political reputation throughout Europe, with Prime Minister Alenka Bratuek conducting numerous meetings with regional heads of state.
Our Short-Term Political Risk Rating is 56.5 out of 100.

2014, when the government continues to target a deficit under the 3% Maastricht ceiling, an unlikely prospect, in our view. Alongside a one-off bump in revenues from the sale of 15 state-owned companies, the government plans to trim the public sector workforce by 1%, secure further wage reductions with trade unions, and reform real estate taxes. A contingency measure of a crisis tax a temporary hike in income tax has also been outlined for 2014 in case sufficient permanent spending cuts cannot be agreed upon. Though we expect the new measures to reduce the budget shortfall, we forecast a deficit at 3.8% of GDP, as we expect delays in the implementation of certain measures. In particular, we foresee problems with efforts to further reduce the public sector wage bill (on account of union resistance), and efforts to reform the pension system (on account of resistance within the governing coalition particularly the pensioners party).

ECONOMIC RISK

Stress On Banking
The Central Bank decided to move forward with the European Commission's request to extend stress testing to more than the three leading banks. In total, 10 lending institutions will be assessed under this programme with results to be published by the end of 2013. Stress-test results for state-controlled Nova Ljubljanska Banka, Nova KBM and AbankaVipa will be available by September. While the extension of the tests could send a positive signal, it could also result in more fiscal imbalances if capital needs in excess of the EUR1.2bn currently estimated by the central bank appears to be required. This would put more pressure on the government expected to fill this capital gap.
Our Short-Term Economic Risk Rating is 58.8.

BUSINESS RISK

Privatisation Checkpoint
Reinsurer Pozavarovalnica Sava, partly state owned, is being progressively acquired by foreign companies. In August Croatia Osiguranje, an insurance group, disclosed it was planning to increase its equity stake in order to obtain a controlling interest. We have seen increasing signs in recent months that companies appear to be receptive to government attempts to privatise its large stakes in domestic industries. Talks about the privatisation of Telekom Slovenije hint at a potential acquisition by Deutsch Telekom. We would see such a deal as a strong signal that the government's privatisation plan could yield positive results for the Slovenian business environment.
Our Business Environment Rating is 62.7.

e/f = BMI estimate/forecast. 1 Registered unemployment; 2 General government. Source: 3 World Bank, UN, BMI; 4 Statistical Office of the Republic of Slovenia; 5 Statistical Office of the Republic of Slovenia, BMI; 6 Ministry of Finance, BMI; 7 ECB, BMI; 8 BMI; 9 Bank of Slovenia, BMI; 10 IMF, BMI; 11 Bank of Slovenia

www.emergingeuropemonitor.com

OCTOBER 2013 SOUTH EAST EUROPE

 MACEDONIA
RISK SUMMARY
POLITICAL RISK ECONOMIC OUTLOOK

Unemployment Hurts Profile

Macedonia maintains a below-average ShortTerm Political Risk Rating score in the region, due mostly to its low 'Social Stability' score. At 56.2, Macedonia is significantly below the regional average of 68.4 in the Short-Term Political Risk Ratings, below Croatia (68.1), Hungary (66.0), Romania (65.4) and Slovakia (65.2). We attribute this relative underperformance largely to elevated unemployment, which at over 30%, is weighing on Macedonia's political risk profile. That said, compared with other Balkan economies, excluding Croatia, Macedonia performs relatively well, above Albania (54.2), Serbia (49.8), Kosovo (40.4) and Bosnia & Herzegovina (33.8).
Macedonia's Short-Term Political Risk Rating is 56.2 out of 100.

BMI Stays Below Consensus On Economic Recovery

BMI View: A weak external environment will prevent a more rapid expansion in real GDP in Macedonia over the next two years, keeping our forecasts below consensus expectations. We forecast real GDP growth at 1.5% and 2.8% in 2013 and 2014 respectively, following a year of zero growth in 2012.
While we foresee a steady economic recovery in Macedonia over the coming years, we err on the side of caution with regards to our real GDP projections. A recent economists' survey by Bloomberg confirms that we remain below-consensus in our expectations for 1.5% real GDP growth in 2013 and 2.8% in 2014. Consensus expectations place growth higher, at 2.0% in 2013 and 3.1% in 2014. Although we see scope for a steady recovery in private consumption we forecast real private consumption growth of 2.0% in 2013 following a 1.2% contraction in 2012 we see a slowdown in fixed investment and muted export growth as key factors underpinning our more cautious stance on Macedonia's economic recovery. Our more sceptical forecasts for economic growth are rooted in a subdued outlook for economic growth in the eurozone. Although
DATA & FORECASTS
BMI View: Macedonia's public finances have displayed some fiscal slippage on the part of the government in the opening months of 2013. On a 12-month rolling basis, the fiscal deficit widened to the equivalent of 5.1% of GDP by March, based on our calculations. This marks a substantial widening of the nominal fiscal deficit since 2012, when the government posted a 3.9% of GDP budget deficit. Negative revenue growth and a continued expansion in expenditures (6.5% y-o-y in the year-to-date) have been the main cause. In June the government shortfall narrowed somewhat on a rolling basis, coming in at 4.9% of GDP . Measuring MKD13.8bn in H113, we forecast the deficit to widen to MKD23.6bn, or 4.9% of GDP , in 2013.
Population, mn [4] Nominal GDP, MKDbn [5] GDP per capita, US$[ 5] Real GDP growth, % change y-o-y [5] Industrial production index, % y-o-y, ave [5] Budget balance, % of GDP [1,6] Consumer price index, % y-o-y, eop [2,5] Exchange rate MKD/US$, eop [7] Exchange rate MKD/EUR, eop [7] Goods imports, US$bn [3,8] Goods exports, US$bn [8] Balance of trade in goods, US$bn [3,8] Current account balance, % of GDP [3,8] Foreign reserves ex gold, US$bn [9] Total external debt stock, % of GDP [10] 2011 2.1e 446.4 4,793 2.8 3.9 -2.6 2.7 44.89 61.74 6.8 4.4 -3.2 -3.0 2.3 62.2 2012 2.1e 460.5 4,564 0.0 -6.6 -3.8 4.7 44.89 62.23 6.2 3.9 -3.0 -3.7 2.5 70.8 Latest period 2.9 4.0 46.27 61.49 2.0 1.2 -0.7 Jan-Mar Jul 14-Aug 14-Aug Jan-May Jan-May Jan-May 2013f 2.1 481.5 4,941 1.5 5.3 -4.9 3.4 43.31 61.50 6.9 4.4 -3.3 -4.3 2.7 70.0 2014f 2.1 511.1 5,006 2.8 4.5 -4.4 3.6 43.31 61.50 7.4 4.7 -3.3 -4.8 2.8 68.0

ECONOMIC RISK

Regional Underperformer
Price stability and a relatively sound fiscal outlook are mostly offset by an elevated current account deficit and weak economic growth outlook. Even with the economy in the midst of a gradual recovery, elevated unemployment is weighing heavily on the economic risk profile of the EUR7.57bn Balkan economy. Macedonia scores substantially lower than the regional average in our Short-Term Economic Risk Ratings, at 39.6. This compares with a regional average of 56.8, and leaves the country just ahead of Kosovo (35.2) and Bosnia (30.2).
Our Short-Term Economic Risk Rating is 39.6.

the eurozone economy came out of recession in Q213, we expect a full-year contraction of 0.5%, and do not expect growth to accelerate beyond 0.9% in 2014. Given Macedonia's reliance on the eurozone for its exports and the vast majority of investments, we currently expect a slowdown in gross fixed capital formation growth from 12.1% in 2012 to 5.5% in 2013, and see only moderate growth in exports of goods and services (at 2.4%) following a 0.4% contraction in 2012. Imports, meanwhile, are set to grow more robustly in 2013 due to some improvement in domestic demand, which will keep the net export contribution to headline growth firmly negative. We forecast a -2.1 percentage point contribution to real GDP growth from the balance of exports and imports of goods and services in 2013.

BUSINESS ENVIRONMENT

South Stream Pipeline Deal

Macedonian authorities recently signed an agreement to connect the country to the South Stream pipeline project, which would improve access to natural gas and could significantly help to cut energy costs. Prime Minister Nikola Gruevski hailed the agreement as a key project, which would help to ensure access to natural gas. Lower energy costs could help to reduce the overall operational costs for industry in the economy, and help to improve confidence in businesses looking to invest in the region.
Macedonia scores 54.4 out of 100 in our Business Environment Rating.

e/f = BMI estimate/forecast. 1 Central government budget; 2 COICOP; 3 US$ data derived from EUR data beyond 2002. EUR data derived from US$ data before 2003. Source: 4 World Bank, UN, BMI; 5 State Statistical Office, BMI; 6 Ministry of Finance, BMI; 7 BMI; 8 National Bank of the Republic of Macedonia, BMI; 9 IMF, BMI; 10 National Bank of the Republic of Macedonia, BMI

SOUTH EAST EUROPE OCTOBER 2013

www.emergingeuropemonitor.com

SERBIA
POLITICAL OUTLOOK

RISK SUMMARY
POLITICAL RISK

Continuity Despite Reshuffle

BMI View: Despite the ousting of finance minister Mladjan Dinkic, we do not see a disruption to the administration's main policy goals: fiscal consolidation and EU integration. We expect the two-party coalition to remain intact, and the influence of Aleksander Vucic, the leader of the liberal Serbian Progressive Party (SNS) to rise, with the coalition likely to push ahead with necessary reforms.
Despite the ousting of Dinkic, we expect Prime Minister Ivica Dacic's administration to remain in power, while we see continuity in its policy course premised on budgetary belt-tightening and EU integration. Talks of dismissals in the coalition now comprising the centre-right SNS, led by Deputy Premier Aleksander Vucic, and the leftist Socialist Party of Serbia (SPS), led by Dacic have been ongoing in the past few months. However, it was only at the end of July that the reshuffle culminated in the ousting of the third junior coalition partner, the United Regions of Serbia (URS), and the finance minister. Dinkic had been at the helm of economic policy in the past 13 years and was a pillar of the liberal and pro-EU policy. Under Dacic's supervision, the government recently revised its budget, with a privatisation agenda, aimed at shedding 90 state-run companies and entailing cutting subsidies and public sector jobs. The cabinet now has a slim majority of 126 seats in the 250-seat parliament, rattling investor confidence in its ability to push ahead with reform and ability to pay its debts. Despite speculation that the balance of power in the coalition is tilted towards the left, we believe Vucic and his SNS will see their clout enhanced. Recognising that with the support
DATA & FORECASTS
BMI View: Serbia posted real GDP growth of 0.7% y-o-y in Q213, after 2.1% growth in Q113, but we still forecast amodest recovery, to 1.3% in 2013, rising to 3.4% in 2014, driven by a pickup in agricultural production and exports, as well as oil and automotive exports. This would offset the negativecontribution from government consumption.
Population, mn [1] Nominal GDP, US$bn [2] Nominal GDP, RSDbn[ 2] GDP per capita, US$ [2] Real GDP growth, % change y-o-y [2] Unemployment, % of labour force, eop [3] Budget balance, % of GDP [4] Consumer price index, % y-o-y, eop [2] Central bank policy rate, % eop [5] Exchange rate RSD/US$, eop [6] Goods imports, US$bn [7] Goods exports, US$bn [7] Current account balance, % of GDP [7] Total external debt stock, % of GDP [7] 2011 9.6e 43.3 3,175.0 4,510 1.6 23.6 -5.0 7.1 9.75 82.61 19.1 11.7 -9.2 72.2 2012 9.6e 38.2 3,363.1 4,002 -1.8 24.6 -6.5 12.2 11.25 85.18 18.1 11.2 -10.5 82.8 Latest period 0.7 12.4 11.00 86.68 Q213 Feb June 26-Mar 2013f 9.5 44.5 3,682.4 4,681 1.3 24.0 -6.0 5.0 10.25 81.20 20.5 13.1 -9.0 84.1 2014f 9.5 46.0 3,983.7 4,858 3.4 23.0 -3.9 4.5 9.00 89.60 21.4 14.0 -8.5 84.6

Serbia An EU Associate State From September

The Stabilisation and Association Agreement (SAA) between Serbia and the EU will enter into force on September 1 2013, fulfiling the formal conditions for the initiation of membership talks and granting Serbia the status of EU associate country.Although we believe that this agreement is an important step in Belgrade's path towards integration with the EU, a number of uncertainties remain around the implementation of the Kosovo-Serbia EU-brokered accord signed in April, and these could serve to delay the country's progress.
Serbia's Short-Term Political Risk Rating is 49.8 out of 100.

from a few minor parties the SNS would be able to form a majority government in the case of early elections, the SPS is likely to follow the Progressives' lead to remain in power. Vucic, similarly to Dinkic, is liberal and pro-EU, and we expect the government to continue with austerity measures to anchor investor confidence. We are sceptical that the budget programme will meet fiscal targets. The revision does not see any changes to the social security and state pension systems. However, we believe Vucic would likely overhaul social expenditure if the privatisation projects are insufficient to meet fiscal targets. Risks To Outlook Risks to our view that the coalition will remain intact and ramp up fiscal consolidation are to the downside. Belt-tightening could stoke discontent, which might dissuade the coalition from reforms, or could lead to the SPS splitting off (its traditional voter base is pensioners and public sector employees) or boost support for the opposition Democratic Party, an opponent of Kosovo's independence and likely to seek to hamper further EU integration.

ECONOMIC RISK

IMF Arrangement Likely

Serbias finance minister-designate, Lazar Krstic, has stated that the administration is targeting a budget deficit of 4.0% of GDP in 2014, after striving to meet its 2013 target of 4.7%. He has also announced that Belgrade will turn to the IMF as well as the World Bank to stabilise its finances, stating that an arrangement with the IMF would be a positive signal to investors that the country is pursuing a responsible economic policy. However, we reiterate our view that the government remains likely to miss its fiscal target in 2013, due to falling revenues and an unwillingness to address its overburdened social expenditure.
Serbia's Short-Term Economic Risk Rating stands at 43.8.

BUSINESS ENVIRONMENT

A Boost To Infrastructure And Industry

The government signed a memorandum of cooperation with UAE-based Global Capital Advisors Management (GCAM), which intends to finance industrial and infrastructure projects in the country. The Minister of Construction and Town Planning, Velimir Ilic, told the press that GCAM would invest in projects such as residential developments, tourism, highways and agribusiness. He said that these investments will be implemented through joint funding via a fund in which GCAM will invest first EUR10mn to EUR15mn.
Serbia's Business Environment Rating is 47.5.

e/f = BMI estimate/forecast. Source: 1 World Bank, UN, BMI; 2 Serbian Statistics Agency, BMI; 3 Serbian Statistics Agency; 4 Ministry of Finance, BMI; 5 National Bank of Serbia; 6 BMI; 7 National Bank of Serbia, BMI

www.emergingeuropemonitor.com

OCTOBER 2013 SOUTH EAST EUROPE

 ALBANIA
RISK SUMMARY
POLITICAL RISK ECONOMIC OUTLOOK

Rama Raises Issue Of Border With Greece

Albania wants a settlement with Athens on the issue of maritime borders between the two states, the country's prime ministerdesignate, Edi Rama, said in an interview in August. Albania's Constitutional Court has annulled a territorial agreement signed with Greece in 2009 delineating the continental shelf between the two countries in the Ionian Sea, with the court arguing that the deal had serious legal flaws. Although Athens has so far been unwilling to renegotiate the accord, we do not believe the issue will lead to any significant deterioration in relations between the two countries.
Albania's Short-Term Political Risk Rating is 54.2 out of 100.

25bps More Cuts In 2013

BMI View: Inflationary pressures will remain subdued, due to easing agricultural prices and low demand-pull price dynamics. The National Bank of Albania (BoA) will lower its policy interest rate by 25bps to 3.25% by the end of 2013, and by a further 75bps in 2014, as low prices allow it to try to stimulate growth through more accommodative monetary policy.
The BoA lowered its policy interest rate 25bps to 3.50% in July. We believe it will lower the policy interest rate by a further 25bps to 3.25% by the end of 2013, and forecast rates to be cut to 2.50% in 2014. The downgrade comes against a backdrop of dovish statements by BoA Governor Ardian Fullani, who said that the July cut was needed to create better conditions for the growth of domestic demand. Weak inflationary pressures will predicate an increasingly accommodative monetary policy direction by the BoA, which will try to provide stimulus to support lending and growth. CPI growth was 2.3% y-o-y in June, (below the BoA target of 3.0%), down from 2.7% in January 2013. We forecast inflation to average 2.4% in 2013 and 2.0% in 2014. Food and non-alcoholic beverages' price growth has been the most significant contributor to inflationary pressures over the past few months. Food prices rose 5.4 % y-o-y in June, against a backdrop of a poor harvest in the major grain producing countries, partly reflected by a 30.6% y-o-y rise in vegetable prices in June. The BoA estimates agricultural prices accounted for over 90% of headline price growth in 2013, due to volatile global prices and their
DATA & FORECASTS
BMI View: We forecast real GDP growth of 2.1% in 2013 and 3.2% in 2014, driven by a modest recovery in private consumption and healthy export growth. A more significant recovery will be limited by the government's unfavourable fiscal position and weak fixed investment growth, ensuring real GDP growth remains well below potential for some time.
Population, mn [1] Nominal GDP, US$bn [2] GDP per capita, US$ [2] Real GDP growth, % change y-o-y [2] Unemployment, % of labour force, eop [3] Budget balance, % of GDP [3] Consumer price index, % y-o-y, eop[ 4] Central bank policy rate, % eop [5] Exchange rate ALL/US$, eop [6] Goods imports, EURbn [3] Goods exports, EURbn [3] Current account balance, % of GDP [6] Total external debt stock, % of GDP [3] 2011 3.2 12.7 4,028 3.0 13.4 -3.6e 1.7 4.75 106.88 3.6 1.4 -13.0 48.9 2012 3.2e 13.2 4,161 1.5 13.3e -3.5e 2.4 4.00 106.90 3.5e 1.5e -9.9e 51.9 Latest period 1.7 12.9 2.3 105.35 -0.2 0.1 Q113 Q113 Jun 13-Aug Mar Mar 2013f 3.2 13.1 4,138 2.1 12.7 -3.6 2.2 3.25 107.70 3.5 1.6 -8.6 56.9 2014f 3.2 12.9 4,048 3.2 12.5 -3.5 1.8 2.50 115.60 3.6 1.7 -8.2 62.6

ECONOMIC RISK

Government Raises Wages Despite Revenue Shortfall

The outgoing government raised wages at the end of July, despite a revenue shortfall and rising public debt, brushing off calls for fiscal tightening from the World Bank. Former prime minister Sali Berisha said pensions will go up 4.0% while state sector wages will rise 5.4%, adding US$23.6mn to the 2013 government budget. Central bank governor Ardian Fullani cautioned that government spending posed a serious risk to economic stability, and we believe the changes will put further pressure on the new Socialist government to rein in public debt.
The Short-Term Economic Risk Rating is 47.5.

large weighting in the CPI basket (39.4%). We see falling food prices driving inflation lower. Price growth has remained subdued in other key components of the consumer price basket, ensuring Albanias core inflation rate has remained low. In June utility prices contracted 1.0% y-o-y, as a result of fuel prices following a downward trajectory since start of the year. Prices for clothing and footwear, a key export industry, contracted 3.6% y-o-y. Weak demand for clothing is a product of unfavourable economic conditions. We believe weak domestic demand will moderate price growth over the next few quarters, as uncertainty over the direction of the economic recovery undermines consumer spending. Low wage growth makes consumers reluctant to consume, while high unemployment highlights slack in the labour market. While we expect the economic recovery to pick up in 2014, consumer spending is unlikely to return to pre-crisis levels soon. Risks To Outlook A slower-than-expected economic recovery would prolong the slump in domestic demand, and we would not rule out the BoA lowering the interest rate to 3.0% by the end of 2013, in an attempt to spur growth.

BUSINESS ENVIRONMENT

Corruption Progress
Officials welcomed a report by the European Council's Group of States against Corruption that the country has made progress in its anti-corruption efforts. Outgoing prime minister Sali Berisha lauded the report, and praised the close collaboration between Tirana and the European Council on legislative matters. Nevertheless, corruption is likely to remain a significant problem in the country, and the new government will have to continue the reform process if it wants to significantly improve Albania's business environment.
Albania's Business Environment Rating is 50.7 out of 100.

e/f = BMI estimate/forecast. Source: 1 World Bank, UN, BMI; 2 INSTAT, BMI; 3 BoA, BMI; 4 INSTAT; 5 IMF, BMI; 6 BMI; 7 BoA

10

10

SOUTH EAST EUROPE OCTOBER 2013

www.emergingeuropemonitor.com

CROATIA
ECONOMIC OUTLOOK

RISK SUMMARY
POLITICAL RISK

Bank Lending To Contract

BMI View: The profitability of Croatia's banking sector will come under pressure as deteriorating asset quality and the sectors exposure to deleveraging parent banks in Southern Europe restricts lending. We have pencilled in loan contraction of 1.0% in 2013, but a healthy deposit base and strong capital buffers should shelter banks from any unforeseen funding requirements.
Despite tentative signs of economic recovery, banking sector gross profit fell to HRK331.8mn in Q113, down 25.7% y-o-y. We believe profitability will continue falling as loan growth is restricted by parent banks in Southern Europe pulling capital out of subsidiaries,and as banks increase capital holdings in the face of deteriorating asset quality. This has been playing out, with data from the National Bank of Croatia (HNB) showing that assets grew just 1.7 % y-o-y in April (having averaged 7.1% from 2006 to 2012). We forecast asset growth of 1.2% in 2013. While the size of the banking sector is likely to continue increasing relative to GDP, this is largely due real GDP contracting 2013. Although deposit growth is reasonably healthy, we believe client loan growth will remain negative in 2013, on the back of the banking sectors reliance on non-traditional forms of loan financing. In Croatia, the banking sector relies on financing from foreign banks, which in 2012 held 90.1% of the sectors assets and owned 16 out of 31 banks. With a weaker-than-expected economic recovery in Southern Europe (where most parent banks are based), we have downgraded our
DATA & FORECASTS
BMI View: Inflation will continue to ease in H213, due to weak domestic demand, the deregulation of the energy sector and a better agricultural harvest in 2013. We forecast headline inflation to average 3.0% in 2013 and 2.5% in 2014, and believe any significant inflationary spikes should be prevented by the HNB, which could act to limit kuna depreciation towards the end of 2013.
Population, mn [1] Nominal GDP, US$bn [2] Nominal GDP, HRKbn [2] GDP per capita, US$ [2] Real GDP growth, % change y-o-y [2] Unemployment, % of labour force, eop [3] Budget balance, % of GDP [4] Consumer price index, % y-o-y, eop [2] Exchange rate HRK/US$, eop [5] Goods imports, EURbn [6] Goods exports, EURbn [6] Current account balance, EURbn [6] Current account balance, % of GDP [6] Foreign reserves ex gold, US$bn [6] Total external debt stock, % of GDP [6] 2011 4.3 61.7 330.2 14,275 -0.0 18.7 -4.5 2.0 5.81 16.1 9.8 -0.4 -1.0 14.5 103.4 2012 4.3e 56.5 330.2 13,108 -2.2 20.9e -3.6 4.7 5.73 15.9 9.8 0.0 0.0 14.8e 99.5 Latest period 0.8 18.6 2.0 5.68 3.7 2.1 -1.4 Q213 June June 13-Aug Q113 Q113 Q113 2013f 4.3 57.5 336.6 13,403 -0.4 21.0 -4.6 2.5 6.11 16.0 9.5 -0.1 -0.3 14.6 103.4 2014f 4.3 57.0 348.8 13,339 1.1 19.0 -4.4 2.1 6.14 16.8 9.8 -0.2 -0.5 15.0 106.8

Croatia Pledges EU Accession Cooperation

Leaders of the eight Balkan countries that emerged from the breakup of Yugoslavia pledged closer ties and support for future EU membership in a meeting co-chaired by the French president, Franois Hollande. The meetings are only the second time that the heads of the former Yugoslav republics and Albania have met, and came after Croatia became the 28th member of the EU on July 1. The bloc's leaders are pressing Balkan countries to make the region more secure and prosperous, and we believe Croatia will try to serve as a political and economic bridge between Brusells and the region in an attempt to bolster regional stability.
Croatia's Short-Term Political Risk Rating is 68.1 out of 100.

forecast for client loans, which we expect to contract by 1.0% in 2013. The sector should become less reliant on foreign financing, with a stable domestic funding base and weak loan growth combining to lower the loan-to-deposit (LTD) ratio. The LTD ratio fell to 109% in April 2013, from 116% a year earlier, as households remain inclined to save in light of the uncertain economic environment. This contributed to deposit growth expanding 4.0% y-o-y in April. Deteriorating asset quality will continue weighing on profitability, as rising non-performing loans (NPL) force banks to retain a higher proportion of earnings as capital. NPLs reached 14.6% of total loans in April and we see high unemployment, stagnant wage growth and falling disposable incomes restricting the ability of households to pay back loans. Croatian banks are exposed to FX risk, as a high proportion of housing loans are indexed or denominated in foreign currencies. We see potential for currency deprecation to undermine households ability to repay loans. We expect summer kuna strength to give way to depreciation at end-2013, which is likely to ramp up NPLs and weigh on banking profits.

ECONOMIC RISK

Eurozone Pickup To Help

The eurozone's expected exit from recession in H213 will support Croatia's economic recovery, according to economy minister Ivan Vrdoljak. Although the minister suggested the improved conditions in the eurozone (where the majority of Croatian exports are sent) would allow real GDP to return to positive growth in 2013, we stress that weak consumption and investment will restrict a more significant economic recovery over the next few quarters . We forecast real GDP to contract 0.4% in 2013, and grow by 1.1% in 2014.
The Short-Term Economic Risk Rating is 52.7.

BUSINESS ENVIRONMENT

Farmers Protest Over Lost Subsidies

Croatian farmers said on August 13 that they would press ahead with protests to demand the government pay them HRK600mn in lost subsidies, cut in a budget crunch to meet deficit targets set by the EU. The farmers said they would continue to block roads in eastern Croatia after talks with the agriculture and finance ministries failed to bring about a satisfactory resolution. The finance ministry said there was no money in the budget for an increase in subsidies, and with the country's fiscal position increasingly shaky, we do not expect a u-turn in policy anytime soon.
The Business Environment Rating is 57.1.

e/f = BMI estimate/forecast. Source: 1 World Bank, UN, BMI; 2 CBS, BMI; 3 CSO, BMI; 4 Ministry of Finance, BMI; 5 BMI; 6 HNB, BMI

www.emergingeuropemonitor.com

OCTOBER 2013 SOUTH EAST EUROPE

11

BOSNIA
ECONOMIC OUTLOOK

RISK SUMMARY
POLITICAL RISK

EU Losing Patience
Bosnia's already tense relationship with the EU is coming under more strain as authorities in Sarajevo fail to tackle key reforms while also entering a trade dispute with neighbour and new member, Croatia. While growing pressure at home and abroad may push the government to approve certain measures, we expect ethnic concerns to continue to trump EU ambitions within the political leadership. The upcoming national census and 2014's elections are two key flashpoints on the short-term horizon.
Our Short-Term Political Risk Rating remains at 33.8 out of 100 this month.

Well Placed For Growth

BMI View: Tepid economic growth and deteriorating asset quality will restrict both the supply and demand for credit in Bosnia, weighing on banking sector profitability in coming quarters. However, the sector is well positioned to benefit from accelerating economic activity in 2014 and beyond.
Amid a sluggish recovery from recession in 2012, non-performing loans (NPL) in the Bosnian commercial banking sector have grown steadily, reaching 13.8% of total loans in Q113. However, with adequate capital buffers and a growing deposit base, banks will be able to expand their loan books as domestic demand improves. Ongoing compliance with IMF guidance on legal and regulatory reform will further improve the stability of the sector. Although remaining positive throughout 2012, loan growth has failed to gain momentum in 2013 as household deleveraging, high unemployment and weak business investment continue to restrict demand for credit. Furthermore, commercial banks have had to increase loan loss provisions and capital adequacy ratios in light of rising NPLs, leading to tightening credit standards. Although well below pre-crisis peaks, we forecast loan growth to accelerate to 5.0% and 7.0% in 2014 and 2015. An uptick in lending in line with improving macroeconomic conditions in 2014 will be facilitated by a stable and growing deposit base, which proved resilient despite the economic downturn. Client deposits increased by
DATA & FORECASTS
BMI View: Latest data from the statistics office show consumer prices stagnated in June, on a monthly basis, with annual inflation at 1%, down from 1.8% at the start of the year. This is largely due to easing food and energy costs, driven by lower commodities prices. While we expect some pick up in headline inflation in H213, in line with the beginnings of an economic recovery, data from H113 adds a downside risk to our forecast for average inflation of 1.8% in 2013.
Population, mn 1 Nominal GDP, US$bn 2 Nominal GDP, BAMbn 2 GDP per capita, US$ 2 Real GDP growth, % change y-o-y 2 Unemployment, % of labour force, eop 3 Budget balance, % of GDP 4 Consumer price index, % y-o-y, eop 5 Exchange rate BAM/US$, eop 6 Goods imports, EURbn 3 Goods exports, EURbn 3 Current account balance, % of GDP 3 Total external debt stock, % of GDP 3 2011 3.8 18.5 25.7 5,007 1.0 43.6 -2.9 4.2 1.41 6.9 2.6 -9.3 39.9 2012 3.8e 16.7e 25.8e 4,551e -1.1e 44.5 -2.6e 1.8 1.48 6.9 2.6 -9.5 44.9e Latest period 1.47 4.4 2.5 18-Aug Jan-Jul Jan-Jul 2013f 3.8 18.0 26.5 4,921 0.8 46.0 -2.2 2.1 1.47 7.1 2.7 -8.9 48.1 2014f 3.8 18.0 27.8 4,948 1.9 45.0 -1.7 3.0 1.56 7.4 2.8 -8.0 48.5

ECONOMIC RISK

Fiscal Discipline
Provisional data for 2012 show the government outperformed in its fiscal consolidation programme, achieving a below-target budget deficit of 2.6% of GDP . The overall figure came in below our estimate and the government's own target (both 3%), despite a shrinking economy. With the IMF providing a strong anchor, we expect the deficit to shrink further in 2013 (to 2.2% of GDP) and beyond, although economic headwinds and political instability do pose risks to this core scenario.
Bosnia scores 30.2 in our Short-Term Economic Risk Ratings this month.

2.6% over the course of 2012, and through May grew by 4.5%, exhibiting steady upward momentum. We expect deposit growth to continue outpacing loan growth throughout 2014. This dynamic will prove important as banks reduce reliance on wholesale funding. Although profitability will continue to suffer in the short term from deteriorating asset quality and sluggish loan growth, we expect the sector to follow a reasonably profitable trajectory. Despite significant headwinds, sector-wide return on assets grew even as NPLs surged in 2012. With outstanding client loans representing just 54.8% of GDP, banking penetration in Bosnia remains relatively low, providing ample room for expansion of the sector. Owing largely to Bosnias currency board, which makes the local currency freely convertible to the euro at a pegged exchange rate, significant foreign exchange mismatches on banks balance sheets have proved sustainable. Furthermore, this dynamic has bolstered profitability, as paying a lower rate on FX deposits while collecting a higher rate on local currency loans has strengthened net interest margins.

BUSINESS ENVIRONMENT

More Aluminij Relief

Bosnia & Herzegovina's biggest exporter, Aluminij, signed a new deal in late July with Slovenian electricity trader GEN-I to provide some relief from energy costs through to the end of 2013. The aluminium smelter came close to shutting down operations earlier in the year after heavy losses as a result of falling demand and metal prices, but the government, which owns a 44% stake in the company, agreed to provide subsidies to reduce costs. The deal with GEN-I is encouraging for the firm, which is key for economic activity and employment, although reducing dependence on state support will remain a challenge.
Our Business Environment Rating is 38.0.

e/f = BMI estimate/forecast. Source: 1 World Bank, UN, BMI; 2 Bosnia Agency for Statistics, BMI; 3 CBBH, BMI; 4 CBBH; 5 Republika Sprska Institute of Statistics, Federal Office of Statistics for BH, BMI; 6 BMI

2013 Business Monitor International. All rights reserved.

All information, analysis, forecasts and data provided by Business Monitor International Ltd is for the exclusive use of subscribing persons or organisations (including those using the service on a trial basis). All such content is copyrighted in the name of Business Monitor International, and as such no part of this content may be reproduced, repackaged, copied or redistributed without the express consent of Business Monitor International Ltd. All content, including forecasts, analysis and opinion, has been based on information and sources believed to be accurate and reliable at the time of publishing. Business Monitor International Ltd makes no representation of warranty of any kind as to the accuracy or completeness of any information provided, and accepts no liability whatsoever for any loss or damage resulting from opinion, errors, inaccuracies or omissions affecting any part of the content.

www.emergingeuropemonitor.com
Copy Deadline: 23 August 2013 Analysts: Michael Richards, Thaddeus Best, Ekaterina Staykova, Luca Dos Santos, Marc Rogers, Mark Schaltuper Editor: Richard Hamilton Sub-Editor:Nicola Gollan Subscriptions Manager: Lucinda Morek Marketing Manager: Julia Consuegra +44 (0)20 7246 5131 Production: Deepti Suman Publishers: Richard Londesborough/Jonathan Feroze