Restarting Belgrade-Pristina talks could unlock funds for COVID recovery

Policy Pulse - George Anjaparidze - 24 June 2020

On 27 June 2020 the leaders from Belgrade and Pristina plan to meet in Washington, DC with the goal of restarting formal dialogue. The meeting has potential to be a turning point on the road to normalization of relations.

Political analysts have suggested that the timing looks promising. Both sides are at the start of their political mandates. Furthermore, key roadblocks that derailed previous efforts at dialogue have, at least in part, been addressed. Perhaps of most significance, the 100% tariffs imposed by Kosovo in November 2018 on imports from Serbia and Bosnia have been removed in April 2020. Earlier in June 2020, the new Kosovo leadership also removed the recently imposed non-tariff measures.

Both sides need international support to sustain a post-COVID recovery. Restarting Belgrade – Pristina talks on normalization can unlock additional funds to support the economic recovery following the COVID-19 shock.

Removing trade barriers is good for Kosovo and will ease recovery from COVID

The decisions taken earlier in the year to lift the mentioned tariffs and other non-tariff barriers are good for consumers and businesses in Kosovo. Reduced trade restrictions make it easier for Kosovo to bounce back from the COVID-19 shock as it becomes less costly to source inputs for the recovery.

As our previous analysis examined, these tariffs were harmful to Kosovo. A year ago, experts also warned that import taxes would lead to higher prices in Kosovo.

Estimated consumer prices inflation for 2019 shows that despite using the Euro, inflation in Kosovo was more than two times higher than the Eurozone average. The process used by the Kosovo Agency of Statistics (KAS) for estimating inflation could benefit from greater transparency, nevertheless, taking the published figures at face value indicates that inflation in Kosovo was 2.7% compared to the Eurozone average of 1.2%.

The higher rate of inflation captures only part of the impacts. A retrospective assessment of the tariff impacts would likely show that the tariffs led to a combination of higher prices, consumption of lower quality products and potentially lower profit margins in the distribution chain within Kosovo.

Restarting talks can help unlock new resources to accelerate post-COVID recovery

The IMF expects the outbreak of COVID-19 will severely curtain Kosovo’s economic performance through depressing tourism receipts, remittances, exports and FDI. Even at the beginning of April, IMF forecasted the economy to shrink by 5% in 2020, with external financing inflows cut by half. In 2018, personal remittances received were equal to 15.6% of GDP or €1.1 bn and expectation for 2020 point to a sharp contraction. Since these forecasts, the response to the epidemiological situation has led to an even weaker economic backdrop and implies an even worse outlook.

Across Serbia, COVID-19 is expected to have a significant adverse impact on the economy. The travel and tourism sector contributed to nearly 6% of GDP in 2019 and grew nearly two percentage points faster than the overall economy. In 2018, personal remittances received were equal to 8.8% of GDP or €3.9 bn. A major contraction in remittances and the travel and tourism sector combined with a challenging external environment pose serious difficulties to the post-COVID recovery.

Formally restarting the normalization discussions can help unlock additional international support for the recovery. Immediate opportunities for leveraging additional funds, beyond those already announced in the EU post-pandemic recovery plan, could come from EU instruments such as the Stabilization and Association Process (SAP) and investment initiatives targeting the Western Balkan region.

In the medium term, a particularly promising source of additional funds could come from the new EU methodology for enlargement, which promises to front load some of the benefits associated with the EU accession process. Historically, there was a big difference in the support provided through the instrument for pre-accession and the scale of funds that would be available upon EU membership through the EU cohesion program (see chart).

As illustrated in the chart, economic transfers from the EU under the instrument for pre-accession were significantly lower than the potential funds that would be available through the EU Cohesion program if Kosovo and Serbia were EU members. One of the aims of the new methodology for enlargement is to front load the benefits of EU membership and make them available throughout the accession process. While operational aspects of the new methodology are still being finalized, this new approach could serve as a major opportunity for accessing additional resources and lead to a scale-up in EU assistance during the accession process.

Combining economics and international support improves prospect of normalization

Imbedding economic issues as part of the dialogue on normalization has potential to improve the negotiation dynamics. A greater focus on the economic dimension could change the negotiation from a “slicing the pie” to a “growing the pie” dynamic.

Focusing on economic benefits in combination with targeted international support has potential to greatly improve the prospects of normalization.

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Conflict Economics: Eastern Europe 2020

Policy pulse - George Anjaparidze - 28 January 2020

Belgrade – Pristina: cautious optimism for 2020

Economic costs continued to mount in 2019

Kosovo’s consumers continued to be harmed by the 100% tariffs imposed by Pristina on Serbian imports. The indecision of the EU on enlargement, especially with respect to North Macedonia, was perhaps the most discouraging development of 2019. By making EU enlargement in the Balkans more elusive the EU diminished prospects for normalization of relations between Pristina and Belgrade. The prospect of EU membership, in particular the eventual access to EU structural funds, is a major economic incentive for normalizing relations between Pristina and Belgrade. Access to EU structural funds would result in about a 20-fold increase in public finance flows from the EU.

There is room for cautious optimism in 2020 for restarting negotiations but economic incentives are still needed

2020 holds greater promise. At the local level, annual data will soon be available that will make it possible to assess the negative impacts of tariffs on consumers in Kosovo. Such an assessment would empower the incoming Kosovo government with evidence on the economic benefits of suspending the tariffs. Given the solid nationalist credentials of the likely incoming government, suspending the tariffs would unlikely be perceived by the public as appeasement to Belgrade.

Internationally, a greater US involvement is likely to yield results. President Trump’s appointment of US Ambassador to Germany as US special envoy for talks between Belgrade and Pristina can be a source of positive leverage. The agreement to in principle resume direct rail and air services is evidence of US effectiveness. Furthermore, the new EU Foreign Policy Chief, Josep Borrell, could play a key role by putting on the table the promise of near-term economic support for parties to resume dialogue. This could be done credibly given the on-going review of the methodology for EU enlargement. The updated methodology, in part, aims to front load the economic benefits to candidate countries from EU integration.

Ukraine – Russia: in need of a rebalance?

The situation in Ukraine continues to impose economic costs on all parties

The conflict in Ukraine imposes significantly higher costs on Ukraine (compared to Russia) in both relative and absolute terms. External estimates from academics indicate that output in the Donbass region has fallen by about 50% due to factors directly attributable to armed conflict. In comparison, like for like estimates point to a fall in economic activity of about 15% in the rest of Ukraine. There are no readily available like for like comparison for assessing the impacts on Russia. However, the range of estimates of the relative impact of Western sanctions on Russia, suggest that sanctions have lowered economic output by 0.5 - 1.5%.

The cost of waging war is also lower for Russia. For most of the conflict, Russia’s direct military resource commitment has been relatively small (estimated at one battalion plus tactical operations combined with positional warfare and indirect fire). In contrast, Ukraine has incurred major losses while having to approximately double its military expenditure. This means Russia is able to perpetuate the conflict at a fraction of the cost incurred by Ukraine. While Ukraine’s recently improved readiness has enhanced its ability to increase costs for Russia, Ukraine’s ability to deploy this capability at scale is constrained by overall Russian military superiority and the threat of a massive invasion of Ukraine.

Rebalancing the cost equation of the Ukraine conflict and introducing a “Marshall Plan for Donbass” can help normalization

Under these circumstances, the outcome of negotiations in 2020 is unlikely to be successful or at best will be extremely unbalanced (disproportionately favoring Russia). In terms of economic instruments, there are two important steps that should be considered by Ukraine’s Western partners. First, there is a need to rebalance the cost dynamic (e.g. new rounds of more intense sanctions). Second, predictable and long-lasting resources need to be provided on an unprecedented scale that will economically integrate the Donbass region into Ukraine and Europe. A “Marshall Plan for Donbass” needs to be committed to ahead of further Zelensky - Putin negotiations. This should give confidence to Ukraine that with time the region will be integrated into Ukraine, even if in the short-term Russia continues to hold sway. Crimea is a more complex issue, with conditions in 2020 unlikely to be conducive for dialogue. However, there may be attempts to bundle the Crimea issue as part of the Donbass negotiations.

Georgia – Russia: from bad to worse

Georgia – Russia relationship goes from bad to worse in 2019

2019 saw the Georgia – Russia relationship hit lows not seen since Russia’s 2008 invasion of Georgia. Georgia still does not have diplomatic relations with Russia. Nevertheless, in recent years, relations improved with resumption of direct flights and more trade. However, in June 2019 an error of protocol sparked mass protests in Georgia against continued Russian occupation of two Georgian territories. In response, President Putin issued a decree banning all direct flights between Russia and Georgia. As a result, Russian airlines and consumers have incurred the biggest absolute losses. The impacts on the Georgian tourism sector were to a large extent mitigated due to good connectivity available through regional hubs such as Minsk, Riga, Almaty and Istanbul. In a more strategic context, the flight ban is a missed opportunity for Russia to recover its soft power potential and makes it more difficult to forge closer economic and human to human ties.

Political volatility is expected in 2020 but economic initiatives can create opportunities for collaboration

2020 is an election year in Georgia, with an uncertain outcome. According to the latest polling data, no political party has more than 20% of public support. The ruling party still leads but current polls suggest it is unlikely to win an outright majority. However, there is high uncertainty in the polling data as about 1 in 3 survey participants either refused to answer or do not support any political party. During the period in the lead up to elections, Georgia is particularly vulnerable to external meddling. For example, Russia may give a platform and engage in dialogue with fringe political groups in Georgia to resolve an engineered crisis or credit them with a removal of the ban on direct flights. There is also continued concerns about how Russia might react to any developments related to Georgia’s closer integration with NATO.

On a more optimistic note, Georgia’s closer cooperation with the EU on economic issues has not been a source of confrontation with Russia. The joint statement, by foreign ministers of Georgia, Moldova and Ukraine, calling for an enhancement of integration with the EU could also create opportunities for cooperation with Russian investors and business community.

Other trending topics to watch in 2020:

• The Moldovan presidential elections are scheduled for the Fall of 2020. It is also unclear how long the current minority government will hold, so parliamentary elections in 2020 may also be a possibility. In the lead up to elections, Russia will likely exercise more soft power in Moldova through supporting investments projects, proposing collaboration through the Eurasian Customs Union and offering other economic incentives. Russia may also use its leverage in the Transnistria region to help Moldovan authorities show results from striking a collaborative approach with Russia. Therefore, some incremental improvements in the lead up to the 2020 elections are a possibility in the Transnistria region.

• The negotiations between Armenia and Azerbaijan have made little progress in 2019 on the normalization of the Nagorno Karabakh conflict. The latest indication is that parties may no longer be comfortable with using previously accepted principles as the basis of negotiation. Therefore, the risk of an increase in hostilities in 2020 is more likely. This could be triggered by domestic political considerations, economic crisis or an attempted to repositioning on the ground.

#Europe #EuropeanCommission #Kosovo #Serbia #Russia #Georgia #Armenia #Azerbaijan #Moldova #Transnistria #NagornoKarabakh #economics

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Kosovo: disappointing economic data to come?

Policy Pulse - 19 June 2019 - George Anjaparidze

Last week, Pristina hosted foreign dignitaries in celebration of 20 years since the departure of troops of former Serbian President Milocevic. It was also an occasion to showcase Kosovo’s progress in recent years across a number of critical areas. According to the World Bank 2019 Doing Business report, Kosovo was ranked as the 44th easiest place to do business, scoring higher than the Eastern European regional average. Life expectancy has risen from 69.2 in 2007 to 71.9 years in 2017. Despite these successes, there have also been misguided policy interventions. In particular, the decision in November 2018 to impose a 100% tariff on goods originating from Serbia is particularly damaging to Kosovo’s economy.

As a result of these tariffs, we forecast a significant reduction in the purchasing power of Kosovo consumers. Our impact analysis (How harmful are trade tariffs to Kosovo consumers?) estimates a reduction in purchasing power by 6.4% due to 33% higher import costs on goods impacted by tariffs (mid-range estimate). The chart above presents a sensitivity analysis on the range of cost impacts on goods covered by these tariffs. The chart also offers a breakdown on drivers behind the higher import costs. The analysis is top down in nature and assesses the expected future short-to-medium term impacts.

Domestic production in Kosovo is not well suited to offer effective substitutes for imports impacted by tariffs. Our analysis (Kosovo status quo has a high cost) highlights the lack of competitiveness of domestic production. This is consistent with the findings of a bottom-up assessment produced by the GAP Institute, which concludes that domestic production has not seen an increase in activity since the introduction of tariff measures.

The GAP institute uses Kosovo Customs commodity level and country of origin data to assess impacts. Perhaps the most surprising finding of the GAP Institute report is that 12% of exports from Serbia continue to be imported by Kosovo despite the 100% tariff. This points to the difficulty of finding effective import substitutes from other trading partners. While Veritas Global does not have access to this data, we find the GAP Institute assessment is a useful preliminary retroactive review of impacts. Once new data becomes available, we expect results will converge with our mid-range estimate of impacts.

Annex: Further details on sensitivity analysis on import costs from tariff measures

Logistics and weak transit system

On average, global logistics costs make up about 13% of the value of trade. Although, landlocked economies and those with less developed transit infrastructure have much higher costs, which can be as high as 25%. For purposes of being conservative, this assessment uses the global average of 13% as the basis of the estimate for logistics costs for imports into Kosovo. To estimate the impact of having to substitute imports for tariff impacted goods from more distant markets, the high-range estimate assumes a doubling in logistics cost for these goods. Meaning that an additional 13% in cost will be incurred. Sensitivity analysis is used to present a mid-range scenario whereby logistics cost will add 8.7% to import costs and low-range scenario of 6.5%. We consider this range to be appropriate, given the research findings from the World Bank on transport economics in landlocked countries.

Rent-seeking due to lower competition

The product markets for imported goods into Kosovo are best characterized as monopolistic competition. On average, the "monopolistic component" is likely to be significantly higher in Kosovo compared to economies that are well integrated into global trade. This is due to higher transaction costs, smaller market size and higher operational barriers. Therefore, in the short-to-medium term, the goods markets covered by tariffs will result in increase in rent-seeking behavior from existing supplies (non-tariff impacted suppliers). Evidence from rapid market exit (due to liquidation) in the US airline industry shows that following disorderly market exit an increase in fares of 12% was observed. The impact on fares was found to be persistent over time. For purposes of being conservative, this impact is estimated based on the share of the value of imports impacted by the tariffs rather than all products in impacted product markets. For the high-range estimate an additional 12% in cost is modelled. 8% and 6% is used for the mid and low-range estimates respectively.

Search and switching costs

In the context of the tariffs imposed by Kosovo, search costs are the costs incurred by importers in identifying an alternative market from which to source products impacted by the tariffs (for example staff time, travel expenses, relationship building etc.). Switching costs are the costs incurred by importers from changing suppliers (for example the need to make new currency conversions, open new accounts, draft new and close existing contracts etc.). It may not always be practical to distinguish between search and switching costs. Empirical research from Loughborough University highlights the need to look at search and switching costs together. Additional search and switching costs may also be incurred by consumers in the process of familiarizing themselves with substitute products.

Empirical evidence on search and switching costs suggest a significant range. For the high-range estimates this assessment uses findings on search and switching costs in the US auto insurance industry, where these costs are estimated at about 18%. Sensitivity analysis is used to present a mid-range estimate of 12% and low-range estimate of 9%. The unplanned and immediate effect with which the tariffs were introduced suggests that the range presented in the sensitivity analysis is appropriate. It is important to note that search and switching costs will dissipate over time as new trading relationships are established.

Delay and disruption

Delay and disruption costs will arise given the unplanned and immediate nature in which Kosovo introduced the tariffs. These are likely to arise as importers look for substitutes and establish new supply routes for products from other import markets. Empirical evidence on the impact of delay and disruption costs suggests a wide range. For example, an assessment of the Niigata-Chuetsu earthquake quantifies economic loss resulting from lower intra and interregional trade due to seismic transport network disruption in the range from 20-40%. Given the high variability and context specific factors, a conservative approach has been taken for estimating the short-run delay and disruption costs. For the high-range estimate an additional 6.5% in cost is modelled. 4.3% and 3.3% is used for the mid and low-range estimates respectively. It is important to note that delay and disruption costs are likely to be more immediate in nature and will dissipate over time.

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#kosovo #economics #tradetariffs #serbia #balkans