The Economic Consequences of the Kosovo Crisis: A Preliminary Assessment of External Financing Needs and the Role of the Fund and the World Bank in the International Response

Kosovo: Gearing Policies toward Growth and Development, July 2005

Kosovo -- Progress in Institution-Building and the Economic Policy Challenges Ahead
December 6, 2001

Building Peace in South East Europe: Macroeconomic Policies and Structural Reforms Since the Kosovo Conflict
A joint IMF-World Bank paper for the Second Regional Conference for South East Europe
Bucharest, 25-26 October 2001

Economic Prospects for the Countries of Southeast Europe in the Aftermath of the Kosovo Crisis

The International Community Reponds to the Kosovo Crisis

Press Briefing: The International Comunity Responds to the Kosovo Crisis

IMF Assistance to Post Conflict Countries

Emergency Assistance

INTERNATIONAL MONETARY FUND AND WORLD BANK

The Economic Consequences of the Kosovo Crisis:
A Preliminary Assessment of External Financing Needs and the Role of the Fund and the World Bank in the International Response

Prepared jointly by the staffs of the International Monetary Fund
and the World Bank

April 16, 1999

Contents

Introduction
The Regional Economic Impact of the Crisis
1. The Economic Effects of the Crisis
2. Estimated Financing Needs
Coordinating the International Response
Modalities of Use of Fund Resources
Modalities of World Bank Assistance

Tables

Six Most Affected Countries: Projected Average Number of Refugees from the Kosovo Crisis, 1999 Q2-Q4
Six Most Affected Countries: Additional External Financing Needs in 1999 Arising from the Kosovo Crisis

I. Introduction

1. The Kosovo¹ crisis is a humanitarian tragedy that necessitates a coordinated economic and financial response from the international community on two fronts: providing immediate aid to relieve the suffering of a large number of refugees; and ensuring that the countries neighboring the FR Yugoslavia have access to adequate external financing to help them deal with the adverse macroeconomic consequences of the crisis. Of the neighboring countries, the ones most affected are, in the first instance, Albania and the former Yugoslav Republic of Macedonia (FYR Macedonia), in the second, Bosnia and Herzegovina, Bulgaria, Croatia, and, to a lesser extent Romania. Even if the crisis were to be resolved quickly, some of these countries would face sizable extrabudgetary and balance of payments gaps at least through end-1999.

2. This paper provides a highly preliminary quantitative assessment of the possible regional economic costs of the crisis and suggests a framework for coordinating external financing, including from Fund and Bank resources.² Already the international community, including the European Union (EU) and bilateral donors, have signaled their intentions to provide assistance, and humanitarian aid has begun to flow. Coordination of the assistance efforts will be important if countries are to receive sufficient aid and external financing on a timely basis and on appropriate terms. This paper is being circulated simultaneously to the Executive Boards of the Fund and the Bank, which will hold meetings next week with a view to obtaining endorsement for the proposed approach to coordination. The Board meetings will also provide guidance ahead of the Spring meetings, where the response to the Kosovo crisis will be discussed. Fund and Bank staff will continue to be actively engaged in devising, with the relevant national authorities, appropriate policies to cope with the changed economic circumstances.

II. The Regional Economic Impact of the Crisis

A. The Economic Effects of the Crisis

3. The Kosovo crisis affects the economies of countries in the vicinity of FR Yugoslavia through a number of channels. Most vividly, the displacement of large numbers of refugees puts strains on the social and economic infrastructures of these countries. As the refugees have, by and large, been stripped of their possessions and savings, they are reliant on others—humanitarian organizations, local residents, recipient country governments—to provide for their basic needs. The countries most affected by the presence of large numbers of refugees are Albania and FYR Macedonia, both poor (ESAF and IDA eligible) countries.³

4. At the same time, all economies in the neighborhood of FR Yugoslavia are impacted to a greater or lesser degree by disruptions to their trade. Whilst the military conflict is underway, and perhaps even for some time afterwards, trade with FR Yugoslavia will remain suspended. In any event, damage to transport and storage infrastructure in FR Yugoslavia will mean that a sizable portion of transit trade through FR Yugoslavia will have to be rerouted for an extended period. FYR Macedonia and Bosnia and Herzegovina are particularly hurt, as FR Yugoslavia is a major export market for these countries, but Bulgaria and Romania are affected by the need to find alternative and more costly transit routes around FR Yugoslavia.

5. The uncertainty engendered by the crisis adversely affects the confidence of both local and foreign investors and of consumers, with effects on spending and on the external current and capital accounts. All neighboring countries—and especially those bordering Kosovo—can be expected to experience a reduction in inward foreign direct investment. Some countries (notably Croatia) may be hurt by a loss of tourism receipts. Croatia and other countries (including Bulgaria and Romania) may also pay a higher country risk premium on borrowings from international capital markets, and private financing may become more difficult to obtain.

6. Finally, the crisis could lead to the postponement of structural reforms, which will hamper longer-term development goals. Postponing privatization because of a lack of foreign investor interest, or lower prices, is one obvious possibility. And governments could choose to deal with the resulting strains on particular sectors of the economy by allowing quasi-fiscal deficits, in the form of wage and enterprise arrears or non-performing loans, to increase.

7. On balance, while there would be some offsetting impact of lower domestic real incomes and expenditures on imports in the affected countries, it is clear that for all of them lost export earnings, trade diversion, weaker capital accounts, and potentially higher debt service costs will create balance of payments gaps in 1999 and, probably, beyond. Budgetary gaps will also arise from lost revenues—as a result of both lower incomes and disruptions to customs collections—and from expenditures related to the refugees that are not covered by humanitarian aid, as well as increased spending for defense and public order. Such gaps will arise even if the international community fully provides for the basic needs of the refugees. In the absence of external financing, adjustment could require additional compression of domestic demand and imports as well as cuts in essential social expenditures.

B. Estimated Financing Needs

8. Based on UNHCR average refugee cost estimates, and the Fund and Bank staffs' assumptions about the proportions of refugees living with local residents and those housed in refugee centers, the two staffs have made preliminary projections of the costs of humanitarian assistance. They have also projected the size of the incremental budgetary and balance of payments gaps that are likely to arise in 1999 as a result of the Kosovo crisis. As the nature and duration of the crisis are impossible to predict, two scenarios have been examined in order to provide an indicative range of possible financing needs. The estimates take into account the specific situation in each of the six most affected countries neighboring FR Yugoslavia, including its trade structure and likely vulnerability to confidence effects, as well as the projected duration and country distribution of refugees.

9. It must be emphasized, though, that even these scenarios may not provide a realistic guide to the full range of costs expected to be caused by the crisis. Not only is the current situation still evolving in a highly uncertain manner, but the economic responses to the crisis are themselves difficult to predict and quantify with any precision. Refugees are still fleeing Kosovo in large numbers and the total number could considerably exceed the projected numbers in either scenario. And owing to the scale of the problem for some countries, there are major risks of a deterioration in governance, with unpredictable economic consequences. The estimated cost of humanitarian aid in the six countries covered in the scenarios does not include aid destined for displaced persons in Kosovo itself that might be recorded as aid to these neighboring countries. Nor does it include any subsequent costs of repatriating refugees. For all these reasons, even the high estimate of the range of costs may prove to be conservative. Moreover, even without a prolongation of the crisis into 2000, additional costs related to the crisis will occur in later years.

10. The first scenario (Scenario A) assumes that the military campaign is prolonged and the refugee crisis lasts throughout 1999. All official trade with FR Yugoslavia is assumed to be suspended, although limited transit trade to third countries (at 25 percent of the pre-crisis level, and at a higher cost) resumes in the second half of 1999. It is assumed that the total number of refugees sheltered in the neighboring countries peaks in the second quarter of 1999 at about ¾ million, and declines only modestly in the remainder of the year as a result of some relocation of refugees to other countries (Table 1). The basic needs of the refugees are assumed to be financed by humanitarian assistance. The preliminary estimate of the required humanitarian assistance for the six most affected neighboring countries under this scenario amounts to more than US$300 million in 1999.

11. In addition to the direct cost of humanitarian aid, the combined balance of payments gap under Scenario A is projected at US$1.5 billion for 1999.⁴ While it is premature to present gaps for individual countries, it can be expected that the gaps in FYR Macedonia and Bosnia and Herzegovina are likely to be the largest relative to their GDPs, perhaps on the order of 7-8 percent, owing to these countries' trade dependence on FR Yugoslavia. However, the balance of payments gaps for other countries are also likely to be large. The aggregate budgetary gap for the region is projected to amount to about US$650 million (Table 2). In relation to GDP, the biggest budgetary gaps (on the order of 3 percent) would occur in Albania, Bosnia and Herzegovina, and FYR Macedonia.

12. The second, more optimistic, scenario (Scenario B) assumes that the crisis is resolved quickly. In the second half of 1999, official trade with FR Yugoslavia is assumed to return to 75 percent of its pre-crisis level and transit trade through FR Yugoslavia to 50 percent of its pre-crisis level. About three quarters of the refugees are assumed to return home in the third quarter of 1999 and all have returned by year end. In this more optimistic scenario the estimated bill for humanitarian aid is about one half that in Scenario A, but still about US$150 million.⁵ The balance of payments gap for the six most affected countries is estimated at over US$650 million and their combined budgetary gap is estimated at about US$300 million.

13. The estimates for each scenario are, of course, highly sensitive to the assumptions. Furthermore, as noted earlier, the Scenario A estimate for the incremental external financing requirement arising from the Kosovo crisis in 1999 does not represent an upper bound, but rather an attempt at a reasonable estimate of the consequences of a protracted crisis; the estimate could prove conservative. It might be added that the countries affected by the crisis are currently projecting that their incremental balance of payments financing gaps will be considerably larger than those estimated here.

III. Coordinating the International Response

14. The Fund and Bank can play a coordinating role in the financial response of the international community to the Kosovo crisis. The two institutions are collaborating closely with other international financial institutions (IFIs), the donor community, and the affected countries to refine the estimates of regional and country-specific financing needs and to assess the availability of external financing. A number of initiatives are already underway to coordinate assistance. On April 2, the World Bank sponsored an emergency Informal Donors' Meeting on the Kosovo Crisis where IFIs and bilateral participants, including representatives from the affected countries, exchanged views on the immediate impact of the Kosovo crisis on affected countries and on ongoing and planned donor support programs. A coordination meeting for the relevant IFIs will be held in London on April 18. The regional economic impact of the Kosovo crisis will be discussed during the Spring meetings.

15. The coordination of assistance could benefit from the establishment of a regional donor group under the guidance of high-level political leadership. Individual country needs will also be taken up in country-specific donor meetings. Preparations for donor meetings organized by the World Bank and EU on Bulgaria, FYR Macedonia, and Bosnia and Herzegovina are already well advanced. The World Bank and the EU are also considering holding a donors' meeting for Albania.

16. The Fund and Bank staffs have the following views on the principles for the provision of external financing:

All costs directly related to supporting the basic needs of the refugees should be financed by grants from bilateral donors and the relevant international agencies.
In the main, the balance of payments gaps for 1999 arising as a direct consequence of the macroeconomic effects of the crisis should be closed by increased bilateral donor assistance and official external financing on appropriate terms and conditions. However, domestic adjustment and use of international reserves would also be appropriate.
External financing to ESAF-eligible countries (Albania, Bosnia and Herzegovina, and FYR Macedonia) should be provided on highly concessional terms. For other countries, the form of external financing will depend on their individual circumstances.
For some countries, notably FYR Macedonia, the case for official debt relief should be explored.

IV. Modalities of Use of Fund Resources

17. The Fund can play a direct role in helping countries affected by the Kosovo crisis through its policy advice and through the provision of Fund financial resources. Fund support will need to be geared to the specific circumstances of each of the affected countries. In this regard, a distinction can be drawn between those countries which are already implementing Fund-supported adjustment programs that are broadly on track and those countries which are either without programs or for which programs would require significant modification in light of changed circumstances.

For those countries with programs that are broadly on track, the Fund staff believes the preferable approach would be to rephase and augment access under existing Fund arrangements, assuming the broad program goals—including, for example, key structural reforms—can be maintained in the face of the Kosovo crisis shock.
For other countries, a new program may be required. In the main, a stand-by arrangement would probably be appropriate.
Recourse to the Compensatory and Contingency Financing Facility (CCFF) may also be considered.
A member may always request the use of Fund resources on an emergency basis and it would be up to the Executive Board to respond to such a request, with due regard to the principle of uniformity of treatment.

V. Modalities of World Bank Assistance

18. The World Bank is planning to provide emergency financing assistance to the affected countries to help close balance of payments and budgetary gaps. World Bank financial assistance will also be geared to the particular circumstances of each affected country. In addition, depending on the duration of the crisis, the World Bank will look closely at the prospects for restructuring/re-orienting already existing investment operations to make them more responsive to the needs arising out of the crisis in the affected countries.

19. So far, the following emergency assistance plans are formulated:

In Albania: Two separate US$1 million post-conflict grants have been approved to provide institutional support to assist refugees arriving at the border area from Kosovo. Bank staff are currently in Albania preparing an emergency budget support operation ("Public Expenditure Support Program") on an accelerated basis. This assistance is in addition to the Structural Adjustment Credit that was under preparation prior to the outbreak of the Kosovo crisis.
In FYR Macedonia: Bank staff are currently in FYR Macedonia preparing an emergency rehabilitation credit to finance a positive list of critical imports. A post-conflict grant is also under preparation.
In Bosnia and Herzegovina: The Bank intends to increase the amount of the already planned Public Finance Structural Adjustment Credit II in part to respond to additional budgetary needs of the two entities in the wake of reduced tax revenues and trade flows stemming from the crisis.
In other affected countries: The Bank has also initiated discussions with officials of Croatia, Bulgaria, and Romania to determine the modalities of Bank support in response to the crisis.

20. Any balance of payments or budgetary assistance in these countries would also be prepared in close collaboration with Fund programs.

21. Bank staff are aware that the implications of this crisis for the social sectors and physical infrastructure could be significant, especially if the crisis persists for an extended period. In addition to the plight of refugees, the decline in economic growth could potentially slow or reverse progress on poverty reduction. Damage to infrastructure and increased demand on alternative transport infrastructure will also increase the need for investment in transport in some affected countries. Bank staff will examine the implications of the Kosovo crisis for the design and implementation of existing and proposed lending operations.

* * *

The following additional information on the impact of the Kosovo crisis was prepared by the staffs of the Fund and Bank subsequent to the internal issuance of the paper:

1. Humanitarian aid to refugees. The line entitled "refugee costs" in Table 2 of the paper includes only the projected costs of humanitarian relief provided directly by foreign agencies. It does not include the direct incremental budgetary costs borne by the neighboring countries for providing humanitarian assistance. The staffs of the Fund and Bank have now been able to produce an initial estimate of this component of the overall budget gap reported in Table 2 of EBS/99/59. For the six most affected countries, the direct, host country budgetary cost of humanitarian assistance is estimated at US$118 million under Scenario A and US$52 million under Scenario B. This implies that the total direct refugee costs borne by both humanitarian aid agencies and the domestic budgets of these countries in 1999 amounts to US$429 million and US$191 million in the respective scenarios. Recent discussions with country officials and relief organizations suggest that these figures probably underestimate the budget costs in host countries, implying that budgetary and associated balance of payments gaps for countries sheltering large numbers of refugees—Albania, FYR Macedonia, and, to a lesser extent, Bosnia and Herzegovina—could also be significantly underestimated at this stage. The risk that the large number of displaced persons still in Kosovo could swell the tide of refugees well beyond the levels assumed even in Scenario A provides a further source of potential underestimation.

2. Impact on economic activity. As emphasized in the paper, the economic effects of the Kosovo crisis vary widely across countries depending on the numbers of refugees present, the means used to shelter them, and the relative importance of different macroeconomic linkages. For the six most affected countries taken as a group the crisis is projected to have a significant overall impact on economic growth, even assuming that adequate external financing is made available. On a weighted average basis, the crisis is projected to knock nearly 5 percentage points off growth in the most affected countries (excluding Romania) in 1999 under Scenario A and 2 percentage points under Scenario B. Those countries with the strongest trade links to the Federal Republic of Yugoslavia, particularly Bosnia and Herzegovina and FYR Macedonia, suffer the largest declines, although growth is also reduced significantly in Bulgaria and Croatia.

¹Kosovo is a region within the Federal Republic of Yugoslavia (FR Yugoslavia) which comprises the republics of Serbia and Montenegro. FR Yugoslavia is not a member of the IMF or the World Bank.
²The Fund and the Bank played similar analytical and coordinating roles during the 1990-91 Gulf crisis and in assessing the impact of earlier UN sanctions on FR Yugoslavia.
³Montenegro has also received a large number of displaced persons.
⁴The staff is still in the process of refining its projections, which have not yet been fully discussed with country authorities.
⁵The estimate does not include repatriation costs, which could be significant in 1999 in this scenario.

Table 1. Six Most Affected Countries: Projected Average Number
of Refugees from the Kosovo Crisis, 1999 Q2-Q4
(In thousands)

	Scenario A "Prolonged Military Campaign"	Scenario B "Crisis Quickly Resolved"

Albania	417	168
Bosnia and Herzegovina	33	14
Bulgaria	4	2
Croatia	7	3
Former Yugoslav Republic of Macedonia	182	74
Romania	6	2
Total for 6 countries above	649	262
Other countries and regions	276	91
Of which: Montenegro	79	33
TOTAL	925	354
Sources: UNHCR; World Bank and IMF staff estimates.

Table 2. Six Most Affected Countries: Additional External Financing
Needs in 1999 Arising from the Kosovo Crisis¹
(In millions of U.S. Dollars)

	Scenario A "Prolonged Military Campaign"	Scenario B "Crisis Quickly Resolved"

Refugee cost²	311	139
BOP gap	1,515	668
Total financing need	1,826	807
In percent of GDP	2.5	1.1
Memorandum item:
Budgetary gap	652	308
In percent of GDP	0.9	0.4
Source: IMF and World Bank staff estimates. ¹Albania, Bosnia and Herzegovina, Bulgaria, Croatia, former Yugoslav Republic of Macedonia (FYRM), and Romania. ²Additional cost for displaced persons in Montenegro estimated at US$43 million under scenario A and US$22 million under scenario B.