1.  Executive Directors, in their discussion of the paper on the economic consequences of the Kosovo crisis jointly prepared by the staffs of the Fund and the World Bank (EBS/99/59, April 16, 1999) welcomed the preliminary assessment of the economic impact of the crisis on the countries in the region (EBM/99/48, April 23, 1999). They noted, however, that the estimates of the external financing needs of the most affected countries for 1999 were necessarily tentative and subject to a wide margin of uncertainty. In view of the rapidly evolving situation in the region, Directors asked the staff, in cooperation with the World Bank and other relevant institutions, to continue to provide economic analysis and detailed assessments of the impact of the crisis on individual countries, as well as on the region as a whole (Summing Up, Buff/99/57, 4/25/99).

2.  The Interim Committee of the Board of Governors of the Fund, at its meeting on April 27, endorsed the need for a rapid, substantial, and coordinated response by the international community to the economic consequences of the Kosovo crisis. The Committee stressed that such a response was urgently needed to ensure that sufficient assistance was provided to alleviate the suffering of the refugees from Kosovo and to ensure that countries in the vicinity of the crisis have access to external financing to support their efforts toward macroeconomic stability and structural reform. On the same day, a high-level meeting of governments and international agencies—including representatives of the six Balkan countries most affected by the crisis, viz. Albania, Bosnia and Herzegovina, Bulgaria, Croatia, former Yugoslav Republic of Macedonia (FYRM), and Romania—was held in Washington under the auspices of the Fund and the World Bank. The meeting—co-chaired by the Managing Director and Mr. Wolfensohn—broadly endorsed the methodology adopted in EBS/99/59 to assess the economic, financial and social costs of the crisis (Joint Press Release of the Bank-Fund Staff, 4/27/99). The World Bank and the European Union were called upon to co-ordinate needs assessment and modalities for assistance. A joint statement on the economic co-ordination mechanism was issued by the World Bank and European Commission (EBD/99/60, 5/20/99).

3.  This paper provides an updated assessment of the economic impact of the crisis on the six most affected member countries and discusses the progress so far in covering identified external financing gaps. The paper includes estimates for each of the six countries and assessments of the overall impact on each country (Appendix I). The impact on several other countries in the region is also outlined briefly. The staff's revised estimates of external financing and budgetary gaps for individual countries have now in most cases benefited from discussions with national authorities, although they do not reflect shared assessments with the authorities in all cases. The paper does not address the impact of the crisis on the Federal Republic of Yugoslavia (Serbia-Montenegro) (FRY), which is not a member of the Fund (see Box 1). Also, as before, the paper focuses on projections for 1999 only and does not address the costs of reconstruction in the region.

4.  As discussed in EBS/99/59, the crisis is affecting the economies of individual countries through a variety of channels. Although the six most affected member countries (Albania, Bosnia-Herzegovina, Bulgaria, Croatia, FYRM, and Romania) share a basic fragility of economic structures, they are exposed to the crisis in differing degrees and through different channels. The main channels of influence are: the influx of refugees; the disruption to international trade in goods and services; closing of transportation routes through FRY; damage to consumer and investor confidence; reductions in access to international capital markets; and setbacks to the process of structural reform and development, including weakened governance.

5.  The total flow of refugees from Kosovo has now almost touched the one million mark.¹ The major refugee influx has been to Albania and the FYRM, with the latest estimates of refugees in the two countries amounting to 430 thousand and 200 thousand. These totals are equivalent to 13 percent of the local population of Albania and 11 percent of that of Macedonia. The third largest number of refugees is in Bosnia and Herzegovina.² While a large part of the direct costs of providing humanitarian relief to refugees (food, shelter, medicines, clothing) is being borne directly by the foreign agencies, a significant part of this humanitarian relief cost is also being borne by the budgets of the host countries, putting pressure on their already weak fiscal positions. The presence of a large number of refugees is also having a destabilizing impact on the social structures of host countries, which already have weak structures of governance. Maintaining law and order is thus a major challenge. Moreover, the stress of the refugee influx, as well as attempts to deliver humanitarian relief, have begun to strain the economic infrastructures of the host countries, as exemplified by the heavy congestion of ports in Albania.

6.  The damage to trade routes and the transportation network in the region now appears likely to be somewhat greater than the staff had assumed a month ago. The staff's assessment is made on a country-by-country basis in close consultation with World Bank staff. The closing of the border with FRY has its most severe impact in the case of FYRM as direct and transit trade through FRY represented over two-thirds of that country's exports. Bosnia-Herzegovina is also affected substantially, owing to the importance of the Yugoslav market for it. Bulgaria and Romania, countries with little direct trade with FRY, are affected through the cessation of transit trade with third countries via FRY. The damage to transport and storage infrastructure in FRY now appears to be extensive, requiring that transit trade through FRY—including both road and rail transit trade and trade along the Danube—be re-routed for an extended period, even after the cessation of hostilities. This has resulted in congestion, major increases in transportation costs, and some loss in export markets for Bulgaria and Romania. Some trade losses for all the countries in the region could be offset by increased smuggling, especially once hostilities end.

7.  All the countries in the vicinity of Kosovo will suffer the adverse effects of the crisis on confidence of consumers and investors. In particular, a serious loss of foreign direct investment is projected for Albania, FYRM, Bulgaria, and Croatia. Croatia and Bulgaria are likely to suffer a significant loss of tourist receipts. Most countries are projected to face higher borrowing costs in international capital markets and in some cases access to private financing may dry up entirely.

8.  In a number of the affected countries, the process of structural reform could suffer major setbacks as administrative capacity becomes more thinly spread in some countries and consensus for reform becomes difficult to sustain under weaker economic conditions. For instance, in FYRM, there is a risk that quasi-budgetary expenditures will escalate as a result of increased indirect subsidies to enterprises. Enterprises are likely to run arrears to government, suppliers and banks, undermining credit availability and confidence, and further burdening the budget. In Albania, tax collection efforts could suffer, and in several countries, privatization prospects have worsened.

9.  As in the earlier paper, the staff has evaluated two scenarios differentiated by the assumed length of the crisis: prolonged disruption (Scenario A) and a more quickly resolved crisis (Scenario B). For each scenario, these assumptions are uniformly more pessimistic than in the original exercise as regards both refugee numbers and the impact on trade.

10.  Scenario A now assumes that the number of refugees outside Kosovo will peak at over 1 million, about 100 thousand more than in the earlier paper (Table 1, Figure 1). In view of the number of displaced persons currently estimated in Kosovo, this assumption is clearly not the most pessimistic that could be made. The majority of refugees are expected to stay in the six most affected neighboring countries during the remainder of 1999, with only a small proportion leaving for other countries. Reflecting the experience so far in Albania, a higher proportion of refugees is now assumed to reside with local families. For those not living with families, the associated humanitarian costs would rise sharply in the fourth quarter as winter approaches. As to trade, Scenario A now assumes that, in addition to no official trade with the FRY in the remainder of 1999, transit trade through FRY is blocked. In the earlier exercise, some modest possibility for transit trade had been envisaged in the second half of 1999, but this would now seem inconsistent with the damage already inflicted to transit routes.

12.  The caveats noted in the earlier paper regarding the projections apply with equal force to these projections. The principal uncertainties relate to the evolution of the crisis in general; the changing nature of the scale and duration of the humanitarian dimensions of the crisis; the difficulties of quantifying the macroeconomic effects of the crisis with precision in the absence of reliable information on some of the key channels of transmission; and perhaps most important, the unpredictable consequences for governance in some affected countries. As before, the scenarios do not measure repatriation costs, particularly the sizeable cost of providing livable conditions for refugees returning to Kosovo under Scenario B.

13.  Based on these new assumptions, the revised estimate for the required direct humanitarian assistance under Scenario A now amounts to over US$530 million in 1999, compared with about US$310 million in the earlier paper (Table 2) and US$240 million in Scenario B, compared with US$140 million earlier. In addition to the humanitarian relief provided directly by foreign agencies, the direct host country budgetary cost of humanitarian assistance is estimated at US$230 million under Scenario A. This implies that the total direct refugee costs in 1999 would amount to US$760 million under Scenario A, up from US$430 million earlier. Under Scenario B, the corresponding total cost, is US$400 million, up from US$190 million estimated earlier.

14.  The overall macroeconomic impact in 1999 is expected to vary widely across countries depending on the relative importance of different macroeconomic linkages. It is also important to note that the impact of the Kosovo crisis is superimposed on adjustment scenarios that were in place in the affected countries prior to the crisis. Even assuming that external financing is available in adequate amounts to cover the incremental balance of payment gaps, the crisis is projected to cut the average rate of economic growth in the six countries by 3-4 percentage points in 1999, with much larger declines in Bosnia-Herzegovina and FYRM, and significant declines in Bulgaria and Croatia.³ Unemployment—which is already very high in some countries, notably FYRM—would likely rise and so could wage arrears. Reflecting the lower aggregate demand in most countries, the rise in inflation is not projected to be significant, with only modest increases in Bulgaria and FYRM.

15.  The risks to growth are predominantly on the downside, stemming from less tangible factors, such as the effects of weakening public administration and law and order. Uncertainty regarding the availability of timely and adequate external assistance is also an important source of downside risk (see Section IV below). These factors could significantly magnify output losses in several countries, notably Albania, FYRM, and Bosnia-Herzegovina. Other country-specific risks are described in Appendix I containing individual country sections.

16.  The aggregate incremental balance of payments gap for the six most affected countries as the direct result of Kosovo under Scenario A is now projected at US$1.7 billion in 1999 (Tables 2 and 3). This is only slightly higher than the earlier estimate under the corresponding Scenario of EBS/99/59 because the refugee numbers are only somewhat higher and the original projections had already anticipated severe trade disruption and loss of confidence. However, under the revised Scenario B, the aggregate balance of payments gap rises sharply to US$1.1 billion, thus narrowing the range of estimated gaps under the two scenarios considerably. This reflects the greater disruption to trade under the revised Scenario B relative to the earlier version. Relative to GDP, the largest gaps are projected for FYRM and Albania, amounting to 11¼ percent and 4¼  percent respectively, reflecting the former's heavy dependence on trade through FRY and the large burden of refugees on both countries. The aggregate balance of payments gap is split about evenly between the current and capital accounts (Table 3). Inclusive of the refugee cost, the total financing need for the region is on the order of US$2.2 billion under Scenario A and US$1.3 billion under Scenario B.

17.  Budgetary gaps are also higher in both scenarios.⁴ The gaps arise from two factors: budgetary costs of humanitarian aid and lost revenues as well as higher expenditures related to macroeconomic affects. Revenue losses reflect lower economic activity and incomes and reduced customs receipts. Expenditure increases relate to refugee costs that are not covered by humanitarian aid as well as increased spending for law and order, defense and social welfare. Such expenditure burdens are highest in FYRM and Albania. Under revised Scenario A, the aggregate budgetary gap is US$750 million, about US$100 million larger than earlier. Under Scenario B, the aggregate budgetary gap rises to US$530 million. Once again, the range of estimates under the two scenarios has considerably narrowed compared with the previous range.

18.  The estimated balance of payments and budgetary gaps are subject to large uncertainty. On the one hand, more extreme assumptions (as, for example, regards refugee numbers) could raise the gaps beyond those estimated in Scenario A. This would also be the case if trade disruption, confidence, and governance factors are greater. On the other hand, a larger collapse in output than estimated could in principle reduce the gaps through import compression. However, the net impact would also depend on whether exports contracted and capital accounts weakened by more or less than assumed.

19.  In discussions over the past few weeks, the authorities of the six most affected member countries have generally agreed with the staff's estimates of the macroeconomic effects and incremental financing needs. Specifically, the authorities in Albania, Bulgaria, FYRM, and Romania broadly agree with the estimates. The Croatian authorities agree with the staff's estimates of tourism-related losses, but believe the impact on trade, investment, and financing to be smaller than estimated by the staff. The figures on Bosnia-Herzegovina are still being discussed, with the authorities' initial estimates being somewhat larger than those presented here. Overall, country officials stress Scenario A to be the most relevant one at this juncture, with many regarding Scenario B as increasingly unrealistic.

20.  Donor assistance for non-budgetary humanitarian costs comes in many forms, both cash and kind, and is difficult to quantify. However, the humanitarian support being provided appears to be both timely and broadly sufficient to cover the basic needs of refugees. In contrast, the total amount pledged so far by donors to the six most affected countries for covering the balance of payments gaps is about US$620 million, of which well under half is concessional financing. This leaves an unfilled incremental balance of payments gap of over US$1 billion for 1999 under Scenario A, and about US$500 million under Scenario B (Table 4). The sizable unfilled gap indicates the urgency of securing external financing commitments. Given the already heavy external debt burden in many of the affected countries, it will be important for the additional financing to be on appropriately concessional terms. The planned donor meetings are therefore critical for mobilizing such assistance.

21.  A lack of adequate and timely balance of payments financing would result in further severe damage to the economies in the region. In FYRM, shortfalls in external financing would in the first instance cause import compression and further output losses, but given the limited room for expenditure cuts, the authorities might also have to resort to inflationary domestic financing, threatening macroeconomic stability. In Bosnia-Herzegovina and Bulgaria, the currency board arrangements would force a further sharp contraction of output, adding to budgetary pressures and undermining support for reform. In Albania, Croatia, and Romania, unfilled balance of payments gaps could to some extent be met by reducing official reserves, but at some loss of confidence and with an increased threat to exchange rate stability.

22.  While the main adverse impact of the Kosovo crisis falls on the six countries discussed in this paper, the repercussions in Europe are likely to be broader. The economic impact on other, less severely affected countries is felt principally through reduced receipts from tourism and the increased budgetary cost of financing the war.

23.  Hungary stands to be affected by the Kosovo crisis primarily via adverse effects on tourism. Refugee inflows of 15,000 have been reported, primarily of ethnic Hungarians from the Vojvodina province of FRY. Overall, a prolonged crisis may reduce growth by up to ½ percent of GDP in 1999. Additional military and border control expenditures, along with tax revenue losses, may imply budgetary costs in the order of ¼ percent of GDP. Slovenia's losses in terms of lost exports to FRY and FYRM are estimated at around 1 percent of GDP in 1999. Tourist revenues are also likely to decline by US$100-200 million ( ½ to 1 percent of GDP). Economic growth in Greece may be reduced by up to ½ percentage points due to the crisis. This would result in part from a loss of exports due to delays and higher delivery costs as more expensive or indirect transportation routes are used. Tourism and outward direct foreign investment would also be adversely affected—Greece is the largest foreign investor in FRY, with more than US$1 billion in assets. Ukraine and Moldova are also experiencing adverse effects of the crisis, the former primarily on account of lost shipping revenues and the latter reflecting reduced exports to Romania. In Italy, concerns about economic growth have been magnified by the Kosovo crisis. The authorities estimate that the impact of lower tourism might reduce growth by 0.1-0.2 percentage points in 1999. In the case of Austria, banks have significant investments in Hungary and Slovenia and a broader economic slowdown in the area, if it were to occur, could have an adverse impact on their balance sheets. The effect on the Austrian economy, however, is likely to be small.

24.  The following main conclusions emerge from the staff's updated assessment of the consequences of the Kosovo crisis for the six most affected neighboring countries:

• The economic costs are likely to be significantly higher than estimated earlier (Table 2). Even if the conflict were quickly resolved, the damage already done to trade routes and the time it will take to repatriate refugees implies that costs (including direct humanitarian) will exceed US$1¼ billion in 1999. This excludes the costs of making Kosovo habitable to the returning refugees. The cost estimates climb to about US$2¼ billion if the disruption is prolonged, the refugees do not return home, and trade with FRY is not resumed in any form. Future refugee repatriation costs would presumably also be substantially higher. It should be stressed that Scenario A should not be seen as the upper bound to the costs of the Kosovo crisis for the six most affected countries.

• Even with adequate external financing, the Kosovo crisis will have a major negative impact on growth in most of the six affected countries (Table 3). Growth will be reduced on average in the six countries by 3–4 percentage points, with the impact sufficiently large in some countries to cause output to contract. The estimates assume adequate and timely external assistance, but they do not fully take into account the less quantifiable impact of potential setbacks to structural reforms and deterioration in governance. Such setbacks could lead to broader instability in the short run in some countries, and to lower growth in the medium term.

• Concrete pledges of external financing so far fall well short of what is required to fill balance of payments gaps in the six affected countries, even under the more optimistic assumption of a quick resolution to the crisis (Table 4). If the financing is not forthcoming, several of the countries would be forced to implement additional painful adjustment, with a further negative impact on growth. The risk of a further setback to structural reforms would also increase markedly.

Table 1. Six Most Affected Countries: Projected Average Number of Refugees from the Kosovo Crisis, 1999 Q2-Q4 (In thousands)
	Scenario A			Scenario B
	Old1	New2		Old3	New4
Albania	417	446		168	294
Bosnia and Herzegovina	33	53		14	35
Bulgaria	4	4		2	3
Croatia	7	6		3	4
Former Yugoslav Republic of Macedonia	182	203		74	134
Romania	6	6		2	4
Total for 6 countries above	649	718		262	474
Other countries and regions	276	270		91	197
Of which: Montenegro	79	73		33	49
TOTAL	925	988		354	670
Sources: UNHCR and IMF staff estimates. 1Prolonged military campaign: The total number of refugees sheltered in the neighboring countries peaks in the second quarter of 1999 at about 3/4 million, and declines only modestly in the remainder of the year as a result of some relocation of refugees. 2Prolonged crisis: Refugees remain outside Kosovo throughout the year, into next winter. The number of refugees continues to increase through May to about 1 million. 3Crisis quickly resolved: About three quarters of the refugees are assumed to return home in the third quarter of 1999 and all have returned by year end. 4Crisis resolved before winter: Refugees return to Kosovo before winter.

Table 2. Six Most Affected Countries: Incremental External Financing Needs in 1999 Arising from the Kosovo Crisis1 (In millions of U.S. Dollars)
	Scenario A			Scenario B
	Old2	New3		Old4	New5
Direct non-budgetary refugee cost6	311	534		139	236
BOP gap	1,515	1,687		668	1,104
Of which: current account	...	886		...	668
Total financing need	1,826	2,221		807	1,340
In percent of GDP	2.5	3.0		1.1	1.8
Memorandum items:
Budgetary gap7	652	749		308	532
In percent of GDP	0.9	1.0		0.4	0.7
Of which: budgetary costs of refugees	114	224		49	160
Total (budget and non-budget) refugee-related costs	425	758		188	396
Source: IMF staff estimates. 1Albania, Bosnia and Herzegovina, Bulgaria, Croatia, former Yugoslav Republic of Macedonia (FYRM), and Romania. 2Prolonged military campaign: The total number of refugees sheltered in the neighboring countries peaks in the second quarter of 1999 at about 3/4 million. 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. 3Prolonged crisis: Refugees remain outside Kosovo throughout the year, into next winter, necessitating a major upgrading of refugee centers. The number of refugees continues to increase through May, and remains at that level in the remainder of the year. All official direct and transit trade with FR Yugoslavia is assumed to be suspended, but some unofficial trade is assumed to take place. 4Crisis quickly resolved: About three quarters of the refugees are assumed to return home in the third quarter of 1999 and all have returned by year end. Official trade with R 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. 5Crisis resolved before winter: Refugees return to Kosovo before winter. Direct and transit trade with FR Yugoslavia is assumed to return to 50 percent of pre-crisis level in the last quarter of 1999. 6Additional cost for displaced persons in Montenegro estimated at US$41 million under the new scenario A and US$26 million under the new Scenario B (under the old Scenarios A and B, US$43 million and US$22 million, respectively). 7As there is no viable domestic financing for this incremental budget gap, it is part of the total external financing gap listed above.

Table 3. Six Most Affected Countries: Incremental Effect Arising from the Kosovo Conflict, 1999
	Albania	Bosnia and  Herzegovina	Bulgaria	Croatia	FYR        Macedonia	Romania	Total1
Number of refugees (in thousands)2
Scenario A	446	53	4	6	203	6	718
Scenario B	294	35	3	4	134	4	474
Refugee cost (US$ millions)
Scenario A	324	46	3	5	151	4	534
Scenario B	144	19	1	2	67	2	236
Balance of payment gap (US$ millions)
Scenario A	161	89	345	454	392	246	1,687
Scenario B	133	44	209	205	337	176	1,104
Of which: Current account gap    (US$ millions)
Scenario A	113	-60	174	203	259	197	886
Scenario B	84	-13	87	137	226	147	668
Total financing need (US$ millions)
Scenario A	485	135	348	459	543	250	2,221
Scenario B	277	63	210	207	404	178	1,340
(In percent of GDP)
Scenario A	12.9	3.0	2.7	2.3	15.8	0.9	3.0
Scenario B	7.4	1.3	1.6	1.0	11.6	0.6	1.8
Budgetary gap (US$ millions)
Scenario A	154	110	123	117	193	52	749
Scenario B	111	58	77	77	167	42	532
(In percent of GDP)
Scenario A	14.0	2.4	0.9	1.7	5.5	0.2	1.0
Scenario B	12.9	1.2	0.6	0.4	4.7	0.1	0.7
GDP growth (in percent)2
Scenario A	0.0	-8.0	-2.5	-3.0	-9.0	-0.5	-2.4
Scenario B	0.0	-5.0	-1.5	-2.0	-8.0	-0.4	-1.7
Memorandum items:
GDP (1998 current prices, US$ billions)	3.0	4.1	12.3	21.3	3.5	38.1	82.4
Population (in millions)	3.3	4.2	8.2	4.6	2.0	22.6	44.9
Per capita GDP (US$)	923	972	1,487	4,662	1,773	1,687	1,834
Literacy rate (in percent)	...	...	98	98	...	...	...
Physicians (per one hundred thousand)	...	...	345	204	225	181	...
Enrollment in higher education institutions       (per thousand)	...	...	27	89	31	51	...
Sources: UNHCR; and IMF staff estimates. 1Sums of the individual country estimates, except for per capita GDP, GDP growth, and items expressed in percent of GDP. For these, the totals are averages weighted by projected 1999 GDPs (in US dollars). 2Average for Q2-Q4 1999.

Table 4. Six Most Affected Countries: Kosovo Related Pledges and Disbursements, 1999 (In millions of U.S. Dollars)
Disbursements	30
Grants	0
Concessional	30
Non-concessional	0
Pledges	591
Grants	175
Concessional	70
Non-concessional	326
Unspecified	20
Total	621
Unfilled incremental BoP gap
Scenario A	1066
Scenario B	484
Source: IMF staff calculations.

APPENDIX I

The primary impact on Albania of the Kosovo crisis is through the flood of refugees. In early May, the number of refugees amounted to some 13 percent of the local population, and the number is projected to rise to 15 percent of the population in Scenario A. The refugees put a huge strain on the economic and social infrastructure, as well as on the budget and balance of payments. Albania's already weak administrative capacity will be even more thinly stretched, risking a breakdown in law and order. On the other hand, trade diversion effects will be negligible as officially recorded trade, either with or through FR Yugoslavia, is very small. Assuming social stability holds, the staff estimates that, on balance, the impact of the crisis on growth will be small: disruptions to production, primarily in the north, will be offset by the effects of increased incentives in other sectors, for example for the provision of goods and services for the refugees. Assuming further that the sizable expenditures related to helping the refugees are financed by foreign donors, and the additional demand from the refugees is met in large part by imports, inflationary pressures will be small. Some upward pressure on the prices of food and other essentials might, however, be expected in the short term. Rising import demand and some weakening of export growth will raise the current account deficit. The capital account deficit will be weakened as increased political risk reduces inward foreign direct investment.

The incremental balance of payments gap arising from the Kosovo crisis is estimated at US$161 million (4.3 percent of GDP) in Scenario A and US$133 million (3.5 percent of GDP) in Scenario B. In both cases, about two thirds of the gap reflects a higher current account deficit. The budget gaps are US$154 million (4.1 percent of GDP) in Scenario A and US$111million (3.0 percent of GDP) in Scenario B. The authorities broadly agree with the estimates, although they believe that refugee cost estimates, even in Scenario A, are conservative. They view a return of the refugees in 1999 (as assumed in Scenario B) as unlikely. In fact, refugee totals could well exceed those assumed in Scenario A.

Identified financing so far amounts to US$118 million with an estimated grant element of about 80 percent. A Consultative Group meeting has been organized for May 26. A shortfall in external financing could in principle be absorbed through a reduction in reserves, although a small reduction in reserves is already factored into the baseline projection.

There is considerable uncertainty attached to the estimates. On the one hand, projected budgetary and balance of payments gaps could be substantially underestimated. Not only could there be many more refugees in Albania, but estimated costs continue to rise as new strains on the infrastructure are identified. Higher per capita winter costs, assumed to be borne directly by the relief agencies, could also end up as a burden on the budget and balance of payments. On the other hand, balance of payments gaps could be lower if risks to growth were to materialize. A breakdown of law and order, for example, could considerably reduce growth and imports. A more immediate concern is the overloading of the ports with humanitarian and military supplies. If the problem is not solved quickly, imports of investment and intermediate goods could be crowded out with an adverse impact on growth, inflation, and tax collection.

The conflict in Kosovo will have a substantial impact on Bosnia and Herzegovina in 1999. The primary channels are: reduced exports, especially heavy industry linked with FRY; reduced disbursements of project-related donor assistance; and decreased foreign and domestic investment in the face of increased uncertainty and security considerations. Under Scenario A, GDP growth is reduced by 8 percentage points. Inflation projections remain unchanged owing to strict adherence to currency board requirements and restrictions under the SBA on domestic government borrowing. Exports are expected to decline by 7 percent, reflecting decreased exports to FRY and delays in establishing new markets, as well as increased transport costs. Imports decline by 11 percent, primarily due to the fall in aid-financed imports and higher transport costs. In response to the decline in pension repatriation and lower remittances, private transfers will also fall. On the capital account side, FDI is predicted to fall by more than half, given security considerations. On the fiscal side, customs and excise revenues are reduced as a result of lower economic activity; these losses are offset only partially by the elimination of preferential trade arrangements between the Federation and Croatia. The tax base for the Republika Srpska is affected by a decline in economic activity, reflecting the integration of the RS economy with that of FRY. As with the Federation, the downward pressures on the revenue base are expected to more than offset any gains from the elimination of preferential trade arrangements with FRY. Expenditures are expected to be held to previously budgeted levels, with most refugee costs absorbed by humanitarian assistance. In Scenario B, the effects are typically half of the magnitudes in Scenario A.

The incremental financing gap is US$89 million under Scenario A, and US$44 million under Scenario B. The corresponding budget gaps amount to US$109 million and US$58 million respectively.

The latest estimates have not yet been fully discussed with the authorities. Although the authorities have not yet estimated the impact of the crisis on the economy, they have indicated that it has had a substantial impact on the level of economic activity. Trade links have been disrupted and transportation routes destroyed, with the RS economy most severely affected. The authorities fear that aid committed to BH may be diverted to other countries in the region. The refugee burden will strain further the limited budgetary resources. There is considerable concern as to the potential for a further, substantial influx of refugees. There is also a wide range of estimates among members of the government as to the number of refugees already in the country.

The main downside risk for 1999 is inadequate external financing. Project-related aid disbursements are expected to slow down, particularly to the RS, declining by 12½ percent in Scenario A, and by 6 percent in Scenario B. The incremental financing gap corresponds to the combined budgetary gaps of the constituent entities. Shortfalls in external financing would result in lower budget expenditures and lower growth: the budgets are run on a cash basis with no recourse to domestic financing (the currency board rules do not allow even a partial offset of any external financing shortfall, and commercial banks are illiquid). Budget expenditures are already extremely compressed in both entities; if there are financing shortfalls, the associated further expenditure compression could have an adverse impact on social peace.

The Kosovo crisis will inflict significant damage to the Bulgarian economy in 1999. The main channels of transmission are lower exports, a loss of tourism receipts, and reduced foreign direct investment (FDI). Under Scenario A, exports decline as the closing of the border with the FRY has forced a large part of Bulgaria's total exports to be rerouted at markedly higher cost, with some loss of markets. Direct exports to FRY have been only a small share of the total, and their loss is likely to be offset by increase in trade through unofficial channels. Tourism receipts are also expected to decline, given Bulgaria's proximity to the war zone. Subdued sentiment toward the region will likely result in lower-than-envisaged investment, including FDI. Overall GDP growth is reduced by 2½ percentage points, and the current account deficit increases by 1¼ percent of GDP. Inflation increases by 1 percentage point, stemming mainly from higher transportation costs reflected in import prices. The deterioration of the overall fiscal balance is estimated at about 1 percent of GDP, mostly because of revenue losses reflecting lower activity but also because of additional spending on social assistance, unemployment benefits, and humanitarian aid to refugees in Macedonia. In Scenario B, the main difference is that exports and FDI are expected to partially recover in the fourth quarter. As a result, the estimated decline in GDP growth, 1½ percentage points, is smaller but still significant.

The incremental balance of payments gap for 1999 is estimated at some US$350 million (almost 3 percent of GDP) under Scenario A and about US$210 million in Scenario B. The additional financing need is attributable to the current and capital accounts in roughly equal proportions. The corresponding budgetary gaps are around US$125 million and US$75 million. A donors' meeting in Brussels on April 21, 1999 generated pledges sufficient to broadly cover the US$140 million gap for 1999 that existed before the Kosovo conflict started. Hence, the incremental gap related to the crisis is still completely unfinanced.

The authorities broadly agree with the staff estimates. At the Prime Minister's request, a staff team visiting Sofia in March-April already formulated and discussed initial estimates of the impact of the Kosovo conflict. In subsequent discussions, and in their public pronouncements, the authorities' estimates have been in line with those of Scenario A. The authorities view that scenario as the central case, regarding the more optimistic scenario as unrealistic.

The main downside risk for 1999 is the lack of gap-filling financing. If the required additional external financing does not materialize, under the currency board arrangement output is forced to contract further, adding to budgetary pressures and undermining support for reform. The impact could well be substantial: if half of the incremental gap under Scenario A remains unfinanced, GDP growth in 1999 is likely to be negative, compared with the authorities' target of 3.7 percent. Other risks are of a longer-term nature, but may require attention already this year. First, a prolonged conflict may force a rerouting of Bulgaria's trade on a more permanent basis. This would necessitate major new investment in regional infrastructure (at present, there is only one bridge over the Danube along the border between Bulgaria and Romania) the financing of which is not included in the present calculations. Second, a long-lasting crisis could weaken governance, with adverse economic consequences. In particular, as at the time of the sanctions against the FRY, organized crime may increase. The main upside risk would be a quick resolution of the crisis and an immediate start of reconstruction, with positive spill-over effects on Bulgaria.

The Kosovo conflict will have a significant deleterious effect on the Croatian economy in 1999, through two main channels: a reduction in foreign tourism receipts, and lower privatization-related foreign direct investment. Under Scenario A, foreign earnings from tourism drop sharply as tourists stay away primarily from the southern coastal region. Since direct trade with FRY prior to the conflict was minimal, the blockade against Serbia will impact Croatia through higher transportation costs for rerouting trade with countries downstream on the Danube--but with little change in volumes--but this will be partly offset by revenues from increased transit trade to and from the EU by countries neighboring Serbia. Concerns about the long-term stability of the region will reduce privatization earnings from abroad, reflecting a combination of delays in closing transactions and lower sale prices. Real growth is expected to be reduced by 3 percentage points, reflecting the direct and indirect effects of the drop in tourism receipts. The decline in domestic demand would offset in part the drop in tourism receipts, generating an external current account deficit that would be 1.2 percent of GDP higher than otherwise. Prices, which are exchange-rate sensitive, would be unchanged reflecting the closing of the external financing gap through external assistance. The fiscal position would deteriorate by more than ½ percentage point of GDP, reflecting the loss of VAT revenues and customs duties. Also, the budget would lose more than one percent of GDP in privatization-related financing. In Scenario B, the effect on tourism (and real growth) is only about a third less than under Scenario A--reflecting the concentration of travel receipts in the summer months--while foregone privatization revenues are relatively small, given the planned concentration of transactions toward end year.

The incremental balance of payments gap for 1999 is estimated at US$450 million (2¼ percent of GDP) under Scenario A and just over US$200 million under Scenario B. Under Scenario A, the capital account contributes more than half of the external gap, while shortfalls in the current account dominate in Scenario B. The corresponding budgetary gaps are around US$115 million and US$75 million, respectively. The incremental Kosovo-related external financing gap for 1999 could be partially covered by the Fund and the Bank, leaving a residual gap of US$265 million under Scenario A.

The authorities' agreed with the staff's estimates of lost tourism and travel receipts, but expected little effect on trade, investment, or other financing flows. While they acknowledged that there would be indirect effects, they felt that it was not possible to predict them reliably. As a result, the authorities expected the current account to deteriorate by the full amount of foregone tourism and travel revenues, giving a current account gap more than twice as large as the staff's estimate under Scenario A, and similar in size to the staff's estimate of the total gap in external financing.

The main downside risk for 1999 is the lack of gap-filling external and budgetary financing. Insufficient external financing would result in running down reserves from their already low level, which could threaten exchange rate stability. Shortfalls in privatization-related budgetary financing could prevent the envisaged layout from the budget of insured deposits in failed banks and further erode confidence in the banking sector. Increased unrest in Montenegro would further damage the Croatian tourism and shipping industries, and lead to a large influx of refugees to Croatia. Prolongation of the conflict could have enduring effects on tourism-earnings potential by reducing internally-generated savings needed to upgrade facilities.

The Kosovo crisis is inflicting enormous costs on the Macedonia economy as a result of the disruption to trade, the influx of refugees and the perceived increased risk of political and economic instability. The closure of the border with FR Yugoslavia is likely to lead to a dramatic loss in export markets as direct and transit trade through FR Yugoslavia represented roughly 70 percent of Macedonian exports in 1998. Imports are projected to decline reflecting supply disruptions, higher transport costs, and lower investment but the decline will not offset the fall in exports. The current account deficit is projected to increase by 8 percent of GDP under Scenario A and 7 percent in Scenario B. The increase in political and economic risk will lead to a sharp drop in FDI, foreign borrowing, and access to trade credit and, as a result, a significant deterioration in the capital account under both scenarios. The general government deficit is estimated to increase by 5.7 percent in Scenario A and 4.9 percent in Scenario B. This deterioration reflects lower revenues, higher social benefits, and direct refugee-related expenditures. Investment will fall sharply in response to increased uncertainty but this will be partly offset by increased refugee expenditures in the budget. Overall, growth is projected to decrease by 9 percent under the Scenario A and 8 percent in Scenario B. The higher cost of imported goods will push up inflation by 1-2 percentage points

The incremental balance of payments gap arising from the Kosovo crisis is estimated to be US$392 million (11.2 percent of GDP) in Scenario A and US$337 million (9.5 percent of GDP) in Scenario B. Of this, two thirds is the result of the deterioration in the current account and one third reflects the deterioration in the capital account. The budgetary gaps for the two scenarios are US$193 million (5.5 percent of GDP) and US$167 (4.7 percent of GDP) respectively. Total pledges of US$254 million were made at the Consultative Group meeting on May 5 in Paris (representing new pledges of US$194 million).

The authorities are in broad agreement with the figures for Scenario A and presented them to the Consultative Group meeting in Paris. However, the authorities believe that the assumptions behind Scenario B, in particular the rapid resumption of trade with and through FR Yugoslavia, are unrealistic. In addition the authorities believe the budgetary costs associated with refugees could be higher as the number of refugees continues to increase.

There are substantial risks associated with the above estimates. In particular if significant additional external financing is not forthcoming there will be an even sharper compression of imports, a further decline in output and a deterioration of the budget deficit. As there is limited room for expenditure cuts, the government may resort to domestic financing of the deficit with the result that inflation may increase and/or the exchange rate regime be undermined. The above scenarios may prove optimistic if there is a substantial increase in tax arrears, significant pressure on the banking system, or it proves more difficult than expected to redirect exports to new markets. Finally, even if the conflict ends rapidly there is a danger that trade will not revive at the expected level in the final quarter because of damage to railway lines, roads, bridges, and enterprises in FRY.

The Kosovo crisis will have limited effects on the Romanian economy in 1999. The largest adverse effect stems from the closure of transit routes through the FRY, which is expected to lead to significantly higher transport costs and the loss of some export markets. Direct exports to the FRY are small, and 40 percent of the direct exports lost are expected to be recouped through unofficial channels or redirection to other markets. Investor concern toward the region is expected to dry up some of the initially envisaged portfolio investment inflows. However, these effects are of a temporary nature and their attendant contractionary impulse is expected to be limited. Accordingly, in Scenario A, the additional decline in real GDP is estimated to be contained to 0.5 percent--GDP growth in 1999 would amount to -3.5 percent. Unemployment and inflation are not projected to increase. The current account deficit is expected to widen by 0.7 percentage points to 7.6 percent of GDP while the overall fiscal balance is expected to worsen by 0.2 percentage points to 3.9 percent of GDP, as a result of lower revenue collections. Under Scenario B, real growth is projected to decline by 0.4 percent, and the current account and overall fiscal balance to widen by 0.5 and 0.1 percent of GDP, respectively.

The incremental balance of payments gap for 1999 is estimated at US$246 million in Scenario A and 176 million in Scenario B, i.e., 0.9 and 0.6 percentage points of GDP, respectively. Notwithstanding the increase of access under the proposed stand-by arrangement by US$70 million, most of the gap is still unfilled.

The authorities broadly agree with the staff's technical estimates, and have requested additional access under the envisaged stand-by arrangement in line with the estimated gap. Estimates prepared by the National Bank (NBR) indicate a negative Kosovo impact of US$288 million on the BOP in 1999.(A higher estimate was provided by the Ministry of Foreign Affairs but so far staff has not secured the underlying technical calculations behind that estimate.)

The main downside risk for Romania stems from a further deterioration of financial market sentiment. The need to secure private sector financing of US$600 million in 1999 to refinance maturing bond obligations in May-June to the tune of US$750 million will require a sustained improvement in the market sentiment towards Romania. Against this background, it is worrying that Romania may have to meet any unfilled incremental gaps through reduced reserve accumulation, which may only serve to undermine market confidence.