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ISSN: 1469-5286

June 2017 Contents

Vol 24 Issue 6

Emerging Europe Monitor

Romania: Disinflationary Pressures
To Delay Tightening 5
Slovenia: Returning Loan Growth
South East Europe On Improved Fundamentals And
Confidence 7
Turkey: Referendum Polarisation To Keep Macedonia: Construction
Political Risk High Underpins Solid Growth Outlook,
BMI View: Turkey's April 16 referendum will move the country's system of governance But Political Risks Mounting  10
in a more autocratic direction, with negative implications for EU relations and long-term
Serbia: Public Finances Sustainable
growth. The close and contested nature of the result will keep political and societal ten-
But Risks Rising 11
sions high, with the 2019 general elections already coming into focus.
Albania: Domestic Demand To
On April 16, Turkey held a referendum on a new constitution that will abolish the post of Drive Economy Despite External-
prime minister, hand the president sweeping executive powers at the expense of checks Led Growth Upgrade  12
and balances and usher in a more autocratic system of governance (for an overview of the
Croatia: Robust Domestic Demand
changes see 'April Referendum To Consolidate Erdoan's Power', 19 January). President
Pushes Up Growth Forecast  14
Recep Tayyip Erdoan's constitutional changes were voted through by a narrow margin of
just over one million votes, with preliminary results showing 51.4% voting in favour and a Montenegro: Policy Stagnation
turnout of 85%. The president will be handed major executive and legislative powers after the Remains A Risk To Economic
next general election in 2019, including considerable influence over the judiciary and state Prospects Forecast  15
budgets, and could see Erdoan serve two five-year terms if re-elected. This marks Erdoan's
Copy Deadline: 21 April 2017
latest major step in consolidating political power following the failed military coup in July 2016,
since when Turkey has been governed under a state of emergency and the ruling Justice and Analysts: Edward Stevenson, Lorenz
Unger, Alexander Fraser, Matthias
Development Party (AKP) has cracked down on opposition lawmakers, journalists, academics Karabaczek, Lucas Dos Santos, Tiziana Papa
and the judiciary, including by means of detentions and job dismissals.
...continued on page 2 Editor: Lucas Dos Santos

Sub-Editor: Matthew Farrell

Romania: Fiscal Stance Raises Headwinds For RON  4
Subscriptions Manager: Lyan Chan
Rising fiscal risks, coupled with a loose monetary policy and an unstable political backdrop,
will add downward pressures to the Romanian leu. We expect the unit to underperform Marketing Manager: Julia Consuegra
regional peers including the Hungarian forint and the Polish zloty over the coming months.
Production: Anshu Kumar

Bulgaria: No Rate Hikes Despite Accelerating Inflation  6

While rising supply and demand-side pressures will push Bulgaria out of deflationary
territory, the country's currency peg to the euro precludes any interest rate hikes until at
least end-2017. That said, the currency board erodes the country's export competitiveness
and thus necessitates the implementation of structural reforms.


South Eastern Europe Indicators 2015 2016e 2017f 2018f 2 Broadgate Circle, London
Nominal GDP, USDbn 1,265.4 1,277.4 1,150.8 1,201.8
Population, mn 128.0 128.7 129.3 129.7
GDP per capita, USD 9,889.9 9,926.1 8,902.9 9,265.1
Real GDP growth, % 5.1 3.2 2.7 2.9
Inflation, % 5.1 5.0 6.1 6.4 Company Locations
Goods Exports, USDbn 290.6 295.4 298.6 315.1 London | New York | Singapore
Goods Imports, USDbn 372.7 371.7 376.6 399.8
Hong Kong | Dubai | Pretoria
Notes: South East Europe = Turkey, Romania, Bulgaria, Slovenia, Macedonia, Serbia, Montenegro, Albania, Croatia,
Bosnia; e/f = BMI estimate/forecast. Source: BMI

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South East Europe | June 2017
...continued from front page
Contested Victory To Keep Tensions High
The narrow victory for the 'Yes' campaign is a reflection of a deeply polarised society and high levels of scepticism over the merits of an
executive presidency, even from within segments of the AKP's core support base. For example, Turkey's three largest cities Ankara, Izmir
and Istanbul voted against the new constitution, marking Erdoan's first defeat in the latter his hometown since 2002. Moreso than
in previous elections, Erdoan's support was thus concentrated in the traditionally more religious and conservative central Anatolian
heartland. The 'Yes' campaign also received significant support from Turkish immigrants across Europe, with over 70% of voters in the
Netherlands, Austria and Belgium supporting the changes.

Furthermore, the 'Yes' campaign which was backed by the AKP and the Nationalist Movement Party (MHP) fell well short of the two
parties' combined vote shares in previous elections, suggesting that supporters of both strayed from the party line. Finally, the election
result is being contested by the opposition Republican People's Party (CHP) and pro-Kurdish People's Democracy Party (HDP) amidst
concerns over voting irregularities, including a last-minute decision by the Supreme Electoral Council contrary to Turkish law and prior
custom to count ballots as valid even if they did not carry an official seal. Foreign monitors including the Organization for Security and
Co-operation in Europe (OSCE) and Council of Europe have expressed similar concerns over voting irregularities, concluding that the
referendum fell short of international standards and citing that the election was not held on a level playing field in light of, among other
factors, the AKP's firm grip over the media, the large number of displaced voters in Turkey's traditionally anti-AKP south east and the
jailing of numerous opposition HDP members since 2016.

Erdoan and the AKP will nonetheless treat the result as a clear mandate and this will only exacerbate current societal rifts. Lingering
questions over the legitimacy of the referendum will prevent the government from pursuing a more conciliatory approach and encourage
it to continue in its ongoing attempts to suppress opposition voices. We do not believe the protestations of the CHP and HDP will lead to
any formal review or recount, and supporters of both parties are thus highly unlikely to ever view the result as legitimate. In a sign that the
government's hostile stance is unlikely to change in the near term, the state of emergency in place since the failed coup attempt in July
2016 was extended for another 90 days just two days after the referendum.

2019 Elections Already In Sight

We believe the victory for the 'Yes' campaign means the prospect of early elections is low. That said, Erdoan and the AKP will remain
focused on ensuring a sizeable parliamentary majority in the 2019 general election, and on preventing the referendum result from
galvanising the opposition. This will help ensure that political tensions remain elevated, despite the referendum having gone in Erdoan's
favour. In particular, Erdoan will want to ensure that the HDP falls below the 10% electoral threshold, the result of which would be to
hand the majority of their 59 parliamentary seats over to the AKP. Combined with the need to continue courting nationalist voters, this
suggests a low probability that the government will attempt to restart peace talks with the separatist Kurdistan Workers' Party (PKK),
given that the last attempt at doing so boosted the performance of the HDP in subsequent elections. Significant portions of south-
eastern Turkey remain in a state of low-level armed conflict and the AKP has succeeded in affiliating the HDP with the PKK in the minds
of voters by jailing many of its members on terrorism charges.

Despite the potential for the referendum to galvanise Erdoan's opponents, we do not see a credible opposition emerging between
now and the 2019 elections. The MHP faces serious internal divisions over the decision of its leader Devlet Bahceli to support the 'Yes'
campaign, while the HDP will face an uphill battle to enter parliament after winning just 13.1% of the vote in the November 2015 general
election. The main opposition CHP, which has traditionally represented Turkey's secular elite, has not breached 26% of the vote in any
general or local election even as Erdoan has become an increasingly divisive figure. This reflects in part the failure of its leadership to
modernise and rally a younger generation.

Relations With Europe On Ice

One of our core pre-referendum views was that Turkey's relationship with the EU would deteriorate as a result (see 'Referendum Pushes
EU Membership Further Out Of Reach', March 8) and early signs suggest that this will indeed be the case. The government has been quick
to criticise OSCE and Council of Europe conclusions, which have been echoed by the European Commission, as biased and reflective of
ongoing attempts by the West to undermine Erdoan's authority. Meanwhile, in post-referendum speeches Erdoan has brought up the Page 2
South East Europe | June 2017

possibility of holding a referendum on Turkey's EU accession process and on reinstating the death penalty, both common themes during
the campaign. The latter would be grounds for immediately halting Turkey's already-stalled accession process in the eyes of the EU. That
Erdoan decided to reiterate these themes even after victory in the referendum suggests that relations with the EU, which reached a low
point after a diplomatic row erupted between Turkey and the Netherlands in March, are unlikely to improve soon.

The EU has come out strongly against Turkey's constitutional changes concentrating power in the hands of the presidency, as such a
system is unlikely to meet the rule of law criteria required of any country hoping to join the bloc. We cannot rule out that the EU will decide
to unilaterally end Turkey's accession bid even if Erdoan and the AKP do not move to take such steps. That said, the EU has a delicate
balancing act to play with Turkey in light of the migrant deal currently in place between the two sides, which has been partially responsible
for significantly reducing the flow of migrants into Europe. Visa-free travel for Turkish citizens was a cornerstone of the original deal,
although it has yet to be implemented and will face significant obstacles in many EU capitals. Any movement on the migrant deal will thus
be an important indicator of future relations between the two sides, with a breakdown likely to presage a more formal split. Any such split
would also carry negative implications for Cyprus' reunification prospects (see 'Reunification Odds Diminishing Quickly', April 3).

US To Look Past Authoritarian Drift

Turkish-US relations are unlikely to deteriorate to a similar degree, however, with US President Donald Trump more willing to overlook
Erdoan's autocratic tendencies and continue regarding him as a valuable ally against both Islamic State and Syrian President Bashar al-
Assad. Trump has so far been the only Western leader to call Erdoan to congratulate him on the referendum victory, and this is despite
the US State Department issuing a decidedly more cautious statement in which it acknowledged voting irregularities and urged Turkey to
uphold human rights. While we note significant potential for a long-term reorientation of Turkey away from its long-standing alliance with
Western countries manifested in the country's NATO membership (see 'Relations With West To Deteriorate Further', March 24), Turkey's
overwhelming geopolitical importance will continue acting as a key buffer against a breakdown in relations in the near term.

Deteriorating Macro Backdrop In Focus

We previously laid out the bullish economic scenario following a 'Yes' vote (see 'Precarious Fundamentals No Matter Referendum Outcome',
March 29). This involved an easing of populist and nationalist rhetoric following the vote, and a refocused effort on the structural reform
agenda. The first criterion looks unlikely to be met in the near term, given the contested result and initial post-referendum rhetoric
coming from Erdoan. It remains to be seen whether the structural reform agenda will gather pace, but it is clear that it is crucial to boost
Turkey's growth prospects. Turkey's business environment has stagnated in recent years as the AKP government has had to devote much
of its attention to consolidating power and pursuing constitutional change, as evidenced by the country falling well behind peers in the
World Bank's Ease of Doing Business rankings.

2015e 2016e 2017f 2018f 2019f 2020f 2021f
Nominal GDP, USDbn 858.3 856.6 741.1 768.9 806.9 844.9 894.2
Real GDP growth, % y-o-y 6.1 2.9 2.3 2.7 3.2 3.2 2.9
GDP per capita, USD 11,191 11,054 9,473 9,741 10,133 10,520 11,039
Industrial production, % y-o-y, ave 3.2 4.5 4.8 4.8 4.3 4.0 4.0
Population, mn 78.7 79.6 80.4 81.1 81.7 82.3 82.8
Consumer price inflation, % y-o-y, eop 8.8 8.5 8.8 8.2 8.0 7.0 7.0
Consumer price inflation, % y-o-y, ave 7.7 7.8 8.7 8.5 8.1 7.5 7.0
Central bank policy rate, % eop 7.50 8.00 8.50 9.00 9.50 9.50 9.50
Exchange rate TRY/USD, ave 2.72 3.02 3.85 4.13 4.38 4.63 4.80
Exchange rate TRY/USD, eop 2.92 3.52 4.00 4.25 4.50 4.75 4.85
Budget balance, TRYbn -24.1 -41.3 -72.8 -74.4 -74.3 -74.0 -80.3
Budget balance, % of GDP -1.0 -1.6 -2.5 -2.3 -2.1 -1.9 -1.9
Goods and services exports, USDbn 198.2 187.4 195.3 209.3 222.7 235.6 248.8
Goods and services imports, USDbn 222.3 212.8 221.0 237.3 252.4 265.0 278.3
Current account balance, USDbn -32.2 -35.4 -36.8 -39.4 -41.6 -41.6 -42.1
Current account balance, % of GDP -3.8 -4.1 -5.0 -5.1 -5.2 -4.9 -4.7
Foreign reserves ex gold, USDbn 92.9 93.9 98.5 103.5 108.6 114.1 119.8
Import cover, months 5.0 5.3 5.3 5.2 5.2 5.2 5.2
Total external debt stock, USDbn 397.9 427.3 461.2 502.1 546.9 595.4 647.2
Total external debt stock, % of GDP 46.4 49.9 62.2 65.3 67.8 70.5 72.4
Crude, NGPL & other liquids prod, 000b/d 48.4 49.3 48.2 46.9 45.5 44.1 42.8
Total net oil exports (crude & products), 000b/d -822.3 -890.9 -917.6 -945.4 -996.9 -1,045.8 -1,064.7
Dry natural gas production, bcm 0.4 0.4 0.4 0.4 0.4 0.3 0.3
Dry natural gas consumption, bcm 47.6 46.6 47.5 48.5 49.9 51.9 54.5
e/f = BMI estimate/forecast. Source: National sources, BMI Page 3
South East Europe | June 2017

The referendum was held against an increasingly precarious macroeconomic backdrop. Despite Q416 GDP coming in much higher than
consensus expectations (see 'Quick View: Q416 Performance Poses Upside Risk', March 31), the unemployment rate in January reached a
seven-year high of 13%. Government stimulus efforts also played an important role in supporting growth, but this will not be sustainable
over the coming quarters in light of a rapidly widening budget deficit. Prudent fiscal policy has been a key anchor of investor sentiment,
underpinning continued capital inflows which are necessary to cover Turkey's large 'hot money'-financed current account deficit (see
'Current Account Remains Primary Macro Vulnerability', February 24). While the election victory is likely to diminish the urgency to
kickstart growth in the near term, we nonetheless believe that the government under an empowered Erdoan presidency will seek to
expand its role in the economy over the coming years. This is highlighted by the creation of a sovereign wealth fund in 2016, which in our
view will serve to increase state-directed spending and obscure the true state of the public finances (see 'Wealth Fund To Obscure Rising
Fiscal Risks', February 15).

Alongside a more precarious fiscal policy outlook, it remains to be seen whether government interference in monetary policy will be
reduced. In recent years, the government has pressured the Central Bank of the Republic of Turkey (CBRT) to keep borrowing costs
low, even in the context of elevated inflation. This has eroded markets' confidence in the CBRT, weighing heavily on the lira. Moving
forward, the key question is whether the government will continue to impinge on the independence of the CBRT. In turn, this depends
on whether the government's hostile rhetoric towards the CBRT and the 'interest rate lobby' in recent years was simply an election ploy,
or representative of a firm belief that lower interest rates in Turkey are needed and warranted. We lean towards the latter interpretation
and as such expect the interplay between government and the central bank to remain a source of weakness for the lira. Absent more
significant monetary tightening and higher real interest rates, the CBRT will be constrained in its ability to materially bring down longer-
term inflation expectations.


Fiscal Stance Raises Headwinds For RON

BMI View: Rising fiscal risks, coupled with a loose monetary policy and an unstable political backdrop, will add downward pressures
to the Romanian leu. We expect the unit to underperform regional peers including the Hungarian forint and the Polish zloty over the
coming months.

Rising fiscal risks in Romania will weigh on investor confidence and add downside pressure RON Trending Weaker
Romania RON/EUR Exchange Rate (weekly)
to the Romanian leu over the coming quarters. Data from January shows consolidated 4.75

budget revenues fell by 5.7% y-o-y, while consolidated expenses rose by 3.5% y-o-y. 4.65

Official budget forecasts assume a 13.8% increase in revenues in 2017, which in turn is 4.55

based on an overly optimistic real GDP growth forecast of 5.2% (BMI forecasts 3.6%). We 4.45

expect Romania's budget deficit to widen to 3.5% of GDP in 2017 (see 'Fiscal Deterioration 4.35

To Undermine Sovereign Creditworthiness', February 24), breaching the EU's 3.0% limit, 4.25

although downside risks are increasingly evident. The European Commission and IMF, as 4.15
well as Romania's Fiscal Council have recommended the adoption of corrective measures,
adding tension to an already unstable political situation (see 'Weak Government To


















Undermine Policy Formation', March 14). However, the Romanian government has so far
Source: Bloomberg, BMI
not signalled a willingness to deviate from its expansionary economic programme, and low
public debt levels suggest scope for increased borrowing.

Mounting fiscal risks, coupled with a loose monetary policy (see 'Disinflationary Pressures
To Delay Tightening', February 28) and an unstable political backdrop, will raise downward
pressures on the Romanian leu. The unit has underperformed regional peers including
the Hungarian forint and Polish zloty in recent months, a trend we believe will continue.
The National Bank of Romania (NBR) has scaled back FX interventions of late, perhaps
suggesting a greater tolerance for depreciation, and the leu is testing long-term support at
RON4.58/EUR. A break above this level would force us to reassess our relatively optimistic Page 4
South East Europe | June 2017

forecasts for the unit (see 'Political Instability Will Not Hold Back Appreciation', March 3). Further depreciation could be driven by a more
formal warning from the EU, which looks increasingly likely over the coming months. That said, the government's expansionary fiscal
policy is a key reason we expect the NBR to begin monetary tightening in 2017 despite still subdued levels of inflation in Q117. This, in
combination with real GDP growth above regional averages, should lend some support to the currency.


Disinflationary Pressures To Delay Tightening
BMI View: We have revised down our forecasts for Romanian inflation and policy rates in 2017. However, we still project the NBR to
hike interest rates by the end of 2017 to counteract the build-up of inflationary pressures stemming from robust domestic growth.

Driven mainly by rising commodity prices, Romania's consumer price index (CPI) returned to positive growth of 0.1% y-o-y in January
2017. This marks the end a two-year deflationary period, which saw prices contracting by 0.9% in 2015 and 0.5% in 2016. Looking ahead,
Romania's inflation will remain below that of Central and Eastern European (CEE) peers in 2017, largely due to tax and administrative price
cuts. Moreover, while base effects from supply-side pressures will gradually fade towards the end of the year, further tailwinds to inflation
will be brought about by strong economic growth and rising inflation expectations, which in turn will direct the central bank to adopt a
tighter monetary policy by the end of 2017.

Persistent Disinflationary Pressures in 2017

Although we continue to project a gradual build-up of inflationary pressures, we have revised down our inflation forecasts for 2017. We
now project end-of-period inflation to stand at 2.5%, and for average inflation to come in at 1.5%, down from previous projections of 3.0%
and 1.6%, respectively. Two main factors underpin our adjustments. Firstly, we expect stronger disinflationary pressures throughout 2017
on the back of a 1 percentage point (pp) VAT tax reduction in January 2017 and several administered price cuts implemented over the
last quarter of 2016. Secondly, there have been weaker-than-expected developments in services and core inflation, despite the robust
performance of the economy in recent quarters, which saw annual real GDP growth in 2016 reach 4.8%. Core inflation saw a more
subdued uptick compared to the headline figure, standing at 0.0% in January 2017, while month services prices fell to a 0.6% contraction,
down from a 0.4% contraction in December 2016.

On the back of our inflation forecast adjustments, we now expect fewer and more delayed key rate hikes for this year. We project the key
rate to end 2017 at 2.25%, 0.25pp below our previous estimates, while we maintain our projection at 3.0% for 2018. This is in line with the

2015e 2016e 2017f 2018f 2019f 2020f 2021f
Nominal GDP, EURbn 160.1 169.0 176.2 190.6 206.0 225.2 241.7
Real GDP growth, % y-o-y 3.9 4.8 3.6 3.4 3.2 3.2 3.1
GDP per capita, EUR 7,627 8,088 8,466 9,197 9,979 10,956 11,805
Industrial production, % y-o-y, ave 2.8 3.0 3.9 3.7 3.5 3.5 3.5
Population, mn 19.5 19.4 19.2 19.1 19.0 18.8 18.7
Consumer price inflation, % y-o-y, eop -0.9 -0.5 1.9 3.3 3.5 3.5 3.5
Consumer price inflation, % y-o-y, ave -0.6 -1.5 1.3 2.9 3.4 3.5 3.5
Central bank policy rate, % eop 1.75 1.75 1.75 2.50 3.00 3.50 3.50
Exchange rate RON/USD, ave 4.01 4.06 4.36 4.34 4.38 4.28 4.25
Exchange rate RON/USD, eop 4.16 4.31 4.36 4.31 4.35 4.20 4.30
Budget balance, USDbn -1.3 -5.1 -6.3 -6.6 -6.8 -6.5 -6.0
Budget balance, % of GDP -0.8 -2.7 -3.5 -3.4 -3.3 -2.9 -2.5
Goods and services exports, EURbn 65.9 69.6 73.3 77.1 81.2 86.0 91.2
Goods and services imports, EURbn 56.9 61.4 65.0 68.2 71.6 75.2 79.0
Current account balance, EURbn -1.8 -3.9 -4.9 -5.8 -6.8 -7.1 -7.5
Current account balance, % of GDP -1.1 -2.3 -2.8 -3.0 -3.3 -3.2 -3.1
Foreign reserves ex gold, EURbn 29.0 31.7 34.6 35.4 36.5 38.1 39.8
Import cover, months 6.2 6.3 5.9 5.7 5.5 5.4 5.4
Total external debt stock, EURbn 88.1 96.0 98.1 103.6 110.7 118.4 126.5
Total external debt stock, % of GDP 54.0 54.0 55.1 54.4 53.8 52.6 52.3
Crude, NGPL & other liquids prod, 000b/d 87.4 84.6 84.1 80.8 77.9 74.4 71.0
Total net oil exports (crude & products), 000b/d -92.6 -119.3 -119.4 -121.1 -123.1 -127.8 -132.2
Dry natural gas production, bcm 11.5 9.9 9.9 9.7 9.4 9.1 8.8
Dry natural gas consumption, bcm 11.9 11.4 11.4 11.5 11.6 11.8 12.0
e/f = BMI estimate/forecast. Source: National sources, BMI Page 5
South East Europe | June 2017

Central Bank of Romania's (CBR)'s more dovish tone and forecasts. At the last monetary policy meeting, held in February, the CBR kept
the key rate unchanged at 1.75%, marking a stall of 22 consecutive months, and maintained the corridor of interest rates on its standing
facilities at 1.50pp. The CBR also revised its inflation projections for headline and core CPI in Q416 down by 0.4pp and 0.6pp, respectively,
compared to its November forecasts. The bank now forecasts inflation to re-enter the 2.5% 1pp target corridor only after the third
quarter of 2017, rather than in the first half of the year, as previously estimated.

That said, we believe that a tighter monetary policy by end-2017 will be necessary to counteract a build-up of inflationary pressures,
driven primarily by domestic factors. The trajectory of core inflation will remain the main factor underpinning our view, given that
this measure best gauges the trajectory of long-term price growth. We also expect stronger core inflation to be brought about by the
country's robust economic growth, its tightening labour market, which will continue to drive robust wage growth, and the government's
expansionary fiscal policy, which foresees further wage increases and a boost in social spending. Rising inflation expectations are also
evident in markets, which in February 2017 saw the spread between 10- and two-year government bond yields reach a historic high.


No Rate Hikes Despite Accelerating Inflation
BMI View: While rising supply and demand-side pressures will push Bulgaria out of deflationary territory over the coming quarters,
the country's currency peg to the euro precludes any potential interest rate hikes until at least end-2017. That said, and although
the peg has been an anchor for relative price stability, the currency board erodes the country's export competitiveness and thus
necessitates the implementation of structural reforms.

After four years of deflation, 2017 and 2018 will mark the turning point of negative price growth in Bulgaria. This will be reflected in rising
supply- and demand-side inflationary pressures, pushing year-on-year inflation to average 1.3% and 2.0% in 2017 and 2018 respectively.
That said, rising inflationary pressures will not be accompanied by interest rate hikes by the Bulgarian National Bank (BNB), as the country's
currency peg to the euro deprives the BNB of independent interest rate policy.

Supply And Demand Side Pressures Mounting

While growth in Bulgaria's Harmonised Consumer Price Index (HICP) the European Central Bank (ECB)'s indicator of inflation and price
stability remained in deflationary territory throughout 2016, inflation recorded by the national methodology accelerated to 0.1% y-o-y
in December. We expect price growth to remain on an upward trajectory over the coming quarters. This will primarily reflect higher global
Brent crude oil prices, which we expect to rise by 26.3% y-o-y and 5.3% on average in 2017 and 2018 respectively. As a result, we expect
to see an uptick in transport, fuel and energy prices, which account for one-third of Bulgaria's aggregate inflation basket. Additionally,
accelerating eurozone inflation, which in January rose to its highest rate since February 2013, will fuel imported inflation in the country. In
Bulgaria, the share of foreign value-added in domestic consumption amounts to 42.0%, implying that eurozone price increases will spill
over into domestic value chains.

On top of the aforementioned supply-side factors, we believe that demand-side inflationary pressures will gain momentum over the
coming quarters. This is supported by our forecast for rising household expenditure, which we expect to rise by a robust 3.1% y-o-y on
average over the next two years. Surging consumption of loans (having risen to their highest level in six-and-a-half years in December
2016) and strong consumer confidence indicate heightened domestic demand over the coming quarters. Additionally, record low
unemployment, coupled with intrinsic labour market shortages, will continue to fuel strong wage growth (from Q116 to Q316 nominal
wages accelerated by an average 7.7% y-o-y). This will boost household purchasing power, increasing private demand and pushing up
consumption goods prices.

Monetary Policy Guided By The ECB

Notwithstanding rebounding inflation, we do not expect the BNB to counteract rising price pressures via interest rate hikes, as the country's
currency peg to the euro (at BGN1.96/EUR) precludes national authorities from pursuing an independent interest rate policy. Consequently,
our view on Bulgarian interest rate hikes almost exclusively pertains to our view on ECB refinancing rates, which will be kept on hold at 0.0%
until at least 2020, according to our forecasts (see 'Quick View: ECB Tightening A Long Way Off', January 19). That said, we caution that while Page 6
South East Europe | June 2017

the lev's peg to the euro has been a source of relative price stability, it also strains the country's export competitiveness. Euro appreciation
and relatively higher inflation rates vis-a-vis the country's primary trading partners (the EU accounts for 60.0% of Bulgaria's overall exports)
caused Bulgaria's consumer price index-based real effective exchange rate (REER) to appreciate significantly in the years prior to the global
financial crisis, and its subsequent depreciation has been slow despite Bulgaria's deflationary backdrop. Accordingly, Bulgaria cannot rely
on the exchange rate channel to boost export competitiveness and must instead pursue structural labour market reforms or internal
devaluation to maintain a competitive edge in trying to remain an attractive destination for low labour cost-based production.

2015e 2016e 2017f 2018f 2019f 2020f 2021f
Nominal GDP, EURbn 45.3 47.3 50.0 52.7 55.2 57.8 60.5
Real GDP growth, % y-o-y 3.6 3.4 3.6 3.4 2.9 2.7 2.4
GDP per capita, EUR 6,370 6,697 7,148 7,593 8,016 8,469 8,941
Industrial production, % y-o-y, ave 2.9 3.1 2.6 2.0 1.5 1.7 1.8
Population, mn 7.1 7.1 7.0 7.0 6.9 6.9 6.8
Consumer price inflation, % y-o-y, eop -0.9 -0.5 1.4 2.2 2.1 2.2 2.4
Consumer price inflation, % y-o-y, ave -1.1 -1.3 1.3 2.0 1.8 2.0 2.2
Central bank policy rate, % eop 0.01 0.00 0.01 0.30 0.50 1.00 1.25
Exchange rate BGN/USD, ave 1.76 1.77 1.90 1.92 1.96 1.96 1.96
Exchange rate BGN/USD, eop 1.80 1.86 1.92 1.92 1.96 1.96 1.96
Budget balance, USDbn -1.4 0.8 -0.6 -0.6 -0.3 -0.3 -0.2
Budget balance, % of GDP -2.8 1.5 -1.2 -1.1 -0.5 -0.4 -0.4
Goods and services exports, EURbn 29.3 30.1 30.9 31.9 33.5 35.3 37.3
Goods and services imports, EURbn 28.5 28.6 29.8 31.1 32.8 34.6 36.8
Current account balance, EURbn 0.6 1.3 0.7 0.4 0.3 0.2 0.1
Current account balance, % of GDP 1.3 2.7 1.4 0.8 0.6 0.4 0.2
Foreign reserves ex gold, EURbn 17.8 19.2 22.2 23.7 26.6 30.6 32.1
Import cover, months 7.5 8.0 9.0 9.1 9.7 10.6 10.5
Total external debt stock, EURbn 34.4 34.2 32.0 31.1 30.7 30.3 30.0
Total external debt stock, % of GDP 74.6 68.8 63.3 59.0 55.6 52.4 49.6
Crude, NGPL & other liquids prod, 000b/d 1.4 1.3 1.3 1.2 1.2 1.1 1.1
Total net oil exports (crude & products), 000b/d -72.1 -72.5 -72.1 -72.8 -73.5 -74.3 -75.1
Dry natural gas production, bcm 0.1 0.1 0.1 0.1 0.1 0.1 0.0
Dry natural gas consumption, bcm 2.6 2.6 2.7 2.8 2.8 2.9 2.9
e/f = BMI forecast/estimate. Source: National sources, BMI


Returning Loan Growth On Improved Fundamentals And Confidence
BMI View: Loan growth is likely to turn positive again in 2017 on the back of accelerating economic growth and the improved health
of the banking sector. Lending to non-financial corporations will be the last to recover, turning positive only in 2018.

After six years of decline, we expect a return to credit growth in the Slovenian banking sector during 2017. This will be driven by improving
macroeconomic conditions, with GDP growth set to accelerate to 2.9% this year and 3.1% in 2018 on the back of stronger domestic
demand (See 'Domestic Demand To Drive Growth Upswing', March 8). Latest indicators already show consumer confidence and retail
trade on the rise, and this will continue in the coming quarters as real wage growth remains positive. Crucially, we believe the drawn-out
restructuring in the private sector is reaching its final stages, and should pave the way for renewed demand for credit in the years ahead.

Latest figures from the National Bank of Slovenia (NBS) point to the improved health of the banking sector during 2016. Though total
sector assets continued to decline on an annualised basis, the fall of 3.4% y-o-y at end-2016 was the lowest in three years. Client loans
dipped by 4.2% y-o-y in December 2016, but this was better than the 7.5% decrease at end-2015 and hides positive growth in loans to
households, which the NBS estimated rose by 4.6% y-o-y. The sector also recorded improved asset quality, with the gross non-performing
loan ratio falling to a preliminary 8.2% at the end of the year, compared to over 25% during the 2013 banking crisis. The NBS reported that
a sharp reduction of impairment provisions helped drive strong profit growth among all banks in 2016.

Non-Financial Corporations Still a Weak Spot

Though households are already seeking credit to support faster spending, the recovery among businesses especially state-owned
enterprises will take longer. Though gradually improving, the NPL ratio for loans to non-financial corporations stood at 25.6% at the
end of 2016; the alarmingly high figure suggests that there is further deleveraging ahead. At the same time, private sector debt has fallen Page 7
South East Europe | June 2017

considerably since 2012, and the government is pushing ahead with its privatisation programme; we expect this restructuring to reach
a conclusion in the coming quarters. With this in mind, we expect lending to corporations to turn positive around the end of the year,
helping to drive up growth in total client loans to 5.0% in 2018 and 6.7% in 2019.

NLB Privatisation Should Go Ahead In 2017

The improved macroeconomic and banking sector outlook will help push through the delayed privatisation of Slovenia's largest bank,
NLB, in the coming months. The bank recently reported a 20% hike in net profit in 2016, and the government launched roadshows in
March as part of its plan to sell 75% of its holding in the bank via an initial public offering (IPO). Other bank privatisations are also likely
in the coming years, though the 2018 general election could delay the process given ongoing political resistance to reducing state
involvement in the domestic banking sector.

In line with a long-standing goal of the NBS and demands from the IMF, we also expect to see further consolidation in the sector. Indeed,
at the start of January, Nova KBM absorbed KBS Banka to form the second-largest entity in the country, following the completion of the
merger between third largest bank Abanka and its state-owned peer Banka Celje a year earlier.

Asset Quality: Asset quality remains a major concern, but continues to improve, with bad loans falling to 8.2% in Q416, from 18.4% of the
total loan book in Q414 (according to NBS data). The corporate sector in particular remains over-leveraged, with over 25% of corporates
possessing debt-to-EBITDA ratios above 10x. The EBRD estimates that between 44% and 60% of all companies in Slovenia face a debt
burden that is unsustainable and which will ultimately require some form of restructuring. These costs are likely to be at least partially
borne by the banking sector, indicating that further issues lie ahead.

Nonetheless, we highlight that there is a significant divergence between domestic banks and foreign-owned banks in terms of asset
quality. The bulk of the long-standing impaired loans in the banking sector is concentrated within domestic banks, while majority
foreign-owned banks tend to report much lower NPL ratios. The improving macroeconomic outlook should contribute to the ongoing
improvement in NPLs, but more work by the government is needed to tackle residual bad loans on bank balance sheets.

FX Exposure: The sector has some FX exposure in the form of Swiss franc (CHF) loans. The Swiss National Bank's decision to cease
defending the currency ceiling against the euro did not have a significant impact on Slovenia's banking sector, in contrast to other
regional markets with higher levels of CHF borrowing. The government did not act to forcibly convert CHF-denominated loans into local
currency as was the case in Croatia and Bosnia-Herzegovina. While shifts in the exchange rate may result in a higher default rate, the total
sum of loans relative to the size of the total loan book is such that the effect is unlikely to materially affect profitability. The risk to the
overall banking sector stability is therefore small.

Funding Structure: There is a growing shift towards a primarily domestic deposit-based funding mix. Banks have continued to reduce
their dependence on wholesale funding, primarily due to growing difficulties gaining access to international financial markets following
the downgrading of Slovenia's sovereign debt and banks back in 2012. Consequently, the banking sector has increasingly moved towards
a deposit-based funding structure.

The loan-to-deposit ratio fell from 183% in 2009 to 104% in 2015, and declined further to 93% in H116 as banks' loan portfolios continued
to shrink. The return to growth in household deposits reflects a restoration in confidence in the banking sector following the 2013-2014
crisis. Subsequently, funding risks have declined substantially, and will continue to do so, as the sector moves towards a deposit-funded
model. This will reduce the vulnerability of the banking sector to external shocks by lowering its reliance on cross-border financing.

Capital Adequacy: Levels are adequate, and gradually improving. Overall capital adequacy stood at 20.8% at the end of 2015 (latest
available data), while Tier 1 capital stood at 20.1%. Slovenian banks Nova Ljubljanska Banka (NLB) and Nova Kreditna Banka Maribor
(NKBM) failed the European Central Bank (ECB)'s stress tests in October 2014, but have since improved their capital buffers and are now
in the process of being re-privatised. According to the National Bank, large domestic banks have relatively high capital ratios (19.7% in
2015), while small domestic banks remain more vulnerable at around 11%. Page 8
South East Europe | June 2017

Sovereign Support Capacity: While Slovenia was able to recapitalise its banking sector in 2013 without recourse to an international
bailout, it would likely be unable to do so a second time. High levels of corporate indebtedness and poor asset quality remain major risks to
the stability of the sector, which the government was forced to recapitalise in Q114, nearly leading to an external sovereign bailout. While
real GDP growth is accelerating, the pace of improvement is unlikely to be sufficient to solve the challenges facing the overburdened
corporate sector without additional intervention. However, the Bank of Slovenia has established a bank rescue fund to cover any bank
capital shortfalls in the future. The fund will remain operational until end-2024, and banks had contributed around EUR191 to the fund by
April 2016. In June 2016, parliament approved a law to reduce the cost to taxpayers of rescuing ailing banks and to avoid a repeat of the
2014 bailout. This is in line with demands made by the European Commission.

The relative importance of state-level aid should gradually diminish in the coming years on the back of the Single Resolution Mechanism
(SRM) and Single Resolution Fund (SRF), both key pillars of the EU's improved banking union. Effective January 2016, the SRM provides
a unified framework for recovery and resolution of credit institutions and allows for troubled banks to be restructured with funds from
the SFRF, which will be built up with contributions from member states over an eight-year establishment phase. That said, the SRF will
not cover all financial institutions and it will take many years before it is fully funded, meaning that Italy's weak fiscal position will remain
a potential source of risk for some time.

Ownership Structure: Foreign ownership of Slovenia's banking sector is around 30%, which has historically proved advantageous
during periods of financial volatility. For example, foreign-owned banks enjoyed considerably cheaper debt funding and deposit funding
versus domestic banks during the post-financial crisis period. Furthermore, foreign-owned banks tend to report significantly higher asset
quality, which may relate to better credit controls and monitoring.

Regulatory Body Assessment: Local lenders are currently required to pay 1.3% of all state-guaranteed deposits held by them into the
bank rescue fund set up by the Bank of Slovenia, which amounts to around EUR200mn. The lenders will also be required to hold liquid
investments worth 1.0% of state-guaranteed deposits, amounting to around EUR154mn.

2015e 2016e 2017f 2018f 2019f 2020f 2021f
Nominal GDP, EURbn 38.6 39.8 41.6 43.7 45.8 47.9 50.1
Real GDP growth, % y-o-y 2.3 2.5 2.9 3.1 2.9 2.6 2.5
GDP per capita, EUR 18,564 19,096 19,927 20,908 21,904 22,886 23,901
Industrial production, % y-o-y, ave 5.5 6.6 7.6 5.0 5.0 4.0 3.0
Population, mn 2.1 2.1 2.1 2.1 2.1 2.1 2.1
Consumer price inflation, % y-o-y, eop -0.6 0.6 1.8 2.0 2.0 2.0 2.0
Consumer price inflation, % y-o-y, ave -0.8 -0.2 1.5 1.9 2.0 2.0 2.0
Central bank policy rate, % eop 0.05 0.00 0.00 0.00 0.00 0.25 0.75
Exchange rate EUR/USD, ave 0.90 0.90 0.97 0.98 1.00 1.00 1.00
Exchange rate EUR/USD, eop 0.92 0.95 0.98 0.98 1.00 1.00 1.00
Budget balance, USDbn -1.3 -0.8 -0.7 -0.7 -0.6 -0.4 -0.5
Budget balance, % of GDP -2.9 -1.9 -1.6 -1.6 -1.4 -0.9 -0.9
Goods and services exports, EURbn 31.6 32.7 35.4 36.4 38.7 40.5 40.7
Goods and services imports, EURbn 26.5 27.6 29.2 30.8 32.5 34.3 36.1
Current account balance, EURbn 2.0 2.7 2.6 2.5 2.3 2.2 2.3
Current account balance, % of GDP 5.2 6.8 6.4 5.7 5.0 4.5 4.6
Foreign reserves ex gold, EURbn 0.7 0.7 0.8 0.8 0.9 1.0 1.0
Import cover, months 0.3 0.3 0.3 0.3 0.3 0.3 0.3
Total external debt stock, EURbn 41.4 43.7 43.2 44.0 45.2 46.6 47.9
Total external debt stock, % of GDP 105.3 104.6 102.9 100.7 98.7 97.2 95.8
Crude, NGPL & other liquids prod, 000b/d 0.3 0.3 0.3 0.3 0.3 0.3 0.3
Total net oil exports (crude & products), 000b/d -50.4 -51.1 -51.4 -51.8 -52.3 -52.6 -52.9
Dry natural gas production, bcm 0.0 0.0 0.1 0.1 0.1 0.3 0.5
Dry natural gas consumption, bcm 0.8 0.8 0.8 0.8 0.8 0.9 0.9
e/f = BMI estimate/forecast. Source: National sources, BMI Page 9
South East Europe | June 2017

Construction Underpins Solid Growth Outlook,

But Political Risks Mounting
BMI View: Macedonia's economy will benefit from strong leading indicators in the eurozone, specifically in the country's biggest trading
partner, Germany, as well as robust construction sector activity. However, heightened political risk and a reliance on EU funding for infra-
structure spending pose some potential downside risks to the economy; we therefore maintain our below-consensus growth outlook.

Positive growth momentum in the eurozone economy and a vibrant construction sector will maintain economic growth in Macedonia
at around 3.0% over the coming years. Germany's delayed rebalancing and strong business sentiment indicators (see 'Growth Outlook
Robust, But Rebalancing Slowing', February 8) are favourable dynamics for Macedonia's manufacturing exports and could encourage
a continued recovery in business investment in the EUR9.2bn economy. We forecast real GDP growth of 3.0% in 2017 and 2018, after
growth decelerated to an estimated 3.1% in 2016 from 3.8% in the previous year.

Although robust export performance and signs of improvement in fixed investment growth point to the potential for higher economic activity
rates, we note that a decline in government consumption and a renewed contraction in real gross fixed investment in Q316 (down 4.0%
y-o-y) push us to err on the side of caution. High levels of political risk will overshadow Macedonia's economic outlook over the coming years,
particularly relating to continued reform impetus, increasing concerns over Macedonia's future commitment to further EU convergence,
as well as the potential for growing ethnic tensions in the small Balkan country (see 'Failed Government Formation Another Heavy Blow
To Political Stability', March 3). Accordingly, we are moderately below consensus expectations for economic growth in Macedonia in 2017
(Bloomberg median consensus forecast: 3.2%, BMI: 3.0%), despite an above-consensus outlook on real GDP growth in Germany (1.8% in
2017 and 2018).

Growing Reliance On Construction

Rising construction sector activity and agricultural output have been key drivers of economic growth in Macedonia in recent quarters. The
construction sector still only accounts for about 7.0% of GDP, but has more than doubled since the start of 2012. Looking at construction
sector activity on a four-quarter rolling basis, the sector has been posting strong double-digit growth.

We have previously noted that sentiment in this sector has been pointing upwards, as financial conditions have been seen as improving
and public sector spending on physical infrastructure indicated boosted construction activity (see 'Investment Recovery Will Support
Strong Growth', December 1 2016). Nevertheless, although the current business situation in Macedonia's construction sector and
expectations for total orders over the coming months are seen as improving, there has been a recent dip in the assessment of future
selling prices. The year-long decline in price expectations, as illustrated by the Macedonian State Statistic Office's quarterly Business
Tendencies Survey, could catch up with investment and overall confidence levels.

2015e 2016e 2017f 2018f 2019f 2020f 2021f
Nominal GDP, EURbn 9.1 9.3 9.8 10.3 10.8 11.4 12.1
Real GDP growth, % y-o-y 3.8 3.1 3.0 3.0 3.2 2.6 2.4
GDP per capita, EUR 4,308 4,417 4,623 4,863 5,135 5,426 5,769
Industrial production, % y-o-y, ave 4.9 6.5 4.3 4.0 4.0 4.0 4.5
Population, mn 2.1 2.1 2.1 2.1 2.1 2.1 2.1
Consumer price inflation, % y-o-y, eop -0.3 -0.2 1.9 2.5 2.7 3.0 3.0
Consumer price inflation, % y-o-y, ave -0.3 -0.2 1.1 2.2 2.2 2.5 3.0
Central bank policy rate, % eop 3.25 4.00 3.75 4.00 4.50 4.50 4.50
Exchange rate MKD/USD, ave 55.45 55.59 59.71 60.29 61.50 61.50 61.50
Exchange rate MKD/USD, eop 56.49 58.48 60.29 60.29 61.50 61.50 61.50
Budget balance, USDbn -0.4 -0.3 -0.3 -0.3 -0.3 -0.3 -0.3
Budget balance, % of GDP -3.5 -2.8 -2.5 -2.6 -2.6 -2.7 -2.7
Goods and services exports, EURbn 4.4 4.8 5.4 5.8 6.4 7.1 7.9
Goods and services imports, EURbn 5.9 6.3 6.8 7.4 8.1 9.0 9.9
Current account balance, EURbn -0.2 -0.3 -0.2 -0.2 -0.2 -0.2 -0.2
Current account balance, % of GDP -2.1 -3.3 -2.5 -2.3 -1.8 -1.6 -1.4
Foreign reserves ex gold, EURbn 2.0 2.3 2.5 2.6 2.7 2.9 3.0
Import cover, months 5.0 5.2 5.4 5.3 5.1 4.9 4.7
Total external debt stock, EURbn 6.4 6.9 6.9 7.1 7.4 7.7 8.0
Total external debt stock, % of GDP 68.9 70.2 70.0 69.5 68.6 67.5 66.0
e/f = BMI estimate/forecast. Source: National sources, BMI Page 10
South East Europe | June 2017

Moderating price expectations at a time of heightened political tensions in the country could weigh on future investment activity and
lead to a more moderate growth outlook for Macedonia. This, in part, informs our more muted growth outlook for the economy. Moreover,
should the latest developments surrounding the presidential blocking of a coalition government being formed restrict Macedonia's
access to future capital transfers and multilateral structural funds, we would revisit our growth assumptions as downside risks to our
growth outlook would grow in importance.


Public Finances Sustainable But Risks Rising

BMI View: The end of fiscal consolidation efforts in Serbia will see the budget deficit widen only moderately in the next two years,
with public debt continuing to fall as a percentage of GDP. That said, with IMF support ending and EU accession remaining elusive,
greater fiscal slippage, in the absence of more reforms, cannot be ruled out.

After three years of fiscal consolidation, the budget deficit will rise slightly in 2017 and 2018, driven by decelerating revenue growth
and accelerating expenditure growth.
Public debt is set to decline gradually, but remain substantial for a developing country.
Risks to Serbia's debt sustainability will become more prominent in the coming years, including a greater chance of fiscal slippage
with IMF support ending, and EU accession looking more elusive.

Although the budget deficit is set to rise slightly for the first time in three years, Serbia's public finances will remain sustainable. Supported
by an IMF Stand-By Arrangement worth EUR1.2bn, the budget deficit has fallen from 6.6% of GDP in 2014 to 1.4% in 2016. We are expecting
the deficit to begin widening somewhat, coming in at 1.5% and 1.8% of GDP in 2017 and 2018 respectively. The widening deficit reflects
the conclusion of the government's budget deficit consolidation strategy, which has been dependent on increasing one-off revenue
sources rather than expenditure reduction, as planned in previous government budgets. However, with economic growth accelerating,
public debt as a share of GDP will decline to 70.8% by 2018, down from 72.8% in 2016.

Government spending will increase over the next few years, rising by 5.3% and 5.6% in 2017 and 2018 respectively, from a fall of 1.9% in
2015 and an increase of 3.1% in 2016. The failure to implement planned public expenditure cuts and structural reform, with the Fiscal
Council of Serbia noting that only slightly over half of the originally planned savings in 2014 have been accomplished, suggests that
certain aspects of government expenditure will accelerate. State-owned enterprises (SOEs) are a notable example of such spending, with
the 2017 Budget released in December 2016 noting that the repayment of SOE debt comprises the largest part of the planned budget
deficit in the coming years, at around RSD40bn. We anticipate that austerity fatigue will support greater public expenditure growth, with
the government agreeing to increase the salaries of public workers by around 4.0% and pensions by about 1.5% in 2017.

We also expect that revenue growth will decelerate in the coming years. The recent robust public revenue growth performance, with an annual
average of 6.2% since 2014, has primarily relied upon greater income from one-off non-tax revenues (e.g. the 4G network license sale which
earned RSD13.0bn in 2016 and the sale of construction land in Novi Sad at RSD4.0bn) and the improvement of revenue collection through
the suppression of the grey economy (see 'Revenue Outperformance Masks Precarious Finances', January 6). We expect that these sources
are now effectively exhausted, and forecast average annual growth of 4.7% in the next five years, as a more favourable macroeconomic
environment, notably through further falls in unemployment, supports subdued public revenue growth and a limited widening of the budget
deficit (see 'Faster Growth Constrained By Sluggish Investment', March 9).

No Immediate Threat To Debt Sustainability...

We do not foresee Serbia struggling to manage its substantial public debt in the coming years, as the debt repayment schedule is largely
denominated in local currency and will be easily rolled over given that bond yields are around historic lows, averaging 4.0% across 2016
and early 2017. Domestic interest rates are also at historically low levels, which will support the repayment of RSD588,725mn treasury
bonds (see 'Lower Inflation Target To Boost Credibility', January 10), and a dovish European Central Bank (ECB) will ease the repayments on
EUR2,663mn treasury bonds, representing 35% of all treasury bonds (see 'ECB Nowhere Near Tightening', December 8 2016). Moreover,
economic growth and inflation in Serbia are set to accelerate in the coming years, which will reduce the debt burden and ease debt Page 11
South East Europe | June 2017

repayments. That said, we note that Serbia's debt schedule is frontloaded and contains sizeable USD-denominated Eurobond repayments
in 2020 and 2021, which could raise pressures on debt sustainability in the medium term given further rate hikes by the Federal Reserve
(see 'Chart Pack: Payrolls Release Cements March Rate Hike', March 13).

...But Risks Are Rising

A rapid return to the large budget deficits of around 5.0% of GDP recorded between 2009 and 2014 has the potential to place an unsustainable
premium on Serbian debt through a deterioration of fiscal reform efforts moving forward, with the government placing too much confidence
in the largely one-off accomplishments of its fiscal consolidation strategy. This could result in large loss-making nationalised industries never
receiving the structural reforms necessary to resolve rising state support as revenue growth decelerates faster than anticipated. The end of
official IMF support will also increase the risk of a more pronounced deterioration in Serbia's public finances than currently forecast. The SBA
agreement struck in 2014 has anchored government policy and investor confidence in Serbia. However, the programme is set to conclude
in February 2018, which means that further fiscal slippage could place a greater weight on investor confidence.

A distant, but increasingly prominent risk comes from strained relations with Kosovo (see 'Temporary Heightening Of Tension After
Nationalist Provocation', January 18) and the sluggish pace of debt consolidation impeding Serbia's EU accession process, which requires
prospective members to hold debt levels under 60% of GDP and for Serbia to support regional stability. Should the prospect of EU
membership lose its appeal as a policy anchor as a result, the country's risk profile will become elevated further, as it marks a reduced
commitment to a more conservative fiscal policy.

2015e 2016e 2017f 2018f 2019f 2020f 2021f
Nominal GDP, USDbn 37.2 37.5 37.7 39.8 41.7 44.6 47.8
Real GDP growth, % y-o-y 0.8 2.8 2.8 3.1 3.1 3.0 3.5
GDP per capita, USD 5,229 5,295 5,340 5,664 5,960 6,392 6,874
Industrial production, % y-o-y, ave 8.3 5.0 5.0 6.0 6.5 7.0 7.0
Population, mn 7.1 7.1 7.1 7.0 7.0 7.0 7.0
Consumer price inflation, % y-o-y, eop 1.5 1.6 2.6 3.3 3.3 3.4 3.3
Consumer price inflation, % y-o-y, ave 1.4 1.1 2.4 3.0 3.2 3.3 3.4
Central bank policy rate, % eop 4.50 4.00 4.50 4.50 4.75 5.00 5.00
Exchange rate RSD/USD, ave 108.78 112.03 119.61 120.10 121.50 120.50 120.00
Exchange rate RSD/USD, eop 111.89 117.30 120.59 119.61 121.00 120.00 120.00
Budget balance, RSDbn -148.6 -57.1 -65.6 -84.8 -114.2 -146.2 -173.9
Budget balance, % of GDP -3.7 -1.4 -1.5 -1.8 -2.3 -2.7 -3.0
Goods and services exports, USDbn 17.3 19.2 19.5 21.0 22.2 24.1 26.0
Goods and services imports, USDbn 21.0 22.0 22.0 23.4 24.8 26.7 28.6
Current account balance, USDbn -1.7 -1.5 -1.3 -1.3 -1.5 -1.7 -1.8
Current account balance, % of GDP -4.7 -4.0 -3.3 -3.2 -3.5 -3.8 -3.8
Foreign reserves ex gold, USDbn 10.7 10.0 10.7 11.5 12.0 13.0 14.0
Import cover, months 6.1 5.5 5.8 5.9 5.8 5.8 5.9
Total external debt stock, USDbn 30.8 34.4 35.8 38.8 41.5 45.3 49.5
Total external debt stock, % of GDP 82.9 91.9 94.9 97.4 99.5 101.6 103.7
Crude, NGPL & other liquids prod, 000b/d 18.6 17.7 16.9 16.1 15.3 14.6 13.9
Total net oil exports (crude & products), 000b/d -59.3 -62.5 -65.0 -66.6 -64.8 -64.7 -65.8
Dry natural gas production, bcm 0.5 0.5 0.5 0.5 0.5 0.4 0.4
Dry natural gas consumption, bcm 2.3 2.4 2.5 2.4 2.4 2.7 2.8
e/f = BMI estimate/forecast. Source: National sources, BMI


Domestic Demand To Drive Economy Despite

External-Led Growth Upgrade
BMI View: We have made upward revisions to our 2017 real GDP growth forecast for Albania on an improved outlook for the external
sector. That said, the improvement will not prove long-lived and we believe that domestic demand will be the main driver of growth
over the next two years, with the construction sector a particularly bright spot.

We have revised up our 2017 Albanian real GDP growth forecast from 3.3% to 3.6% on the back of a brighter outlook in the economies of
Italy (an important trade partner and remittance source) and the wider European region in 2017. We maintain our 2018 forecast at 3.3%. Page 12
South East Europe | June 2017

Although the reason for our upgrade to the 2017 figure is related to the external sector, we maintain our view that domestic demand
will be the main driver of economic activity over the next two years. The recent upgrade to 2017 growth aside, the outlook for the Italian
economy is fairly bleak, while Greece, Albania's other important external economic partner, faces significant uncertainty over the next
two years. Domestically, however, things look far brighter, with the construction sector in particular set to benefit from a healthy pipeline
of infrastructure projects, both planned and already underway. Uncertainty surrounding upcoming elections presents the biggest risk
to our two-year outlook, with project funding and implementation likely to come into question if the election process leads to instability
or policy uncertainty.

Italian Upgrade A Temporary Boost But External Sector Outlook Remains Weak
The upward revision to our 2017 real GDP growth forecast for Italy (from 0.6% to 0.9%) is mainly due to a brighter outlook for industry
and export growth evident in a variety of survey-based and hard economic data (see 'Despite Stronger Outlook, Still Biggest Threat To
Eurozone', March 2). With around 50% of Albania's exports, which make up 30% of GDP and are comprised largely of clothing, textiles and
hydrocarbons, ending up across the Adriatic Sea in Italy, the brighter outlook for Italian growth in 2017 will provide a boost to Albanian
economic activity. Albanian growth will also benefit from greater remittance flows on the back of stronger Italian growth; around a third
of total Albanian remittances (which make up around 10% of GDP) come from Italy.

However, banking sector weakness and political uncertainty following Prime Minister Matteo Renzi's resignation in December 2016 will
stand in the way of more robust Italian growth performance over the longer term. The magnitude and longevity of the boost to Albanian
economic activity will therefore be limited.

Renewed uncertainty surrounding Greece's bailout program will also weigh on Greek growth and this will constrain remittance flows
(just under half of which come from Greece). Against this backdrop, we believe that, although the external sector is the reason for the
upgrade to our 2017 growth forecast, it will actually be a weak area for the economy beyond the near term.

Domestic Demand Will Be The Driving Force

We believe that domestic demand will be the driving force of economic activity, with both investment and private consumption set
to perform strongly in the years ahead. The authorities have an ambitious infrastructure program, with several projects that include
railway lines, roads and utilities either at planning stage or underway. These projects, many of which are being financed under a public-
private partnership (PPP) model, will keep activity in the construction sector buoyant over the next two years. Construction output
growth has outperformed other major sectors since late 2014 and we expect this outperformance to persist, especially in relation to the
manufacturing sector, which is more exposed to the ill health of Albania's main trading partners.

2015e 2016e 2017f 2018f 2019f 2020f 2021f
Nominal GDP, EURbn 12.2 10.9 11.8 12.9 15.3 16.8 17.3
Real GDP growth, % y-o-y 2.6 3.5 3.6 3.3 3.5 3.7 4.0
GDP per capita, EUR 3,822 3,398 3,655 4,003 4,732 5,175 5,324
Population, mn 2.9 2.9 2.9 2.9 2.9 2.9 2.9
Consumer price inflation, % y-o-y, eop 2.0 2.1 3.1 3.4 3.5 3.5 3.5
Consumer price inflation, % y-o-y, ave 1.9 2.0 2.6 3.3 3.5 3.5 3.5
Central bank policy rate, % eop 1.75 1.25 1.50 2.00 2.50 3.00 3.00
Exchange rate ALL/USD, ave 105.61 122.83 130.00 127.50 117.50 115.00 120.00
Exchange rate ALL/USD, eop 115.65 130.00 130.00 125.00 110.00 120.00 120.00
Budget balance, USDbn -0.5 -0.4 -0.4 -0.3 -0.3 -0.4 -0.4
Budget balance, % of GDP -4.0 -3.6 -3.1 -2.6 -2.1 -2.3 -2.2
Goods and services exports, EURbn 2.8 3.1 3.3 3.5 3.7 3.9 4.1
Goods and services imports, EURbn 4.6 4.9 5.1 5.3 5.5 5.7 5.9
Current account balance, EURbn -1.1 -1.0 -1.0 -1.0 -0.9 -0.8 -0.8
Current account balance, % of GDP -9.0 -9.4 -8.2 -7.4 -5.8 -4.9 -4.6
Foreign reserves ex gold, EURbn 2.8 2.8 3.1 3.3 3.4 3.5 3.6
Import cover, months 7.3 6.7 7.4 7.4 7.5 7.4 7.4
Total external debt stock, EURbn 7.6 8.2 8.7 9.1 9.8 10.2 10.7
Total external debt stock, % of GDP 61.0 71.2 73.5 70.8 63.9 61.0 61.8
Crude, NGPL & other liquids prod, 000b/d 22.4 18.1 17.6 17.7 17.7 17.6 17.2
Total net oil exports (crude & products), 000b/d -1.7 -5.9 -6.2 -6.0 -5.7 -5.8 -6.1
Dry natural gas production, bcm 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Dry natural gas consumption, bcm 0.0 0.0 0.0 0.0 0.0 0.3 0.3
e/f = BMI estimate/forecast. Source: National sources, BMI Page 13
South East Europe | June 2017

Strong activity in the construction sector is helping to drive down unemployment, which fell to 14.2% in Q416, the lowest level since
Q412. The decline in unemployment will help to offset weaker remittance flows and bolster private consumption. As unemployment has
fallen over recent quarters, there has been a discernible uptick in retail sales growth. We expect unemployment to continue falling thanks
to the infrastructure project pipeline, boding well for private consumption growth.

Political Risk Looming With Elections

Parliamentary elections are scheduled to take place on June 18 this year and this presents some risk to our economic forecasts. Our core
view is that Prime Minister Edi Rama's Socialist party will be returned to power, boding well for policy continuity and investor confidence.
However, the opposition has been boycotting parliament since February, demanding that the prime minister step down before the election
to allow a transitional government to oversee the vote. The main opposition Democratic Party has said that it will not participate in the
parliamentary elections if its demands are not met. The boycott could well result in elections being delayed, which would not bode well for
stability or for investor confidence, and which could see funding for infrastructure projects withheld or lead to difficulties in implementing
the projects. As such, our economic forecasts are subject to downside risks depending on how the election process unfolds.


Robust Domestic Demand Pushes Up Growth Forecast

BMI View: We have upgraded our GDP growth forecasts for Croatia to 3.3% in 2017 and 3.0% in 2018 on expectations of accelerating
domestic demand, a cyclical regional upswing and an ongoing boom in tourism.

Latest preliminary data from the Bureau of Statistics show GDP growth hit 2.9% in 2016 after the economic rebound gathered strength
in the latter part of the year. Growth in Q416 peaked at 3.4%, driven by strong private consumption and investment activity, while export
growth remained robust on the back of another bumper tourism season and improved demand in key foreign markets.

On the back of this, as well as encouraging regional trends for trade and macroeconomic stability, we have a more sanguine short-term
outlook for Croatia. We have raised our forecasts for GDP growth in 2017 and 2018 to 3.3% and 3.0%, respectively, up from 2.9% and 2.6%.

Our forecast upgrade is based on the assumption that the key dynamics driving growth in 2016 will remain in place in the coming quarters.
Chief among these is the acceleration of household consumption, which rose by 3.3% in 2016 on the back of improved confidence
and rising disposable income. A deal with key public sector unions to provide a 6% wage hike triggered, as promised under a 2009

2015e 2016e 2017f 2018f 2019f 2020f 2021f
Nominal GDP, EURbn 43.9 45.6 46.6 48.1 50.3 52.8 55.4
Real GDP growth, % y-o-y 1.6 2.9 3.3 3.0 2.6 2.4 2.4
GDP per capita, EUR 10,305 10,744 11,039 11,419 11,994 12,631 13,297
Industrial production, % y-o-y, ave 2.4 5.1 5.0 3.0 3.0 3.0 3.0
Population, mn 4.2 4.2 4.2 4.2 4.2 4.2 4.1
Consumer price inflation, % y-o-y, eop 0.1 0.7 1.8 2.3 3.0 3.0 3.0
Consumer price inflation, % y-o-y, ave -0.3 -0.6 1.6 2.0 2.4 3.0 3.0
Exchange rate HRK/USD, ave 6.86 6.81 7.45 7.66 7.83 7.86 7.89
Exchange rate HRK/USD, eop 7.02 7.18 7.65 7.67 7.84 7.88 7.90
Budget balance, USDbn -1.6 -0.8 -0.7 -0.6 -0.7 -0.7 -0.7
Budget balance, % of GDP -3.2 -1.6 -1.5 -1.3 -1.3 -1.3 -1.3
Goods and services exports, EURbn 21.5 22.8 24.0 25.2 26.6 28.0 29.6
Goods and services imports, EURbn 20.4 21.4 22.7 24.2 25.8 27.5 29.4
Current account balance, EURbn 2.1 1.2 0.9 0.6 0.2 -0.3 -0.7
Current account balance, % of GDP 4.8 2.6 2.0 1.3 0.5 -0.6 -1.2
Foreign reserves ex gold, EURbn 12.8 13.1 14.6 16.2 17.0 19.0 21.0
Import cover, months 7.4 7.4 7.7 8.0 7.9 8.3 8.6
Total external debt stock, EURbn 40.0 39.9 39.1 39.9 41.5 43.7 46.3
Total external debt stock, % of GDP 89.4 83.2 83.1 83.0 82.5 82.7 83.6
Crude, NGPL & other liquids prod, 000b/d 16.3 18.1 17.4 16.7 16.1 15.5 15.0
Total net oil exports (crude & products), 000b/d -50.3 -43.9 -55.9 -58.1 -60.2 -62.5 -64.9
Dry natural gas production, bcm 1.5 1.4 1.4 1.3 1.3 1.3 1.2
Dry natural gas consumption, bcm 2.6 2.7 2.7 2.8 2.9 2.9 3.0
e/f = BMI estimate/forecast. Source: National sources, BMI Page 14
South East Europe | June 2017

agreement, after two consecutive quarters of growth above 2% in three installments during 2017 will provide another boost to real
income, as will tax cuts that came into effect at the start of the 2017 and the government's decisions to delay gas prices increases until
the end of the year.

We also expect an acceleration in business investment due to a more stable political climate, as well as a boost from the increased
absorption of EU funds and recent government measures to trim costs and remove bureaucratic hurdles for corporations. A gradual
improvement in the health of the financial sector should pave the way for a recovery in credit growth to support renewed investment
activity. Business confidence will also be buoyed by reduced fiscal risks, reflected by the decision of all three major international ratings
agencies to upgrade their outlook on Croatia's sovereign rating from negative to stable in recent months.

There are also other factors that will support faster short-term growth. The tourism sector continues to expand, and is likely to post robust
growth in 2017 (first estimates suggest a 20% y-o-y surge in arrivals in the first two months of the year). This will provide the double
benefit of direct export income and an indirect boost for wages and employment. Meanwhile, a regional and global cyclical upswing will
continue to drive export growth, with BMI recently upgrading forecasts for major trade partners, including top three export destinations:
Italy, Slovenia and Germany.

Sanguine Medium-Term Outlook

We maintain our view that growth will moderate in 2018 as a return to inflation erodes the positive impact of real wage growth, particularly
as the government is set to increase domestic gas prices sharply after delaying hikes this year. In addition, the overall impact of net
exports is likely to turn negative as domestic demand fuels faster import growth. This will be compounded by higher prices of imported
fuel as we expect global oil prices to rise during 2017 and further still in 2018.

Nonetheless, the outlook remains relatively upbeat compared to the last decade, with annual growth expected to remain in the 2.5-3.0%
range through to 2020. Our core medium-term view remains that structural flaws will undermine Croatia's growth potential and limit
convergence with more developed EU states. Chief among these is the extensive involvement of unwieldy State-Owned Enterprises
(SOE) in the domestic economy, while weak labour productivity and a relatively unwelcoming business climate are also deterrents to
investment. The country also faces longer-term problems related to an ageing population and high levels of emigration, which both
threaten to reduce the size and skill of the local workforce.


Policy Stagnation Remains A Risk To Economic Prospects

BMI View: The incumbent DPS formed a coalition government with a narrow majority on November 28 2016, which was in line with
our expectations. It is likely that broad policy continuity will remain intact over the coming years, but there is a high risk of policy
stagnation, which is reflected in sluggish economic reforms, especially on the privatisation of state companies. Together with the
potential for the opposition parties to create tensions, the business environment will likely suffer.

In line with our expectations, the government of Montenegro was formed on November 28 2016 by the ruling Democratic Party of
Socialists (DPS), which won the most seats at 36 out of 81 in the October 16 parliamentary elections, through a coalition with parties that
have previously collaborated with the ruling party. These include the centre-left Social Democratic Party (SDP, four seats) and parties
representing ethnic minorities such as the Bosniak Party (BS, two seats), Albanians Decisively (AO, one seat) and the Croatian Civic
Initiative (HGI, one seat).

Broad Policy Continuity, But High Risks Of Policy Stagnation

With the DPS still in power and having a narrow majority, we believe that Montenegro will likely enjoy broad policy continuity over the
coming years, even as Duko Markovi has taken over from Milo ukanovi (who has served Montenegro either as prime minister or
president for most of the past quarter of a century) as prime minister. ukanovi resigned just after the elections, nominating Markovi,
but history shows that he has frequently returned to office (either as PM or President) after resignations, and he could still be wielding
power from behind the scenes. The dominance of a single party over a long period of time runs the risk of policy stagnation. Page 15
South East Europe | June 2017

The country ranked 51st out of 190 countries on the World Bank's 2017 Ease of Doing Business report, but its score of 72.1 out 100 is only
slightly above the regional average of 71.1 for Europe and Central Asia, and below that of Bulgaria (73.5), Serbia (72.3) and Hungary (73.1).
This suggests that the DPS government has room to improve the openness of the country to foreign investors.

Privatisation Plans Have Been Underwhelming Since 2015 Announcements

Montenegro's government has been looking to enact economic reforms, with the Council for Privatisation and Capital Projects, chaired
by ukanovi, having announced its privatisation plans in early 2015. Its aims of boosting the competition and efficiency of the state-
owned sector by breaking down barriers to entry are positive, but the progress so far has been underwhelming. This, in our view, strongly
indicates that the government is unwilling to loosen its control, even though it has began the tendering process for some companies.
For example, the national air carrier, Montenegro Airlines, has been on the privatisation list for years, and the government aims to keep
a majority stake in the company. The transport minister, Osman Nurkovi, also added that: 'there have not been appropriate conditions
for the sale of the air carrier.' The only sign of progress is that policymakers started negotiating the privatisation of the airline with Etihad
Airways back in February 2016.

Opposition To Continue Creating Tensions

The highly volatile political situation in Montenegro has calmed down somewhat, but we believe that the opposition, in particular the
Democratic Front (DF), will continue to challenge the ruling DPS and attempt to force the party out. The opposition parties all refuse to
recognise the results of the parliamentary elections as they claim that the voting process was marked with numerous irregularities such
as the blocking of popular messaging services for several hours during the elections. With the official unemployment rate still remaining
elevated at above 20%, it is likely that the opposition will take the opportunity to blame the ruling party. In addition, it is likely that the DF
will organise public demonstrations against the government.

Downside Risks To Economy

The aforementioned factors are negative for Montenegro's business environment, and they are therefore likely to put a cap on the
country's economic growth prospects, despite our expectations for investment and the tourism sector to drive growth. We are forecasting
the country's real GDP growth to pick up to 2.9% in 2017 from an estimated 2.0% in 2016, still be below the rate of 3.2% registered in 2015.

2015e 2016e 2017f 2018f 2019f 2020f 2021f
Nominal GDP, USDbn 4.8 4.3 3.7 4.3 4.6 5.0 5.4
Real GDP growth, % y-o-y 3.2 2.0 2.9 3.4 3.4 3.4 3.1
GDP per capita, USD 7,686 6,843 5,945 6,850 7,413 8,092 8,664
Industrial production, % y-o-y, ave 9.2 -8.7 1.5 3.1 3.7 4.1 4.0
Population, mn 0.6 0.6 0.6 0.6 0.6 0.6 0.6
Consumer price inflation, % y-o-y, eop 1.4 2.0 2.2 2.2 2.2 2.2 2.2
Consumer price inflation, % y-o-y, ave 0.5 1.7 2.1 2.2 2.2 2.2 2.2
Exchange rate EUR/USD, ave 0.90 0.90 0.97 0.98 1.00 1.00 1.00
Exchange rate EUR/USD, eop 0.92 0.95 0.98 0.98 1.00 1.00 1.00
Budget balance, EURbn -0.2 -0.2 -0.1 -0.1 -0.1 -0.1 -0.1
Budget balance, % of GDP -5.4 -4.4 -3.4 -2.4 -1.9 -1.2 -1.0
Goods and services exports, USDbn 1.7 1.8 1.9 2.1 2.2 2.4 2.7
Goods and services imports, USDbn 2.4 2.6 2.6 2.8 2.9 3.2 3.4
Current account balance, USDbn -0.5 -0.5 -0.5 -0.5 -0.5 -0.5 -0.5
Current account balance, % of GDP -11.1 -12.3 -13.7 -12.2 -11.4 -10.6 -10.1
Foreign reserves ex gold, USDbn 0.7 0.8 0.8 0.9 0.9 1.0 1.1
Import cover, months 3.5 3.5 3.8 3.8 3.9 3.8 3.8
Total external debt stock, USDbn 2.7 2.7 2.8 2.8 2.9 3.0 3.0
Total external debt stock, % of GDP 55.8 64.4 75.6 66.7 63.0 59.2 56.7
e/f = BMI estimate/forecast. Source: National sources, BMI. Page 16