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– A surprisingly strong rebound in the first half of this year boosted economic activity in emerging market and developing countries in the Europe and Central Asia region, with the regional economy now projected to expand by a better-than-expected 5.5 percent in 2021, says the latest edition of the World Bank’s Economic Update for the region, released today. The Croatian economy has also recorded a strong recovery, with GDP growth for 2021 now forecast at 7.6 percent.

The rebound in the region was largely driven by a strong recovery in exports during the first half of this year, as activity in the Euro area bounced back and commodity prices rose sharply, as well as strengthening domestic demand due to vaccinations and support packages. The boost to exports, however, may be fading due to the ongoing global and regional spread of more contagious COVID-19 variants, which has also dampened the recovery in regional domestic demand.

In Croatia, GDP growth was broad based with all components of aggregate demand positively contributing to such developments, supported by less stringent social distancing restrictions, higher external demand, and improved labor market conditions. Strong economic activity continued also in the third quarter with tourism activity rebounding much faster than previously expected.

In 2022, regional growth is forecast to moderate to 3.4 percent, as external and domestic demand stabilize, and pandemic stimulus is withdrawn. The outlook remains highly uncertain given the continuation of the pandemic, especially in the context of unequal vaccine access and hesitancy. The regional recovery has been accompanied by a rapid acceleration of inflation and remains vulnerable to financial stress, which could be triggered by an abrupt tightening of external financing conditions or a sharp rise in policy uncertainty and geopolitical tensions. In Croatia, if a broadly favorable epidemiological situation continues and social distancing measures remain limited, strong and broad-based growth is expected to continue over the 2022-2023 period.

“The pandemic continues to shape the economic outlook for Europe and Central Asia. However, with vaccination rates picking up in the region, policymakers can now focus on ensuring that the post-pandemic recovery is inclusive, resilient and sustainable. Ensuring a competitive business environment that facilitates entrepreneurship and fosters private sector dynamism are important for long-term growth,” said Anna Bjerde, World Bank Vice President for Europe and Central Asia.

A special analysis on ‘Competition and Firm Recovery after Covid-19’, using data from World Bank Enterprise Surveys and Business Pulse Surveys, finds that the pandemic had a profound and varied impact on firms. On average, firms in the region saw significant drops in monthly sales and number of full-time employees. By May this year, one in four firms anticipated falling into arrears on outstanding liabilities in the next six months. Smaller, younger, and female-run businesses had not yet seen their sales improve since the initial drop.

Crises can be devastating for many firms, but they often have a silver lining, reallocating resources from less productive to more productive firms. There is also evidence of this in Europe and Central Asia, particularly in countries with more competitive markets. Indeed, firms with high pre-crisis labor productivity experienced significantly smaller drops in sales and employment than firms with low pre-crisis labor productivity. More productive firms were also more likely to adapt to the crisis by increasing online activity and remote work.

“The role of competition is important because it is associated with dynamism, incentivizes firms to innovate, forcing more efficient firms to enter and grow, while facilitating the exit of less efficient ones,” said Asli Demirgüç-Kunt, World Bank Chief Economist for Europe and Central Asia. “In countries with more competitive markets and stronger policies that protect competition, this reallocation towards more productive firms was even greater.”

Many governments implemented broad policy support programs to promptly address the initial economic fall-out from the crisis. These policies provided immediate relief that protected firms and workers from the worst effects. While the reach of government support measures varied widely across countries, on average 50 percent of firms reported receiving some government support in response to the economic fall-out of the pandemic. In Croatia, a large fiscal stimulus package and introduction of loan moratoriums protected employment and prevented a sharper economic contraction and rise in poverty.

Overall, based on the surveys, less productive firms were more likely to receive government support, larger firms were more likely than smaller firms to receive support in the form of payment deferrals and fiscal relief, and support measures were given to firms regardless of the level of their pre-crisis innovation. In Croatia, SMEs were the largest recipient of support in the form of employment protection subsidies while large companies relied more on loan moratoriums, guarantees and new loans.

As economies enter the economic recovery phase, it will be important for policy makers in all countries to phase out broad policy support measures as soon as appropriate and focus on fostering a competitive business environment which is key to a strong recovery; resilience to future crises; and sustainable, long-term economic growth.

Most countries in Europe and Central Asia can improve both the institutional framework and enforcement of laws for a strong competition environment, including policy reforms to strengthen insolvency and dispute resolution, ease entry for new firms, and improve financial sector capacity to provide credit for the business sector.

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