The New Member States in the context of the European financial and economic crisis: differentiation and prospects Michael A Landesmann

1
The New Member States in the context of the
European financial and economic crisis
differentiation and prospectsMichael A
Landesmann

• Lecture at the University of Finance and
  Administration, Prague, 25.11.2011

2
Topics to be covered

• Features of the European economic and financial
  crisis
• The position of Emerging Europe GIPSI and
  CEECs
• The growth model of the CEECs pre-crisis
• The crisis and pitfalls in the growth model
• Differentiation across CEE economies
• Prospects and policy lessons

3
The growth model in the NMS prior to the crisis

• In the last two decades the region experimented
  with unique model of growth through integration
  into the EU
• Key features
• Strong institutional anchoring a model of
  unconditional convergence
• Trade and FDI integration
• Financial integration (downhill capital flows)
• (Labour mobility)
• Made considerable sense in view of initial
  conditions
• Foster institutional build-up after transition
• Substitute lack of domestic saving by foreign
  saving
• Make use of wealth of human capital

3
4
Pre-crisis growth model, contd

• Integration boosted capital inflows
• low level of physical capital offering higher
  return on capital complementary highly-educated
  labour force and low level of wages
• EU accession prospect and improvement in the
  business climate
• low level of domestic credit offering the
  potential for substantial credit expansion
• Seemingly low exchange rate risk
• Rapid productivity growth up-grading of
  production and trade structures

5
Features of the pre-crisis growth model

• targeted at integration with the EU area
• was associated with significant internal and
  external liberalization (trade, capital
  transactions, financial market integration,
  labour mobility)
• benefits capital inflows, trade integration,
  technology transfer institutional convergence
• the model worked - convergence process but
  emergence of severe structural imbalances (not
  everywhere)

6
Growth GDP at constant pricesAverage annual
growth rates, 1995-2002 and 2002-2008, in
1995-2002
2002-2008
Source wiiw Annual Database incorporating
national statistics, Eurostat.
7
Growth GDP at constant pricesAverage annual
growth rates, 2002-2008, in
8
The NMS/CEECs and the build-up to the crisis

• Features of the development experiences prior to
  the crisis
• Differentiation across NMS/CEECs
• - Extent of external imbalances
• - Private vs. public debt build-up
• - De- and re-industrialisation and the build-up
  of export capacity
• - Differences in the sectoral allocation of FDI

9
CEECs and comparisons with other emerging
economies

• CE-5 Czech Republic, Hungary, Poland, Slovakia
  and Slovenia
• BB-5 Bulgaria, Romania (SE-2) Estonia, Latvia,
  Lithuania (B-3)
• WB-6 Albania, Bosnia and Herzegovina, Croatia,
  Former Yugoslav Republic of Macedonia, Montenegro
  and Serbia
• EU-Coh (Ireland), Greece, Portugal, Spain
• Asia-6 Indonesia, Korea, Malaysia, Philippines,
  Taiwan and Thailand
• Latam-8 Argentina, Brazil, Chile, Columbia,
  Ecuador, Mexico, Peru and Uruguay

10
Common characteristic 1 Reliance on foreign
savings
Post-1998, Asia and even Latin America go into
surplus
Until 2007, most of emerging Europe goes into
deficit
10
11
Net private financial flows in the main emerging
country regions (GDP), 1980-2009
12
Composition of the current account of the balance
of payments, 1995-2009

• Note ASIA-6 excl. Taiwan.Source IMF
  International Financial Statistics and IMF WEO
  October 2010.

13
Net foreign assets, 2008in of GDP

• Source wiiw Annual Database incorporating
  national statistics, Eurostat.

14
Composition of the current account of the
balanceof payments, 1994-2010, in of GDP

• Source wiiw Database incorporating Eurostat
  statistics.

15
Net private financial flows in of GDP,
1993-2009
LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 SEE-2
B-3 WB-6 TR

• Source IMF Balance of Payments Statistics.
  ASIA-6 excl. Taiwan.

16
Net private financial flowsin of GDP, 1995-2010
Folie 55

• Source wiiw Database and Eurostat

17
Common characteristic 2Credit booms
Slowdown in Asia
Boom in emerging Europe (from very low levels)
Slowdown in LatAm
17
18
CESEE GDP growth was well above the interest
rate before the crisis

• Nominal interest rate on government debt and
  nominal GDP growth (), 2000-2010

• Note Interest rate government interest
  expenditures / previous year gross debt.

19
Common characteristic Foreign bank ownership,
1998-2005 (assets owned by foreign banks as of
banking system assets)
20
Common characteristic 3Its not mostly public
debt
If anything, more favourable public debt
developments until 2008, especially in BB
countries
20
21
Savings and investment in of GDP
CE-5
Baltics
SEE
NMS-5 CZ,HU,PL,SK,SI (from 2000-2007). SEE BG
(2000-2006) and RO (from 2004-2007). Source
wiiw Annual Database incorporating national
statistics, Eurostat.
22
External debt public and private ( of GDP),
2008

• Note ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY.
  B-3 excl. FYROM, BA, RS.
• Source World Bank, World Databank.

23
Gross private and public debt ( of GDP), 2009

• Source Eurostat, IMF.

24
Relationship between pre-crisis credit growth and
current account balances
25
DifferencesReal exchange rate developments
Misalignment in the Baltics/Balkans
Appreciation hands-in-hands with catching-up in
Central Europe
Stable real X-rate in Asia post crisis
25
26
DifferencesComposition of capital flows
NFA as percentage of GDP, 2006-2008
Mostly FDI in central Europe
Mostly credit in Baltic countries
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27
Summary of pre-crisis growth period and
differentiation amongst the CEECs

• CEE region in general had a classic pre-crisis
  pattern of catching-up with down-hill capital
  flows other emerging economy regions had changed
  their patterns
• A lot of differentiation amongst CEECs
• - extent of capital inflows
• - nature and composition of capital inflows
• - private and public debt build-up
• - real exchange rate (mis)alignments

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Differentiation amongst the CEECsfurther
relevant features

• Prior periods of de- and re-industrialisation
• Exchange rate regimes
• Distortions tradable/non-tradable sectors
• Structure and up-grading of export sector

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Industrial production, cumulative change
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Differences in the composition of FDI
Large part in real estate, finance in Baltic
region
Large part in manufacturing, infrastructure,
trade in central Europe
30
31
Real lending NB/ECB interest rates, 2008-2010
CPI-deflated, in p.a.
Flexible ER
Fixed ER
Note For Estonia 1-month interbank lending rate
(Talibor) for Lithuania 1-month interbank
lending rate (Vilibor). Source Eurostat.
32
Structural features the role of exchange rate
regimes Fixers and floaters amongst the CESEEs
  CESEE float CESEE fix
Credit/GDP, change from 2004 to 2008 (percentage points) 20.5 32.8
Real interest rate average, 2005-2007 1.6 -1.6
Current account balance/GDP, 2007 () -6.6 -11.8
Gross external debt, 2009 ( of GDP) 78.8 95.6
GDP-growth, 2008-2010 1.18 -1.78
FDI to finance and real estate sectors, 2007 (per cent of total FDI stock) 26.5 40.2
Change in unemployment rate from 2007 to 2010 (percentage points) 1.5 3.9

• Source wiiw calculations.

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The crisis and its aftermath

• Sudden stops in net capital flows
• Turn-around in current accounts
• - differences in GDP declines
• - sharp credit contraction
• - differences between fix-ex and flex-ex
  countries

34
GDP, 2008 Q3 100 (2005 Q12010 Q2)
CE-5 Czech Republic, Hungary, Poland, Slovakia
and Slovenia Baltic/Balkan-5 Bulgaria,
Estonia, Latvia, Lithuania and Romania Asia-6
Indonesia, Korea, Malaysia, Philippines, Taiwan
and Thailand Latam-7 Argentina, Brazil, Chile,
Columbia, Ecuador, Mexico and Uruguay
Starting point severe shock and weak recovery
35
Development of real GDP1995100

• Source wiiw Database incorporating Eurostat
  statistics.

36
Net private financial flowsin of GDP, 1995-2010
Folie 55

• Source wiiw Database and Eurostat

37
Net capital flows to CESEE countriesin of GDP

• Source IMF.

38
Composition of the current account of the
balanceof payments, 1994-2010, in of GDP

• Source wiiw Database incorporating Eurostat
  statistics.

39
Current accountin of GDP
CE-5
Baltics
SEE
NMS-5 CZ, HU, PL, SK, SI. Baltics EE, LV, LT.
SEE BG, RO, HR, MK, BA (from 1998), RS (from
1999), ME (from 2001). Source wiiw Annual
Database incorporating national statistics,
Eurostat.
40
Pre-crisis credit growth and GDP growth in 2009
41
Quarterly GDP developments (2008Q3100),
2005Q1-2010Q2
42
Bank loans to non-financial private sectorchange
in against preceding year

• Source National Bank of respective country.

43
Development of gross industrial
productionSeptember 2008 100, Seasonally
adjusted

• Source wiiw Database incorporating Eurostat
  statistics.

44
Development of quarterly household final
consumption3Q08 100, Seasonally adjusted and
adjusted data by working days

• Source wiiw Database incorporating Eurostat
  statistics.

45
Interest rates on government bondsMaturity 10
years

• Source International Finance Statistics (IMF),
  Eurostat,National Banks and National Ministries
  of Finance.

46
Interest rates - Loans to non-financial
corporationMaturity between 1 and 5 years

• Source Eurostat

47
Non-performing loansin of total

• Note Non-performing loans defined as credits
  more than 90 days overdue. EE loans more than 60
  days overdue.
• Source National Bank of respective country.

48
Real appreciation, 2008-2010EUR per NCU, PPI
deflated, January 2008100
Values over 100 indicate appreciation relative
to January 2008. Source wiiw Database
incorporating national statistics.
49
Real appreciation, 2008-2010EUR per NCU, PPI
deflated, January 2008100
Values over 100 indicate appreciation relative
to January 2008. Source wiiw Database
incorporating national statistics.
50
Contributions to the GDP growth ratesin
percentage points )

• ) Contributions of changes in inventories are
  not shown. Source wiiw estimates incorporating
  national sources.

51
Contributions to the GDP growth ratesin
percentage points )

• ) Contributions of changes in inventories are
  not shown. Source wiiw estimates incorporating
  national sources.

52
Development of unemployment rates (LFS)

• Source wiiw Database incorporating Eurostat
  statistics.

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Resurrecting growth?

• New constraints following the crisis

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Constraints following the crisis

• Internal factors
• Deleveraging of private sector, affects
  private sector spending
• Public debt has gone up less fiscal space
• Weak and cautious banking sector
• Differentiated processes of real exchange rate
  adjustments

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Constraints following the crisis

• External factors
• Volatile risk assessment of the region (debt
  overhang)
• Difficult external (and internal) financing
• Contagion effects of banking crisis in Western
  Europe consolidation process of banks balance
  sheets
• Reduced growth expectations in the most important
  export markets
• Crisis in the eurozone new OCA debate
  unfinished governance structure leads to
  wait-and-see w.r.t. EMU membership

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Principal policy lessons

• In national and EU policy frameworks neglect of
  private sector debt build-up relative to public
  sector
• Fixed exchange rate regimes bear high risks much
  stronger emphasis on OCA criteria on the way to
  EMU and after
• Financial market regulation severely
  underdeveloped specific issue of cross-border
  banking
• Use of taxation or insurance to prevent bubbles
  in financial markets (sand in the wheels taxes on
  particular types of investments)
• Use scope for counter-cyclical policy, but beware
  of debt sustainability and restructure public
  finance in growth-enhancing manner
• Direct policies towards tradable sector
  structural policies, avoid distorting
  macro-policies use EU funds

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Unresolved issues

• Will Euro-zone deal with governance issues?
• Will there be recapitalisation of banks?
• What would be repercussions of a break-up of the
  Euro-zone?
• New timetables if at all for further
  Enlargements and EMU memberships