Klas Eklund Riga, January 24, 2003

1
Klas EklundRiga, January 24, 2003
THE ROAD TO THE EU AND THE EURO CONSEQUENCES
FOR POLAND AND THE BALTIC ECONOMIES
2
TOPICS

• General macro overview
• Macroeconomic effects of EU accession
• Investment and migration
• Policy challenges
• The road to the euro
• The company perspective
• Institutional challenges

3
GLOBAL UNCERTAINTY

• Lengthy hangover from the burst bubble -
  underestimated by most economists
• What potential US growth rate after the burst
  bubble?
• Deflation or reflation?
• Will there be a war?
• How long will Germanys troubles persist?

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THE GLOBAL ENVIRONMENT

• A wobbly international environment
• Slow European growth - bleak German performance
• Volatile financial markets
• Bond yields up in 2003
• Euro somewhat stronger
• Baltics and Poland must rely on own strength
• - and impetus from EU convergence

5
BALTICS POLAND

• Impressive shift to independence and democracy
• Credible fiscal policies, but external
  vulnerability
• Positive medium term growth outlook
• Potential growth rates 5-6 in Baltics, 4-5 in
  Poland
• Main constraints Ageing populations in Baltics,
  weak public institutions, oversized public sector
  and imbalanced economic policy in Poland
• Fairly attractive to foreign investors
• What impact of EU/EMU?

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THE EU

• Single market
• Increasing trade within EU
• Increasing investments
• Utilising economies of scale
• Higher productivity growth
• Cross border transfers
• But also increasing transformation pressure and
  vulnerability for individual companies and sectors

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REAL CONVERGENCERatio of per capita GDP to EU
average
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CONVERGENCE TO CONTINUE
GDP/cap level of EU av.
Price level of EU av.
Source EU Commission, Nov 2002
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GROWTH PROJECTIONS FOR NEW MEMBERS 2005-2009

• 2.9
• 4.6
• 6.1

• Reference
• No EU membership
• No changes
• Central scenario
• Integration into Internal Market
• Increasing FDI
• Sectoral shifts
• Optimistic
• Comprehensive reforms
• Rapid sectoral shifts

Source EU Commission 2001
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FISCAL PRUDENCE - AND TRANSFERS

• Macroeconomic stability in EU presupposes strong
  public finances
• Avoid crowding out, support low inflation and c/a
  stability
• Stability Pact Balanced budgets or surpluses to
  have room for stabilisation policies
• Challenge Tax revenue
• Political aim to cut taxes - while reaching
  surpluses
• EU harmonisation ahead - meant increasing taxes
  in Club Med
• EU transfers and common tariff
• Necessary Strict budget procedures,
  institutional reform

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MAIN STRUCTURAL REFORMS NEEDED IN ENTERPRISE
SECTORSAccording to EU Commission

• Strengthen SMEs
• Complete privatisation
• Liberalise utilities
• New bankruptcy law
• Stamp out corruption
• Strengthen SMEs
• Continue privatisation
• Liberalisation of Energy
• New bankruptcy law
• Strengthen SMEs
• Continue privatisation
• Restructure industries
• Promote entrepreneurship
• Revise bankruptcy law

• Estonia
• Latvia
• Lithuania
• Poland

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EUROPEAN FDI TO SPAIN AND CANDIDATE COUNTRIESBn
USD
Source laCaixa
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MIGRATION FROM NEW MEMBERS TO OLDAnnual
migration from year 1 of membership, Per cent of
home countries population
Source EU Commission, 2001 Note Peak equals
some 220,000 persons
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THE EMU

• Strengthens the single market
• Transparency, economies of scale, lower costs
• Means higher productivity and growth
• But also
• Greater pressure on individual companies through
  pricing
• Greater difficulties in finding an optimal
  stabilisation policy
• Monetary policy decided in Frankfurt, fiscal
  policy left on the national level
• And some risks along the road

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TIME TABLE FOR BALTICS AND POLAND

• Referendum 2003
• EU accession May 2004
• ERM Autumn 2004? Maybe even spring?
• No great change for Estonia Lithuania
• But Latvia and Poland must peg to EUR
• 2005-2006 Assessment of Maastricht criteria
• EMU entry January 2007?
• Maybe 2006 if short ERM period is allowed?

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MAASTRICHT CRITERIAMembers-to-be 2001, Club Med
1994
Budget Debt Inflation Bond deficit
yields
Estonia 0.5 5 5.8 6.8 Latvia -1.6 16 2.5 10.2
Lithuania -1.9 23 1.3 6.3 Poland -3.9 39 5.3 8.4
Average -1.7 21 3.7 7.9
Portugal -5.9 61 6.9 9.5 Spain -6.7 59 5.3 10.1
Italy -9.4 118 5.5 11.1 Greece -10.5 109 8.9 n.
a Average -8.1 87 6.7 10.2
Source CEPS 2002
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VULNERABLE EXTERNAL POSITIONS

• All four countries run c/a deficits
• Dependence on FDI makes them vulnerable to shifts
  in investor confidence

Source SEB Baltic Outlook, Oct 2002
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POSSIBLE STRAINS DUE TO MAASTRICHT CRITERIA ERM

• Criteria are nominal
• Low inflation, low interest rates, low debt, low
  budget deficit, stable exchange rate
• But a higher inflation is natural during the
  catch-up process
• To fight it with appreciating currency is not
  compatible with ERM - and to respond to stronger
  currency with low interest rates (Hungary!) may
  cause even higher inflation
• To fight it with tight budgets is politically
  difficult
• So Nominal criteria can cause real problems

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EXCHANGE RATES

• Baltic states should not face severe problems
• Poland A conflict between the need for a weak
  zloty and appreciation pressure
• Conclusion Preserve flexibility as long as
  possible!
• Or persuade ECB to move straight from currency
  boards to the euro
• Probable compromise Keep currency boards within
  ERM
• Or to adjust inflation target up

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THE NEED TO FIND THE RIGHT CONVERSION RATE

• Strong currency
• Slower exports - slower growth - lower inflation
  - higher real rates - negative effect on asset
  markets - even slower growth
• Weak currency
• Stronger exports - stronger growth - higher
  inflation - lower real rates - booming asset
  markets - even stronger growth

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STRATEGIC CHOICES FOR COMPANIES

• Larger domestic market
• Single market and common currency will give
  economies of scale
• New procurement policy, aiming for the whole of
  EU
• Price transparency for comparable products
• Sharper competition More competitors and pricing
  in common currency
• Higher costs for consumer environment
  protection
• Less graft corruption. Insider contacts less
  important

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WINNERS OR LOSERS?

• More joint ventures will come
• Deeper integration of East European firms into
  supply chains of leading Western manufacturers
• To make only operational preparations is a
  defensive policy for short-term survival
• An aggressive, long-term strategy means focusing
  on markets, competitors, products and prices
• The choice made can make the difference between
  survival or disaster

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CONSEQUENCES FOR BANKS

• Opportunities for cross-border business in EU
• Means also tightening competition
• EU structural funds will support projects -
  opportunities to participate as a co-financier
• EMU means smaller FX volume
• Less volatile interest rates devaluation risks
  disappears
• Potentially stronger demand for lending - but
  watch out for changing credit risks!
• Prepare new euro products!
• Prepare systems updates!

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INSTITUTIONAL REFORMS

• More members mean todays institutions must
  modernise
• The Nice treaty
• The ECB
• The Stability Pact
• The need for institutional reform of national
  fiscal policy
• The Convention
• The Nordic/Baltic fear of a superstate Lets
  work together for openness!

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CONCLUSIONS

• EU membership is beneficial to growth
• But a challenge to companies - and individuals
• Transformation pressure will sharpen
• Prudent fiscal policy necessary
• ERM is a risk
• Several imbalances may result
• Institutional reforms on EU and national level
  will change economic policy-making
• Companies face crucial strategic decisions
• As do banks!