Launch Forum:

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• Launch Forum
• Regional Impact of the Global Economic Crisis
• Yerevan, 8 July 2009

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Development and Transition newsletter

• Published three times annually by UNDP, London
  School of Economics
• Distributed to
• All UNDP staff in Europe, Central Asia region
• 3000-plus external subscribers
• Goals
• Provide UNDP, independent views on development,
  transition issues in the region
• Disseminate lessons of successful UNDP projects
• Current issue Regional impact of global economic
  crisis

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Presentation goals

• Focus on some key economic policy issues that
  are
• Explored in the newsletter
• Not covered by the other presentations
• Relevant for Armenia
• These are
• Lessons from the Baltic economies collapse
  (Rainer Kattel)
• Eurozone expansion? (Anders Åslund)
• Banking nationalisation (Anja Shortland)

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Baltic conundrumThe Baltic states

• Did a lot of things right . . .
• . . . But still became regions worst crisis
  victims (along with Ukraine)
• Large declines in GDP, incomes, employment
• Much development progress lost
• No end to the crisis in sight
• Realistically, its not clear that Baltic policy
  makers could/should have done something
  differenteven ex post
• Conclusion Black swans can be deadly

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Baltic model Some similarities with Armenia

• Macro characteristics
• Relatively small state sectors
• Small role of state redistribution
• Privatisation to foreign investors (including
  banks)
• Currency-board/hard-peg exchange rates
• Micro characteristicsLiberal approach to
• Tax systems (flat tax pioneers)
• Labour market regulation
• Social protection systems
• Structural characteristicsVery small, open,
  transition economies
• Small domestic savings poolsFDI needed
• Weak diversification prospects

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Structural comparison (2008 data)
In mlns
(XM)GDP
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Pre-crisis performance Good on GDP growth . . .
Average annual GDP growth 2005-2008
points above NMS average
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. . . And employment
Average annual employment growth 2005-2007
point difference from NMS average
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Reforms did not hurt state finances . . .
General government budget ( of GDP), annual
averages for 2002-2007 period. Eurostat data.
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. . . Or produce large public debts
General government debt, of GDP, 2007. Eurostat
data.
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Crisis hits Baltics first (in 2008) . . .
Source IMF World Economic Outlook, April 2009
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. . . And deepens in 2009Q1
Change relative to 2008Q1. Sources Eurostat,
CIS Statistical Committee, national statistical
offices, JPMorgan, press reports.
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Unemployment Baltics hit hard here, too
Numbers of unemployed (LFS data), June 2008 100
Romania not included
Source Eurostat
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Cause Rapid growth in private sector foreign debt
Ratio of gross foreign debt to GDP. EIU data,
UNDP calculations.
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Large current account deficits financed by parent
banks

• Baltic banks
• Privatised in 1990s to Scandinavian banks
• Benefitted from parents
• Financing of rapid credit growth
• Corporate governance
• Credit growth aided by
• Fixed exchange rates
• EU accession (free movement of capital)

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Did competitiveness suffer? Effective unit labour
cost trends
Nominal depreciation since mid-2008 boosts
competitiveness
Changes in annual average effective unit labour
costs, 2004-2008. Sources Eurostat, Oxford
Analytica UNDP calculations.
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Baltic conundrumCurrency boards, EU membership

• Preclude use of discretionary monetary, exchange
  rate policies
• Leave financial system open to hot money
• May cause competitiveness problems
• Place entire burden of macro adjustment on fiscal
  policy . . .
• . . . But discretion here limited by the EUs
  Stability and Growth Pact . . .
• . . . And fiscal space is in any case limited

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Causes of Baltic conundrum

• Small, open economies European integration ?
• Extensive Euroisation
• Balance sheet mismatches
• Small savings pools large modernisation needs
  (e.g., for competitiveness on single market) ?
  large capital inflows
• Baltic states could raise capital on markets very
  easily until 2008
• Cheaper than borrowing from IFIs
• Access to post-accession EU funds further reduced
  cost of capital

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What could have been done?

• Capital controls?
• Not compatible with EU membership
• Tighter fiscal policies?
• Baltic fiscal policies already tightest in EU
• High economic costs in terms of foregone output,
  employment, poverty reduction
• High political costs
• Unilateral Euro adoption?
• This would help with balance sheets . . .
• . . . But it would not
• create more fiscal space
• be permitted by European Central Bank

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What should be done now?

• Things that must be done by EC, ECB
• Euro adoption
• Åslund ECB should have a change of heart (and
  not only for the Baltics . . . )
• Expansion of fiscal transfers to reduce intra-EU
  productivity disparities
• Towards a federal European economy
• Things that could be done nationally
• Vienna process to prevent spread of financial
  contagion from subsidiary to parent banks
• Further reforms of labour market, social policy,
  to reduce nominal wages (rather than employment)

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Implications for Armenia

• Structural similarities
• Small, open, transition economies
• Current account deficits
• Private banking system
• Key differencesArmenia
• Banks, formal economy not as dollarised
• Forex-denominated private sector foreign debt is
  small
• Result Armenia can devalue without ruinous
  balance sheet effects

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Bank nationalisation (Shortland)

• Many private banks have been bailed out, or
  nationalised, during the crisis
• Both in developed countries and emerging markets
• Counter-argument to Washington consensus
• Socialism for the rich
• Large emerging market data set shows state-owned
  bank performance is not inferior to private
  banks
• Reason In emerging markets, it may be harder for
  the state to regulate private banks than it is to
  own, manage them directly
• Conclusion Its OK to nationalise your banks

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Is Sberbank the answer? Baltic, Armenian
experience suggests not

• Armenia Effective regulation of private banks
  is possibleeven during crisis

• Baltics
• Vienna process reduces capital flight
• Only one major bank nationalisation (Parex Bank,
  Latvia)
• Other countries
• Nationalisation Better than bailouts (moral
  hazard)?
• Post-crisis prospects for privatisation?

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• Launch Forum
• Regional Impact of the Global Economic Crisis
• Yerevan, 8 July 2009