Macroeconomic Issues from a European Perspective

1
Macroeconomic Issues from a European Perspective

• Fabrizio Coricelli
• Euro-Latin Network
• Madrid October 9, 2002

2
Lessons from EU Enlargement

• Institutional reforms before or with
• market liberalization
• Real (trade) integration hand in hand with
  financial integration
• Safety nets key for successful reforms

3
Issues

• Real and nominal convergence satisfy inflation
  criteria while catching up in income levels.
  Choice of exchange rate regime
• Speed of adoption of the Euro (two views)
• Development of financial sector low financial
  depth
• Fiscal rules

4
..Issues

• No mechanisms to avoid crises are present in the
  EU(currency crises in Italy, UK and Sweden at the
  beginning of 1990s)
• Development of financial sector

5
Low financial depth
Domestic Credit in percent of GDP, 2000
EURO AREA AVERAGE
140
120
Portugal and Spain (1986 enlargement)
100
80
Greece (1981 enlargement)
60
40
20
0
Malta
Latvia
AC-12
Poland
Cyprus
Estonia
Romania
Bulgaria
Hungary
Slovenia
Slovakia
Lithuania
CEECs-10
Czech Rep.
Source IFS, Accession Countries' National
Central Banks
6
Institutional Reforms

• Importing institutions (against Rodriks view)
• May not be optimal, but more credible
• Safety nets to support reforms

7
.lead to

• Credibility bonus due to accession to EU
• Accession anchor for market expectations
• Lower spreads in international borrowing
• Interest rate convergence

8
Creditworthiness
9
Interest Rate Convergence
10
Potential drawbacks

• Premature eurosclerosis unemployment rates
  close to 20 in Poland and Slovakia
• Large governments high tax rates
• Rigidity in labor market
• Large implicit debt for pensions

11
Total expenditure ( of GDP)
12
Emerging market themes
13
Integration has not reduced volatility

• Volatility is much higher than in the European
  Union
• Although cycle is highly correlated amplitude
  much higher
• CEECs are small open economies

14
Correlation with EU cycle
15
Volatility(standard deviation)
16
Financial sector

• Can magnify the cycle
• Small and medium size firms are leading growth
  but they are generally cut off from borrowing and
  thus from the possibility of smoothing output
  decline
• Alternative to bank credit trade credit, higher
  risk (chain)
• Dominant role of foreign banks does not help

17
Vulnerability to crises

• Government debt not high as a ratio to GDP
• Even less in terms of tax revenues (compared to
  LAC)
• However, large share of foreign debt (as in Lac)

18
Debt indicators
19
External constraint
20
External constraint..

• Ext. Debt high in terms of GDP but
• much lower (than in LACs) in terms of exports
• FDI inflows match current account deficit
• Privatization-related FDIs very large
• Current flows unlikely to be sustained

21
Non-FDI flows

• Pro-cyclical
• Sharp reduction after Russian crisis

22
Growth and capital flowsPoland
23
Czech Republic
24
Fiscal policy pro-cyclical
25
After entry?

• Full liberalization of K-flows
• Short term K-flows bound to increase
• Exchange rate policy?
• Fiscal rules?

26
Risks ahead

• Delayed entry in Euro
• EU fiscal rules inappropriate
• Maastricht criterion is an ex post limit on
  deficit with a pro-cyclical bias
• Need for ex ante expenditure rules

27
Conclusions.

• Trade integration possibly an insurance for
  sudden capital flow reversals
• Candidate countries are affected by convergence
  play expectation of entry in the eurozone
  (interest rates converge and spreads on
  international borrowing very low).

28
..Conclusions

• However, postponing accession can be a severe
  shock.
• Test of capability to manage large capital
  inflows yet to come
• Exchange rate policy a key issue
• Mechanisms to avoid currency and financial crises
  at the EU level could be devised