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Eastern Europe: the longer-term economic impact of the 2009 crisis Laza Kekic, Economist Intelligence Unit Stockholm, SITE, April 14th 2009. Outline. The crisis and why Eastern Europe has been the weakest emerging market performer Longer-term impact of the 2009 crisis
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Eastern Europe: the longer-term economic impact of the 2009 crisisLaza Kekic, Economist Intelligence UnitStockholm, SITE, April 14th 2009
Outline • The crisis and why Eastern Europe has been the weakest emerging market performer • Longer-term impact of the 2009 crisis • Foreign direct investment trends • Growth outlook for 2011-2020
Eastern Europe and the crisis • Eastern Europe as the worst-performing emerging market region in 2009 • Russian performance very poor—knock-on impact on other CIS • The worst crisis since the 1990s • Only a few exceptions, notably Poland • Could have been worse: at least a meltdown and disaster scenarios averted • “It’s better than Greece” a standard refrain-hardly much of a consolation • Threat of longer-term adverse impact
How did it happen? • Factors that underpinned the previous party—high growth rates and increases in consumption—also in part associated with the downfall • Premature liberalisation of capital accounts. As elsewhere, large debt and portfolio capital inflows ended in tears. Domestic credit bubbles, overvalued exchange rates, low domestic savings, high vulnerability • Little evidence of any positive link between long-term growth and debt and portfolio capital inflows (FDI the notable exception) • Preference for fixed exchange rate regimes (formal and de facto) has been a recipe for trouble
ASIA Fiscal stimulus big and worked fast Healthy government finances Low private-sector debt High domestic savings Less reliance on foreign capital inflows Increased intra-regional trade Banks in better shape than elsewhere and able to lend Strong states Growth and the “X factor” EASTERN EUROPE High degree of trade and capital market integration Macro imbalances in some Big increase in private sector debt, inflating credit and housing bubbles Low domestic savings Overvalued exchange rates Institutional weaknesses (masked during credit and commodity boom) Little scope for fiscal stimulus Heavy reliance on auto sector A tale of two regions
Poland’s resilience • Could rely more on its domestic market; less exposed to international trade--exports/GDP ratio 39% compared with 62% for other new EU members from CEE • Generally pursued prudent macroeconomic policies before the crisis • Central bank intervened informally to prevent bank lending in foreign currencies • A flexible exchange rate and the weakening of the zloty in early 2009 • Benefits from Germany's subsidised car-replacement scheme • Good fortune (cuts in income tax took effect and EU infrastructure funding just as crisis starts)
Only a modest recovery in 2010 • As in 2009, EE will be weakest-performing emerging market region • Modest euro zone recovery • Still tight credit conditions • Impact of high unemployment on consumption • Fiscal issues • Conditionality in IMF programme countries, with a lag • NPLs and fragile financial sectors
Key global risks to the outlook • Mistimed policy tightening • A double-dip recession in G7 • Euro zone and the Greek crisis • More asset bubbles burst and renewed financial turbulence • Sovereigns default as public debt spirals out of control • Political instability • Protectionism undermines globalisation • Geopolitical risks
The impact on long-term growth • Context of existing factors constraining long-term growth—continuing institutional problems, poor demographic outlooks and weak innovation • Some positives: • Adjustment of external imbalances • Exchange rate corrections in some • Less financial globalisation may not be a bad thing • But negative impact on: • Trade, weak demand, competitiveness problems • Banking sectors (rising NPLs) • Public finances • FDI flows • Possible negative impact on innovation • Political risk and the appetite for reforms
Changing global FDI patterns • Sharp decline in global FDI in 2009 (45% in US$ terms); less to emerging markets (35%) • For the first time ever in 2009 emerging markets will have attracted more than 50% of global inflows • Not only differential impact of recession • Some emerging markets regions have to a degree “decoupled” from developed economies • Impact of improving business environments • Increasing competitive pressure on companies increase opportunity cost of not going into more dynamic and lower-cost destinations • Recent EIU survey: strong positive link between firm performance and presence in emerging markets • Increased outward FDI by emerging markets; disproportionate share to other emerging markets
EE still resilient in 2008; delayed impact of global crisis on FDI inflows Slump in 2009, affects all FDI drivers (recession, credit squeeze; lower commodity prices) Macroeconomic imbalances and risks greater than in other emerging markets Problems in business environments Increased political risk Skills shortages, infrastructure deficiencies, institutional constraints Labour costs still competitive vis-a-vis developed Europe, but not Asia East Europe slips down in investor surveys Above-average decline in FDI inflows in 2009, by 50% Modest recovery in 2010 FDI trends in Eastern Europe
Innovation in eastern Europe • R&D/GDP ratio above 1% only in Slovenia and Czech Rep • Innovation performance (patents, scientific citations, high & medium tech output, surveys)—generally modest • On average, EE ICT lags well behind West and Asia • Mobile penetration very high, but fixed line often still poor, relatively low Internet penetration and uptake of broadband • Weaknesses in regulatory environments
Model for long-term forecasts • -Initial GDP per worker: catch-up potential • -Demography: working-age and total population • -Human capital: schooling; health of workforce • -Policy variables: openness to trade; government savings; exchange rate overvaluation • -Index of quality of institutions: rule of law, quality of bureaucracy, property rights • -A regulatory index: regulatory burden in product, credit and labour markets • -ICT index: quantitative and qualitative features • -External environment: terms of trade • -Geography: location; primary products • -Historic legacies: independent statehood
Long-term growth prospects • C Europe Baltics Balkans CIS • Fixed/slowly changing factors: • Scope for catch-up + + + ++ • Geography ++ + + neg • Demographics neg neg neg neg • Institutions mixed mixed neg neg • Policy-sensitive: • Regulation mixed mixed mixed mixed • Openness + + mixed mixed • Macro policies mixed neg mixed mixed • Infrastructure + + neg neg • Innovation mixed mixed neg neg
Conclusions • East Europe – from star pupil to worst emerging market performer • Traditional convergence model runs aground • Present crisis to have longer-term negative impact, although growth will still be faster than in developed EU • Doing business in emerging markets – “go east young man”; does not mean EE closed for business • But will be tough environment, no return to pre-2008 boom; opportunities not general, but in specific sectors in specific countries
Eastern Europe: the political risksJoan Hoey, Economist Intelligence UnitStockholm, SITE, April 14th 2009
“I predict a riot” • Economic crisis and deep recessions in 2009 • Expectations of widespread social unrest globally, including in eastern Europe • US director of national intelligence, Admiral Dennis C. Blair, in early 2009: risk of global political instability triggered by the economic crisis “the primary near-term security concern” of the US • But so far, only one government in the region (Latvia's) has fallen as a direct result of the crisis • Unrest in Bulgaria and Moldova in part related to the crisis. Also recently in Kyrgyz Republic • Economic crisis backdrop to the resignation of the Hungarian PM and the fall of Czech minority government in March 2009 • The crisis influenced the results of the elections for the European Parliament in June 2009
Political risk: a perfect storm is brewing? • Overall only scattered signs of unrest so far; but historically instability follows economic distress with a lag • Popular dissatisfaction even during pre-2008 boom • Falling incomes and sharp rise in unemployment • Despite progress in poverty reduction, 40% in the region are still considered poor or vulnerable • No of poor to rise by about 5m people for every one percent decline in GDP--so by about 30m in 2009 • Average unemployment rate in 2009 and 2010 to 9.8% from 7.4% in 2008 • No of unemployed to rise from 14.8 to 19.5 million between 2008 and 2010—by almost 5 million
Conditions for political instability • Many countries in the region have characteristics that are associated with vulnerability to political upheaval: • New and inexperienced states and bureaucracies • A history of unrest • Ethnic and border disputes • Many intermediate regimes (neither full democracies nor autocracies; these non-consolidated regimes most prone to unrest) • Very high levels of popular dissatisfaction • Corruption and low levels of trust in political institutions
The special case of Russia • Crisis yet to affect significantly popularity ratings for Messrs Putin and Medvedev • Lack of a credible opposition. Liberals are in disarray; the Communists are a declining force • Any protests likely to remain limited in scope and to remain isolated and localised • So far, the only significant mass protests—against an increase in tariffs on imported used cars—have been reported in Vladivostok • Combination of repression and conciliation • The use of riot police in Vladivostok showed government is ready to use force to quell protests • Government has enough funds with which to placate the population
The outlook for reforms • Political impact of crisis has so far been limited and no reform backlash • …but may be early days yet • In 2010 many countries in the region are due to hold elections: Poland, Hungary, the Czech Republic, Slovakia, B&H, Latvia • Baseline outlook—neither major reform reversals nor reform advance • But there are appreciable risks of regression • Even at the height of the boom in 2006, almost half the people in the region said that they lived worse than in 1989 (EBRD Life in Transition) • EIU quality of life index--in 20 out of 28 east European countries it was lower in 2009 than in 1989
EBRD/World Bank Life in Transition • Only 30% of people in the region believe that their households live better than in 1989 • Strong nostalgia for the past and a high degree of dissatisfaction with political institutions • Only 15% of respondents in the region believe that there was less corruption than in 1989 • Support for the core values associated with the transition, markets and democracy, surprisingly low (even in advanced transition countries) • Roots of the new order still appear shallow two decades after the onset of transition; new system not yet embedded in prevailing norms and values • There is a deep divide across the region and within countries between winners and losers
Surveys as a starting point • Surveys used to derive weights for index of the quality of life • Life satisfaction survey scores (on a 1-10 scale) for the year 2006 for 130 countries • Multivariate regression: 10 indicators explain more than 80% of variation in inter-country life satisfaction scores • The values of life satisfaction scores predicted by these factors yield quality of life index • The coefficients in the equation weight automatically the component factors
Quality of life index components • Material well being—GDP per head at PPP. • Health—Life expectancy at birth, years. • Family Life—Divorce rate (per 1,000 population) • Political Freedom—Average of indexes of political and civil liberties, Freedom House. • Job security—Unemployment rate, %. • Climate—Minimum and maximum temperatures. • Political stability/security—EIU ratings. • Gender equality—parliamentary seats for women. • Community life—Variable based on church attendance and social organisations membership. • Governance—Corruption rating.
EU integration: the positives: Defuses regional tensions Fosters political liberalisation and democratisation Trade liberalisation and access to markets May stimulate FDI (debated) Reform anchor (up to a point) EU integration: the negatives: Associated with monetary regime problems Fostered irresponsible foreign lending (belief in EU umbrella) Undermined national politics and policymaking capacity (acquis a set menu) Not a substitute for unfinished national modernisation and statebuilding (Greece) Can the EU fix it?
