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Regional Competitiveness Initiative

Regional Competitiveness Initiative. Coming Out of the Crises: Central and Eastern Europe Paul Marer, Ph.D. Central European University Business School Prepared for the USAID 5 th Annual Regional Event Sarajevo, Bosnia-Hercegovina, May18-20, 2010.

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Regional Competitiveness Initiative

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  1. Regional Competitiveness Initiative Coming Out of the Crises: Central and Eastern Europe Paul Marer, Ph.D. Central European University Business School Prepared for the USAID 5th Annual Regional Event Sarajevo, Bosnia-Hercegovina, May18-20, 2010

  2. Global Overview, 2008-11Real GDP Growth Rates Region* Year_________ 2008 2009 2010** 2011*** World 3.0 -0.6 4.2 4.3 Euro area 0.6 -4.1 1.0 1.5 Central/EE 3. -3.7 2.8 3.4 CIS-Russia 5.3 -3.5 3.9 4.5 Asia (LDC) 7.9 6.6 8.7 8.7 * Average, weighted by PPP GDP ** Estimate *** Forecast

  3. Global Overview, 2008-11GDP Growth Rates (cont’d) • Developing Asia (mainly China &India) had grown faster before global crisis, avoided a significant downturn, and are growing rapidly again (after a slight dip) • CEE and the CIS (w/o Russia) have started to recover, much slower than developing Asia, but much faster than Western Europe.

  4. Global Overview, 2008-11GDP Growth Rates (cont’d) • Caution: 1. data problems; 2. huge differences within each group • Data issues: WE-EE comp. problematic • The EU now includes 10 CEE countries • The Eurozone includes 2 CEE countries • IMF definition of CEE excludes Czech (dev!) & Slovakia and Slovenia (eurozone!) and includes Turkey, B-H, Croatia, Serbia, Macedonia, Montenegro.

  5. Real GDP Growth Rates in CEE, 2007-2011 Country 2007 2008 2009 2010 2011 Latvia 10.0 - 4.6 -18.0 - 4.0 2.7 Lithuania 9.8 2.8 -15.0 -1.6 3.2 Estonia 7.2 3.6 -14.1 0.8 3.6 Ukraine 7.9 2.1 -15.1 3.7 4.1 These 4 had the largest declines in the world last year. One lesson: high growth rates, if not sustainable, can mean trouble later on

  6. The Baltic Story Commonalities: Years ago, all had pegged their currencies to the euro (almost the same as if they had adopted the euro, making the LC/euro ER fixed), which greatly lowered domestic r. That, joining the EU, good location, relations with Scandinavia, and well-educated L-force, generated decade-long booms: growth rates among the world’s highest.

  7. The Baltic Story (cont’d) Large K-inflows (prompted by, and supporting, the boom) were channeled mainly into the non-tradable sector (consumption, banking, construction, real-estate- & stock-market speculation) Large K-inflows allowed these (and the other CEE countries) to maintain levels of investment much above what could be financed from domestic saving.

  8. The Baltic Story (cont’d) Large K inflows (2000-2007) were used mainly to finance current-account (CA) deficits (and to acquire reserves (R) and financial assets abroad (Table). When the global crises hit and K inflows collapsed, the Baltic countries were forced to make immediate dramatic adjustments.

  9. K-Inflows & Uses, 2000-2007(Annual Average As % of GDP) Country K CA Δfor.ΔR*inflow deficit assets________ Latvia 25.8% 12.2% 10.2% 3.4% Lithuania 13.5% 7.8% 3.6% 2.1% Estonia 23.7% 11.1% 11.2% 1.4% _____ • Includes “Errors and Omissions” • Source: IMF

  10. Government Deficit(As Percent of GDP) Country 2006 2007 2008 2009 2010 Latvia 0.5 0.6 -7.5 -7.7 -12.9 Lithuania -0.4 -1.0 -3.3 -8.9 - 8.6 Estonia 3.3 2.9 -2.3 -2.1 - 2.4 Bulgaria 3.5 3.5 3.0 -0.8 - 1.8 Estonia and Bulgaria among the very few countries in Europe (the world!) to strictly observe the Maastricht deficit criteria

  11. Public Debt, 2000-2011(As Percent of GDP) Country 2000 2007 2009 2011* Latvia 12.3 7.8 32.4 64.7 Lithuania 23.7 16.9 29.3 47.3 Estonia 5.1 3.8 7.2 9.3 Bulgaria!! 77.1 19.8 16.1 16.5 * Forecast Source: IMF, World Econ. & Financial Survey, May 14, 2010, p. 85

  12. External Debt (As Percent of GDP) 2000 2007 2009 2011* Latvia Total 127.7 160.0 183.0 Sovereign 12.3 7.8 32.4 64.7 Lithuania Total 72.5 88.4 95.4 Sovereign 23.7 16.9 29.3 47.3 Estonia Total 12.2 130.9 130.0 130.0 Sovereign 5.1 3.8 7.2 9.3 *Forecast; Source: IMF, various publications & country reports

  13. The ERs of Baltic States & Bulgaria Pegged to the Euro The only CEE countries to have done so -for econ & political reasons (stability) and their strong desire to join the euro area. Maintaining the peg requires responsible fiscal policies: OK (unlike the imprudent PIGS!). But a successful peg also requires controlling (1) sustained large CA deficits (excess consumption); (2) too large private foreign borrowing; & (3) external competitiveness factors, such as wages, inflation, and productivity gains in the tradable sector. But neither the 4 CEEs nor the PIGS did this well.

  14. The Baltic Story:Conclusions • They are gritting their teeth, admit their mistakes & are determined to maintain the euro peg and to enter EMU. • This has required the authorities • to ax excess domestic consumption and • to force “internal devaluation” (of w & P) to transfer resources to the tradable sector • Both require even tighter fiscal policies and further restructuring

  15. Bulgaria

  16. The Baltic StoryConclusions: • Notwithstanding the many similarities, there are also significant differences: • Latvia was hardest hit because it was the most lax on credits, inflation, and foreign borrowing, while • Estonia is the best off: it has met all Maastricht criteria, may join the EMU next year; has the region’s best growth prospect

  17. The Remaining SixCEE Countries • Share with the other 4 (and also w/the rest of emerging Europe, the Caucasus, and Central Asia) of having received large K-inflows (debt- & equity-portfolio, other non-bank inflows, and FDI) through mid-2008. • During the last decade, foreign-owned banks had come to dominate the region’s banking sector (Chart)

  18. Rising Share of Foreign-Owned Banks in CEE

  19. Foreign-Owned Banks: The Main Credit Source in CEE

  20. The Extent of Decline & the Speed of Recovery …. … are closely linked to the rate of growth of credit expansion and level of overheating going into the crisis. It is probably no accident that the Czech Republic, Poland, and Slovakia – with relatively low shares of foreign-currency loans (next chart) have fared relatively the best among the other six.

  21. Shares of Foreign-Currency Loans in CEE Households

  22. Real GDP Growth Rates in Six CEE Countries, 2007-08 Country 2007 2008 2009 2010 2011 Poland 6.8 5.0 1.7 2.7 3.2 Czech Rep. 6.1 2.5 -4.3 1.7 2.6 Bulgaria 6.2 6.0 -5.0 0.2 2.0 Hungary 1.0 0.6 -6.3 -0.2 3.2 Romania 6.3 7.3 -7.1 0.8 5.1 Slovenia 6.8 3.5 -7.3 1.1 2.0 --------- 2010 estimated; 2011 forecast. Source, IMF, Regional Economic Outlook: Europe, May 2010, p. 5.

  23. Real GDP Growth: Poland • Poland stands out as the only country – not only in CEE but in all of Europe – with no recession in 2009, due to: • Limited reliance on exports & flexible ERs • Relatively small pre-crisis imbalances • Well-capitalized banks; no major bailouts • An IMF credit line (unused) • Structural reforms (privatization, tax cuts) • Vibrant entrepreneurship • Poland is again attractive for K-inflows (FDI), with good growth prospects.

  24. GDP Growth - The Czech Republic … had a smaller decline in 2009 than any of the other 8 countries, & good prospects: - A liquid and conservative banking sector contained vulnerabilities. - Prudent pre-crisis fiscal and monetary policies provided cushions during the crisis. - However, as a small, open economy, it was hurt by the compound effects of the financial, liquidity and real-sector crises.

  25. GDP Growth in Bulgaria … was strong before the crisis, helped by prudent fiscal policy. (As a previous chart showed, Bulgaria’s public debt relative to GDP fell from 77% in 2000 to 20% in 2007 (!), and the ratio has moved even lower since then!). Because its currency is pegged to a euro that had appreciated (until recently), and because of the inflationary expansion of the non-tradable sector, Bulgaria’s main problem is regaining competitiveness. This is the reason for its modest projected expansion this year and next.

  26. GDP Growth in Hungary … became an early victim of imprudent fiscal policies and reform stagnation during the 2000-07 boom years. This pushed Hungary on the brink of external default in October 2008, which was prevented by a large IMF-EU-World Bank loan, tied to austerity as well as to pension and tax reforms. Consequently, Hungary’s growth recession is lasting longer (2007-10) than those of its regional peers.

  27. GDP Growth in Romania … has been subject to a similar boom-bust cycle as those described for the Baltics. Romania, too, had obtained a large, joint IMF-EU-World Bank loan. A particularly critical issue for Romania is when will its economy be in good enough shape to re-start the inflow of foreign capital, especially FDI

  28. GDP Growth in Slovenia … …was impacted badly by the global crises, given its small, open economy (reliance on exports and K-inflows) and the rapidly appreciating euro through 2009. (It joined the eurozone in 2007.) Since the currencies of several competitors (P, C, H, R) had depreciated during the crisis, Slovenia has been facing a particularly difficult situation. Slovenia also needs structural reforms (tax and pension systems and in the labor market). Hence the reasons for Slovenia’s deep recession and the modest pace of recovery.

  29. Reflections and Conclusions A year ago, at the Kiev conference, I offered two conclusions on the longer-term impact of the global crises in CEE: 1. W. Europe’s recovery & medium-term growth will be sluggish, which does not bode well for CEE. I reaffirm this today. 2. For this reason, & because net K-inflows will slow, the CEE countries will need to rely relatively more on internally-generated sources of Δproductivity, competitiveness, and growth. I’d like to calibrate the statement.

  30. Reflections and Conclusions (cont’d) First, it became clear that the pre-crisis growth model is not only unsustainable but had serious inherent problems to begin with. Net K-inflows can be partitioned into beneficial and dysfunctional segments. “Beneficial” flows are those that help the host country narrow the development gap with the developed world, mainly by improving the host country’s international competitiveness. Dysfunctional flows are those that overheat the economy, mainly by raising costs and prices in the non-tradable sector, contributing to excess consumption, loss of competitiveness, & vulnerability to K-flow reversals.

  31. Reflections and Conclusions (cont’d) • Given the large variability among the CEEs in their prospects – in terms of growth rates and ability to absorb foreign K flows of various types – I see that certain countries may face the prospect of too large (and not always of the right kind) of K inflows (for ex: Poland). If so, this requires (regulatory, structural, fiscal or ER) policies to direct and offset (if necessary) the inflows’ undesirable effects.

  32. Reflections and Conclusions (cont’d) • Other countries, in turn, need to gear their policies to re-start the inflow of K (of the right kind) from the rest of the world. • In conclusion, my recommendation a year ago that “the CEE countries need to focus more on internally-generated sources of productivity growth”, stands. In some cases, such policies will be needed to purposefully replace K inflows that are too large or not of the right kind; in others cases, to be able to attract K-flows that are badly needed.

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