3 rd Bank of Greece Workshop on the Economies of Eastern Europe and Mediterranean Countries

1. Rethinking the Economies of SEE, South Mediterranean Economies and the Euro Area Debt Crisis in the Light of Turkish Experience Eray Yucel, Ph.D., Economist, Central Bank of the Republic of Turkey 3rd Bank of Greece Workshop on the Economies of Eastern Europe and Mediterranean Countries Athens, 18 May 2012 1

2. An Array of Crises • The 2008+ Global Financial Crisis • made a web of systemic problems visible • Underlined the importance of prudential policies and better regulations • Resolution of one crisis might make a separate set of systemic problems visible • the Greco-European debt crisis (or Eurozone/EZ debt crisis) • A solid understanding of vulnerabilities (exposures) is essential to draft recovery

3. Greek Debt at a Glance Debt-to-GDP Ratio (%) Source: IMF, March 2012

4. Greek Debt at a Glance - II • Baseline Scenario • Alternative Scenario Source: IMF, March 2012

5. Greek Debt Problem • Involves widespread participation of EZ countries • Resolution is not straightforward • Commitment issues • Political uncertainties • Healthy functioning of euro system • Uncertainties regarding each country • Even the baseline scenario requires commitment to an ambitious set of targets • Still a high degree of uncertainty after resolution • Resolution of Greek debt might unveil other countries’ embedded problems

6. In this presentation… • An account from an outsider’s angle of view • Southeast European economies • South Mediterranean economies • The EZ debt crisis • For each, the Turkish experience might yield useful insights

7. Southeast European Economies • Assessments of different –yet interrelated– types of exposures are fundamental • Mostly pertaining to short-to-medium term performance/crisis prevention • Trade integration • Equity market integration • Credit market ties • A longer term view, though, might require further assessment of socio-demographic factors

8. Trade Integration • Gravity Analysis: Dataset for 130 countries and 48 years • Fixed effects estimates extracted from the gravity equation • If (+) “above” average trade ties • If (-) “below” average trade ties • Simply counting the positive fixed effect estimates and measuring trade intensity relative to the average of the dataset

9. Trade Integration - II

10. Trade Integration - III

11. Integration of Equity Markets • Tri-variate GARCH regressions • Conditional error term covariances: Capture the transmission of shocks from the US and EU stock markets • Time varying conditional correlations for US and German stock indices is on average 0.6 with a standard deviation of 0.16 • The average conditional correlation is taken as reference and using its standard deviations, SEE stock markets’ integration levels were identified

12. Integration of Equity Markets - II • Estimated Conditional Correlations • Turkey • Croatia • Romania

13. Integration of Equity Markets - III • Estimated Conditional Correlations • Bulgaria • Macedonia • Slovenia

14. Integration of Equity Markets - IV • Estimated Conditional Correlations • Serbia • Bosnia Herzegovina • Montenegro

15. Credit Market Integration • Credit liabilities to outer world • Interpreted as an indicator of integration • Further indicating availability of international funding • Until 2008 there observed a clear increasing trend • During the global financial crisis, credits stall

16. Credit Market Integration - II

17. Short-term Risks and Prospects • Gravity model • The SEE has potential to benefit from further intra-regional trade • Trade potential with EU and the rest of Europe is promising • High trade intensity might also indicate potential systemic risks in case of external trade shocks • GARCH model • Stock market capitalization and integration with advanced stock markets remain limited in SEE countries • A clear trend of ongoing integration • Spillovers from the advanced equity markets to the SEE markets during the global financial crisis suggest that SEE countries are not immune to external shocks • Credit linkages • Prior to global financial crisis credit flows to the SEE countries were buoyant • Through entry of foreign banks (mainly of EU origin) into the SEE market and subsequent large capital flows from parent banks to the SEE subsidiaries and affiliates • Triggering growth in the region through private consumption and investment • The initial reaction after the global crisis was a rapid drop in credit flows • The “Vienna Initiative” to avoid a sudden stop • A second commitment to minimize the effects of deleveraging process • Exposure to EZ debt crisis still high due to parent bank risks

18. Sources of Instability: Long Term • Main demographic trends are crucial to understand the macroeconomic trends of the future • Pace of population growth • Old age dependency: Ratio of population aged above 65 to the working population

19. Sources of Instability: Long Term - II Population % Change (2000 – 2010)

20. Sources of Instability: Long Term - III Old Age Dependency Ratio (2000 – 2010) Old Age Dependency Projections (2010-2050)

21. Sources of Instability: Long Term - IV Population Projections (2010 – 2050)

22. Setting up a Strategy for SEE • Short term macroeconomic imbalances and financial vulnerabilities • Short term stabilization efforts • Long term instabilities • Structural solutions • Increase competitiveness, diversify export markets and products • Secure a stable flow of remittances • Labor market reforms • Ageing and migration policies • Innovation and technological development • Support private sector initiatives • Attract FDI • For both, the EU accession perspective might provide well-structured guidance

23. South Mediterranean Economies • A multi-faceted problem • Liberalization • Higher degree of private sector orientation • Improving polity • Elevated democratic demands • Both requires or both are equivalent to • Wisely ordered reforms and commitment • Measures to avoid reform fatigue • Improved institutional capacity • Rethinking about the term “institution”

24. The EZ Debt Crisis • Turkish experience of debt • Issues of fiscal dominance • Post-2001 changes • Policy design based on updated priorities • Commitment • Private sector orientation • Internalization of risks  improved hedging capacity • Istanbul Approach: mirroring balance sheets of non-financial corporations and banks

25. Summing Up • Thinking out of the box • “Go by the book, but be the author” strategy might perform well under certain circumstances • Collaboration at an institutional level • Exchange of experiences: higher pace of capacity building

26. Rethinking the Economies of SEE, South Mediterranean Economies and the Euro Area Debt Crisis in the Light of Turkish Experience Eray Yucel, Ph.D., Economist, Central Bank of the Republic of Turkey 3rd Bank of Greece Workshop on the Economies of Eastern Europe and Mediterranean Countries Athens, 18 May 2012 26