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

1. Launch Forum: Regional Impact of the Global Economic Crisis Yerevan, 8 July 2009

2. 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

3. 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)

4. “Baltic conundrum”—The Baltic states: • Did “a lot of things right” . . . • . . . But still became region’s worst crisis victims (along with Ukraine) • Large declines in GDP, incomes, employment • Much development progress lost • No end to the crisis in sight • Realistically, it’s not clear that Baltic policy makers could/should have done something different—even ex post • Conclusion: “Black swans” can be deadly

5. “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 characteristics—Liberal approach to: • Tax systems (flat tax pioneers) • Labour market regulation • Social protection systems • Structural characteristics—Very small, open, transition economies: • Small domestic savings pools—FDI needed • Weak diversification prospects

6. Structural comparison (2008 data) In mlns (X+M)GDP

7. Pre-crisis performance: Good on GDP growth . . . Average annual GDP growth 2005-2008 % points above NMS average

8. . . . And employment Average annual employment growth 2005-2007 % point difference from NMS average

9. Reforms did not hurt state finances . . . General government budget (% of GDP), annual averages for 2002-2007 period. Eurostat data.

10. . . . Or produce large public debts General government debt, % of GDP, 2007. Eurostat data.

11. Crisis hits Baltics first (in 2008) . . . Source: IMF World Economic Outlook, April 2009

12. . . . And deepens in 2009:Q1 Change relative to 2008:Q1. Sources: Eurostat, CIS Statistical Committee, national statistical offices, JPMorgan, press reports.

13. Unemployment: Baltics hit hard here, too Numbers of unemployed (LFS data), June 2008 = 100 * Romania not included Source: Eurostat

14. Cause: Rapid growth in private sector foreign debt Ratio of gross foreign debt to GDP. EIU data, UNDP calculations.

15. 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”)

16. 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.

17. “Baltic conundrum”—Currency 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 EU’s Stability and Growth Pact . . . • . . . And fiscal space is in any case limited

18. 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

19. 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

20. 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)

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

22. 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: “It’s OK to nationalise your banks”

23. Is Sberbank the answer? Baltic, Armenian experience suggests not • Armenia: Effective regulation of private banks is possible—even 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?

24. Launch Forum: Regional Impact of the Global Economic Crisis Yerevan, 8 July 2009