Global financial crisis: An emerging European perspective

1. Global financial crisis: An emerging European perspective Erik Berglof, Chief Economist, EBRD

2. Comparing to the Great Depression: World industrial production, now vs. then Source: Eichengreen, O´rourke (2010)

3. Comparing to the Great Depression:Volume of world trade, now vs. then Source: Eichengreen, O´rourke (2010)

4. Comparing to the Great Depression:World equity markets, now vs. then Source: Eichengreen, O´rourke (2010)

5. Smaller economies, then and now Czech and Slovak Republics Belgium Poland Sweden

6. Outline • A bad crisis, but stopped in its tracks • Policy response strong, but left scars • Dealing with aftershocks • Unemployment • Fragile banks + regulatory tsunami • Fiscal – Greece, Eurozone… • Altered prospects for emerging Europe – and the Euro

7. The phases of the crisis Source: IMF

8. Phase 1: Financial crisis build-up

9. A fleeting moment of decoupling, followed by precipitous recoupling… Industrial production 2007-2009 (y-o-y)

10. Phase II: Systemic outbreak

11. Emerging markets more resilient Average response of EMBI to daily changes in the VIX during periods of financial volatility in the United States

12. Crisis challenge:Systemic problem – systemic response Source: Bankscope, bank websites

13. Phase III: Systemic response

14. Crisis response: massive, comprehensive and coordinated • Domestic policies: Massive in western Europe and mature in central and eastern Europe • Massive & coordinated international support • IMF resources tripled from $250 to $750 bn • EU BOP support quadrupled from €12.5 to €50 bn • G20: capital to multilateral development banks • Parent banks maintained exposures • A new coordination platform – Vienna Initiative

15. Magnitude of official support massive Official support (percent of GDP)

16. Improvised response: The Vienna Initiative • Fill institutional vacuum - coordinate • Bring together authorities (home and host) • Private and public sector • Incentivise banks to coordinate • Regulatory incentives (IMF/EU prog rams) • Contingent capital (Joint IFI Action Plan) • “Naming/shaming” (memoranda of understanding) • Intensify Information-sharing • Coordinate within IMF/EU programs + IFI collaboration

17. Sudden Stop in Emerging Europe muted Percentage changes in external assets of BIS-reporting banks

18. Currency shooting avoided Currency overshooting avoided Nominal effective exchange rates Current programs Median and interquartile ranges Past crises

19. Output drop deep, sudden, and varied

20. Phase IV: Towards sovereign crises in advanced economies?

21. Unemployment high - still rising in SEE and the Baltics Source: CEIC.

22. Europe’s banks in unclear state • Weak balance sheets • Total loan write-downs (IMF: USD 442 bn) + higher unrecognised share than in other markets • Still net tightening (ECB lending survey) • Compounded by regulatory reform in full swing: • Capital positions and liquidity – costs for growth • Uncertainty over bank tax, requirements of bank restructuring, and collaboration between supervisors • Emerging Europe still depend on bank finance

23. Regulatory tsunami • Stronger financial regulation needed • Financial sectors must share eventual crisis costs But… • Timing in a world of multi-speed regional growth • May stunt market development (e.g., restricting liquidity risks and maturity transformation) • Regional differences lost in global regulation (cross-border banking worked for Emerging Europe before and during crisis, but not everywhere else)

24. Debt increase follows banking crisis Cumulative increase in real public debt in the three years following the banking crisis Source: Reinhart and Rogoff (2008)

25. What if the crisis had not happened?

26. Emerging Europe recovery lagging

27. Recovery lagging, particularly in south-eastern Europe and the Baltics SEE: Compared to January, revised 2010 growth down; negative or flat growth projected for Bulgaria and Romania. Baltic countries: growth outlook remains negative on average

28. Why recovering more slowly? • Export dependence on EU limits export demand • Follows from exceptionally large output drops: • High unemployment weighs on domestic demand • Risk perceptions, non-performing loans → credit growth • Fiscal consolidation 2010-11 → contractionary

29. U Corporate credit stagnating/contracting Corporate credit growth, Q3-09 to Q1-10, annualised Belarus Serbia Moldova Croatia Romania Slovenia Ukraine Albania Slovak Republic Russia Bulgaria Estonia Poland Latvia Lithuania Hungary Kazakhstan GDP growth, Q4-09 to Q1-10, annualised Source: National authorities via CEIC data service, EBRD staff calculations.

30. Large deficits lead to fiscal contractions Source: IMF, European Commission.

31. Emerging Europe out of sync • Slower monetary easing, but quicker ‘fiscal exit’ in Eurozone – premature for emerging Europe • Divergence also within Emerging Europe with some countries getting large capital inflows • Regulation with increased capital requirements risks coming too early

32. Is there a Phase V of sovereign crises in emerging Europe…?

33. Emerging Europe and the Eurozone

34. Eurozone at a crossroads • €750bn buys time to build fiscal sustainability • So far only €60bn – not enough given pressures • ECB shift to purchases of sovereign debt critical • Large permanent mutual fiscal insurance mechanism with rigorously enforced rules… • …or a break up with unimaginable implications for European project…

35. Eurozone as an optimal currency area • Optimal currency areas partly endogenous • Significant convergence since formation • Real business cycle • But also persistent or increasing differences • Diverging inflation => real exchange rates misaligned

36. Eurozone as the end zone Costs and benefits of accession shifted: (1) Costs of loss of flexibility and premature entry? => Prepare better (local capital markets) (2) Commitment value of Euro anchor? • Benefits smaller • Uncertainty about rules and long-term future • Timing for entry more distant => Strengthen/clarify architecture

37. Thank you

38. Needed: a new growth agenda • Safer growth after the ‘great moderation’: • Medium term, counter-cyclical macro policies • Diversify funding sources - local capital markets • Diversify exports and develop intra-regional trade • Strengthened competitiveness: • Preventing a rapid rise of wage costs • Stimulating firm entry and exit, and SME growth • Exploiting cost advantages in the periphery