GKI Zrt ., gki.hu

1. TenYears of Membership and Crisis Management in the Central and Eastern European Member States of the EU AndrásVértes Chairman GKI Economic Research 22 May 2014, Brussels GKI Zrt., www.gki.hu

2. Crisis Hit • Financial and economic crisis hit the region mostly by: • freezing of the international capital flows, • the drop of import needs of the W-E countries • Result: stability failure, butmostlycurrent account balance and foreign debt financing problems, rather than general government debt crisis (asin EAP6). • „Openness” transformed to „exposure”. • These needed fast and radical external equilibrium improvement. GKI Zrt., www.gki.hu

3. Capital plus current account (in per cent of GDP) GKI Zrt., www.gki.hu Source: Eurostat, EU 2014 Spring Forecast

4. Net international investment position (in per cent of GDP) GKI Zrt., www.gki.hu Source: Eurostat, EU 2014 Spring Forecast

5. Broken Convergence? Before the crisis general catching up: „economic miracle” (except HU) Further sizable catching up after 2007 in Poland, Lithuania, Latvia, Bulgaria, Romania, Slovakia Stagnation or decline in Estonia, Hungary, Croatia, Czech Republic, Slovenia Lastdecade = lostdecadefor CZ, HU, SI (2004: threebest) Butgeneral line upto EU averagecontinued GKI Zrt., www.gki.hu

6. GDP (PPS) per capita (as per cent of EU average) GKI Zrt., www.gki.hu Source: Eurostat

7. Fiscal adjustment • Successful internal devaluation (on an extremely flexible labour market) in Baltic States, but unrepeatable elsewhere! • New, more or less sustainable path, excluding Slovenia and Croatia. Potential risk in Hungary and Slovakia. • Fiscal adjustment has the most favourable effects if • well planned in timing (neither too fast, nor too slow), • concerned with the stake-holders, • the banking system is solid with good lending capacity, • social welfare services are strong. • Share of external financing increasing GKI Zrt., www.gki.hu

8. General government gross debt (ESA, as percentage of GDP) GKI Zrt., www.gki.hu Source: Eurostat, EU 2014 Spring Forecast

9. Foreign financed general government gross debt to GDP (2008, 2012 in per cent) GKI Zrt., www.gki.hu Source: Eurostat, GKI calculations

10. Socialtensions • Sharp worsening in: • unemployment rate • income inequality, risk of poverty • government spending on social welfare • Turnaround towards grey and black economy (mostly sme-s) • Young generation has little chance to get the right job on the labour market – migration to W-E • Free movement on the European labour market – debated question!? GKI Zrt., www.gki.hu

11. Unemployment rate(in per cent) GKI Zrt., www.gki.hu Source: Eurostat , EU 2014 Spring Forecast

12. Financial sector • Guilty and victim at the same time • political push and overtaxation • High share of foreign ownership • stagnation of funding (Vienna Initiative) • new tendency: withdrawal behind the national border • Deleveraging and NPL: access to finance • Too low inflation • Instable money markets, yields and exchange rates GKI Zrt., www.gki.hu

13. Percentage of the banking system that is foreign owned, CEE10 and EAP6 Note: Thispercentage is calculatedasthetotalassets of foreignownedsubsidiaries/branchesas % oftotal banking systemassets Source: André Sapir, Guntram B. Wolff (Bruegel) 2013. GKI Zrt., www.gki.hu

14. Banks foreign funding exposure(in per cent of GDP, 2008-2012) GKI Zrt., www.gki.hu Source: Mihály Kovács, ECFIN Country Focus , July 2013

15. Corporate sector debt in the CEE10 and EAP6(in per cent of GDP) Source: Privatesectordeleveragingin Hungary: economiccostsamplifiedbygovernmentpoliciesinthe banking sector, Mihály Kovács, ECFIN Country Focus, July 2013 GKI Zrt., www.gki.hu

16. Household sector debt in the CEE10 and EAP6(in per cent of GDP) GKI Zrt., www.gki.hu Source: MihályKovács (2013)

17. Interest rate spreads over 10ys euro yield(basis point) GKI Zrt., www.gki.hu Source: Eurostat

18. CEcurrenciesexchange rate to the euro (31 December 2009 = 100) GKI Zrt., www.gki.hu Source: ECB

19. Crisis Management in CEE Market assessment: the best three Poland, Estonia and Slovakia, none of them was among top three (SI, CZ, HU) at the time of accession Neither size, nor geography, nor EMU membership, nor developmentlevel mattered! Crucial: performance of the national governance • understanding world changes and deepness of the crisis, • prepared for unexpected, collect and mobilise reserves, • look for international support, • improve ability to adapt(education, LLL, retraining). Future risk: lowgrowthwith high debt! GKI Zrt., www.gki.hu

20. Recommendations 1.Sound budgetary policies, smart budget reforms • MFF should support public services reforms (aiming long term savings and improved quality) • Positive incentives to budget consolidation • common pool for the financing of the state debt in EA • establishment of a EU level Treasury (eurobonds), • yearly maximum 3% of GDP fresh debt financing for a country who meet the new EDP criteria, • the yield could be lower than actual market rate, • the same mightapply to non-euroareacountry if it meets the criteria. GKI Zrt., www.gki.hu

21. Recommendations 2.Sound budgetary policies, smart budget reforms • Coordinated measures at the level of EU against tax evasion and fraud • Promoting joint management of government functionsof member states (foreign representation, R&D&I, higher education, special hospital treatments, etc.) • As under well designed circumstances a modest (2-3%) inflation might help to improve the budget equilibrium and debt rate, rethinking of the regulation is suggested GKI Zrt., www.gki.hu

22. Recommendations 3.Supporting the decrease of government debt • Give incentives to privatisation if it reducing debt and improving competition (togetherwithsmart regulation and consumer protection) • Establishing an independent EU think tank dealing with budgetary reforms, best practices and lessons from mistakes, and country recommendations • The macro assumptionsshould be discussedwith EU-widethink tanks • Fine tuning of new EDP rules GKI Zrt., www.gki.hu

23. Recommendations 4.Supporting growth • New tools of the economic governance (banking union, MIP) should aim to improve growth potential of the EU • Non-bank financing channels should be strengthened accessible for SME sector (cheap refinancing, venture capital, EIB, direct EU budget financing) • EU-level effective deregulation programs • Establishing a fund in EU budget for 200 best universities to attract the best experts of the world (with quotas for students coming from less developed member states) GKI Zrt., www.gki.hu

24. Recommendations 5.Eurozone entry • As euro-zone stabilises it offers stability advantages to CEE member states • Joining to the EMU will have a positive effect on growth and competitiveness of non euro-zone CEE countries and on euroarea as well • Entry criteria can be simplified concentrating on medium term sustainability • It needs the revitalisation of a sizeable catching-up process GKI Zrt., www.gki.hu

25. Recommendations 6.Towards social union • Correction of the macro surveillance with strengthened analyses of employment and social policies, introduction of new EU standards • Principles of pension system and unemployment benefit should be unified and lift to EU level to shape the business cycle • Complementing the social security with a mandatory funded state pension sub-system which should be treated as a part of General Government from the EDP point of view • Increase social solidarity funds in the EU budget (child poverty, homelessness, roma inclusion) • Ensure transferability of social rights and services • Improve mobility of workers by removing regulation barriers GKI Zrt., www.gki.hu

26. Thank you for your attention! GKI Zrt., www.gki.hu