First Bank of Greece Workshop on the Economies and Eastern European and Mediterranean Countries

1. The global financial crisis and macroeconomic policies: the situation in Southeast EuropeMichael A Landesmann First Bank of Greece Workshop on the Economies and Eastern European and Mediterranean Countries May 14th 2010, Athens

2. Topics: The global financial crisis and macroeconomic policies – Southeast Europe Switch of ‘growth model’ in Southeastern Europe? New (external and internal) constraints emerging from the crisis How to deal with structural imbalances Policy issues: - short-run vs. medium- and long-run - fiscal, exchange rates, financial market reform, structural policies - EU and national policy agendas

3. Features of the ‘old’ growth model: • targeted at integration with the EU area • was associated with significant internal and external liberalization (trade, capital transactions, financial market integration) • benefits: capital inflows, trade integration, ‘technology’ transfer • the model worked - ‘convergence process’ – but emergence of structural imbalances

4. Growth – GDP at constant pricesAverage annual growth rates, 1995-2002 and 2002-2008, in % 1995-2002 2002-2008 Source: wiiw Annual Database incorporating national statistics, Eurostat.

5. The crisis

6. Exports totalin EUR, Jänner 2008 = 100 Source: wiiw Database incorporating national statistics, Eurostat.

7. GDPreal change against preceding year in % Source: wiiw Database incorporating national statistics, Eurostat.

8. Gross industrial production, January 2008 = 100 Source: wiiw Database incorporating national statistics, Eurostat.

9. Gross industrial production, January 2008 = 100 Source: wiiw Database incorporating national statistics, Eurostat.

10. Adjustment of the ‘growth model’: • The legacy of structural imbalances • New constraints following the crisis

11. Trade balances of goods and services, 1996-2009in % of GDP CZ HU PL SK SI BG RO HR MK RS AL Source: Eurostat, wiiw calculations.

12. Trade balance of goods and services (BOP)in % of GDP NMS-5 Baltics SEE NMS-5: CZ, HU, PL, SK, SI. Baltics: EE, LV, LT. SEE: BG, RO, HR, MK, BA (from 1998), RS (from 1999), ME (from 2001). Source: wiiw Annual Database incorporating national statistics, Eurostat. Source: wiiw Annual Database incorporating national statistics, Eurostat.

13. Trade balances of goods and services and income balances, 1996-2009in % of GDP CZ HU PL SK SI BG RO HR MK RS AL Source: Eurostat, wiiw calculations.

14. Industrial production cumulative change, 1995-1990, 2000-1990, 2008-1990 Note: ME; RS data for 1995-1990 refer to CS. Source: wiiw Annual Database incorporating national statistics, Eurostat

15. Industrial production cumulative change, 1995-1990, 2000-1990, 2008-1990 Note: ME; RS data for 1995-1990 refer to CS. Source: wiiw Annual Database incorporating national statistics, Eurostat

16. Exports of goods and services (BOP)in % of GDP Source: wiiw Annual Database incorporating national statistics.

17. Low-skill industries,as % of total manufacturing exports to the EU-25 Source: Comext.

18. Technology-driven industries, as % of total manufacturing exports to the EU-25 Source: Comext.

19. Current accountin % of GDP NMS-5 Baltics SEE NMS-5: CZ, HU, PL, SK, SI. Baltics: EE, LV, LT. SEE: BG, RO, HR, MK, BA (from 1998), RS (from 1999), ME (from 2001). Source: wiiw Annual Database incorporating national statistics, Eurostat.

20. Savings and investment in % of GDP NMS-5 Baltics SEE NMS-5: CZ,HU,PL,SK,SI (from 2000-2007). SEE: BG (2000-2006) and RO (from 2004-2007). Source: wiiw Annual Database incorporating national statistics, Eurostat.

21. Summary on structural imbalances: • Severe weaknesses of tradeable sector; • Strongly deteriorating private sector savings-investment imbalances; • Adds up to unsustainable current account imbalances; • Role of exchange rate regimes; • Problematic allocation of FDI across tradable and non-tradable sectors (not shown);

22. Constraints following the crisis: External factors: • higher risk assessment of the region; • more difficult internal and external financing; • reduced growth expectations for most important export markets; • tougher to join the eurozone (new OCA debate)

23. Constraints following the crisis: Internal factors: • ‘deleveraging’ of private sector, increased propensity to save; • more limited room to manoeuvre for fiscal policy; • weaker and more cautious banking sector; • tightened financial market regulation (internal and external)

24. Summary of the argument on ‘redirecting the growth model’: 1. Adjusting to new external constraints and internal behavioural responses following the crisis: - External: lower export market growth, more difficult financing conditions, tougher effective EMU membership conditions; financial market regulation - Internal: weaker financial sector, deleveraging – higher domestic saving rates, less space for fiscal policy but more pressure on streamlining 2. Dealing with sustained structural imbalances: - Differentiation across country groups (e.g. fix- and flex-exchr. economies) 3. Policy challenges: - For the short run and the medium and longer run - At national and at EU levels

25. Redirecting ‘the integration model of growth’ The policy choices: Fixed vs. flexible rates Fiscal consolidation vs. fiscal stimuli Free flow vs. financial market regulation Structural policy issues

26. Exchange rates Flexible exchange rates have supported sustainable current account deficits Countries with flexible exchange rate regimes may have had a less costly adjustment to the crisis Fixed exchange rates tend to mandate pro-cyclical fiscal policies during the crisis and in the medium run EMU membership may not protect against real exchange rate misalignments

27. Exchange rate and current account Current account in % of GDP Nominal exchange rate, average (NCU/EUR) Source: Eurostat.

28. Real appreciation*, 2008-2009EUR per NCU, PPI deflated, January 2008=100 *Values over 100 indicate appreciation relative to January 2008. Source: wiiw Database incorporating national statistics.

29. Exchange rates*Flexible exchange rate: drastic real depreciation after September 20082008-2009, EUR NCU, Jan. 2008 = 100 *Values over 100 indicate appreciation over January 2008. Source: wiiw Database, Eurostat.

30. Exchange rates*De-facto fixed exchange rate: modest real depreciation after September 20082008-2009, EUR NCU, Jan. 2008 = 100 *Values over 100 indicate appreciation over January 2008. Source: wiiw Database, Eurostat.

31. Exchange rates*Currency board or euro as legal tender: minor real depreciation after September 20082008-2009, EUR NCU, Jan. 2008 = 100 Values over 100 indicate appreciation over January 2008. Source: wiiw Database, Eurostat.

32. (Private and public) Debt and Fiscal Policy In catching-up economies, in financially integrated areas, the (nominal) interest rate on public debt is below the (nominal) growth rate which implies that the sustainability of public debt is assured except if primary deficits are permanently higher than those that stabilize public debt to GDP ratios In the current crisis, it does not seem that in most, not necessarily all countries, structural primary deficit has changed permanently so that fiscal balances are not sustainable Finally, some of the hikes in fiscal deficits are the consequence of the deleveraging of private debts and thus fiscal consolidation is not the first best policy in those cases

33. Gross external debt and public debt % of GDP, 2004-2009 Gross external debt Public debt Source: wiiw Annual Database incorporating national statistics, Eurostat

34. Debt in % of GDP Gross external debt Public debt Private debt Source: Eurostat.

35. Debt in % of GDP NMS-5 SEE NMS-5: CZ, HU, PL, SK, SI. Baltics: EE, LV, LT. SEE: BG, RO, HR. Source: wiiw Annual Database incorporating national statistics, Eurostat.

36. Real leading NB/ECB interest rates, 2008-2010CPI-deflated, in % p.a. Flexible ER Fixed ER Note:For Estonia: 1-month interbank lending rate (Talibor); for Lithuania: 1-month interbank lending rate (Vilibor). Source:Eurostat.

37. Policy recommendations for the improvement or the redirection of the integration model of growth:National agenda Exchange rate flexibility wherever that is feasible (countries that already use the euro or have committed to currency boards would have to make sure that the euro is an optimal currency union for them before joining EMU) Countercyclical fiscal policy with sustainable fiscal deficits and public debt to GDP levels Use of taxation or insurance to prevent bubbles in financial markets (sand in the wheels taxes on particular types of investments) Structural policy to strengthen tradable sector

38. Policy recommendations for the improvement or the redirection of the integration model of growth:EU agenda Copenhagen and Maastricht criteria should ensure that accession to the EMU leads to sustainable currency union ex ante Enrichment of the Stability and Growth Pact with short-term crisis management facility (support for anti-cyclical fiscal policy while keeping track of fiscal sustainability) Strengthening financial regulation for systemic risks; facilities for bank restructuring and for regulation of cross-border activities Use of EU Funds to support development of tradable sector

39. Policy challenges for the Short and medium term: - getting credit going again - real exchange rate adjustment vital in some countries - pursue active fiscal policy in countries with room to manoeuvre - labour market policy Medium and long term: - paying much closer attention to external disequilibria - flexible exchange rate regimes have proven to be more successful - sustainability of private and public debt development (cross-border financial market regulation, increased EU monitoring) - policies to promote the tradable sector (also involving EU transfers)