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Crisis Flu and Eastern Europe

 
Tuesday, 14 April 2009 00:00
 
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by EPOS
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The differences between Eastern European countries facing the global crisis are as important as the similarities and they mostly regard the ‘initial conditions’, that is, the situation in each country before the crisis unfolded. Some of these so-called ‘initial conditions’ concern the different relative openness in terms of trade and FDIs of the economic systems, domestic and external imbalances, external debt sustainability, the degree of financial deepening, the role of the banking sector and domestic credit compared with GDP expenditure structure and, last but not least, the progress in the transition process.Also the sheer size of a country, both in economic than in demographic terms, matters. The bigger the population along with per capita GDP the more relevant the domestic market for the economic performance and, comparatively, the more resilient a country to exogenous shocks.

The size of the domestic market is related in inverse proportion to the economic system’s openness in terms of Trade-exchange_to_GDP ratio and FDI penetration (FDI Stock Per Capita;) everyone can appreciate it comparing Poland and Slovenia values of these ratios. The higher the level of FDI penetration, the higher are the level of structural change, the level of interdependence with others economies and so the exposition to the effects of an adverse international conjuncture.

The higher figures for EECs in relation with other emerging economies are also evidence of global trade and production processes integration that, along with financial integration, characterized the distinctive model of growth on which Eastern Europe relied on the last two decades.

The financial integration results from the EECs’ banking sectors profound transformation since the second half of the nineties. Foreign ownership levels of most of Central- and South-Eastern Europe countries are among the highest in the world and domestic credit to private sector expanded rapidly in recent years, particularly from 2004. Domestic credit growth reflects partly a process of catching-up started from low levels of financial intermediation, nevertheless this process has been also stimulated by aggressive business strategies of EU-15 based banking groups.If trade and financial integration processes have been the central aspects of Eastern Europe’s growth mechanism– or the acceding countries’ Hobson’s choice -, the same integration has contributed to sustained trade reorientation and capital inflows. The current account deficits that emerged in the second half of Nineties were called “structural” to indicate the nature of those deficits, namely a side-effect of the “regional growth mechanism”.

The above sketched dynamics of the “regional growth mechanism” interacted with:

  • a) different macroeconomic (monetary and fiscal) policies/policy-mixes and different banking supervision;
  • b) different chances and choices concerning current account deficit financing;
  • c) different levels in reforms progress (particularly public expenditure related reforms) and of Governance Capacity.

The result was a range of (national) growth strategies - often implicit – that proved more or less sustainable. In some countries tight or conservative fiscal policies helped to limit budget deficits, to contain soaring consumption and household debt. In other countries the private sector accumulated high levels of foreign borrowing, including borrowing in foreign currencies. Some countries boasted comparatively large budgetary deficits (Hungary, once more financed from abroad, preserving very limited foreign reserves, and so on.



The effects of the diverging growth strategies can be seen also through the GDP’s expenditure approach. Countries at the moment best-equipped to cope with the crisis have comparatively low levels of private consumption and comparatively low levels of net exports; in two specific cases these countries are also net exporters (Czech Republic and Slovenia). In other words, when national savings are financing/covering investment demand and private consumption is not overly pushed by domestic credit, growth is then sustainable. On the contrary, when comparatively high levels of consumption compound with high levels of investment and low levels of national savings (Bulgaria, Romania and Ukraine, let alone Serbia and Moldavia) growth seems not sustainable.

Therefore it is critical to remember that not every country should be placed in the same basket and also that vulnerability depends basically on domestic conditions. Every country is affected by the crisis, but some countries, without having any systemic, policy or governance problems themselves, are affected mainly by what is occurring around them and now require smaller adjustments. Countries as Poland, Slovakia, Czech Republic, even though they will face stagnation or recession in the current year, should manage with some ease the crisis effects. Others are exposed to risks associated with imbalances, indebtedness and financial vulnerabilities with a broad variety of combinations.

Even in those countries where structural strengths are much more relevant than domestic or exogenous cyclical weaknesses, strong policy action and substantial commitment – both from national and from international institutions – are a precondition to get by with the crisis. Uncoordinated or partial interventions and stimuli will be ineffective. Even if there is no agreement on weather vertical industrial policies (e.g. the support of key sectors/firms) are more appropriate then horizontal industrial policies aimed at improving the business environment, it is fully agreed that industrial policies will be effective if set in packages composed by households’ disposable income protection, fiscal stimulus (tax relieve; public investments; public spending on welfare) and interventions aimed to restore confidence on banking and financial sector.

However just the global crisis in it-self is challenging policies in this countries, as lower revenues will allow less room for an overextension of expenditure. So CEE and SEE countries – with a small number of exceptions – will not be in a condition to enact sizeable demand-stimulating fiscal policies over the medium period avoiding an increase of the fiscal deficit. Another risk is the short-termism, to say the risk of an excessive focus on immediate solutions to the crisis to the detriment of deeper reforms tackling long-term issues as labour-force aging and the productivity gap.

 


Last modified on Wednesday, 11 July 2012 14:31
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