Wiener Institut für Internationale Wirtschaftsvergleiche The Vienna Institute for International Economic Studies Financial Crisis and Consequences Vladimir Gligorov wiiw Spring Seminar March 2009, Vienna

Wiener Institut für Internationale Wirtschaftsvergleiche The Vienna Institute for International Economic Studies Causes of Current Crisis  Lax monetary policy: low interest rates and strong credit expansion  Global imbalances  Deficit countries in Central, Eastern and South-eastern European Countries  In the Balkans: low export capacity

Wiener Institut für Internationale Wirtschaftsvergleiche The Vienna Institute for International Economic Studies Monetary policy

Wiener Institut für Internationale Wirtschaftsvergleiche The Vienna Institute for International Economic Studies Boom-bust in housing starts compared with the counterfactual

Wiener Institut für Internationale Wirtschaftsvergleiche The Vienna Institute for International Economic Studies

 wiiw 6 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Why contagion?  A more cautious banking sector puts the brakes on funding of -Private consumption, private investment, exports and imports -Real estate transactions  Investors in financial markets have become more risk- aware; the destination and composition of flows have changed to the disadvantage of emerging markets

 wiiw 7 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? 1. Evidence from most recent developments Decline in industrial output Decline in foreign trade Decline GDP Decelerated inflation Real depreciation (not everywhere)

 wiiw 8 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Industrial output decline Rates of change in %, monthly, year-on-year Source: wiiw Monthly Database incorporating national statistics. Candidate countries Potential candidates 40.9

 wiiw 9 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Exports of goods: decline after mid-2008 EU candidate countries, euro-based, January 2006 = 100 Source: wiiw Monthly Database incorporating national statistics.

 wiiw 10 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Exports of goods: decline after mid-2008 Potential candidate countries, euro-based, January 2006 = 100 Source: wiiw Monthly Database incorporating national statistics.

 wiiw 11 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? GDP - shift from expansion to contraction Candidate countries, change in %, annual, year-on-year* * 2008 wiiw estimate, 2009 wiiw forecast Macedonia Turkey Croatia Source: wiiw Annual Database incorporating national statistics.

 wiiw 12 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? GDP - shift from expansion to contraction Potential candidate countries, change in %, annual, year-on-year* Albania Montenegro BA Serbia * 2008 wiiw estimate, 2009 wiiw forecast Source: wiiw Annual Database incorporating national statistics.

 wiiw 13 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Decelerating inflation CPI, monthly, change year-on-year in % * wiiw forecast Source: wiiw Monthly Database incorporating national statistics. 16

 wiiw 14 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Currency Board or euro as legal tender: Producer prices vis-à-vis EU: mainly up EUR per unit of national currency, Jan 2007 = 100 Source: wiiw Monthly Database incorporating national statistics. Exchange rate nominal Exchange rate real

 wiiw 15 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Countries with de-facto EUR peg Producer prices vis-à-vis EU: various patterns EUR per unit of national currency, Jan 2007 = 100 Source: wiiw Monthly Database incorporating national statistics. Exchange rate nominal Exchange rate real

 wiiw 16 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Countries with flexible exchange rate: Producer prices vis-à-vis EU: strong reversal EUR per unit of national currency, Jan 2007 = 100 Source: wiiw Monthly Database incorporating national statistics. Exchange rate nominal Exchange rate real

 wiiw 17 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? 2. Imbalances Imbalances: Fiscal imbalances less alarming – so far Alarming external deficits

 wiiw 18 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Relatively low government deficits, government debt and overall external debt in % of GDP, 2008 * External debt at end of 2007 Source: wiiw Database incorporating national statistics. Gov. budgetGov. debtExternal debt Croatia Macedonia*.49 Turkey Albania BiH Montenegro2.14 Serbia

 wiiw 19 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Imports of goods: intensity and coverage by exports in % of GDP, 2008 Source: wiiw Annual Database incorporating national statistics.

 wiiw 20 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Deficit in trade with goods: coverage, Increase in currency reserves in % of trade deficit Deficit in Trade with Goods = 100 Source: wiiw Database incorporating national statistics.

 wiiw 21 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? 3. Potential trouble  Lack of external means for the financing of external deficits and debt refinancing  More balanced current account becoming a must  Either more exports or less imports (goods and services)  Allowing for nominal depreciation as one alternative (additional burden to households and companies with foreign currency debt)  Wage deflation in the context of strong GDP decline as a second alternative

 wiiw 22 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? 4. Southeastern Europe’s prospects  2009 GDP decline  2010 GDP stagnation  2011 some GDP growth again, provided the international business climate improves  2012 ff. growing GDP, but at rates lower than in  Gradual return of FDI inflow

 wiiw 23 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? 5. Financial risks

 wiiw 24 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? What do we see in the financial indicators?  High current account deficits  In most cases – worsening  So, financing them is the key issue

 wiiw 25 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Current account balance in % of GDP Source: National bank of the respective country.

 wiiw 26 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Governments’ foreign debt  Mostly not very high  And the share in total foreign debt - declining

 wiiw 27 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? General government share in gross external debt in % Source: National bank of the respective country.

 wiiw 28 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Short-term debt  In a couple of cases too high  In a number of cases increasing

 wiiw 29 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Short-term foreign debt in % of foreign exchange reserves (excluding gold) Source: National bank of the respective country.

 wiiw 30 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Banks and risks  Credit expansion decelerating  Leverage ratios relatively low  Risks, however, increasing by most measures  Some countries facing bigger problems than others  Banks rely significantly on foreign liabilities  Foreign currency loans important  Not enough data to say something on non-performing loans

 wiiw 31 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Bank loans to non-financial private sector growth in %, eop month (year-on-year) Source: National bank of the respective country.

 wiiw 32 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? 3m...BOR-3mEURIBOR spread in percentage points, eop month Source: National bank of the respective country.

 wiiw 33 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? TED spread (3m...BOR-3mT-Bill) spread in percentage points, eop month Source: National bank of the respective country.

 wiiw 34 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Leverage, banking sector assets to capital ratio, eop month Source: National bank of the respective country.

 wiiw 35 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Share of banks’ external debt in assets in %, eop month Source: National bank of the respective country.

 wiiw 36 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Share of loans in foreign currency in % of total loans, eop month Source: National bank of the respective country.

 wiiw 37 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Share of non-performing loans in % of total loans, eop month Source: National bank of the respective country.

 wiiw 38 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Real estate bubble?  Construction slowing down  Prices for apartments declining  However, not enough data to say more on that

 wiiw 39 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Growth in apartment prices in %, CPI deflated (year-on-year) * Data refer to half year. Source: National bank of the respective country.

 wiiw 40 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Construction sector growth less GDP growth in % (year-on-year) * Data refer to half year. Source: National bank of the respective country.

 wiiw 41 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Development of income inequality in Central Europe, Baltic States, SEE and CIS, unweighted averages of Gini coefficients (income based)

 wiiw 42 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Income inequality in world regions unweighted averages of Gini coefficients (income based), 2003 SEE CIS East Asia Russia USA Middle East & North Africa South Asia Sub-Saharan Africa Latin America Central Europe & Baltics Western Europe China Gini coefficient Source: UNU-WIDER: World Inequality Database Version 2.0b, own calculations.

 wiiw 43 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Distribution of income & source of income Correlation of functional distribution and inequality in transition countries CE & Baltics, SEE and CIS y = -0.40x R = Compensation of employees, in % of GDP Gini coefficient 2002 Sources: AMECO database, CIS STAT database, UNU-WIDER: World Inequality Database Version 2.0c.

 wiiw 44 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Role of labour market institutions

 wiiw 45 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Main causes of inequality development in transition  Loss in output and increase of unemployment  Rising wage inequalities due to liberalization of labour market regulations  Industrial employment and productivity growth reducing inequality  Dampening effect of public expenditure  While price and trade liberalization reduced inequality via job creation, (public utilities infrastructure) privatization did opposite  Economic integration via exports had positive effects on equality

 wiiw 46 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? The outcome  Croatia: Under the assumption of a mild recession, the Gini increases by 0.3pp to 31.2  Hungary: Under the assumption of a strong recession, the Gini increases by 0.9pp to 27.0  Ukraine: Under the assumption of a heavy recession, the Gini increases by 1.2pp to 31.1  Doubling the drop in industrial & overall employment and the increase in unemployment raises the Gini to: HR 31.6; HU 27.3; UA 31.9

 wiiw 47 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Crisis impact on inequality  Given the extent of the recession, the model suggest an increase of inequality from 0.3pp to 1.2pp (0.7pp to 2pp)  In general income inequality does not change rapidly  Still absolute poverty will be on the rise with average income levels falling  Stronger fiscal expansion could reduce the increase of inequality  1pp more government expenditures reduces Gini by 0.1pp

 wiiw 48 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Conclusions  Risks have increased  Not primarily because of the health of the banks (though Montenegro is different)  But because of high demand for foreign financing that has become scarce  Which drives growth down  Which in turn pushes the risks up

 wiiw 49 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? What is to be done?  Stabilization is the key in the short run  In the medium run, it is a question whether it might be necessary to move from a neoclassical to a mercantilistic growth strategy  The choice may depend on the policy of the EU

 wiiw 50 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Rast na kratak rok Trenutna kretanja, ocenjena na osnovu dostupnih podataka, su veoma negativna Industrijska proizvodnja se smanjuje po visokoj stopi gotovo svuda – takođe u Hrvatskoj Spolja trgovina se takođe smanjuje gotovo svuda – isto i u Hrvatskoj Inflacija se usporava, a preti i deflacija, praktično svuda Ova kretanja implicraju značajnan pad bruto domaćeg proizvoda, praktično svuda, a u Hrvatskoj do 4 ili 5%

 wiiw 51 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Stabilnost na kratak rok S obzirom na pad proizvodnje, reč je o “igri sa negativnom sumom”, dakle o raspodeli gubitaka Ovo ide uz promene u relativnim cenama Od kojih je ključan realni tečaj – dakle odnos između (uprošćeno govoreći) izvoza i unutrašnje potrošnje Budući da se smanjuje izvoz, finansiranje postojećih obaveza zavisi od smanjenja potrošnje ili od mera za povećavanje izvoza Ovo poslednje podrazumeva depresijaciju realnog kursa, bilo preko deflacije ili preko nominalne depresijacije Za razliku od okolnosti kada nominalna depresijacija podstiče inflaciju, u deflatornom okruženju je moguća relaksacija monetarne politike čak i uz depresijaciju tečaja Osnovna pretnja stabilnosti jeste prinudna devalvacija usled suviše jakih deflatornih pritisaka

 wiiw 52 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Zaključci G20 i MMF Ključan zaključak jeste da se održi kratkoročna stabilnost i da se podstakne globalna tražnja Ključnu ulogu ima MMF – triplira se njegova kreditna sposobnost i značajno povećava sposobnost da podrži likvidnost MMF se reformiše, pri čemu su ključni sledeći elementi Cilj je održanje rasta a ne samo stabilnosti Monetarni i fiskalni uslovi se rukovode održivošću, dok su kvantitativni kriteriji indikativni, a ne bezuslovni Strukturni kriteriji su takođe indikativni, a ne obavezujući MMF ima ključni zadatak da podrži globalnu tražnju i da obezbedi da ne dođe do sloma sistema tečajeva što bi vodilo finansijskom haosu i rastu protekcionizma

 wiiw 53 wiiw Spring Seminar, 27 March 2009 Fragile Europe: the Path in and out of the Crisis – What Is to be Done? Srednjoročne perspektive Najvažnije pitanje izbora metoda stabilizacije jeste šta to znači za razvoj na srednji rok? Ovde je važno poći od pretpostavke da je malo verovatno da će rast na srednji rok moći da se finansira na isti način kao i u prethodnom periodu Kako će se onda hrvatska privreda vratiti na put visokih stopa rasta? Ukoliko ne dođe do korekcije realnog tečaja, dakle ukoliko se samo recesijom očuva nominalni tečaj, postoji opasnost da će to imati za posledicu produženu stagnaciju ili preovladavanje niske stope rasta Ovo zato što će rast morati mnogo više da se finansira povećanjem unutrašnje štednje, a mnogo manje kreditima i ulaganjima iz inostranstva To znači da je potrebno značajno povećati konkurentnost hrvatske privrede To je problem i većine drugih zemalja u tranziciji