World Bank EU-8 Quarterly Report (July 2004) Bratislava, July 15, 2004

EU-8 Quarterly Report The second report in a new WB series Monitors economic and reform developments in the eight Central European and Baltic EU accession countries (the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, the Slovak Republic, and Slovenia) Special topic: regional policy Prepared by a team of Bank economists in the region and presented in Warsaw, Riga, Bratislava and Vilnius

Contents of the Report Highlights External Environment Overview of EU-8 Country-specific sections Special topic – regional policy Forecasts, data, annexes

The Political Economy Background The EU-8 joined the European Union on May 1, and while this is a major political achievement, the potential economic gains will have to be earned Euro adoption is now the main medium-term economic policy goal, and countries will move at different speeds along this road Weak popular support for governments and political instability in some countries is complicating economic policy-making and reform implementation

Macroeconomic Policies and Developments The external environment weakened Output growth accelerated, but inflation increased Monetary policy was appropriately tightened in some countries Fiscal policy was supported by buoyant revenues related to high nominal output growth, but further underlying adjustment remains elusive

Special Topic: Regional Policy There may be a trade-off in the medium term between external convergence and internal convergence Sound economic policies are key to reducing this trade-off EU aid and national co-financing should be directed toward the highest long-run economic returns The National Development Plans for should be improved relative to existing plans

Different roads to Euro adoption Estonia, Lithuania, and Slovenia were admitted to the ERM-2 in June and aim to adopt the Euro from January 2007 Latvia aims to join the ERM-2 in January 2005, while Euro adoption would follow in January 2008 Slovakia plans to adopt the Euro from This plan look feasible Poland aims to achieve the fiscal deficit limit in 2007, but this will be a major challenge. In Poland, Czech republic and Hungary, Euro adoption is unlikely before 2010

The Maastricht Criteria and EU-8, 2003

Some convergence programs are rather optimistic

European Parliament: EU-8 more to the Right

Popular support for governments down: political cycle or reform agenda?

The external environment deteriorated somewhat in Q2-2004

Private Consumption in Baltic States, while Domestic Demand and Export in Visegrad Countries Fuel Growth

Inflation has been on an upward trend since mid-2003 with a further acceleration in Q2

Regional Policy in the context of EU accession pluses Access to free movement of goods and services Enhanced regional aid programs Support to agriculture (Common Agricultural Policy) minuses Increased competition from existing and new member countries

Is there a tradeoff between external and internal convergence? Evidence from the EU member states suggests that there is a tradeoff: Periods of rapid growth have been typically associated with rising internal income disparities Emergence of growth poles due to economies of scale

EU-8 Experience Early 90 ’ s – support oriented towards supporting regions with declining traditional industries Pre-accession partnerships, financial support for regional development through EU aid programs EU accession – aid flows based on formal development programs (Community Support Frameworks and Single Programming Documents); challenge – focus on objectives rather than additional funds

Sources of Regional Income Disparities Factor concentration (investment concentrates around the major cities) Labor mobility – a key obstacle to smoothing income and employment disparities (cultural factors, skills mismatches, inadequate transportation links)

Policy Recommendations (1) There is a clear need to formulate regional policy in the context of country ’ s overall economic and social objectives: -Macro-fiscal framework -Assessment of capacity at different levels of government -Evaluate trade-offs between internal and external convergence

Policy Recommendations (2) The regional policy would be best directed towards supporting market-driven growth poles: -Investment in physical and human capital -Improvement in investment climate, strengthening capacity at lower levels of government -Public interventions should generally be focused on addressing market failures and externalities

Slovakia: Health Care Reform Restructuring was delayed: lobbies Important steps were taken to stabilize health care finances in H The more substantive parts of the health care financing reforms are scheduled for the second reading in Parliament in September A test of the ruling coalition?

First results of health care reform are encouraging

Pension reform The second pension pillar consisting of mandatory pension funds, to be managed by private operators, will operate from January The new regulatory scheme is under preparation, and effective supervision will be key to the success of the 2nd pillar. The new legislation on the third pillar of pension system will be submitted to the government in August 2004.

Education Parliament opposed a law in the spring of 2004 aimed at establishing tuition fees and scholarships for tertiary education citing the possible negative impact on the poor. The government plans to submit a new law proposal in the fall.

Public finance management reform The 2005 budget will be the first in which all chapters present their budgets in a programmatic and multi- annual format. A new Debt and Liquidity Management Agency is now fully operational and borrowing costs for the Slovak Republic have been reduced. Financial Policy Institute (FPI) in the Finance Ministry has been established, and its macroeconomic forecasts now form an important input to the budget. A Committee for Macroeconomic Forecasts has been set up, and its forecasts are compared with those of the MOF. The process is one of transparent peer review and international best practice.

World Bank Activities Country Partnership Strategy approved in May ($17m lending in ) EFSAL completed Pension policy note being prepared Living Standards Assessment started Higher Education Financing

Thank you! Comments/ideas are welcome