1. Regional impact of the crisis: Political economy, governance dimensions Ben Slay Senior economist UNDP Bureau for Europe and CIS 6 July 2010

2. Main points n Macroeconomic impact of the crisis –First phase over... –... Second phase now starting? n Threat of European “double-dip” recession n Less fiscal space—pressure on social sector –Which countries are most at risk? n Regional impact of crisis: –Political economy dimensions –Governance dimensions (“six myths”)

3. Macroeconomic impact of the crisis n First phase over –Global economy recovering... –... Thanks to significant policy stimulus –Much fiscal space used in 2008-2009 n Greek crisis: Threat of European “double-dip” recession? –Less favourable public debt dynamics n In EU-15: “PIIGS” n In our region: Hungary –Regional recovery: Very uneven

4. Who’s the worst hit region? We are... Who’s the worst hit region? We are... Regional GDP growth trends (I) Source: IMF World Economic Outlook, April 2010

5. Regional growth trends: Another perspective Regional growth trends: Another perspective Source: IMF World Economic Outlook, April 2010

6. Which economies got hit worst in 2009? Double-digit GDP declines: Latvia (-18%), Ukraine (- 15%), Estonia (-14%), Lithuania (-14%), Armenia (- 14%), Iceland (-10%) Smaller declines: Russia (-8%), Romania (-7%), Moldova (-7%), Ireland (-7%), Georgia (-6%), Hungary (-6%), Croatia (-6%), Bulgaria (-5%), Montenegro (-5%), Turkey (-5%), Slovakia (-5%), Czech Rep. (-4%), BiH (-3%), Serbia (-3%), FYROM (-1%) Growth slowdowns: Belarus (0%), Kazakhstan (1%), Kyrgyzstan (2%), Poland (2%) Tajikistan (3%), Albania (3%), Turkmenistan (4%) No real change: Kosovo (4%), Uzbekistan (8%), Azerbaijan (9%) Source: IMF World Economic Outlook, April 2010

7. Is the recovery happening? In much of the world—Yes Growth relative to previous quarter. Source: JPMorgan, June 2010.

8. But not in Europe... Growth relative to previous quarter. Source: JPMorgan, June 2010.

9. “PIIGS” and friends: Bank bailouts boost public debts Gross public debt as share of GDP. Eurostat data.

10. “PIIGS”: Key risks for “neighbourhood” n Trade—slow euro zone growth means: –Slow export growth in “wider neighbourhood” –More pressure on external balances n Capital markets: –Slow growing “wider neighbourhood”—less attractive than other emerging markets –Results: n Weaker currencies n Higher interest rates, less long-term borrowing n Less consumption, investment

11. But: Public debts don’t explain everything Sources: IMF, EIU, Eurostat.

12. National crisis responses: Political economy issues n Policy weaknesses: –Recognition lags –Implementation lags –Uncertain implementation capacity n Philosophical issue: Whom to protect? –Key sectors, firms/banks? –Middle class? –Most vulnerable? n Instruments: Transfers or public works?

13. Policy weaknesses: Causes, implications n Recognition lags: –Economics: Different points of business cycle n Technical issue: Forecasts have been too optimistic –Politics: Electoral cycles, other factors n Implementation lags: –Exchange rate policy: n Devaluation can work fastest... n... But is not an option for many non-CIS countries –Monetary policy effectiveness limited by: n Fixed exchange rates/euro adoption n Deleveraging, dollarisation, demonetisation –Fiscal policy: How much fiscal space?

14. Political economy of response: Country drivers n Political drivers: –Parliamentary democracies: Electoral cycle –CIS countries: n Can political leadership admit there’s a “crisis”? n Do they even know? n Economics—Different countries: –Are at different points in business cycle –Have more or less fiscal space –Are affected differently by markets’ risk appetite: n Collapsed in mid-2008 n Recovered in 2009:H2 n Weakened in 2010:Q2 with Greek crisis

15. Uncertain implementation capacity: Social safety nets Source: World Bank. Social insurance (e.g., pensions) not included

16. Social policy reform implications % of GDP devoted to social protection Below average Above average % of poor covered by social protection Below average Weakest ability to protect: Albania, Armenia, Bulgaria, Georgia, Kazakhstan, Kyrgyzstan, Kosovo, Poland, Tajikistan Biggest pay-offs to social policy reform: BiH, FYROM, Ukraine, Uzbekistan Above average Good at targeting; more resources needed: Azerbaijan, Belarus, Latvia, Lithuania, Romania, Russia, Serbia Best performers: Croatia,Hungary

17. Governance and the crisis: Myths and realities (I) n Myth I: Quality of governance and market reform are correlated with extent of crisis –Reality: No clear relationship, positive or negative –Economies that did well in 2009: n Were resource exporters... n... With fiscal reserves from previous years... n... That attracted FDI n Myth II: Exporting primary products minimizes effects of crisis –Reality: Not necessarily—Russia, Ukraine are also exporters of primary products

18. Governance and the crisis: Myths and realities (II) n Myth III: Devaluations are good –Reality: Successful devaluations with relatively small tradable sectors (Poland, Turkey, Central Asia) –For other countries—devaluation risks: n Significant pass-through inflation n Balance-sheet mismatches  financial crash n “Beggar-thy-neighbour” competitive devaluations n Myth IV: The crisis was exported to the region by foreign banks –Reality: Region’s banks didn’t acquire “toxic assets” –Instead: Foreign parent banks—and taxpayers—have bailed out local banks across region

19. Governance and the crisis: Myths and realities (III) n Myth V: ECB’s emphasis on price stability (over growth)  EU must rely on fiscal policy –Reality: EU is torn between “constitutional” SGP and fiscal discretion (pragmatic use of “fiscal space”) n Myth VI: Greek crisis—calamity for Europe –Reality—Greek crisis is helping solve some of Europe’s problems: n Euro too strong, exports not competitive? –Greece  Weaker Euro n Absence of integrated fiscal framework, to support monetary union? –Greece  European Stabilization Mechanism

20. Thank you very much! I don’t claim to have the answers...... But I hope I’m asking the right questions Ben.Slay@undp.org