1.  wiiw 1 The New Member States in the context of the European financial and economic crisis: differentiation and prospects Michael A Landesmann Lecture at the University of Finance and Administration, Prague, 25.11.2011

2.  wiiw 2 Topics to be covered  Features of the European economic and financial crisis  The position of ‘Emerging Europe’: GIPSI and CEECs  The ‘growth model’ of the CEECs pre-crisis  The crisis and pitfalls in the ‘growth model’  Differentiation across CEE economies  Prospects and policy lessons

3.  wiiw 3 3 The ‘growth model’ in the NMS prior to the crisis In the last two decades the region experimented with unique model of growth through integration into the EU: Key features -Strong institutional anchoring – a model of ‘unconditional convergence’ -Trade and FDI integration -Financial integration (downhill capital flows) -(Labour mobility) Made considerable sense in view of initial conditions -Foster institutional build-up after transition -Substitute lack of domestic saving by foreign saving -Make use of wealth of human capital

4.  wiiw 4 4 Pre-crisis growth model, cont’d  Integration boosted capital inflows -low level of physical capital offering higher return on capital; complementary highly-educated labour force and low level of wages -EU accession prospect and improvement in the business climate -low level of domestic credit offering the potential for substantial credit expansion -Seemingly low exchange rate risk  Rapid productivity growth; up-grading of production and trade structures

5.  wiiw 5 Features of the ‘pre-crisis’ growth model:  targeted at integration with the EU area  was associated with significant internal and external liberalization (trade, capital transactions, financial market integration, labour mobility)  benefits: capital inflows, trade integration, ‘technology’ transfer; institutional convergence  the model worked - ‘convergence process’ – but emergence of severe structural imbalances (not everywhere)

6.  wiiw 6 Growth – GDP at constant prices Average annual growth rates, 1995-2002 and 2002-2008, in % Source: wiiw Annual Database incorporating national statistics, Eurostat. 1995-2002 2002-2008

7.  wiiw 7 Growth – GDP at constant prices Average annual growth rates, 2002-2008, in %

8.  wiiw 8 The NMS/CEECs and the build-up to the crisis  Features of the development experiences prior to the crisis  Differentiation across NMS/CEECs: - Extent of external imbalances - Private vs. public debt build-up - De- and re-industrialisation and the build-up of export capacity - Differences in the sectoral allocation of FDI

9.  wiiw 9 9 CEECs and comparisons with other emerging economies  CE-5: Czech Republic, Hungary, Poland, Slovakia and Slovenia  BB-5: Bulgaria, Romania (SE-2); Estonia, Latvia, Lithuania (B-3)  WB-6: Albania, Bosnia and Herzegovina, Croatia, Former Yugoslav Republic of Macedonia, Montenegro and Serbia;  EU-Coh: (Ireland), Greece, Portugal, Spain  Asia-6: Indonesia, Korea, Malaysia, Philippines, Taiwan and Thailand  Latam-8: Argentina, Brazil, Chile, Columbia, Ecuador, Mexico, Peru and Uruguay

10.  wiiw 10 Common characteristic 1: Reliance on foreign savings Post-1998, Asia and even Latin America go into surplus Until 2007, most of emerging Europe goes into deficit

11.  wiiw 11 Net private financial flows in the main emerging country regions (%GDP), 1980-2009

12.  wiiw 12 Composition of the current account of the balance of payments, 1995-2009 Note: ASIA-6 excl. Taiwan. Source: IMF International Financial Statistics and IMF WEO October 2010.

13.  wiiw 13 Source: wiiw Annual Database incorporating national statistics, Eurostat. Net foreign assets, 2008 in % of GDP

14.  wiiw 14 Source: wiiw Database incorporating Eurostat statistics. Composition of the current account of the balance of payments, 1994-2010, in % of GDP Czech RepublicHungaryPolandSlovakiaSlovenia BulgariaRomaniaEstoniaLatviaLithuania

15.  wiiw 15 Net private financial flows in % of GDP, 1993-2009 Source: IMF Balance of Payments Statistics. ASIA-6 excl. Taiwan. LATAM-8 ASIA-6MENA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR

16.  wiiw 16 Source: wiiw Database and Eurostat Net private financial flows in % of GDP, 1995-2010 Folie 55 Czech RepublicHungaryPolandSlovakiaSlovenia BulgariaRomaniaEstoniaLatviaLithuania

17.  wiiw 17 Common characteristic 2: Credit booms Boom in emerging Europe (from very low levels) Slowdown in Asia Slowdown in LatAm

18.  wiiw 18 CESEE: GDP growth was well above the interest rate before the crisis Nominal interest rate on government debt and nominal GDP growth (%), 2000-2010 Note: Interest rate = government interest expenditures / previous year gross debt.

19.  wiiw 19 Common characteristic: Foreign bank ownership, 1998-2005 (assets owned by foreign banks as % of banking system assets)

20.  wiiw 20 Common characteristic 3: It’s not mostly public debt 20 If anything, more favourable public debt developments until 2008, especially in BB countries

21.  wiiw 21 Savings and investment in % of GDP CE-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.

22.  wiiw 22 External debt: public and private (% of GDP), 2008 Note: ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY. B-3 excl. FYROM, BA, RS. Source: World Bank, World Databank.

23.  wiiw 23 Source: Eurostat, IMF. Gross private and public debt (% of GDP), 2009

24.  wiiw 24 Relationship between pre-crisis credit growth and current account balances

25.  wiiw 25 Differences: Real exchange rate developments Appreciation hands-in- hands with catching-up in Central Europe Misalignment in the Baltics/Balkans Stable real X-rate in Asia post crisis

26.  wiiw 26 Differences: Composition of capital flows 26 Mostly FDI in central Europe Mostly credit in Baltic countries NFA as percentage of GDP, 2006-2008

27.  wiiw 27 Summary of pre-crisis growth period and differentiation amongst the CEECs  CEE region in general had a classic pre-crisis pattern of catching-up with ‘down-hill’ capital flows; other emerging economy regions had changed their patterns  A lot of differentiation amongst CEECs: - extent of capital inflows - nature and composition of capital inflows - private and public debt build-up - real exchange rate (mis)alignments

28.  wiiw 28 Differentiation amongst the CEECs: further relevant features  Prior periods of de- and re-industrialisation  Exchange rate regimes  Distortions tradable/non-tradable sectors  Structure and up-grading of export sector

29.  wiiw 29 Industrial production, cumulative change

30.  wiiw 30 Differences in the composition of FDI 30 Large part in manufacturing, infrastructure, trade in central Europe Large part in real estate, finance in Baltic region

31.  wiiw 31 Real lending NB/ECB interest rates, 2008-2010 CPI-deflated, in % p.a. Note: For Estonia: 1-month interbank lending rate (Talibor); for Lithuania: 1-month interbank lending rate (Vilibor). Source: Eurostat. Flexible ER Fixed ER

32.  wiiw 32 Structural features: the role of exchange rate regimes ‘Fixers’ and ‘floaters’ amongst the CESEEs CESEE floatCESEE fix Credit/GDP, change from 2004 to 2008 (percentage points)20.532.8 Real interest rate average, 2005-20071.6-1.6 Current account balance/GDP, 2007 (%)-6.6-11.8 Gross external debt, 2009 (% of GDP)78.895.6 GDP-growth, 2008-20101.18-1.78 FDI to finance and real estate sectors, 2007 (per cent of total FDI stock)26.540.2 Change in unemployment rate from 2007 to 2010 (percentage points)1.53.9 Source: wiiw calculations.

33.  wiiw 33 The crisis and its aftermath  Sudden stops in net capital flows  Turn-around in current accounts: - differences in GDP declines - sharp credit contraction - differences between fix-ex and flex-ex countries

34.  wiiw 34 CE-5: Czech Republic, Hungary, Poland, Slovakia and Slovenia Baltic/Balkan-5: Bulgaria, Estonia, Latvia, Lithuania and Romania Asia-6: Indonesia, Korea, Malaysia, Philippines, Taiwan and Thailand Latam-7: Argentina, Brazil, Chile, Columbia, Ecuador, Mexico and Uruguay Starting point: severe shock and weak recovery GDP, 2008 Q3 = 100 (2005 Q1–2010 Q2)

35.  wiiw 35 Source: wiiw Database incorporating Eurostat statistics. Development of real GDP 1995=100

36.  wiiw 36 Source: wiiw Database and Eurostat Net private financial flows in % of GDP, 1995-2010 Folie 55 Czech RepublicHungaryPolandSlovakiaSlovenia BulgariaRomaniaEstoniaLatviaLithuania

37.  wiiw 37 Source: IMF. Net capital flows to CESEE countries in % of GDP

38.  wiiw 38 Source: wiiw Database incorporating Eurostat statistics. Composition of the current account of the balance of payments, 1994-2010, in % of GDP Czech RepublicHungaryPolandSlovakiaSlovenia BulgariaRomaniaEstoniaLatviaLithuania

39.  wiiw 39 Current account in % of GDP CE-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.

40.  wiiw 40 Pre-crisis credit growth and GDP growth in 2009

41.  wiiw 41 Quarterly GDP developments (2008Q3=100), 2005Q1-2010Q2

42.  wiiw 42 Source: National Bank of respective country. Bank loans to non-financial private sector change in % against preceding year

43.  wiiw 43 Source: wiiw Database incorporating Eurostat statistics. Development of gross industrial production September 2008 =100, Seasonally adjusted

44.  wiiw 44 Source: wiiw Database incorporating Eurostat statistics. Development of quarterly household final consumption 3Q’08 =100, Seasonally adjusted and adjusted data by working days

45.  wiiw 45 Source: International Finance Statistics (IMF), Eurostat, National Banks and National Ministries of Finance. Interest rates on government bonds Maturity 10 years

46.  wiiw 46 Source: Eurostat Interest rates - Loans to non-financial corporation Maturity between 1 and 5 years

47.  wiiw 47 Note: Non-performing loans defined as credits more than 90 days overdue. EE: loans more than 60 days overdue. Source: National Bank of respective country. Non-performing loans in % of total

48.  wiiw 48 Real appreciation*, 2008-2010 EUR per NCU, PPI deflated, January 2008=100 *Values over 100 indicate appreciation relative to January 2008. Source: wiiw Database incorporating national statistics.

49.  wiiw 49 Real appreciation*, 2008-2010 EUR per NCU, PPI deflated, January 2008=100 *Values over 100 indicate appreciation relative to January 2008. Source: wiiw Database incorporating national statistics.

50.  wiiw 50 *) Contributions of changes in inventories are not shown. Source: wiiw estimates incorporating national sources. Contributions to the GDP growth rates in percentage points *)

51.  wiiw 51 *) Contributions of changes in inventories are not shown. Source: wiiw estimates incorporating national sources. Contributions to the GDP growth rates in percentage points *)

52.  wiiw 52 Source: wiiw Database incorporating Eurostat statistics. Development of unemployment rates (LFS)

53.  wiiw 53 Resurrecting growth? New constraints following the crisis

54.  wiiw 54 Constraints following the crisis: Internal factors:  ‘Deleveraging’ of private sector, affects private sector spending;  Public debt has gone up: less fiscal space;  Weak and cautious banking sector;  Differentiated processes of real exchange rate adjustments

55.  wiiw 55 Constraints following the crisis: External factors:  Volatile risk assessment of the region (debt overhang);  Difficult external (and internal) financing;  Contagion effects of banking crisis in Western Europe: consolidation process of banks’ balance sheets  Reduced growth expectations in the most important export markets;  Crisis in the eurozone: new OCA debate; unfinished governance structure leads to wait-and-see w.r.t. EMU membership

56.  wiiw 56 Principal policy lessons:  In national and EU policy frameworks: neglect of private sector debt build-up relative to public sector  Fixed exchange rate regimes bear high risks; much stronger emphasis on OCA criteria on the way to EMU and after  Financial market regulation severely underdeveloped; specific issue of cross-border banking  Use of taxation or insurance to prevent bubbles in financial markets (sand in the wheels taxes on particular types of investments)  Use scope for counter-cyclical policy, but beware of debt sustainability and restructure public finance in growth-enhancing manner  Direct policies towards tradable sector: structural policies, avoid distorting macro-policies; use EU funds

57.  wiiw 57 Unresolved issues:  Will Euro-zone deal with governance issues?  Will there be recapitalisation of banks?  What would be repercussions of a break-up of the Euro-zone?  New timetables – if at all – for further Enlargements and EMU memberships