The Impact of the Current Financial Crisis on the Region of Central and Eastern Europe

1
The Impact of the Current Financial Crisis on the
Region of Central and Eastern Europe

• Vladimír Dlouhý
• seminar of the Informal Meeting of the EU Council
  Working Group on Export Credits
• Prague, May 22, 2009

Data source World Economic Outlook, IMF, April
2009 GS Economic Research Eurostat Haver
Analytics World Bank
2
The world
3
Global framework (1)

• US
• Origin of crisis triggers housing market,
  securitization techniques, accommodative monetary
  policy
• In the short-term, real economy suffered most (
  weakening the geopolitical position)
• Western Europe developed Asia
• Suffering from collapse of global trade own
  financial problems (in some countries) need for
  housing market corrections as well
• Emerging markets (notably CEE and emerging Asia)
• Suffering from collapse of trade as well
  problems with access to external financing

4
Global framework (2)

• Deflationary dangers
• Commodity prices remain weak
• Wages and profits curtailed
• Public policies so far less efficient
• Globally expected write-downs 4 T (1012) USD
• Uncertainty - private capital not active
• No issuance of new securities, limited
  bank-related flows, bond spreads up, equity
  prices down, depreciation of many of EM
  currencies
• Flight to safety USD, Euro, Yen appreciated, as
  well as pegged currencies (Rmb)

5
Outlook - data
6
Outlook - risks (1)

• Financial stabilization - longer than expected
• Developed economies slow-down in credits BOTH in
  2009 and 2010
• EM curtailed access to external financing
• Existing policies will continue
• Monetary interest rates ? 0 and monetary easing
  via central banks B/S
• Fiscal stimulation G20 2 GDP in 2009, 1.5 GDP
  in 2010
• Truly global crisis
• Commodity prices will remain week
• Negative growth will cover about 75 of global
  economy

7
Outlook - risks (2)

• Policies not efficient enough or even
  counterproductive
• Low fiscal multipliers
• Monetary easing and capitalization of financial
  institutions ? slow down in deleveraging
• Both for financial institutions and corporate
  sector, risk on the downside
• Estimated need for recapitalization of banks -
  US 275-500 BUSD, Europe (with UK) 475-950 BUSD,
  UK 125-250 BUSD
• Rising corporate and housing defaults ? further
  fall asset prices and losses across corporate
  B/Ss
• Danger of trade and financial protectionism

8
Outlook - risks (3)

• Financial restructuring
• Dealing with distressed assets
• What are weak, but viable institutions?
• EM corporate sector faces much higher risk from
  collapse of financial sector
• Monetary policies
• Specific for EM, fragile financial flows,danger
  of sudden stops, much more careful easing
• Fiscal policies
• Short-term efficiency?
• Prevailing view yes
• Medium-term sustainability budget deficit,
  inflationary pressures

9
European Union
10
Main facts

• Deeper and longer recession
• Both industrial production and exports still
  suffer
• Increase of unemployment to the level close 10
• Core inflation beyond 1
• Paradox well behaving countries, with strong
  export potential, suffer most (Germany)
• Signs of improvement (PMI, etc.)?
• Too early to call
• Be realistic

11
Background for realism (1)
12
Background for realism (2)
13
Exports collapse
14
Outlook for 2009 - dataselected countries
15
Background banking sector

• Bank's losses and over-leveraging
• self-protecting tightening of credits, well
  beyond a cyclical one
• Extraordinary reaction to shore up confidence in
  banking system so far without effect
• Financial conditions to stay tight for whole 2009
  and first half of 2010
• German and Austrian banks?

16
Credits loans and securities(bn Euro, net
monthly flows)
17
Background fiscal and monetary policies

• Fiscal policies
• Strong automatic stabilizers dampening downturn -
  contribution to growth 2.4 pp in 2009, 0.4pp
  in 2010
• Discretionary fiscal packages in several EU
  countries
• Monetary policies
• ECB cutting down
• Considering unconventional easing

18
Central and Eastern Europe
19
CEE Region

• All countries - similar features of past 5 years
  of economic development fast growth
• driven by external demand
• with deficits and often debt (of households,
  corporation and governments) financed from
  external resources
• in many countries the situation substantially
  worse than in CZ deficits, debts, reliance on
  external financing, loans in foreign currencies,
  vulnerability of banking sector, distortion of
  industrial structure, mandatory budget
  expenditures, etc.
• Global markets ? until recently, unified view on
  the region
• Not distinguishing enough among the countries
• General view influenced by the worst performing
  country (contagion danger)

20
Crisis - two basic facts (1)

• 1. External shock ? slow-down of economic growth
• Fall of demand for exports
• Lower profits, lower wages ? decline of
  consumption
• General consequences of global financial crisis
• uncertainty ? investment decline (including sharp
  decline in FDIs)
• Collapse of equity markets
• Banking sector problems, almost credit crunch
• Unemployment, social consequences, etc.

21
Crisis - two basic facts (2)

• 2. Macroeconomic destabilization
• Lack of confidence, danger of sudden stop of
  external financing ? sustainability of (even
  short-term) debt
• NPL share in domestic banks has dramatically
  increased (with notable exception of some
  countries, namely CZ) ? impact on large, Eurozone
  based banks
• Dramatic decline of capital inflow in general
• In some countries an outflow simultaneously

22
Short-term consequences

• October 08 - March 09 speculation on
  destabilization of some CEE economies
  unnecessary media hysteria with quite unfortunate
  consequences
• Depreciation of all floated currencies in the
  region
• Real economy adjustment more pronounced for
  economies with pegged currencies (SK, SLO less
  so)
• Problems of some short-term governmental bonds
  issue, increase of spreads
• All this at quite low inflation
• Slow pass-through into prices decrease of
  commodity prices

23
Economic policy difficulties

• Contradictory requirements on economic policy
• General impact of the crisis
• Monetary easing (including so called
  non-traditional steps)
• Region's Central Banks could have - at the
  beginning - decreased interest rates disregarding
  the depreciations (on the contrary, some positive
  effects on exports)
• Fiscal policy pressure (higher social
  expenditures, automatic stabilizators, calls for
  fiscal incentives)
• Generally anti-cyclical policies required
• Short-term destabilization
• Very restricted space for increase of deficits,
  but even - at least within past weeks - for
  monetary easing as well

24
Selected data (and what they imply)

• Region has better basic macro-parameters than
  most of Eurozone countries (with important
  exceptions)
• CEE is not a consistent group of countries
• Different countries suffer with different level
  of economic vulnerability
• Sub-group of Eurozone (IRL and a so-called
  southern flank) - reveal an extreme worsening
  of basic macroeconomic forecasts
• However, risks covered by Eurozone

25
Basic forecasts 2009
26
Real GDP growth, forecast 2009
27
General Government Balance of GDP, forecast 2009
28
Government Debt, of GDPforecast 2009
29
Current Account, of GDPforecast 2009
30
Regions vulnerability

• At some countries (Baltics, H, but to some extent
  RO and BG as well) lack of credibility still
  prevails
• Short-term debt sustainability more important
  than basic macro-parameters
• Sudden stop fears
• Market sentiment to much extent determined also
  by countries outside EU (Ukraine, Turkey)
• Recent weeks - stabilization
• International institutions ready to provide
  support
• Risks still exist
• Uncertainty around large banks in the region
  (Erste, KBC, Unicredit, Raiffeisen, )
• Useful (despite many differences) comparison with
  selected south-Asian countries prior to 1997-8
  crisis

31
Credit tightening

• Lower Central Banks rates did not translate
  into lower borrowing costs
• On the contrary
• Credit cycle turned swiftly down, no bottom in
  sight
• Lending rates increased
• Demand or supply credit shock?
• Supply!
• Reasons sharp increase of NPLs and tighter
  external funding
• Czech banks probably positioned best in the whole
  region, but credit tightening will continue in CZ
  as well

32
CEE Proportion of loans, denominated on FX
33
CDS spreads
34
Sharp depreciation in CE
35
External debt, of GDPAsia 1996, CEE 2008
36
Current account, of GDP Asia 1996, CEE 2008
Narrow Balance of Payments CA Net
FDI Source Goldman Sachs, Haver Analytics, WB
37
Conclusions for region (1)

• Different level of stability
• Some countries (CZ, PL) very solid short-term
  debt sustainability
• Vulnerable industrial structure
• Sluggish export demand beyond January 1, 2010
• Credit tightening will continue
• Despite historically low Central Banks interest
  rates
• GDP contraction from around -1 (PL, SLO) to more
  than -10 (Baltics), low inflation, substantial
  increase of unemployment
• Regional and structural differences
• Currencies - depend on stability in the region
  and potential contagion effects
• The fate of pegs?

38
Conclusions for region(2)

• Still possible adjustment on equity markets
• Autumn 2009?
• Forced sales
• Both 2009 and 2010 Government Balance and
  Current Account probably beyond Maastricht
  criteria
• Much better than most of EU countries
• Is it a problem?
• Link to Euro
• Momentum for medium-term reforms?

39
Economic policies (1)

• Solution to todays crisis is outside CEE
• Mostly small open economies, dependent on the
  re-start of Eurozone economic growth
• Stabilization and adjustment homework in
  countries that are most unstable
• Crucial role - Central Banks
• Monetary policies, facing contradictory
  requirements
• Regulation and supervision
• Fiscal policies - contradictory pressures again
• Political pressure to increase expenditures -
  stimulative, social, etc.
• For some countries , violation of Masstricht
  criteria is not - in the short-term - any tragedy
• In other group of countries, Maatricht can serve
  as a political imperative to defend adjustment
  policies
• On the other hand, for all countries, the
  contagion danger is not over - macroeconomic
  stability requirements should prevail

40
Economic policies (2)

• Short-term measures
• Danger of politicization
• Demand-side stimulation
• Efficiency?
• Only when there are no doubts
• Infrastructural projects - yes, but time-lags
  problem
• Future deficits
• Supply-side policies
• Yes, but even here time-lags danger
• Opportunity to pursue the reforms
• Problem of political will
• Social policies - targeted to affected groups and
  regions

41
Economic policies (3)

• In multilateral framework
• Avert trade protectionism
• All available resources to foster trade
• Trade financing is crucial
• Insurance and guarantees of trade and financial
  risks
• Crucial EU policies towards banking sector and
  impact on behaviour of banks present in the
  region
• Adjustment policies in problem countries
• Active discussion on Euro - potential anchor for
  expectations
• Maastricht's criteria - for another countries and
  another time

42
Thank you