The Monetary Union and the NMS the pressure of a onecorner solution: a catch 22 - PowerPoint PPT Presentation

Title: The Monetary Union and the NMS the pressure of a onecorner solution: a catch 22


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The Monetary Union and the NMS (the pressure of
a one-corner solution a catch 22?)

• Daniel Daianu, 17 April 2009

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Agenda

• How does the financial crisis affect the NMS?
• Current risks and macroeconomic challenges for
  the NMS
• Are shortcuts to joining the MU feasible?
• Concluding Remarks

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How does the financial crisis affect the NMS?

• A period of immense uncertainty and turmoil
  (normal vs. extraordinary uncertainty)
• Capital flight triggered by margin calls and risk
  reassessment
• Credit rollover (from very high growth rates)
  more difficultthe importance of voluntary
  agreements (The Vienna Accord in the case of
  Romania)
• Fall in production NMS are more exposed, on
  average, as they provide intermediate products
  with lower value added ? higher unemployment
• Exchange rate volatility (for floating rates
  NMS) if prolonged could inflict long-lasting
  pain to real economy

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How does the financial crisis affect the NMS?
(Contd)

• World trade expected to fall sharply in 2009
  between 9-13 after 2 growth in 2008 and an
  average of 6 over previous years
• Threat of undercapitalisation to banks still
  real. Europes financial system revolves around
  the banking sector in contrast to the USimpact
  on credit markets (cost of credit)
• Bank nationalisations still on the cards (most
  recently in Spain - Caja de Ahorros Castilla La
  Mancha and Germany Hypo Real Estate)

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Current risks and macroeconomic challenges for
the NMS
Maastricht Criteria much more difficult to be
met today Before the crisis

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Source Eurostat
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Current risks and macroeconomic challenges for
the NMS (Contd)
After the crisis

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Source Eurostat
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Current risks and macroeconomic challenges for
the NMS (Contd)

• The macroeconomic situation has started to
  deteriorate at an accelerated pace in mid 2008
  but telling signs were present before (rising
  current account deficits a Dutch disease?)
• Demand falling industrial output and consumption
  decreasing sharply
• Rise in budget deficits due to increased
  government spending and collapsing revenues
• Increased pressure on domestic currencies
  regional and domestic causes
• Falling inflation but upward pressures persist
  (wage demands, exchange rate depreciation).
• Unemployment a problem rising fast. Risk of
  social tensions and political fallout (extremism)
• Contagion effects

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Nominal Exchange Rates Evolution
Increased volatility of exchange rates would
create technical difficulties in setting the
central parity for the ERM II
Source ECB

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CDS Spreads in NMS Going Up

• Higher CDS spreads make debt refinancing more
  costly
• Perceived country risk usually associated with
  the stock/composition of debt and C/A /
  government budget deficits

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External Vulnerabilities, Selected Economies

• Currency board countries tend to have higher
  external debt/GDP ratios

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Graph Source Eurobank, Quarterly Economic
Review, Dec. 2008
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Foreign Trade and Financial Integration
Source World Bank, EU 10 Regular Economic
Report, Feb. 2009
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Current risks and macroeconomic challenges for
the NMS (Contd)

• The role of the banking system in NMS low
  financial deepening
• Most banks in NMS are foreign-owned. High risk
  exposure due to cross-country banking operations.
  These issues are throughout the EU
• Foreign banks have been behind the exponential
  rise of non-governmental credit.(capital account
  liberalization)
• Foreign owned banks need to be willing to keep
  open credit lines to NMS ? more optimal than
  withdrawing

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Some NMS Still Maintain a Competitive Advantage

• Maintaining a competitive advantage is paramount
  for subsequent recovery of NMS economies!
• Currency board monetary regimes prevent NMS to
  adjust and a strong euro puts an upside pressure
  on their domestic labour costs

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Energy Dependency Potential Threat to Future
Economic Development

• The relative price of energy impacts severely on
  economies with low valued added and
  disproportionate energy consumption most NMS are
  among them! (short term vs. long term impact)
• This will show up in adverse dynamics of ULCs

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Are shortcuts to joining MU feasible?

• A recent (confidential) IMF report suggested
  yes but
• This is a debate of o longer vintage, which is
  resuscitated by the current financial crisis
• ECB rejected this idea ECBs stance supported
  also by CBs of Czech Republic and Romania
• Main (suggested) reasons for NMS being rushed
  into the MU
• Exchange rate stability
• Reduced risk in credit refinancing especially
  FX credit
• Possibly more flexible markets (in some NMSs)
  than in older MU member states
• Are these reasons enough?

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Are shortcuts to joining MU feasible? (Contd)

• Distinguish between countries with floating and
  pegged rates!
• For countries with pegged rates (currency
  boards)
• Run the risk of devaluation ? increase in FX
  denominated debt, could be very damaging
• CBs credibility at stake
• On average two thirds of debt is in FX. Highly
  euroised economies
• For floating rates countries
• Some variability in exchange rate is desirable ?
  helps adjustment, but too much can be very
  damaging
• Stability could be achieved through other means
  (i.e. agreements with international financial
  institutions), though this is extraordinarily
  difficult during this crisis..
• EU Treaty specifies that exchange rate policy is
  a matter of common interest (for EU members)

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Are shortcuts to joining MU feasible? (Contd)

• Weigh between short-term benefits and long-term
  costs!
• Lose control over monetary policy ? in medium
  term, the level of interest rates set by the ECB
  may not be appropriate for the development stage
  of the NMS (i.e. Ireland, Spain,)
• Limiting wage growth might be necessary to
  maintain competitiveness and keep inflation low ?
  could be unpopular as a policy (i.e. Portugal)
• Now everyone wants to be in a one corner
  solution!
• Already being in the euro area useful nominal
  anchor but
• Could this have slow-downed the necessary
  adjustment process? Ex. Greece, Italy, Belgium ?
  high public debtfree riders!
• A systemic risk for the euro area as a whole

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Are shortcuts feasible?

• Big vs. small economies
• How long will this crisis last
• Some of NMSs are better equipped to be inside the
  Eurozone than some MU member states
• A catch-22 situation a faster euro adoption
  seems quite tempting, but would it liberate the
  economy over the longer term from other
  constraints?
• Implications for the MU is it made weaker by new
  members? Some NMS have pretty good macroeconomic
  fundamentals

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Concluding Remarks

• NMS economic policies should be aimed towards
  achieving durable macroeconomic stabilitywhile
  the external environment may stay quite
  unfavourable for quite a while
• Distinction between floating and pegged rates
  countries is important.the size of the economy
  does matter.
• Fiscal impulses by developed countries may have
  an impact and relieve some of the current
  pressure.
• Are IMF-backed programs enough?
• EU institutions should support NMS through
  various mechanisms
• Policy coordination and cooperation yield
  superior outcomes! The issue of a EU collective
  response for NMSs

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Concluding Remarks (Contd)

• The length of transition periods for individual
  NMS for euro adoption is an open ended question.
  Relaxation of Maastricht criteria might be an
  option even at the EU level! But this
  relaxation presents pitfalls.
• Abiding to a medium-term structural adjustment
  programme is necessary. Monetary policy
  convergence and sound public finance is paramount
  for NMS in order to avoid long-term economic
  costs

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Concluding remarks (Contd)

• Productivity gains are a must
• The rate of capital formation and education
• The two above mentioned conditions are necessary
  for durable economic growth were a faster euro
  adoption take place

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The Monetary Union and the NMS (the pressure of
a one-corner solution a catch 22?)

• Daniel Daianu, 17 April 2009