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


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

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
The world
Global framework (1)
  • US
  • Origin of crisis triggers housing market,
    securitization techniques, accommodative monetary
  • 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

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
  • Flight to safety USD, Euro, Yen appreciated, as
    well as pegged currencies (Rmb)

Outlook - data
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

Outlook - risks (2)
  • Policies not efficient enough or even
  • 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
  • Danger of trade and financial protectionism

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

European Union
Main facts
  • Deeper and longer recession
  • Both industrial production and exports still
  • 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

Background for realism (1)
Background for realism (2)
Exports collapse
Outlook for 2009 - data selected countries
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?

Credits loans and securities (bn Euro, net
monthly flows)
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
  • Monetary policies
  • ECB cutting down
  • Considering unconventional easing

Central and Eastern Europe
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)

Crisis - two basic facts (1)
  • 1. External shock ? slow-down of economic growth
  • Fall of demand for exports
  • Lower profits, lower wages ? decline of
  • 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.

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

Short-term consequences
  • October 08 - March 09 speculation on
    destabilization of some CEE economies
    unnecessary media hysteria with quite unfortunate
  • Depreciation of all floated currencies in the
  • Real economy adjustment more pronounced for
    economies with pegged currencies (SK, SLO less
  • 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

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

Selected data (and what they imply)
  • Region has better basic macro-parameters than
    most of Eurozone countries (with important
  • 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

Basic forecasts 2009
Real GDP growth, forecast 2009
General Government Balance of GDP, forecast 2009
Government Debt, of GDP forecast 2009
Current Account, of GDP forecast 2009
Regions vulnerability
  • At some countries (Baltics, H, but to some extent
    RO and BG as well) lack of credibility still
  • 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
  • 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

Credit tightening
  • Lower Central Banks rates did not translate
    into lower borrowing costs
  • On the contrary
  • Credit cycle turned swiftly down, no bottom in
  • 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

CEE Proportion of loans, denominated on FX
CDS spreads
Sharp depreciation in CE
External debt, of GDP Asia 1996, CEE 2008
Current account, of GDP Asia 1996, CEE 2008
Narrow Balance of Payments CA Net
FDI Source Goldman Sachs, Haver Analytics, WB
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
  • 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?

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
  • Much better than most of EU countries
  • Is it a problem?
  • Link to Euro
  • Momentum for medium-term reforms?

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
  • 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
  • On the other hand, for all countries, the
    contagion danger is not over - macroeconomic
    stability requirements should prevail

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
  • 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

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
  • Crucial EU policies towards banking sector and
    impact on behaviour of banks present in the
  • Adjustment policies in problem countries
  • Active discussion on Euro - potential anchor for
  • Maastricht's criteria - for another countries and
    another time

Thank you