Global financial crisis: An emerging European perspective

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• Global financial crisis
  An emerging European perspective

Erik Berglof, Chief Economist, EBRD
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Comparing to the Great Depression World
industrial production, now vs. then
Source Eichengreen, Orourke (2010)
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Comparing to the Great Depression Volume of
world trade, now vs. then
Source Eichengreen, Orourke (2010)
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Comparing to the Great Depression World
equity markets, now vs. then
Source Eichengreen, Orourke (2010)
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Smaller economies, then and now
Czech and Slovak Republics
Belgium
Sweden
Poland
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Outline

• A bad crisis, but stopped in its tracks
• Policy response strong, but left scars
• Dealing with aftershocks
• Unemployment
• Fragile banks regulatory tsunami
• Fiscal Greece, Eurozone
• Altered prospects for emerging Europe and the
  Euro

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The phases of the crisis
Source IMF
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Phase 1 Financial crisis build-up
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A fleeting moment of decoupling, followed by
precipitous recoupling
Industrial production 2007-2009 (y-o-y)
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Phase II Systemic outbreak
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Emerging markets more resilient
Average response of EMBI to daily changes in the
VIX during periods of financial volatility in
the United States
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Crisis challengeSystemic problem systemic
response
Source Bankscope, bank websites
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Phase III Systemic response
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Crisis response massive, comprehensive and
coordinated

• Domestic policies Massive in western Europe and
  mature in central and eastern Europe
• Massive coordinated international support
• IMF resources tripled from 250 to 750 bn
• EU BOP support quadrupled from 12.5 to 50 bn
• G20 capital to multilateral development banks
• Parent banks maintained exposures
• A new coordination platform Vienna Initiative

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Magnitude of official support massive
Official support (percent of GDP)
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Improvised response The Vienna Initiative

• Fill institutional vacuum - coordinate
• Bring together authorities (home and host)
• Private and public sector
• Incentivise banks to coordinate
• Regulatory incentives (IMF/EU prog rams)
• Contingent capital (Joint IFI Action Plan)
• Naming/shaming (memoranda of understanding)
• Intensify Information-sharing
• Coordinate within IMF/EU programs IFI
  collaboration

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Sudden Stop in Emerging Europe muted
Percentage changes in external assets of
BIS-reporting banks
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Currency shooting avoided
Currency overshooting avoided
Nominal effective exchange rates
Current programs
Median and interquartile ranges
Past crises
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Output drop deep, sudden, and varied
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Phase IV Towards sovereign crises in advanced
economies?
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Unemployment high - still rising in SEE and the
Baltics
Source CEIC.
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Europes banks in unclear state

• Weak balance sheets
• Total loan write-downs (IMF USD 442 bn) higher
  unrecognised share than in other markets
• Still net tightening (ECB lending survey)
• Compounded by regulatory reform in full swing
• Capital positions and liquidity costs for
  growth
• Uncertainty over bank tax, requirements of bank
  restructuring, and collaboration between
  supervisors
• Emerging Europe still depend on bank finance

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Regulatory tsunami

• Stronger financial regulation needed
• Financial sectors must share eventual crisis
  costs
• But
• Timing in a world of multi-speed regional growth
• May stunt market development (e.g., restricting
  liquidity risks and maturity transformation)
• Regional differences lost in global regulation
  (cross-border banking worked for Emerging Europe
  before and during crisis, but not everywhere
  else)

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Debt increase follows banking crisis
Cumulative increase in real public debt in the
three years following the banking crisis
Source Reinhart and Rogoff (2008)
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What if the crisis had not happened?
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Emerging Europe recovery lagging
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Recovery lagging, particularly in south-eastern
Europe and the Baltics
SEE Compared to January, revised 2010 growth
down negative or flat growth projected for
Bulgaria and Romania.
Baltic countries growth outlook remains negative
on average
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Why recovering more slowly?

• Export dependence on EU limits export demand
• Follows from exceptionally large output drops
• High unemployment weighs on domestic demand
• Risk perceptions, non-performing loans ? credit
  growth
• Fiscal consolidation 2010-11 ? contractionary

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U
Corporate credit stagnating/contracting
Corporate credit growth, Q3-09 to Q1-10,
annualised
Belarus
Serbia
Moldova
Croatia
Romania
Slovenia
Ukraine
Albania
Slovak Republic
Russia
Bulgaria
Estonia
Poland
Latvia
Lithuania
Hungary
Kazakhstan
GDP growth, Q4-09 to Q1-10, annualised
Source National authorities via CEIC data
service, EBRD staff calculations.
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Large deficits lead to fiscal contractions
Source IMF, European Commission.
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Emerging Europe out of sync

• Slower monetary easing, but quicker fiscal exit
  in Eurozone premature for emerging Europe
• Divergence also within Emerging Europe with some
  countries getting large capital inflows
• Regulation with increased capital requirements
  risks coming too early

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Is there a Phase V of sovereign crises in
emerging Europe?
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Emerging Europe and the Eurozone
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Eurozone at a crossroads

• 750bn buys time to build fiscal sustainability
• So far only 60bn not enough given pressures
• ECB shift to purchases of sovereign debt critical
• Large permanent mutual fiscal insurance mechanism
  with rigorously enforced rules
• or a break up with unimaginable implications for
  European project

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Eurozone as an optimal currency area

• Optimal currency areas partly endogenous
• Significant convergence since formation
• Real business cycle
• But also persistent or increasing differences
• Diverging inflation gt real exchange rates
  misaligned

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Eurozone as the end zone

• Costs and benefits of accession shifted
• (1) Costs of loss of flexibility and premature
  entry?
• gt Prepare better (local capital markets)
• (2) Commitment value of Euro anchor?
• Benefits smaller
• Uncertainty about rules and long-term future
• Timing for entry more distant
• gt Strengthen/clarify architecture

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• Thank you

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Needed a new growth agenda

• Safer growth after the great moderation
• Medium term, counter-cyclical macro policies
• Diversify funding sources - local capital markets
• Diversify exports and develop intra-regional
  trade
• Strengthened competitiveness
• Preventing a rapid rise of wage costs
• Stimulating firm entry and exit, and SME growth
• Exploiting cost advantages in the periphery