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Financial turmoil and
Transition Countries
Fabrizio Coricelli
University of Siena and EBRD
Istanbul June 25, 2008
No decoupling, but transition countries
have weathered the storm…so far

Spreads have increased, from extremely low levels

Stock markets have been hit

Growth forecast revised downward, but moderately

With a few exceptions foreign lending has continued

Some countries, Russia in primis is seen as a “safe
heaven” by international investors and rating
agencies (high commodity prices, large stock of
foreign reserves main strength, large presence of the
state in the economy)
CDS spreads significantly increased
(latest data for March 2008)
350
163
300
Spread widening in
bps
163
152
105
116
250
200
150
100
50
173
149
234
146
74
50
36
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R
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C
ro
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B
ul
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ria
R
om
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ia
U
kr
ai
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Se
rb
ia
La
tv
K
ia
az
ak
hs
ta
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0
Jun-07
latest
figures: difference in bps
Equity markets fell
MSCI Em. Europe equity index over the past year
1.4
relative to world
1.3
absolute terms
1.2
1.1
1.0
0.9
relative to all emerging
markets
8
M
ar
-0
-0
8
Ja
n
D
ec
-0
7
7
O
ct
-0
7
-0
A
ug
7
-0
Ju
l
M
ay
-0
7
0.8
But risks have increased

The transition region has benefited from the surge in
capital flows to emerging markets in the past few
years

Domestic credit has boomed, funded by foreign
lending

In most countries, credit --and growth-- has been
concentrated in real estate, construction and financial
sector

Transition countries the only area in the emerging
world with a current account deficit

Largest imbalances in the Baltic states, Bulgaria,
Romania and Kazakhstan
Capital inflows: A large share to
transition countries (US$ bn)
600
500
400
Africa
Asia
Western Hem.
Transition Countries
300
200
100
0
2000
2001
2002
2003
2004
2005
2006
2007
Current account balance (% of GDP)
20%
Africa
Asia
Western Hem.
Transition Countries excl. Russia
15%
10%
5%
0%
-5%
-10%
2000
2001
2002
2003
2004
2005
2006
2007
Extremely rapid credit growth, though
from a low base
Key risks have not been sufficiently
noted

We may have been looking at the wrong indicators
(CA, borowing requirements)

Recycling of petrodollars, the cycle in commodity
prices and associated inflationary pressure, are
perhaps the key issues to look at.

Relevance of the Calvo-Talvi view for transition
countries (for the commodity exporters of the CIS):
they question the relevance relevance of aggregate
current account and net capital flows for countries
that experienced positive developments in the terms
of trade
Recycling of petrodollars

IMF estimates that 50% of foreign deposits of oil
exporting countries have been channelled through
credit to Central-Eastern Europe

Credit boom in transition countries funded through
foreign borrowing

If commodity prices reverse their trend, CEE countries
that absorbed large share of commodity surpluses will
suffer

Commodity exporters in the CIS will suffer as well, if
not more
Highest share of bank loans in transition countries
Shares in total capital inflows to each region (2007)
80%
70%
Africa
Central-Eastern Europe
Western Hem.
Asia
CIS
60%
50%
40%
30%
20%
10%
0%
FDI
Loans
Portfolio
Sectoral imbalances and sudden stop
(Calvo-Talvi view)

Large surplus in the energy sector, combined with
growing indebtedness of non-energy sectors,
especially non tradables (financial sector, construction
and real estate)

A sudden stop in capital inflows in these sectors may
induce a sharp fall in output

Resources of surplus sectors may not be easily
transferred to sectors starved with funds. One reason
is that the surplus sector may invest abroad (capital
outflows).

If surplus is in the hand of the state, the transfer may
be easier. Example of Kazakhstan
Inflows and outflows
15%
10%
Cent. & East. Europe
net inflows
outflows
current account
inflows
20%
CIS
15%
10%
5%
5%
0%
0%
-5%
-5%
-10%
-10%
net inflows
current account
outflows
inflows
-15%
2000 2001 2002 2003 2004 2005 2006 2007
2000 2001 2002 2003 2004 2005 2006 2007
Inflation accelerating

Monetary expansion fuelled inflation, together with
boom in commodity prices

Large share of food in CPI, especially in CIS
countries

Inflation accelerated especially in countries with peg
to the US$: see comparison between Russia and
Ukraine

Response to inflation: tightening of monetary policy in
several transition countries, which combined with
possible stop in foreign financing could imply a sharp
contraction in output
Share of food and non-alcoholic
beverages in CPI basket
60%
50%
40%
30%
20%
10%
0%
Ukraine
Romania
Kazakhstan
Bulgaria
Russia
Poland
Ja
nM 04
ar
M -04
ay
-0
Ju 4
lSe 04
p
N -04
ov
Ja 04
nM 05
ar
M -05
ay
-0
Ju 5
lSe 05
p
N -05
ov
Ja 05
nM 06
ar
M -06
ay
-0
Ju 6
lSe 06
p
N -06
ov
Ja 06
nM 07
ar
M -07
ay
-0
Ju 7
lSe 07
p
N -07
ov
Ja 07
nM 08
ar
-0
8
Inflation (12-month changes)
30
25
Russia
Ukraine
20
15
10
5
0
A few comments on the episode of
sudden stop in Kazakhstan

Kazakhstan an interesting case, as it is the
only country that experienced a sudden stop
following the financial turmoil

Such sudden stop has induces a slowdown of
the economy but not a deep crisis
Sudden stop in Kazakhstan

After the summer of
2007 foreign inflows
stopped and domestic
credit stopped as well

In real terms there was
a decline in the stocks

Growth slowed down
but there was no crisis
Sharp decline in growth rates, but no
recession thanks to commodity production
No crisis yet, thanks to high
commodity prices

High oil and gas prices
have helped to avoid a
deep crisis, in spite of a
sudden stop in capital
inflows

Role of the State: initial
defence of the exchange
rate followed by
commitment to bail out
banks, real estate
companies and the
construction sector
Government steps in

Targeting of resources raised from the energy
sector to other sectors in needs of financing

Pledge budgetary funds for construction
sector

Announce readiness to use oil stabilization
fund to support banking sector

Benefits in the short run, but risks in the longer
run, as the reform process slows down.