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Wiener Institut für Internationale Wirtschaftsvergleiche The Vienna Institute for International Economic Studies www.wiiw.ac.at Can the Euro Hold? Michael A Landesmann IDEAS Tenth Anniversary Conference, Chennai, 24-26 January 2012 2 Main Issues Why has the crisis in the Eurozone escalated that much? Where are we at the moment? Is there a policy master-plan? Is the Euro-zone going to pull through? In which shape? What is the predicament of Europe’s ‘periphery’? wiiw 3 Why has the crisis in the Eurozone escalated that much? Pronounced developments of external imbalances within the Euro-zone, driven by financial market integration and – mostly – fast private sector debt accumulation Policy-mechanisms to deal with these imbalances non-existent or in-effective: financial markets insufficiently (and nationally) regulated; real exchange rates diverge persistently driven by capital inflows (interest rate convergence before the crisis); relative price adjustment very slow – hence rebalancing through incomes; no established crisis management mechanism at EU/Euro level (ECB mandate, no pooling of debt responsibility; no fiscal stabilisation function) Banks very weak; no effective re-capitalisation; implicit liability of states – sovereign debt problem and feed-back processes; national segmentation of responsibility Fiscal policies, deleveraging and weak banks generate stagnation; sustainability of debt of both private and public sectors judged (by markets) as unresolved wiiw 4 Public and private debt in % of GDP Public debt Private debt Corporations Banks Households Ireland Greece 600 160 140 120 100 80 60 40 20 0 500 400 300 200 100 0 2000 200120022003 200420052006 200720082009 2010 2000 20012002 20032004 200520062007 20082009 2010 Spain Portugal 250 250 200 200 150 150 100 100 50 50 0 0 2000 200120022003 200420052006 200720082009 2010 2000 200120022003 200420052006 200720082009 2010 Source: wiiw Annual Database incorporating Eurostat statistics. wiiw 5 Public and private debt in % of GDP Public debt Private debt Corporations Banks Households Poland Bulgaria 80 70 60 50 40 30 20 10 0 200 150 100 50 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 20012002 20032004 2005 20062007 20082009 Croatia Romania 160 140 120 100 80 60 40 20 0 80 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2000 20012002 20032004 2005 20062007 20082009 2010 Source: wiiw Annual Database incorporating Eurostat statistics. wiiw 6 Where are we at the moment? Is there a policy master-plan? Exclusive focus on fiscal consolidation: Germany sees this as a precondition for any move towards joint action/mutualisation on the debt problem and widening ECB’s mandate – focus to bring long-term public debt ratios down (constitutional amendments; tightening of fiscal control) Recapitalisation of banks asked for, but happens through shrinkage of balance sheets – credit crunch Some moves towards EU-wide regulatory and supervisory bodies; but lacking teeth so far; in the short-run more national segmentation of banking Measures to monitor development of competitiveness in the future; details to be worked out; unlikely to be very effective No growth strategy, except lip-service to change revenue and expenditure structures in ‘growth enhancing’ manner; plus liberalisation wiiw 7 Is the Euro-zone going to pull through? In which shape? Economic issues: - recession(s) 2012/13; then medium-term stagnation/low growth - unfolding of fiscal consolidation; widening of ECB activity – important transitory role; slow build-up of EFSF/ESM (role vis-a-vis banking system and sovereign debt); Greek default – contagion effects – ‘ring-fencing’; access to capital markets will remain/become very problematic for a range of countries (IT,SP,PO,GR,HU, Ro,...) Political issues: - How are polities going to react? espec. in high austerity countries - Technocratic handling of the crisis; reaction against MerkMontozy; tensions in and towards inter-governmental processes; reactions in national parliaments/polities; field for populist/nationalist parties; little debate on alternative strategies wiiw 8 What is the predicament of Europe’s ‘periphery’? In many countries (Southern and Eastern periphery) high debt levels of private sectors (corporate and household sectors) – deleveraging processes; public sector debt has significantly increased Foreign banks in retrenchment – credit constraints severe; cross-border banking goes through a process of re-nationalisation Current accounts adjust strongly – mechanisms different in fix- and flex-exchange rate countries; big differences across countries in underlying strength of export sector; in a range of economies strong legacy of distorted tradable/nontradable sector structures The strong slowing down/contraction of German, Italian etc. growth affects peripheral region strongly FDI and inward capital flows sharply down – ‘catching-up model’ (‘downhill capital flows’) will have to be significantly rethought (stronger focus on industrial policy; emphasis on tradable sector; less reliance on fixed exch. regimes; EMU?) wiiw 9 Composition of the current account of the balance of payments, 1995-2009 Goods&Services Income Transfers Current account 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 -20.0 LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR -25.0 Note: ASIA-6 excl. Taiwan. Source: IMF International Financial Statistics and IMF WEO October 2010. wiiw 10 Net private financial flows in % of GDP, 1993-2009 LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 Source: IMF Balance of Payments Statistics. ASIA-6 excl. Taiwan. SEE-2 B-3 WB-6 TR wiiw 11 Is the Eurozone/the EU likely to disintegrate? Analytical approaches to this question: Bolton/Roland; Alesina et al; Rodrik - heterogeneity issues; impact of international liberalisation; importance of EU wide public goods (and scale effects in their supply); problems with transfer Union; role of mobility 2008-2012 crisis is an historical threshold event for the EU: - weakness of the institutional/policy set-up has become very apparent - a large number of institutional reforms are emerging: fiscal policy frameworks (‘fiscal compact’; six-pack); EU wide regulation and supervision; increased tax base of EU?; evolution of crisis and risk management (EFSF/ESM; Bank Risk Fund?; sovereign default procedures); widening of ECB mandate also de jure? Political commitment of European elites (is it changing?); popular resentment towards crisis management/technocratic/legitimacy issues wiiw 12 ‘... As it is, men have devised ways to impoverish themselves and one another; and prefer collective animosities to individual happiness.’ J.M. Keynes: The Economic Consequences of the Peace, 1920 wiiw 14 Economic Integration and Emerging Economies: Main lines of the argument International financial markets integration can strongly accentuate the possibility of external and internal imbalances Exchange rate regimes are very important in this context Catching-up processes can be seriously derailed due to the buildup of imbalances Impact on distorting economic structures (domestic savings behaviour, capital allocations across tradable/non-tradable sectors, asset prices, competitiveness, etc.) The setting for catching-up economies in (EU)rope is special: affects not only EU members but also economies in the neighbourhood (e.g. Balkans) wiiw 15 Comparing emerging market economies (EMEs) European EMEs: CE-5; B-SEE (B-3, SEE-2; WB-6); EU-COH; Turkey Non-European EMEs: ASIA-6 (w/o China, India); LATAM-8; MENA-6 (non-oil) Focus areas: specific characteristics of European integration; European vs. global capital market integration; evolution of disequilibria; policy environment and policy choices wiiw 16 Comparing emerging market economies (EMEs) CE-5: Czech Republic, Hungary, Poland, Slovakia, Slovenia B-3: Estonia, Latvia, Lithuania SEE-2: Bulgaria, Romania WB-6: Albania, Bosnia and Herzegovina, Croatia, Former Yugoslav Republic of Macedonia, Montenegro, Serbia B-SEE: B-3 + SEE-2 + WB-6 EU-COH: Greece, Portugal, Spain, Ireland Turkey ASIA-6: Indonesia, Korea, Malaysia, Philippines, Taiwan, Thailand LATAM-8: Argentina, Brazil, Chile, Columbia, Ecuador, Mexico, Peru, Uruguay MENA-6: Egypt, Jordan, Lebanon, Morocco, Syria, Tunisia wiiw 17 Capital market integration and emerging economies The question of ‘downhill’ vs. ‘uphill’ capital flows in the global economy (see e.g. Prasad/Rajan/Subramanian, 2006; Gourinchas/Jeanne, 2009; Abiad/Leigh/Mody, 2009) The issue of financial and monetary integration and catching-up economies (‘threshold’ effects, ‘institutional anchoring’) The nature of external disequilibria and the composition of capital (in)flows; role of exchange rate regimes Which disequilibria are ‘sustainable’ and under which external circumstances? The available spaces for policy choices wiiw 18 The European integration model of catching-up targeted at integration with the EU/Euro area associated with very far-reaching internal and external liberalization (trade, capital transactions, financial market integration, labour mobility) benefits: ‘downhill’ capital inflows, trade integration, ‘technology’ transfer; institutional convergence the model worked - ‘convergence process’ – but emergence of severe structural imbalances in important groups of European EMEs; heterogeneity of pre- and post-crisis experience of European EMEs wiiw 19 Growth - GDP at constant prices Average annual growth rates, 1995-2010, in % LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR 8.0 6.0 4.0 2.0 0.0 -2.0 -4.0 -6.0 av. 1995-2002 av. 2002-2008 Source: IMF World Economic Outlook, October 2010. EBRD and wiiw Annual Database incorporating national statistics, Eurostat.. av. 2008-2010 wiiw 22 Quarterly GDP developments 3rd quarter 2008 = 100 LATAM-8 ASIA-6 EU-15 EU-COH CE-5 SEE-2 + HR B3 MENA-6 ASIA-6 LATAM-8 110.0 MENA-6 105.0 CE-5 100.0 EU-COH 95.0 SEE-2 + HR 90.0 B-3 85.0 Source: Eurostat, wiiw calculations. 2010Q4 2010Q3 2010Q2 2010Q1 2009Q4 2009Q3 2009Q2 2009Q1 2008Q4 2008Q3 2008Q2 2008Q1 2007Q4 2007Q3 2007Q2 2007Q1 2006Q4 2006Q3 2006Q2 2006Q1 2005Q4 2005Q3 2005Q2 2005Q1 80.0 wiiw 23 Differentiating features of EMEs Degree of openness: - trade integration; financial market integration Private sector borrowing and debt External disequilibria: current accounts, composition of capital flows; real exchange rate developments Sectoral ‘distortions’ (tradable/non-tradable sectors); FDI allocation Fiscal policy during the crisis; public debt development Recovery from the crisis: level and trend effects wiiw 24 Openness indicators: trade and financial integration, 2007 in % of GDP LATAM-8 150.0 ASIA-6 MENA-6 300.0 CE-5 SEE-2 B-3 WB-6 TR 300.0 250.0 100.0 EU-COH 250.0 200.0 200.0 150.0 150.0 100.0 100.0 50.0 50.0 50.0 0.0 0.0 Exports plus Imports Exports plus Imports 0.0 Assets and liablities Assets and liablities Note: Assets and liabilities: EU-COH: 618.1%; ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon. Source: IMF International Financial Statistics. wiiw 25 Financial integration - Changes in: (i) assets plus liabilities; (ii) credit to private sector in % of GDP (percentage point change), 2001-2007 LATAM-8 200.0 ASIA-6 MENA-6 300.0 EU-COH SEE-2 B-3 WB-6 TR 60.0 250.0 50.0 200.0 40.0 100.0 150.0 30.0 50.0 100.0 20.0 150.0 0.0 CE-5 10.0 50.0 0.0 0.0 -50.0 Exports plus Imports Assets and liabilities -10.0 Assets and liablities Credit to private sector Note: Assets and liabilities: EU-COH: 265.82%; WB-6: 212.14%. Source: IMF International Financial Statistics. ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon. wiiw 26 Foreign bank ownership, 1998-2005 (assets owned by foreign banks as % of banking system assets) LATAM-8 ASIA-6 MENA-6 CE-5 SEE-2 B-3 WB-6 TR B-3 WB-6 CE-2 SEE-2 90.0 80.0 70.0 60.0 50.0 40.0 30.0 20.0 10.0 0.0 LATAM-8 ASIA-6 MENA-6 Turkey 1999 2000 2001 Note: ASIA-6 excl. Taiwan, MENA-6 excl. Syria. Source: from Claessens et al (2008). 2002 2003 2004 2005 wiiw 27 Industrial Production - Index 1993=100, 2000, 2008 1993 2000 2008 250.0 200.0 150.0 100.0 50.0 0.0 LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 B-SEE Note: ASIA-6 excl. Taiwan. B-SEE excl. Bosnia and Herzegovina, Montenegro and Serbia. Source: World Bank. TR wiiw 28 Change in openness to trade, 1995-2008 in % of GDP (percentage point change) Source: IMF International Financial Statistics. wiiw 29 Summarizing some of the features of European EMEs compared to other EMEs High growth prior to the crisis High indicators for openness: trade and particularly strong growth in international financial integration Much greater role of foreign banks in European EMEs compared to other EMEs Fast growth of credit to private sector in many European EMEs Differences in industrial production growth and the build-up of export capacity in different EMEs Next: the build-up of significant disequilibria before the crisis wiiw 30 Composition of the current account of the balance of payments, 1995-2009 Goods&Services Income Transfers Current account 15.0 10.0 5.0 0.0 -5.0 -10.0 -15.0 -20.0 LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 SEE-2 B-3 WB-6 TR -25.0 Note: ASIA-6 excl. Taiwan. Source: IMF International Financial Statistics and IMF WEO October 2010. wiiw 31 Net private financial flows in % of GDP, 1993-2009 LATAM-8 ASIA-6 MENA-6 EU-COH CE-5 Source: IMF Balance of Payments Statistics. ASIA-6 excl. Taiwan. SEE-2 B-3 WB-6 TR wiiw 32 Real exchange rate developments, 1995 to 2010 Misalignment in the Baltics/Balkans 70 Relative price level (percent) 1995 2010 60 2010 1995 2010 Appreciation hand-inhand with catching-up in Central Europe 2010 2010 50 1995 40 1997 CE-5 BB-5 30 WB-5 1995 Stable real X-rate in 20 Asia post crisis ASIA-7 LATAM-9 20 30 40 50 60 70 Relative GDP per capita at PPP (percentage points) wiiw 35 Differences in the composition of FDI Large part in manufacturing, infrastructure, trade in central Europe Large part in real estate, finance in Baltic region 35 wiiw 36 Relationship between pre-crisis credit growth and current account balances 20.0 average CA/GDP 2004-2007 15.0 MYS 10.0 TWN 5.0 CHL EGY PHL ARG ECU KOR IDN PER THA MEX URY COL TUN SYR POLCZE 0.0 SVN -5.0 LBN IRL MKD TUR HRV ALB PRT GRC LTU ROU JOR SRB BIH EST HUN SVK -10.0 BRA MAR -15.0 ESP BGR LVA MNE -20.0 -60.0 -40.0 -20.0 0.0 20.0 40.0 60.0 80.0 Change in credit/GDP 2004-2007 Source: IMF World Economic Outlook. wiiw 37 Real lending NB/ECB interest rates, 2003-2010 CPI-deflated, in % p.a. LATAM-8 ASIA-6 EU-COH CE-5 SEE-2 B-3 WB-6 15.0 10.0 5.0 0.0 -5.0 SEE-2 EU-COH B-3 -10.0 2003M01 2004M01 2005M01 2006M01 2007M01 2008M01 2009M01 2010M01 2011M01 Source: IMF International Financial Statistics. ASIA-6 excl. Taiwan, MENA-6 excl. Lebanon. wiiw 39 Debt in % of GDP Gross external debt Public debt Bulgaria 180 160 140 120 100 80 60 40 20 0 Private debt Romania 90 80 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Slovenia 140 Croatia 160 140 120 100 80 60 40 20 0 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: wiiw Annual Database incorporating Eurostat statistics. wiiw 40 Debt in % of GDP Gross external debt Public debt Greece 200 Private debt Ireland 1200 1000 150 800 100 600 400 50 200 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Portugal Spain 250 250 200 200 150 150 100 100 50 50 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: wiiw Annual Database incorporating Eurostat statistics. wiiw 41 Debt in % of GDP Gross external debt Public debt Czech Republic 90 80 70 60 50 40 30 20 10 0 Private debt Slovakia 80 70 60 50 40 30 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Hungary 180 160 140 120 100 80 60 40 20 0 Croatia 140 120 100 80 60 40 20 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: wiiw Annual Database incorporating Eurostat statistics. wiiw 45 CESEE: GDP growth was well above the interest rate before the crisis Nominal interest rate on government debt and nominal GDP growth (%), 2000-2010 CESEE 20.0 15.0 15.0 10.0 10.0 5.0 5.0 Nominal GDP growth 0.0 OECD (non-CESEE) 20.0 0.0 Nominal GDP growth Nominal interest rate Nominal interest rate -5.0 Note: Interest rate = government interest expenditures / previous year gross debt. 2010 2008 2006 2004 2002 2000 2010 2008 2006 2004 2002 2000 -5.0 wiiw 46 General government balance and gross debt (% GDP), 2000-2010 Debt 80.0 Balance 2.0 70.0 1.0 60.0 0.0 50.0 -1.0 40.0 -2.0 30.0 -3.0 20.0 CESEE -4.0 CESEE 10.0 OECD (non-CESEE) -5.0 OECD (non-CESEE) CESEE: low debt (on average), even after the crisis wiiw 2010 2008 2006 2004 2002 2010 2008 2006 2004 2002 2000 2000 -6.0 0.0 47 External debt: public and private (% of GDP), 2008 Intercompany lending Other Sectors Banks Monetary Authorities General Government 120.00 100.00 80.00 60.00 40.00 20.00 0.00 LATAM-8 ASIA-4 MENA-4 CE-5 SEE-2 B-3 WB-3 Note: ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY. B-3 excl. FYROM, BA, RS. Source: World Bank, World Databank. wiiw 48 External debt: public and private (% of GDP), 2008 Intercompany lending Other Sectors Monetary Authorities General Government Banks 250.00 200.00 150.00 100.00 50.00 0.00 LATAM-8 ASIA-4 MENA-4 EU-COH CE-5 SEE-2 B-3 WB-3 Note: ASIA-4 excl. PH, TW. MENA-4 excl. LB, SY. B-3 excl. FYROM, BA, RS. Source: World Bank, World Databank. wiiw 49 Structural features: European and other EMEs LATAM-8 ASIA-6 MENA-6 CE-5 EU-COH B-SEE Credit/GDP, change from 2004 to 2008 (percentage points) 15.85 -8.97 7.02 6.68 56.88 39.21 Real interest rate average, 2005-2007 4.33 3.17 -0.09 1.10 -3.10 -0.26 Current account balance/GDP, 2007 (%) 0.14 3.35 -1.42 -4.88 -10.09 -15.21 Gross external debt, 2009 (% of GDP) 20.8 34.8 20.9 62.7 229.6 80.4 GDP growth, 2008-2010 3.82 3.47 5.38 0.50 -1.67 -1.55 Source: wiiw calculations. wiiw 50 Summarizing the build-up to the crisis – differentiated patterns in the EMEs Different developments amongst European EMEs EU-Coh, CE-5, B-SEE and compared to other EMEs Current account developments; real exchange rate appreciation Composition of net capital inflows (credits, portfolio, FDI) Credit growth to the private sector; low (partly negative) real interest rates Public debt situation not that different between European EMEs and other EMEs Clear link between private credit growth and current account deterioration; and hence foreign debt positions wiiw 51 The impact of the crisis and patterns of recovery wiiw 52 Pre-crisis credit growth and GDP growth in 2009 10.0 TWN URY PER LBN THA ARG PHL MYS KOR IDN EGY CHL SYR MEX COL TUN ECU JOR POL GDP growth in 2009 5.0 0.0 BRA MAR ALB PRT IRL ESP MKD SRB BIH GRC CZE SVK TUR BGR HRV HUN -5.0 MNE ROU SVN -10.0 EST LTU -15.0 LVA -20.0 -60.0 -40.0 -20.0 0.0 20.0 40.0 60.0 80.0 Change in credit/GDP 2004-2007 Source: IMF World Economic Outlook. wiiw 53 Pre-crisis credit growth and GDP growth in 2010 10.0 TWN URY PER LBN TUR BRA THA ARG PHL MYS KOR IDN EGY CHL SYR MEX COL SVK MAR TUN POL JOR ECU ALB CZE EST SRB LTU MKD PRT BIHHUN BGR GDP growth in 2010 8.0 6.0 4.0 2.0 SVN 0.0 HRV -2.0 MNE ROU GRC -4.0 -60.0 IRL ESP LVA -40.0 -20.0 0.0 20.0 40.0 60.0 80.0 Change in credit/GDP 2004-2007 Source: IMF World Economic Outlook. wiiw 54 Structural features: the role of exchange rate regimes ‘Fixers’ and ‘floaters’ amongst the CESEEs CESEE float CESEE fix 20.5 32.8 1.6 -1.6 Current account balance/GDP, 2007 (%) -6.6 -11.8 Gross external debt, 2009 (% of GDP) 78.8 95.6 GDP-growth, 2008-2010 1.18 -1.78 FDI to finance and real estate sectors, 2007 (per cent of total FDI stock) 26.5 40.2 1.5 3.9 Credit/GDP, change from 2004 to 2008 (percentage points) Real interest rate average, 2005-2007 Change in unemployment rate from 2007 to 2010 (percentage points) Source: wiiw calculations. wiiw 55 Fiscal policy reaction: huge adjustment in CESEE Average annual changes in total general government expenditures, 2008-2010 Nominal per cent change Real per cent change 2008 2009 2010 2008 2009 2010 3.7 1.4 4.1 10.3 -9.0 9.4 B-3 20.5 -4.4 1.4 6.5 -7.9 0.2 SEE-2 27.7 2.9 4.0 7.1 -12.0 -1.7 WB-6 16.8 4.5 6.0 4.7 -5.8 -2.2 EU-15 6.3 5.4 1.8 2.8 4.8 0.6 ASIA-6 14.2 6.9 4.7 7.3 5.3 1.4 LATAM-8 20.8 13.0 10.1 12.7 8.0 5.2 CE-5 Note: Nominal from data in EUR. Source: IMF World Economic Outlook, wiiw Database and Eurostat. wiiw 56 GDP development, 2005-2012 2008=100 LATAM-8 ASIA-6 EU-COH CE-5 SEE-2 B-3 WB-6 120.0 TR ASIA-6 LATAM-8 TR WB-6 CE-5 115.0 110.0 105.0 100.0 SEE-2 EU-COH B-3 95.0 90.0 85.0 80.0 2005 2006 2007 2008 2009 Source: wiiw forecast and IMF World Economic Outlook, October 2010. 2010 2011 2012 wiiw 58 Summarizing the crisis impact Stronger impact of the crisis on European EMEs than on other EMEs (level and – medium-term – trend effect) Countries with high current account deficits and high credit growth prior to the crisis have stronger downturn Significant differences between ‘fixers’ and ‘floaters’ amongst European EMEs Substantial pro-cyclical contraction of real government spending in European EMEs during the downturn wiiw 64 Summary: Specific features of European EMEs Opening of the capital account: a rule of the game in the EU; deep financial integration Reliance on massive imports of capital; only 4 CESEE-countries could avoid skyrocketing external (private) debt Bank credit: the overwhelming source of external funding Financial integration: major channel for transmitting shocks (EUCoh, B-SEE regions hit hardest by the crisis) In general no meltdown of financial systems in CESEE (advantage of the presence of foreign banks? Implies also less socialization of private debt in CESEE – i.e. lower public debt effects); difference to EU-Coh in which there was massive nationalisation of private sector debt wiiw 65 The outlook on recovery after the crisis Which pattern of recovery after the crisis? European EMEs show level and trend effect of crisis impact Fiscal policy: less room for manoeuvre because of reduced growth expectations and higher interest rates; in EU-Coh socialisation of private debt; full blown sovereign debt crisis Household deleveraging process and fragile banks (lasting credit constraint); some countries banking system on the brink Capital flows to European vs. non-European EMEs: pattern reversed from before the crisis; depending on built-up debt positions and (revised) growth expectations wiiw 66 Policy space in different environments: Specific policy environment for European EMEs: - no capital controls - highly integrated financial markets; Euro-zone members or Eur anchorage - compliance with Single Market regulations - Maastricht criteria and Growth and Stability Pact (GSP) set fiscal criteria Advantages of this policy environment: - institutional and policy anchorage for trade and production networks and for fast growth of financial intermediation - fast institutional and behavioural convergence Disadvantages: - De facto no independent monetary policy; use of exchange rate as policy instrument severely restricted; prone to credit/asset bubbles - use of industrial policy restricted; other supply side policies (education/training, labour mobility, R&D, regional) encouraged wiiw 67 Principal policy lessons: In national and EU policy frameworks: neglect of private sector debt build-up relative to public sector Financial market regulation severely underdeveloped; but very high degree of financial market integration; specific issue in CESEE region: high level of cross-border banking Fixed exchange rate regimes bear high risks; but what are the options of highly euroized EU members and candidates? Scope for counter-cyclical fiscal policy was used much less in European CE-EMEs during crisis; post-crisis: task to restructure public finance in growth-enhancing manner Current situation characterised by very fragile banking system; protracted deleveraging processes; severe drag on recovery wiiw