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Global financial crisis:
An emerging European perspective
Erik Berglof, Chief Economist, EBRD
Comparing to the Great Depression:
World industrial production, now vs. then
Source: Eichengreen, O´rourke (2010)
Comparing to the Great Depression:
Volume of world trade, now vs. then
Source: Eichengreen, O´rourke (2010)
Comparing to the Great Depression:
World equity markets, now vs. then
Source: Eichengreen, O´rourke (2010)
Smaller economies, then and now
Belgium
Poland
Czech and Slovak Republics
Sweden
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
The phases of the crisis
1200
1000
I.
Financial crisis
build-up
II.
Systemic
outbreak
III.
Systemic
response
VI.
Sovereign
Crisis?
800
600
EMBI Europe
EMBI Global
400
200
0
Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10
Source: IMF
Phase 1: Financial crisis build-up
A fleeting moment of decoupling, followed by
precipitous recoupling…
Per cent
15
Period of decoupling
10
5
0
Turkey and CEB
-5
Russia and EEC
SEE
-10
Euro Area
-15
U.S.
Industrial production 2007-2009 (y-o-y)
Mar-09
Jan-09
Nov-08
Sep-08
Jul-08
May-08
Mar-08
Jan-08
Nov-07
Sep-07
Jul-07
May-07
Mar-07
-20
Phase II: Systemic outbreak
Emerging markets more resilient
Average response of EMBI to daily changes in the VIX
during periods of financial volatility in the United States
18
16
EMBI Europe
14
EMBI
12
10
8
EMBI Poland
6
4
2
0
Jan-Mar91 1/
Jul97-Feb98
Jul98-May03
Jul07-Sep08
Sep08-Jan09
Note: Based on regression of daily changes in EMBI spreads on changes in the VIX in
periods during w hich the VIX consistently exceeded 20 points.
1/ Constrained by data availability. Turbulence period started in July 1990.
Crisis challenge:
Systemic problem – systemic response
Source: Bankscope, bank websites
Phase III: Systemic response
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
Magnitude of official support massive
Official support (percent of
GDP)
Q2 2009
Q1 2009: Drop in foreign inflows
and trade
Q4 2008: Gov. support for large
US, UK and Swiss banks
Q3 1998: Russia default, Braz.
stock market crash, LTCM
Q2 1998: Social unrest in Ind.,
Russian stock market crash
Q1 1998: Social unrest in Ind.,
Korean debt restructuring,
Korea
Thailand
Philippines
Indonesia
Hungary
Latvia
Romania
Ukraine
Q4 1997: Closure of Ind. and Thai
financials, Korean won devalues
Q3 1997: Asian currencies
devalue sharply
0.0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
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
Sudden Stop in Emerging Europe muted
Percentage changes in external assets of BIS-reporting banks
Per cent
15
Avg 2007Q4/2008Q1
Avg 2008Q4/2009Q1
10
5
0
-5
-3.4
-4.4
-7.8
-10
-11.1
-11.9
-15
Emerging
Europe
CA and
Caucasus
Russia &
Ukraine
Latin America Emerging Asia
Currency
Currencyshooting
overshooting
avoided
avoided
Nominal effective exchange rates
Current programs
Median and
interquartile
ranges
Past crises
Q4 2008
Q2 2009
Belarus
Moldova
Mongolia
Bulgaria
Romania
Serbia
Poland
Slovak Rep.
FYR Macedonia
Q1 2009
Russia
Kazakhstan
Croatia
Czech Rep.
Slovenia
Lithuania
Armenia
Georgia
Hungary
Turkey
Ukraine
Estonia
Latvia
Output drop deep, sudden, and varied
Per cent
10
5
0
-5
-10
-15
-20
-25
Phase IV: Towards sovereign
crises in advanced economies?
Unemployment high - still rising in SEE
and the Baltics
Unemployment rates
(Per cent)
18
16
14
12
10
8
6
SEE
Source: CEIC.
Baltics
CE
EEC
CIS
Russia
Dec-09
Nov-09
Oct-09
Sep-09
Aug-09
Jul-09
Jun-09
May-09
Apr-09
Mar-09
Feb-09
Jan-09
Dec-08
Nov-08
Oct-08
Sep-08
Aug-08
4
Turkey
Europe’s 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
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)
Debt increase follows banking crisis
Cumulative increase in real public debt in the three
years following the banking crisis
Source: Reinhart and Rogoff (2008)
What if the crisis had not happened?
General Government Debt: WEO April 2010 Projection and Counterfactual
(Per cent of GDP)
180
Greece
150
130
100
80
50
180
2015
2013
2011
2009
2007
2005
2003
Actual
Counterfactual
Note: Calculations based on assumption that (1) half the actual structural fiscal loosening
(estimated as in WEO April 2010) in 2009 and none thereafter and (2) unit revenue elasticity.
2015
2013
2011
2009
2007
2015
-20
2013
-20
2011
30
2009
30
2007
80
2005
80
2003
130
2001
130
Italy
2005
Portugal
2003
2015
2013
2011
2009
2007
2005
2003
2001
-20
2001
30
0
180
Spain
2001
200
Emerging Europe recovery lagging
Middle East And North Africa
Latin America
Developing Asia
EBRD region
130
120
110
100
90
2008
2009
2010
2011
Recovery lagging, particularly in southeastern Europe and the Baltics
Central Europe
The Baltic States
South-eastern Europe
110
105
SEE: Compared to
January, revised 2010
growth down; negative or
flat growth projected for
Bulgaria and Romania.
100
95
90
Baltic countries:
growth outlook
remains negative on
average
85
80
2008
2009
2010
2011
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
Corporate credit stagnating/contracting
Corporate credit growth,
Q3-09 to Q1-10,
annualised 35
Belarus
30
25
20
Serbia
15
10
Croatia
5
Romania
Moldova
Slovenia
Ukraine
Slovak Republic
Russia
Bulgaria
Estonia
Poland
Lithuania
Hungary
Kazakhstan
Albania
0
-5
Latvia
-10
-15
-7
-6
-5
-4
-3
-2
-1
0
1
2
3
4
Source: National authorities via CEIC data service, EBRD staff calculations.
GDP growth,
Q4-09 to Q1-10,
5 annualised
Large deficits lead to fiscal contractions
Structural Fiscal Balance
(Per cent of GDP)
Source: IMF, European Commission.
Hungary
Poland
Slovenia
Slovak
Republic
Czech
Republic
2011
Ukraine
2010
Russian
Federation
Kazakhstan
2009
Slovak
Republic
0
-1
-2
-3
-4
-5
-6
-7
-8
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
Is there a Phase V of sovereign
crises in emerging Europe…?
Emerging Europe and the Eurozone
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…
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 => real exchange rates misaligned
Eurozone as the end zone
Costs and benefits of accession shifted:
(1) Costs of loss of flexibility and premature entry?
=> 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
=> Strengthen/clarify architecture
Thank you
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