International and domestic policy responses to the financial crisis in Central and Eastern Europe: lessons for Ukraine.

AuthorPolyvana, Tetiana
PositionReport

Introduction

The ongoing financial and economic crisis raised a number of new questions and challenges to be addressed by academics and state officials both on the global and national levels. What are the primary causes of the crisis? What lessons should be learnt? How to adjust the global financial system and prevent such negative consequences in future? Those questions became subject for political discussions at the highest levels, such as the G20 Summits and the World Economic Fora in Davos.

The global crisis has many particular traits. One of them is the unequal distribution of the crisis impact across world regions. Central and Eastern Europe (CEE) is believed to be among the regions most severely hit by the crisis. According to the IMF assessments the overall GDP decline in the region in 2009 was around 8,4%. At the same time the region is anticipated to recover quite soon. The IMF forecasts the region to have a positive output starting already in mid 2010 and reaching 4,0% GDP growth in 2012 (2).

Meanwhile, individual countries in the region were also unevenly hit by the crisis. Estonia, Latvia, Lithuania were the most harshly damaged, registering a GDP decline in 2009 of -4,0%, -18,0%, and respectively -18,5%. At the same time, the Czech Republic (-4,3%), Slovakia (-4,6%) and Slovenia (-4,7%) suffered the least, withe the Polish economy experiencing a 0,97% growth in 2009 (3). The explanations for these differences in crisis impact across countries vary. Diverse macroeconomic and financial vulnerabilities, as well as national policy responses to the crisis are among them.

Central and Eastern European countries in times of the crisis became subject to a number of academic and policy studies and debates. Authors focused on the main causes of the crisis (Anders Aslund (4)), lessons to be learnt (Agnes Benassy-Quere, Benoit Coeure, Pierre Jacquet, Jean Pisani-Ferry (5)), or the role of the EU in dealing with the crisis (Zsolt Darvas, Bela Galgoczi (6)). Ukrainian authors are mostly focused on theoretical approaches to explain root causes of the crisis, its global imperatives and impact on the Ukrainian economy (Umantsiv Y., Shevchenko V Shelud'ko N, Shklyar (7)) . This paper comes to complete the existing literature in the field by analyzing the main successes and failures in policy responses to the crisis in Central and Eastern Europe on the global, regional and domestic levels, and thus revealing relevant lessons for Ukraine. The paper argues that despite the failure to prevent the crisis at all levels, coordination of actions at global and EU levels and high discipline of the CEE countries in national policy supported their efforts to manage the crisis efficiently. First of all, the paper presents key data on the extent to which CEE countries were affected by the crisis. Second, it introduces the main findings on successes and failures in policy responses to the financial crisis in CEE countries on global, EU and domestic levels. It finally reveals key obstacles to successful resolution of the crisis in Ukraine and draws recommendations for Ukraine.

CEE countries in crisis: heavy damages but fast recovery

Central and Eastern Europe was among the regions that were the most severely hit by the financial crisis. In 2009 the regional GDP declined by 8,4%, which was the lowest among all emerging and developing regions (Figure 1.) (8) This was to a large extent influenced by the growth in trade and financial links of the region with the rest of the world and especially with the EU after accession of the twelve new member states in 2004 and 2007. As the Director of the IMF's European Department Marek Belka said "because Europe is very open in terms of trade, and because its financial sector is so closely integrated with the rest of the world, the region cannot avoid being significantly impacted by the financial crisis" (9).

Indeed, market reforms in times of transition, liberalization of trade and financial markets and fast-growing economies of the region spurred international trade, attracted new investments and foreign capital. At the same time these growing links became also major channels of transmission of external shocks to the economies. Financial crisis originated in advanced economies spilled over to the emerging European countries including those from CEE. Liquidity markets were frozen. Shortterm foreign debt capital was withdrawn. Global demand fell bringing to stagnation the commodity markets. Consequently, international trade volumes also declined. Overall, all this had a very negative impact on regional economic growth.

At the same time, the extent to which CEE countries were affected differed from one to the other. The most severely hit were the Baltic states with a GDP decline in 2009 that reached 18,5% in Lithuania, 18,0% in Latvia, and 14,0% in Estonia. Hungary, Bulgaria and Romania also suffered significantly with a fall of GDP by 6,7%, 6,5%, and respectively 8,4%. Meanwhile, the Czech Republic, Slovakia and Slovenia had a GDP drop by less than 5%, while Polish economy even grew by 0,9% in 2009 (Figure 2) (10).

Key explanations can reside in different macroeconomic and financial vulnerabilities in national economies. The countries that suffered the most had very weak macroeconomic fundamentals, such as excessive current account and budget deficits, fixed exchange rate regimes, and huge credit expansions before the crisis. In all of the six countries with the largest GDP decline, current account deficits throughout 2002-2007 were far larger than 5% (Hungary: -6,9%, Bulgaria: -11,1%, Romania: -8,3%, Estonia: -12,3%. Latvia: -14,4%, Lithuania: -8,6%) (11). Estonia, Latvia, Lithuania and Bulgaria have also fixed exchange rates. As a result, much of the current account deficit was supported by increasingly accumulated foreign debt that exceeded 100% of GDP in those states.

Hungary had also a very large budget deficit throughout 2005-2007 (5-10% of GDP) and thus had accumulated a large amount of public debt (more than 70% in 2008). Consequently, when the global liquidity and commodity markets froze and economic activity and export volumes fell, these countries had very few tools to support their economies, while their creditworthiness was undermined. All this brought to a very sharp decline in output growth and challenged macroeconomic stability of the economies.

On the other hand, the region is expected to overcome the crisis successfully and relatively fast. The IMF forecasts the region to have a positive output starting as soon as mid 2010 and reaching 4% output growth in 2012 (Figure 3).

There are various reasons for those projections. Among the mitigating factors are foreign bank ownership in the CEE countries by West European member states, Eurozone membership of some of them (Slovenia and Slovakia) and political and economic integration within the EU. In this paper it argued that successful international and domestic policy responses, supported by EU membership inter alia, had helped CEE countries to deal with the crisis effectively and relatively fast.

Policy responses to the crisis: successes and failures

Global level

One of the main failures of policy-makers at all levels was their inability to prevent the crisis. At global level it is the IMF that is responsible for maintaining the stability of the global financial system. Quite frequently it is argued that post-2000 "the IMF was itself in a crisis, because it had almost no clients left for its emergency lending facilities after the crises of the 1990s" (14). There were plenty of debates on whether it was the responsibility of the IMF for the crisis to become global or not. However, the role of the IMF is not indeed adequate to the current developments in the global financial system. As a result, the issues regarding IMF reform and global financial architecture at large have been vividly discussed at the highest political levels, namely G20 Summits.

Nevertheless, crisis control and resolution policies were quite successful at the global level. Coordination of efforts of the most powerful economies can be assessed as strong enough. Starting November 2008 a new global institution was created--G20--with the purpose to increase the voice of the developing countries in resolution of global problems. So far three G20 Summits have been held: in Washington, London and Pittsburgh. The main outcomes of the Summits are presented in Table I.

One of the most effective outcomes of the Summits was the decision to provide US$1,1 trillion for recovery programs. Great deal of the money was used to provide financial support to the hardest hit economies, including those from CEE, through international financial institutions, mainly the IMF.

As a result, the IMF had allowed around US $50 billion under standby arrangements (SBAs) to 14 countries in crisis (16). Under the SBAs the country gets loans in exchange for reforms in monetary, financial and fiscal policies. Emerging European countries have obtained the largest part of the IMF loans.

In the CEE region main recipients of the IMF loans were Hungary, Latvia and Romania. Along with the IMF support those countries received financial resources from other international financial institutions: the World Bank, the European Commission, the European Investment Bank, or the European Bank for Reconstruction and Development. However, the share of the IMF financial support was the largest, while resources granted by other institutions, especially European ones, were limited (Table 2).

Consequently, coordination of international efforts on the global level to overcome crisis (in CEE countries inter alia) may be assessed as effective so far, even though a number of planned actions for global economy recovery are still to be done.

Box 1. Main policy actions of the EU during the crisis (19) * Refi (interest rate on main refinancing operation) was cut from more than 4% in September 2008 to I% in May...

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