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Alexander Pivovarsky

My presentation is based on the recent EBRD transition report devoted to the economic crisis.

The transition region remains in a deep crisis. We are forecasting that the output decline will be 6,2%  in the 29 transition countries in which EBRD operates. The decline is worse than in any other region of the world. A double digit decline is expected in 5 of our countries of operation, including the Baltic States, Ukraine and Armenia. Unfortunately, the crisis is not over. Non-performing loans continue to rise and credit remains constrained. The recovery is expected to be quite slow. We forecast small growth of 1-2% next year. In many countries, the growth is largely reflecting base effects of the pick-up in the second half of this year.

However, it does not mean that the transition model is in crisis. How did the market-oriented institutions and policies perform during the crisis? Are development paradigms of transition economies still attractive? Do they need to be modified? Will the crisis lead to backlash against reforms?

We make a number of claims in the transition report. I will go through a couple of them.

While many transition countries suffer from large output declines, economic and political systems have been surprisingly resilient in almost all respects. Currency and banking system collapses were avoided, even in very hard hit countries. Net capital outflows were much smaller than in the previous crisis, for example in Asia in the ‘90s. There were no uncontrolled currency collapses and no runs on the banking system (with the possible exception being Kazakhstan). Banking systems kept functioning in all countries throughout the crisis.

Here are some data on the outflow of capital. In Eastern Europe, there were relatively limited outflows of capital compared to emerging Asia. (Only in Russia, there was a temporary outflow of capital which was compensated by large central bank reserves.) Asia continues to grow, although it has initially suffered from a large outflow of capital. Currency depreciations were below the figures of currency depreciations in Asia in the ‘90s (the exception being Ukraine). There were no banking system and currency collapses, no major runs, restrictions on deposit withdrawals or capital controls. Compared to the Asian countries in the ‘90s, Eastern Europe, or emerging Europe, has been more vulnerable. Eastern Europe had larger account deficit before the crisis than the Asian countries. The external debt was quite high: it was largely private sector debt rather than public debt. The output declines were comparable to those during the Asian crisis.

Compared to the Asian crisis and other recent crises in Latin America, in Argentina in particular, the current crisis was not so dramatic. There were fewer populist coercive measures adopted and little violence. The change in governments took place within normal rules. There were no blanket defaults, capital controls and protectionism.

EBRD maintains a record of progress achieved by countries during transition. In autumn, while finalizing this year’s report, we registered very few reversals. There were reversals only in four countries on several measures, but in other countries, including Ukraine, there was only one reversal on one measure: for example, on foreign currency regulations. It was offset by an upgrade due to the introduction of the law on joint stock companies.

Reforms slowed down but were not reversed. This is a big difference with the crisis in the late ‘90s.

Why is there relative resilience this time? One of the reasons is the role of European institutions in Eastern Europe. Other reasons include bigger support of IFIs and the stabilizing role of international banks. Much money came to the region through foreign banks, rather than wholesale markets. These foreign banks had no choice but to support their subsidiaries in the region. 

The financial integration had a mixed role: it contributed to the crisis, but at the same time, foreign institutions had to support their subsidiaries in the region. Eastern Partnership countries are seriously integrated into European structures, and Ukraine is one of them, through trade, integration with European banking groups, etc. EBRD econometrics study showed that foreign banks’ ownership had a positive role in the crisis. Larger shares of foreign banks had a stabilizing role, preventing the contraction of output. The larger presence of foreign banks also had a positive impact on the output decline. This is linked to a relative degree of reversal in capital assets accumulated in these countries. The reversal was smaller than it could have been. The support of IFIs was much bigger: several countries like Hungary, Latvia, Romania and Ukraine receive bigger support than the countries in East Asia in the ‘90s. Also, an ad hoc mechanism of coordination allowed international banking groups to provide support to their banking groups, for example, in Eastern Europe. Parent banks had to support their subsidiaries throughout the region, and the magnitude of this support was higher in countries like Romania, Serbia and Hungary. There was also support from the EBRD, from the European Investment Bank and from the World Bank (up to 25 billion euros in total). So far, 16 billion euros have been spent. There was a serious coordination effort, and even countries not actively involved, like Ukraine, benefited from this framework. 

What kind of implications does the crisis have in terms of the future of transition? Most likely, the crisis will not lead to backlash against reforms; however, it will be more difficult to carry out reforms in many countries. Government policies either have remained the same, or have become reform-friendly in 8 out of 29 EBRD countries. However, the economic and social environment for reforms has become more difficult. There is less fiscal space for fundamental reforms in health, education and infrastructure because governments have used much space to stabilize the financial system. The situation is similar to more developed countries. In many countries, the middle class is under a lot of stress: unemployment, deflation of housing prices and relatively high debt. There is a continued lack of appetite for reforms and safety of the public system.

EBRD has an index of transition challenges in different regions and in different sectors. These challenges remain important in EBRD countries of operation, in particular in Eastern Europe and the Caucasus. In Eastern Europe, the challenges are relatively small and limited to agribusiness and telecom. After the crisis, there will be additional challenges related to the external environment in terms of capital inflows. The public debt hikes and various problems in the financial sector will likely have a negative impact on these countries’ attraction for global savings. Thus, there will be a need to mobilize domestic savings to ensure future growth. There will be a need for reforms to ensure that this growth is sustainable for the middle class. There will be a need to focus on education, health, infrastructure, energy efficiency, etc. After the crisis, there will be also a need for financial sector reforms, including the development of local capital markets in order to reduce reliance on foreign savings, local currency denominated lending reform and the strengthening of cross border cooperation between domestic banking supervisors and home country supervisors of foreign banking groups.

Is the transition model in crisis? No. But there is a footnote: reforms and economic integration achieved over the last 15 years have been quite resilient. At the same time, the crisis raised questions about growth models of many countries in the region: in particular, in countries with large and short-term capital inflows and countries with commodity-based development (Central Asia, Caucasus and Russia). The lessons of the crisis must be incorporated into the transition agenda but the crisis will not replace the transition agenda completely.

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