Macroeconomic Issues Macroeconomic Issues from a European from a European

PerspectivePerspective

Fabrizio CoricelliFabrizio CoricelliEuro-Latin NetworkEuro-Latin Network

Madrid October 9, 2002Madrid October 9, 2002

Lessons fromLessons from EU EU EnlargementEnlargement

Institutional reforms before or with market liberalization“Real” (trade) integration hand in

hand with financial integrationSafety nets key for successful

reforms

IssuesIssues

“Real” and nominal convergence: satisfy inflation criteria while catching up in income levels. Choice of exchange rate regime

Speed of adoption of the Euro (two views)

Development of financial sector: low financial depth

Fiscal rules

…………....IssuesIssues

No mechanisms to avoid crises are present in the EU(currency crises in Italy, UK and Sweden at the beginning of 1990s)

Development of financial sector

Low financial depthLow financial depthDomestic Credit in percent of GDP, 2000Domestic Credit in percent of GDP, 2000

0

20

40

60

80

100

120

140

Roman

ia

Lithua

nia

Bulgari

a

Latvia

Hunga

ry

Poland

Estonia

Sloven

ia

Czech

Rep

.

Slovak

ia

Cypru

s

Malt

a

CEECs-10

AC-12

EURO AREA AVERAGE

Greece (1981 enlargement)

Portugal and Spain (1986 enlargement)

Source: IFS, Accession Countries' National Central Banks

Institutional Reforms…Institutional Reforms…

Importing institutions (against Rodrik’s view)

May not be optimal, but more credible

Safety nets to support reforms

……………….lead to.lead to

Credibility bonus due to accession to EU

Accession: anchor for market expectations

Lower spreads in international borrowing

Interest rate convergence

CreditworthinessCreditworthiness

200

400

600

800

1000

1200

1400

1600

1800

Dec-97 Oct-98 Aug-99 Jun-00 Apr-01 Feb-020

50

100

150

200

250

300

350

400

450EMBI+

EMBI+ Bulgaria

EMBI+ Poland(RHS)

Interest Rate ConvergenceInterest Rate Convergence

0

5

10

15

20

25

30

35

Jun-93 Jul-94 Aug-95 Sep-96 Oct-97 Nov-98 Dec-99 Jan-01 Feb-02

Euribor Poland HungaryCzech Rep.

Potential drawbacksPotential drawbacks

Premature “eurosclerosis”: unemployment rates close to 20% in Poland and Slovakia

Large governments: high tax ratesRigidity in labor marketLarge implicit debt for pensions

Total expenditure (% of GDP)Total expenditure (% of GDP)

20

25

30

35

40

45

50

55

Bulgar

ia

Czech

Rep

.

Estonia

Hungary

Latvi

a

Lithuan

ia

Poland

Roman

ia

Slova

kia

Slove

nia

2000

2004EU

(45,8

Emerging market themesEmerging market themes

Integration has not reduced Integration has not reduced volatilityvolatility

Volatility is much higher than in the European Union

Although cycle is highly correlated: amplitude much higher

CEECs are small open economies

Correlation with EU cycleCorrelation with EU cycle

-5

0

5

10

15

20

25

mar-94 lug-95 nov-96 mar-98 lug-99 nov-00 mar-02

EU

Poland

Hungary

VolatilityVolatility(standard deviation)(standard deviation)

GDPTerms of

trade

Real effective exchange

rate

Real interest

rate

Gov’t revenue/ GDP

CEECs 4,10 4,40 12,66 6,34 2,31

Latin America

3,74 8,70 18,00 13,18 2,19

Emerging Asia

4,11 5,92 8,65 2,52 1,82

Advanced countries

2,09 3,73 5,90 2,07 1,02

Financial sectorFinancial sector

Can magnify the cycleSmall and medium size firms are

leading growth but they are generally cut off from borrowing and thus from the possibility of smoothing output decline

Alternative to bank credit: trade credit, higher risk (chain)

Dominant role of foreign banks does not help

Vulnerability to crisesVulnerability to crises

Government debt: not high as a ratio to GDP

Even less in terms of tax revenues (compared to LAC)

However, large share of foreign debt (as in Lac)

Debt indicatorsDebt indicatorsPublic debtin % GDP

Public foreign% of total

Public debt % of revenues

Public foreign% of revenues

Bulgaria 80,6 91,4 185,3 39,8

Czech Rep.

17,3 10,5 42,6 4,3

Estonia 5,3 67,4 13,6 26,2

Hungary 58,2 n.a. 126,8 n.a.

Latvia 13,0 60,9 43,3 18,3

Lithuania 28,3 77,8 93,7 23,5

Poland 40,9 48,8 103,3 19,3

Romania 31,6 44,9 100,3 14,1

Slovakia 32,8 49,0 92,9 17,3

Slovenia 25,8 48,8 60,3 20,9

avg. CEECs

33,4 55,5 86,2 20,4

ExternalExternal constraintconstraintExternal debt External debt FDI inflow Current account % GDP % exports % GDP % GDP

Bulgaria 86,4 148,3 8,3 5,9Czech Rep. 42,8 56,2 9,1 4,8Estonia 61,4 64,6 6,4 6,8Hungary 67,3 97,3 2,6 3,9Latvia 65,9 144,0 5,6 6,8Lithuania 42,9 95,1 3,3 6,0Poland 42,9 214,5 5,9 6,3Romania 27,0 81,7 2,7 3,7Slovakia 56,3 76,5 10,7 3,7Slovenia 34,3 58,1 0,2 3,3

Avg. CEECs 52,7 103,6 5,5 5,1Latin America 39,0

ExternalExternal constraint…..constraint…..

Ext. Debt high in terms of GDP butmuch lower (than in LACs) in terms

of exportsFDI inflows match current account

deficitPrivatization-related FDIs very

largeCurrent flows unlikely to be

sustained

Non-FDI flowsNon-FDI flows

Pro-cyclicalSharp reduction after Russian

crisis

Growth and capital flowsGrowth and capital flowsPolandPoland

-1500

-1000

-500

0

500

1000

1500

2000

Q4 19

96

Q1 19

97

Q2 19

97

Q3 19

97

Q4 19

97

Q1 19

98

Q2 19

98

Q3 19

98

Q4 19

98

Q1 19

99

Q2 19

99

Q3 19

99

Q4 19

99

Q1 20

00

Q2 20

00

Q3 20

00

Q4 20

00

Q1 20

01

Q2 20

01

Q3 20

01

Q4 20

01

Q1 20

02

Q2 20

02

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0Non FDI capital flows

Gdp a/a%

Czech RepublicCzech Republic

0

500

1000

1500

2000

2500

Q4

1995

Q2

1996

Q4

1996

Q2

1997

Q4

1997

Q2

1998

Q4

1998

Q2

1999

Q4

1999

Q2

2000

Q4

2000

Q2

2001

Q4

2001

Q2

2002

-0.03

-0.02

-0.01

0

0.01

0.02

0.03

0.04

0.05

0.06

0.07Non FDI Capital Flows

GDP a/a%

Fiscal policy pro-cyclicalFiscal policy pro-cyclical

-4

-3

-2

-1

0

1

2

3

-15 -10 -5 0 5 10

output gaps

chan

ges

in C

AB

After entryAfter entry??

Full liberalization of K-flowsShort term K-flows bound to

increaseExchange rate policy?Fiscal rules?

Risks aheadRisks ahead

Delayed entry in EuroEU fiscal rules inappropriateMaastricht criterion is an ex post

limit on deficit with a pro-cyclical bias

Need for ex ante expenditure rules

Conclusions…….Conclusions…….

Trade integration possibly an insurance for sudden capital flow reversals

Candidate countries are affected by “convergence play”: expectation of entry in the eurozone (interest rates converge and spreads on international borrowing very low)……….

…………..Conclusions..Conclusions

However, postponing accession can be a severe shock……….

Test of capability to manage large capital inflows yet to come

Exchange rate policy a key issueMechanisms to avoid currency and

financial crises at the EU level could be devised