Prospects: Short and Long

Vladimir Gligorov

Contents

• Changing monetary regime• European challenges (changing policy

framework)• The Balkans: the adjustment problem

Changing Monetary Regime

• Interest rate hike is all but certain, but the timing is uncertain• The uncertainty is fuelling the volatility of the exchange rates

inter alia • FED wants to normalise, to change the monetary regime, i.e.

go to above 3 per cent rate in two years or so, but does not want to start the process and have to reverse course (as happened to ECB and Bank of Sweden, and also to the FED in 2007)

• However, the FED does not want to remain passive and miss the change in expectations because of too much dependency on the past data – it needs to get ahead of the curve at some point

Effects of Changed Monetary Regime

• Effects on the euro area: mostly positive, assuming non-perverse exchange rate reaction

• In part because lower euro does the work of the ECB for it (in terms of boosting inflation)

• Emerging markets challenged (if the history of past changes in monetary regimes are to go by)

• In part because of oil and commodity prices remaining depressed while currencies are devaluing

European Challenges

• Policy framework will continue to evolve, albeit slowly

• Public and intra-euro foreign debts will push for banking union and some elements of a fiscal union

• Risks of disintegration will increase as EU continues to underperform in supply of the basic public goods: security, justice, and welfare

• Assuming preserved political stability, or sustainable instability, growth prospects will continue to improve, however slowly

New Europe

• Convergence growth returns in the East and even in the South

• Mostly on the basis of export performance and better debt profiles in Central European and Eastern Balkan EU member states

• Especially in countries with strong exporting sectors

The Balkans

• The Balkans still face the adjustment problem due to, in part,

• rigid price and policy structure and low openness

• Examples: Greece and Croatia (slow export and investment recovery)

• Alternative examples: Serbia and Bulgaria (export recovers, but not investments)

• And political instability

Consumption, Deleveraging, and Investment

• Investment decline everywhere• Consumption persistence• Both of households and of governments• Trade and current account deficits closing• i.e. savings increasing (deleveraging)• (all the data is from EUROSTAT, so some

smaller Balkan countries are not covered, but they do not differ substantially)

Gross Fixed Capital Formation/GDP

EU28

EU15

EURO19

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

Albania

Serb

ia0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

20082014

Gross Capital Formation/GDP

EU 28

EURO 19

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

Albania

Serb

ia0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

20082014

Government’s Final Consumption/GDP

EU 28

EURO 19

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

Albania

Serb

ia0

5

10

15

20

25

20082014

Household Final Consumption/GDP

EU 28

EURO 19

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

Albania

Serb

ia0

10

20

30

40

50

60

70

80

90

20082014

Final Consumption/GDP

EU 28

EURO 19

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

Albania

Serb

ia0.0

20.0

40.0

60.0

80.0

100.0

120.0

20082014

Consumption Beats Investment

• Final consumption (as a share of GDP) holds up (in smaller EU states and those in the South)

• Investment plunges• Household consumption less volatile than

government• Consumption of households especially strong

in the Balkans

Export Growth

• Exports have grown strongly in the crisis• But less in Greece, Croatia, Spain, Portugal • While much more in other Balkan countries

and also in the Baltics• Why?• Basically because of the pre crisis loss of

competitiveness and the post-crisis difference in the readiness to adjust

Exports/GDP

EU 28

EURO 19

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

Albania

Serb

ia0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

20082014

Imports/GDP

EU 28

EURO 19

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

Albania

Serb

ia0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

20082014

Exports, euro

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

Serb

ia0.0

50,000.0

100,000.0

150,000.0

200,000.0

250,000.0

300,000.0

350,000.0

400,000.0

20082014

Export and Import Growth, 2014/2008

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

Serb

ia

-40.0

-20.0

0.0

20.0

40.0

60.0

80.0

importsexports

Exports/GDP and GDP growth

-6.00 -5.00 -4.00 -3.00 -2.00 -1.00 0.00 1.00 2.00 3.00 4.000.00

10.00

20.00

30.00

40.00

50.00

60.00

70.00

80.00

90.00

100.00

f(x) = 3.0567250171521 x + 49.1107249323387R² = 0.0639886335904081

growth %

expo

rt/g

dp

Foreign Trade

• There is striking differentiation in export performance

• Where Southern EU countries (including Croatia) do worse or much worse than Balkan and Baltic countries

• One lesson: small economies can increase exports even if external demand is not improving and is even deteriorating (they are price takers)

• So, there is a supply problem in the export performance

Manufacturing

• On the supply side the problem is low share of the tradable sector

• In particular of manufacturing• Both in Southern Europe and the Balkans

Manufacturing Value Added, % GDP

2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

5

10

15

20

25

30

Czech RepublicRomaniaSloveniaSlovakiaHungaryAustriaPoland

Manufacturing Value Added, % GDP

2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

2

4

6

8

10

12

14

16

18

20

EstoniaLatviaLithuaniaEU 28

Manufacturing Value Added, % GDP

2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

2

4

6

8

10

12

14

16

18

GreeceSpainCroatiaPortugalSerbiaMacedoniaAlbania

Growth, Manufacturing, Exports

• More open economies, in terms of exports to GDP, grow faster

• Higher share of manufacturing supports exports

• It helps to manufacture in order to grow (here exports of goods and services)

Growth and Exports

-3 -2 -1 0 1 2 3 4 50

10

20

30

40

50

60

70

80

90

GDP growth

Expo

rt/G

DP

Growth and Manufacturing/GDP (2005-2014), smaller less industrialised countries

4 6 8 10 12 14 16 18 20 22 24

-3

-2

-1

0

1

2

3

4

5

manufacturing/GDP

grow

th

Growth and Manufacturing/GDP (2005-2014), EU plus some candidate countries

4 6 8 10 12 14 16 18 20 22 24

-3

-2

-1

0

1

2

3

4

5

manufacturing/gdp

grow

th

Manufacturing/GDP and Exports/GDP (2005-2014)

20.00 30.00 40.00 50.00 60.00 70.00 80.00 90.000

5

10

15

20

25

export/gdp

man

ufac

turin

g/gd

p

The Adjustment Problem

• If there is a loss of competitiveness and rigid exchange rate regime

• Adjustment has to go via decline of imports to achieve improvement in the current account, and with:

• Real exchange rate depreciation• Decline in wages, and• Increase in unemployment

Current Account

2008 2009 2010 2011 2012 2013 2014 2015 2016

-60

-50

-40

-30

-20

-10

0

MacedoniaTurkeyMontenegroSerbiaAlbania

Current Account

2008 2009 2010 2011 2012 2013 2014 2015 2016

-25

-20

-15

-10

-5

0

5

10

BulgariaCzech RepublicEstoniaGreeceSpainCroatiaLatviaLithuania

Current Account

2008 2009 2010 2011 2012 2013 2014 2015 2016

-15

-10

-5

0

5

10

AustriaPolandPortugalRomaniaSloveniaSlovakiaHungary

Exchange Rate and Employment

• Real depreciation especially strong in Greece and Croatia, but also in Spain and Portugal

• (this is USD REER ULC based against the rest of the world)

• Employment decreases and unemployment increases again more or less in the same group of countries

Real Effective Exchange Rates, 2010=100

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20160

20

40

60

80

100

120

140

AustriaPolandPortugalRomaniaSloveniaSlovakiaHungary

Real Effective Exchange Rates, 2010=100

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20160

20

40

60

80

100

120

140

BulgariaCzech RepublicEstoniaGreeceSpainCroatiaLatviaLithuania

Employment rate, 15-64

EU28

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

20082014

Employment rate, 25-54

EU28

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia

Macedonia

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

100.0

20082014

Unemployment rate

EU28

Bulgaria

Czech Rep

ublic

Estonia

Greece

Spain

Croati

aLat

via

Lithuan

ia

Hungary

Austria

Poland

Portuga

l

Romania

Slove

nia

Slova

kia0.0

5.0

10.0

15.0

20.0

25.0

30.0

20082014

Wages

• Nominal wages mainly held up• But grew very slowly or not at all in Southern European and

Balkan countries• So, with inflation, mostly shared among this group of countries,

that is reflected in the real exchange rate depreciation• Increased unemployment serves to sap the growth of wages• Serbian wages are given separately in euro to correct for the

unusually high inflation• In a number of countries wages have continued to increase, i.e.

if there was no or little loss of competitiveness before 2009 (e.g. Poland and Romania)

Wages (nominal)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

20,000

40,000

60,000

80,000

AlbaniaSerbiaMacedoniaCzech Republic

Wages (real, in euro)

2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

100

200

300

400

500

600

Serbia

Serbia

Wages (nominal)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

Croatia

Croatia

Wages (nominal)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

PolandRomania

Wages (nominal)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 20140

200

400

600

800

1,000

1,200

1,400

1,600

1,800

SlovakiaSloveniaBulgariaEstoniaLatviaLithuaniaBiH

Productivity and Competitiveness

• Productivity improved in majority of the countries, though notably not in Greece, Hungary, Macedonia and not much in Croatia and Slovenia

• Unit labour costs adjusted in countries with overvalued real exchange rates before the crisis

• Higher wage share in GDP is not correlated with higher growth rates

Real Labour Productivity (2010=100)

EU

Bulgaria

Czech

Republic

Estonia

GreeceSpain

CroatiaLa

tvia

Lithuania

Hungary

Austria

Poland

Portugal

Romania

Slovenia

Slovakia

Macedonia

0.0

20.0

40.0

60.0

80.0

100.0

120.0

2008 2009 2014

Nominal Unit Labour Costs (2010-100)

EU

Bulgaria

Czech

Republic

Estonia

GreeceSpain

CroatiaLa

tvia

Lithuania

Hungary

Austria

Poland

Portugal

Romania

Slovenia

Slovakia

Macedonia

0.0

20.0

40.0

60.0

80.0

100.0

120.0

140.0

2008 2009 2014

Wages and GDP

25.0 30.0 35.0 40.0 45.0

-3

-2

-1

0

1

2

3

4

5

wages/GDP

GDP

grow

th

Public Debt/GDP

• Apart from Greece, Croatia and Serbia stand out

• There is a steep trend line in the chart showing the path of Croatian public debt

• Projections for 2015-2016 are from the EU

Gross Public Debt/GDP

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20160

20

40

60

80

100

120

140

160

180

200

BulgariaCzech RepublicEstoniaGreeceSpainCroatiaLinear (Croatia)SpainLatviaLithuania

Gross Public Debt/GDP

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20160

20

40

60

80

100

120

140

AustriaPolandPortugalRomaniaSloveniaSlovakiaHungary

Gross Public Debt/GDP

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 20160

10

20

30

40

50

60

70

80

90

Macedonia FYRTurkeyMontenegroSerbiaAlbania

Legitimacy Risk

• In Macedonia and now in Montenegro, but also in Kosovo and Bosnia and Herzegovina there is either acute or chronic issue of legitimacy

• What is meant by that?• Take the Montenegrin case first, and then the

Macedonian one• Finally the case of Bosnia and Herzegovina

Prospects for Growth• Assumptions and Potential (this mostly applies to the Balkan less open

economies)• Slow growth of household final consumption, e.g. 1 percent• No growth in government final consumption• Strong increase in investment• Faster growth of exports than imports• Potential growth rate for countries like Croatia, Serbia, and most other

less open economies, is about 3 percent – in next 5 years or so• Assuming adjustment is accomplished by the end of that period with no

dramatic changes in the external environment, potential growth rate could be somewhere between 4 and 5 percent as long as employment rates reach the levels characteristic for more developed economies in Europe

Conclusions• Monetary regime is changing – interest rates are going to get

detached from zero• Energy and commodity prices should stay low• EU and euro area, barring major destabilisation, should benefit

from the changed monetary regime and low import prices• Central European countries should benefit from sustainable

overall policy framework and from increased prospects for exports

• Balkan countries and others that face sustainability issues will have to transit to more sustainable macroeconomic conditions with slower potential growth of up to 3 percent in next 5 years or so