Executive Secretary of the UN Economic Commission for Europe United Nations Economic Commission for Europe FfD in Eastern Europe and the CIS:Private Capital Inflows, When Is It Too Much of a Good Thing? Marek Belka Executive Secretary of the UN Economic Commission for Europe Under-Secretary-General of the United Nations

Financing for Development: Obtaining External Finance Fast developing economies can use more capital (than they can obtain domestically) in order to exploit investment opportunities Consumers in fast growing economies wish to borrow in anticipation of rapidly rising future income (permanent income hypothesis) One of the major benefits of financial globalization is supposedly the ability to borrow externally Although official aid is important, especially for the poorest, it is limited and the focus must be on obtaining private capital inflows For these reasons, increasing the availability of external private financial resources became a key component of the Monterrey Consensus

Private Capital Inflows to EM/DC:. -Are Back to 1990s levels Private Capital Inflows to EM/DC: -Are Back to 1990s levels -But are no longer financing imports (except in Europe)

Capital Flows to EM/DC Thus, now capital is flowing “uphill” from the developing/emerging markets to the advanced economies They are using capital inflows to purchase international reserves This situation with China is typical (though larger) However, the emerging economies of Europe (except Russia) are an exception to this pattern in several respects: Private capital inflows are much larger These flows are financing increased imports and not official reserve accumulation And these inflows are associated with growth

Net Private Capital Inflows Are Much Larger In Emerging Europe

Net Inflows Are Large Because Gross Inflows are Large Net Inflows Are Large Because Gross Inflows are Large Unprecedented Levels for Emerging Markets Gross Inflows Are Now Increasing In Other Regions

Only in the Transition Economies in Central, East, and South-east Europe Are Capital Inflows Financing Increased Imports

Current Account Deficits in the Transition Economies Are Widespread and Quite Large Both in EU-NMS and SEE & CIS

Solid Real Growth in the ECE After a Difficult Decade (1990s) There Is Now Solid Growth in the Transition Economies especially since 2002

External Finance and the Transition Economies: Summary of Facts Most emerging markets have recently received little net private external finance However, the emerging economies of eastern, central, and southeast Europe are receiving significant net capital inflows and unprecedented gross capital inflows Most emerging markets are not using their net capital inflows to import addition goods However, the emerging economies of eastern, central, and southeast Europe are using their net capital inflows to finance additional imports This has allowed the growth of national income and consumption in Europe to be higher than it would have been otherwise

Capital Inflows into Eastern Europe: Are They a Problem or a Solution? Most of the previous episodes of significant net capital inflows, especially those connected with current account deficits, ended poorly Historically, ½ of cases of large private inflows end abruptly, including 15% that end with a major currency crisis. Debt crisis of early 1980s Various financial crises of late 1990s Basic Question: Are the eastern European economies repeating the mistakes of the past, or do we finally have a development model that can successfully use external finance and should thus be emulated?

Comparisons to Previous Episodes of Large Net Capital Inflows Emerging Europe is different from conditions prior to bad episodes in that: Europe’s inflows are private; public sector external borrowing is low. FDI represents a significant proportion of inflows. This is occurring within a highly integrated area both in terms of trade, finance, migration, and political engagement. EU new members, candidate countries, stabilization and association agreements, and neighbourhood policy Emerging Europe is similar to conditions prior to bad episodes in that: Countries are running large current account deficits. Increasingly a significant proportion of foreign borrowing is going into real estate. Much of the debt is denominated in foreign currencies- but now its consumers instead of banks and governments that are accepting the risks.

Policies Needed in Emerging Europe to Maintain Stability Additional fiscal restraint: Limits demand and inflationary pressures due to capital inflows Lowers interest rates, reducing inflows Allows for counter-cyclical policy if a reversal occurs Although discretionary tightening may be difficult, they should at least try to hold the line Encourage more domestic savings More exchange rate flexibility may be warranted Better manage credit growth; ensure regulatory & financial standards, limit foreign currency denominated loans

Emerging Europe’s Development Model: Conclusions Europe has been able to use external borrowing to promote growth But this increases risks and requires the implementation of numerous complementary policies Some vulnerabilities have now developed that need to be addressed Hopefully, Europe has devised a development model that takes advantage of external finance that the rest of the world can benefit from