Launch Forum: Regional Impact of the Global Economic Crisis Yerevan, 8 July 2009

Development and Transition newsletter n Published three times annually by UNDP, London School of Economics n Distributed to: –All UNDP staff in Europe, Central Asia region –3000-plus external subscribers n Goals: –Provide UNDP, independent views on development, transition issues in the region –Disseminate lessons of successful UNDP projects n Current issue: Regional impact of global economic crisis

Presentation goals n Focus on some key economic policy issues that are: –Explored in the newsletter –Not covered by the other presentations –Relevant for Armenia n These are: –Lessons from the Baltic economies collapse (Rainer Kattel) –Eurozone expansion? (Anders Åslund) –Banking nationalisation (Anja Shortland)

Baltic conundrumThe Baltic states: n Did a lot of things right... n... But still became regions worst crisis victims (along with Ukraine) –Large declines in GDP, incomes, employment –Much development progress lost –No end to the crisis in sight n Realistically, its not clear that Baltic policy makers could/should have done something differenteven ex post n Conclusion: Black swans can be deadly

Baltic model: Some similarities with Armenia n Macro characteristics: –Relatively small state sectors n Small role of state redistribution –Privatisation to foreign investors (including banks) –Currency-board/hard-peg exchange rates n Micro characteristicsLiberal approach to: –Tax systems (flat tax pioneers) –Labour market regulation –Social protection systems n Structural characteristicsVery small, open, transition economies: –Small domestic savings poolsFDI needed –Weak diversification prospects

Structural comparison (2008 data) In mlns (X+M) GDP

Pre-crisis performance: Good on GDP growth... Average annual GDP growth % points above NMS average

... And employment Average annual employment growth % point difference from NMS average

Reforms did not hurt state finances... General government budget (% of GDP), annual averages for period. Eurostat data.

... Or produce large public debts General government debt, % of GDP, Eurostat data.

Crisis hits Baltics first (in 2008)... Source: IMF World Economic Outlook, April 2009

... And deepens in 2009:Q1 Change relative to 2008:Q1. Sources: Eurostat, CIS Statistical Committee, national statistical offices, JPMorgan, press reports.

Unemployment: Baltics hit hard here, too Numbers of unemployed (LFS data), June 2008 = 100 * Romania not included Source: Eurostat

Cause: Rapid growth in private sector foreign debt Ratio of gross foreign debt to GDP. EIU data, UNDP calculations.

Large current account deficits financed by parent banks n Baltic banks: –Privatised in 1990s to Scandinavian banks –Benefitted from parents: n Financing of rapid credit growth n Corporate governance n Credit growth aided by: –Fixed exchange rates –EU accession (free movement of capital)

Did competitiveness suffer? Effective unit labour cost trends Changes in annual average effective unit labour costs, Sources: Eurostat, Oxford Analytica; UNDP calculations. Nominal depreciation since mid-2008 boosts competitiveness

Baltic conundrumCurrency boards, EU membership: n Preclude use of discretionary monetary, exchange rate policies n Leave financial system open to hot money n May cause competitiveness problems n Place entire burden of macro adjustment on fiscal policy... –... But discretion here limited by the EUs Stability and Growth Pact... –... And fiscal space is in any case limited

Causes of Baltic conundrum n Small, open economies + European integration n Small, open economies + European integration –Extensive Euroisation –Balance sheet mismatches n Small savings pools + large modernisation needs (e.g., for competitiveness on single market) large capital inflows n Baltic states could raise capital on markets very easily until 2008 –Cheaper than borrowing from IFIs –Access to post-accession EU funds further reduced cost of capital

What could have been done? n Capital controls? –Not compatible with EU membership n Tighter fiscal policies? –Baltic fiscal policies already tightest in EU –High economic costs in terms of foregone output, employment, poverty reduction –High political costs n Unilateral Euro adoption? –This would help with balance sheets... –... But it would not: n create more fiscal space n be permitted by European Central Bank

What should be done now? n Things that must be done by EC, ECB: –Euro adoption n Åslund: ECB should have a change of heart (and not only for the Baltics... ) –Expansion of fiscal transfers to reduce intra-EU productivity disparities n Towards a federal European economy n Things that could be done nationally: –Vienna process to prevent spread of financial contagion from subsidiary to parent banks –Further reforms of labour market, social policy, to reduce nominal wages (rather than employment)

Implications for Armenia n Structural similarities: –Small, open, transition economies –Current account deficits –Private banking system n Key differencesArmenia: –Banks, formal economy not as dollarised –Forex-denominated private sector foreign debt is small –Result: Armenia can devalue without ruinous balance sheet effects

Bank nationalisation (Shortland) n Many private banks have been bailed out, or nationalised, during the crisis –Both in developed countries and emerging markets –Counter-argument to Washington consensus n Socialism for the rich n Large emerging market data set shows state-owned bank performance is not inferior to private banks n Reason: In emerging markets, it may be harder for the state to regulate private banks than it is to own, manage them directly n Conclusion: Its OK to nationalise your banks

Is Sberbank the answer? Baltic, Armenian experience suggests not n Baltics: –Vienna process reduces capital flight –Only one major bank nationalisation (Parex Bank, Latvia) n Other countries: –Nationalisation: Better than bailouts (moral hazard)? –Post-crisis prospects for privatisation? n Armenia: Effective regulation of private banks is possible even during crisis

Launch Forum: Regional Impact of the Global Economic Crisis Yerevan, 8 July 2009