1 Regional macroeconomic processes in nutshell Mai 2010 OTP Bank Research Center

2 How the crisis pushed the region into recession? How OTP sees the future of the region? What is happening right now? Which policy mix to follow?

3 Five main factors pushed the region into recession at the beginning of the crisis and made the banking system vulnerable Source: OTP Research Fiscal adjustments Fall in revenues (lower economic activity) Rising expenditures (higher unemployment) Adjustment should be done ASAP!!! Falling external demand for exports Demand for main export goods of the region - investment and durable consumer goods and tourism services - falls much sharply, than for non durable consumer goods. Sudden stop in capital flows Convergence and the growth of CEE relies heavily on capital absorption. Sudden stop in capital flows & lending: domestic demand collapsed. Labor adjustment Lower output: lower employment This may last for many years, and also pull consumption back. Depreciation Where FX lending is strong, depreciation, higher debt burden and lower bank lending also cut back consumption and investment External factorsDomestic factors

4 With the sudden stop of capital flows regional capital absorption comes to an end, C/A deficits are down… Source: Consensus Economics, Eurostat Current account deficit to GDP (%) Russia Ukraine Bulgaria Romania Croatia Slovakia Serbia Montenegro Hungary

5 Resulting also in a sharp drop in bank lending Source: Consensus Economics, Eurostat Private sector loan flows (in % of GDP)

6 And a drastic fall in domestic demand… Source: Consensus Economics, Eurostat Domestic demand (in % of GDP)

7 How the crisis pushed the region into recession? How OTP sees the future of the region? What is happening right now? Which policy mix to follow?

8 Subprime crisis & decoupling story Fall of Lehman & widespread credit crisis Consolidation, hope of V shaped recovery Sovereign defaults also in the developed world??? From:2007Q Q Q ??? Until:Q Q Q ??? ???? Only developed countries Everyone, especially CEE countries with high fiscal or C/A deficit Everywhere Countries with unsustainable debt With Greece new phase of the crisis has started? Who:

9 Why Greece? Debt sustainability in focus Source: Eurostat, OTP Bank Estimations Public debt to GDP (%) 1. After Nov it became very clear, that the debt path is not sustainable 2.Manipulated statistics 3. Nothing until January 4. Low adjustment, too optimistic conditions in January (rates, growth, spreads) 5. Eur 45 bn. was far from enough

10 Why Greece? II. After the EUR 110 bn package and a fiscal restriction of 11% the debt sustainability is still dubious Source: Consensus Economics, Eurostat Public debt to GDP (%) 1. Too slow adjustment (nothing happens in 2011) 2. Debt ratio peak is too high 3. Low adjustment: below 100% only in 2050? 4. Package is not supported by residents 5. How will the budget be financed after 2013?

11 Who’s next? Source:, Eurostat Public

12 What to do? Source: IMF, World Bank Fiscal policy: Debt sustainability is a must Adjustment should be carried out as soon as possible In the lack of puffers (very low debt or fiscal reserves) no room for counter cyclical policy Monetary policy: Textbook says to depreciate in the case of an external demand shock Depreciation is dangerous in the case of debt euroisation Effect of depreciation to growth, through: Exports: +, marginally decreasing FX debt burden: -, linear Precautionary savings: -, marg. incr. Bank lending: -, marginally increasing So depreciation above 10-15% will have recessionary effects (contractional depreciation)

13 How the crisis pushed the region into recession? How OTP sees the future of the region? What is happening right now? Which policy mix to follow?

14 As it became clear that the developed world would fall into recession, expectations on divergence emerged… Source: Consensus Economics Evolution of expected GDP growth for developed and CEE countries, 2009 (%) ConvergenceDivergence

15 Main drivers are intact: Labor is still cheap (-40% even if we take into account productivity) EU is still a unified market Integrated banking system Convergence will return in 2010 or 2011 latest as the main drivers of convergence are intact The pace of convergence depends on growth in the core counties Theory and empirical evidence: Convergence goes on until core countries do not fall into recession. During a crisis export demand falls, capital flows reverse, spreads rise resulting in a temporary divergence. After the core counties start to grow again, convergence process revives with some delay

16 Debt to GDP, 2009 (in % of GDP) Budget deficit avergae (in % of GDP) Change in public debt to GDP between között (%-point) Potential growth after the crisis (%) France 110Greece Ireland UK USA Netherland Denmark Germany Bulgaria Croatia Hungary Romania Slovakia Ukraine Russia Brazil India China source: EU Commission, Bloomberg, Focus Economics, IMF, IIF, OTP Bank Countries facing structural problems due to the crisis Balanced developed countries Commodity exporters Emerging countries with huge domestic markets Adjusted fiscal and external position, higher growth potential: CEE countries are likely to outperform developed countries again after the crisis Small open economies in CEE Trade effects

17 Source: Consensus Economics, Eurostat But risks are still remarkable What can be expected for the coming years: Root sign recovery: Modest growth after rebuilding stocks, construction will not be a driver any more Much lower capital and loan flows: risk aversion, higher, than the pre-crisis spreads, new banking regulation, fiscal policies should be built on lower employment numbers Rising unemployment for at least H2 2010, but negative risks are dominating Construction will fall everywhere Main risks: External: Another wave of recession Fiscal adjustment will be forced out in many developed countries The role of quantitative easing in the fast recovery is not known How much funds were misallocated before the crisis? Are there any output gap? Country specific: Wrong economic policies Structural problems: high share of construction, rigid labor markets

18 Thank you for your attention!