Eastern Europe and Central Asia: Economic Outlook and Challenges Ahead ISTANBUL CHAMBER OF INDUSTRY - 6th INDUSTY CONGRESS November , 2007 Klaus Rohland Country Director

2 Main Messages Strong growth, supported by: o Domestic factors (policy reforms: macro, structural) o External factors (Trade, FDI) Short-term challenges: oMacro vulnerabilities oFinancial sector vulnerabilities Medium-term challenges: oBoost productivity to maintain competitiveness, spur innovation and sustain economic growth oUnfinished structural reform agenda: oStronger investment climate; export sophistication (higher added value products); deeper financial markets

3 I. ECONOMIC OUTLOOK

4 Economic Expansion Continues…

5 Poverty Has Fallen in most countries

6 Strong Productivity Growth is Driving the Economic Expansion… Labor Productivity Growth drives per capita output growth in most countries

7 Output Growth Was Supported by Domestic Policies… Prudent Fiscal Policies Helped Improving Fiscal Balances

8 … And Progress in Structural Reforms Source: EBRD Transition reports Note: The measurement scale for the indicators ranges from 1 to 4+, where 1 represents little or no change from a rigid centrally planned economy and 4+ represents the standards of an industrialized market economy. The infrastructure reform ratings are calculated as the average of five infrastructure reform indicators covering electric power, railways, roads, telecommunications, water and waste water. The enterprise ratings are calculated as the average of large and small scale privatization, and enterprise restructuring. The market and trade ratings are calculated as the average of price liberalization, trade&forex system and competition policy. The financial institutions ratings are calculated as the average of banking reform & interest rate liberalization and securities markets & non-bank financial institutions.

9 External Factors Also Contributed to the Economic Expansion Trade and FDI flows increased across the region, contributing to the economic expansion

10 Overall, Much Progress Achieved But Further Reform Efforts are Needed II. CHALLENGES AHEAD

11 Short-term Challenges: Macro Vulnerabilities Remain… Large current account deficits (except in resource-rich countries), inflationary pressures and real exchange rate appreciation are also an issue of concern…

12 Short-term Challenges: Financial Sector Vulnerabilities Rapid Credit Growth has led to Higher Exposure to Financial Risks: (risk (maturities shortened, portfolio risks increased, risk premia and interest rates rose) calling for stronger financial supervision

13 Medium-Term Challenge: Boosting Productivity Growth Even in the EU Accession countries income per capita is less than half the EU-15 average. Productivity Growth can accelerate income convergence and improve competitiveness…..

14 Boosting Productivity Growth Calls for Further Progress on Structural Reforms STRONGER INVESTMENT CLIMATE: Reduce barriers to firm entry, exit and expansion (reducing regulatory burden, reforming tax systems, and increasing labor market flexibility) Higher export sophistication (higher value added products) and deeper financial markets are needed to spur innovation and boost productivity growth

15 Conclusions Strong economic growth, driven by domestic reforms and greater integration into global markets But further progress in structural reforms is needed to boost productivity growth, maintain competitiveness and spur innovation

16 Thank you for your attention