1. Financial sector crisis in emerging Europe and international policy response Alexander Pivovarsky EBRD Office of the Chief Economist USAID Regional Competitiveness Conference 16 June 2009

2. Crisis in the region preceded by capital inflows, largely by European banks … Total external asset stocks of BIS reporting banks (vis-à-vis all sectors, in billion US dollars) Exposure of European banking groups in EBRD countries of operation

3. … leading to high levels of private debt, much of it in foreign currency.

4. The global crisis hit the region hard in October of 2008 … Global risk spreads Cross border bank lending Export volumes, y-o-y, % Net FDI inflows

5. … with immediate impact on exchange rates, monetary conditions, and output. Domestic monetary conditions Exchange rates Real GDP, y-o-y change %

6. Domestic policy responses: overview Priority has been stabilization of financial systems and in some cases (Ukraine, Russia) exchange rates; Monetary policy has ranged from cautious easing (CEE countries) to very tight, depending on credibility of monetary institutions, currency composition of debt, pressures on exchange rate, and domestic inflation; Fiscal policy has ranged from expansionary (Russia, Kazakhstan) to highly contractionary in countries with large revenue collapses and no fiscal reserves; IMF has been called in in a reasonably timely fashion.

7. Domestic policy responses: has it been adequate? By and large, mature reactions:  Remarkably little populism: no wholesale bailouts or unaffordable fiscal boosts,  Few coercive actions (exceptions: currency controls and regulatory interference to stabilize exchange rates in some countries); However, in most countries, domestic policies are overwhelmed by the scale of the problem:  Revenue shortfalls combined with external financing constraints,  Exchange rate pressures limit scope for monetary easing,  Large bank recapitalisation needs.

8. The international response: overview 1.IMF rescue packages, with EU collaboration and cofinancing in case of EU members Armenia, Belarus, Bosnia-Herzegovina, Georgia, Hungary (w/EU), Latvia (w/EU), Moldova, Romania (w/EU), Serbia, FCL for Poland; 2.The joint IFI (EBRD-EIB-World Bank/IFC) action plan in defence of CEE financial systems (€25 bn, Feb); 3.EU political commitment that domestic packages for international banking groups can benefit subsidiaries; 4.ECB liquidity support to Eurozone banking groups, which “trickles East”; 5.The “Vienna Initiative”: an IFI led, multilateral effort to secure commitments by both international banking groups and home and host country authorities.

9. The international response: has it been adequate? 1.Quick IFI support, probably instrumental in preventing a systemic meltdown: Critical role of IMF packages in Ukraine, Hungary (w/EU), Latvia (w/EU), and probably also Serbia and Romania (w/EU), EBRD: major investments involving both domestic (Parex), and international groups (Unicredit, OTP); large pipeline; EIB lending to parents as well as subsidiaries. 2.International banking groups have so far remained committed – IFI and government policies may have helped; 3.However, the present response may be insufficient in light of second round financial stresses (in particular, as corporate defaults materialize in full).

10. Recent signs of stabilization Industrial production seems to have bottomed out in a number of countries; Confidence indicators stabilized; Risk spreads came down; Currencies strengthened; Stock markets recovered.

11. What else is needed 1.Emergency fiscal financing to avoid counterproductive and politically destabilizing tightening; 2.Willingness to scale up IFI initiative if current funding proves insufficient, and possibly widen its scope to supporting corporate restructuring; 3.A stronger direct role of European institutions; 4.For EU countries outside Eurozone, reaffirming Euro entry objectives with a clear Euro timetable.