How Central Europe dealt with the global crisis

Like many other regions around the world, Central Europe (CE) was profoundly affected by the global economic crisis. This article discusses the way CE countries have been handling the effects of the global crisis in the region by looking into changes in the macroeconomic indicators over the past 2 years.

A direct result of the worldwide economic downturn in Central Europe is evident by the change in average GDP. Average GDP growth across 18 CE countries reached 6.6% in 2006-2008, but registered a decline of −6.0% in 2009.

To counteract the crisis in the region, the CE governments and central banks applied similar instruments of economic policy to that of developed countries in order to soften the immediate blow from the downturn. In particular:
together with an increase in governments’ guarantees on bank deposits, they used ample liquidity buffers to meet deposit withdrawals and avoid bank panics;
they loosened monetary conditions, at first by quantitative easing via direct liquidity injections from the central banks, followed by interest rate cuts; and
they provided considerable fiscal stimuli.

There were no governments in Central Europe that applied rescue packages (cash, credits, guarantees, debt-shares swaps) to financial institutions or companies in the region at the same level as governments providing comparable help to companies or financial institutions in more developed economies, such as the US and the EU-15. CE countries also did not receive any significant external support by international financial organisations, such as the IMF or the World Bank.

For example, in November 2008, Ukraine and Hungary signed Stand-By Arrangements worth 11 billion SDR* (€9.5 billion) and 10.5 billion SDR (€9.1 billion) respectively. And in May 2009, Poland was granted access (which was never used) to the exclusive IMF Flexible Credit Line worth 13.7 billion SDR (€12.5 billion). This amount is approximately the same sum of funds which exited Poland from mid-2008 till mid-2009, through speculative investor activity.

Other EU-10 countries (including Albania, Bosnia-Herzegovina, Latvia and Moldova) also took advantage of IMF credit lines. From November 2009 until August 2010, the IMF signed 10 agreements with CE countries (also taking into account two extensions of the agreements) worth a total of 64.5 billion SDR (€57.1 billion). From this, only 18.4 billion SDR (€16.3 billion) was drawn in this period, with the overwhelming majority (87%) of this devoted to two countries: Ukraine and Hungary.

*SDR:Special Drawing Rights, effectively the currency of the IMF

EU — 10:Hungary, Slovakia, Poland, Czech Republic, Estonia, Latvia, Lithuania, Slovenia, Romania, Bulgaria

EU — 15:Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden and the United Kingdom

CE region:Albania, Bosnia-Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Macedonia, Moldova, Serbia, Montenegro, Poland, Romania, Serbia, Slovenia, Slovakia, Ukraine

The IMF funding could be compared to one-third of the CE current account deficit financing in 2009 and might have been regarded as a significant factor, but it was not the only means of managing the global crisis in the region.

Domestic responses to the downturn throughout the Central European region have also been effective in tackling the situation. Within one year, the average trade deficit in CE countries was slashed by half to 4.1% of GDP in 2009 from 9.3% of GDP in 2008. A decline in the current account deficit was even higher — by more than two-thirds — from 7.6% of GDP in 2008 to 2.2% of GDP in 2009. Irrespective of a very significant decline in the real GDP, unemployment levels in the region actually rose modestly to 13.5% in 2009, from 10.1% in the previous year, while the economic activity rate stood unchanged at 61%. Meanwhile, the average CE gross wages in euros decreased by just 2% in 2009 and domestic currencies depreciated significantly against the euro: the Ukrainian hryvna lost 47%, the Polish zloty 23%, and the Romanian leva 15% of their value. Surprisingly, given the global situation, most enterprises in the region actually maintained their competitiveness, increasing productivity and even being able to increase wages domestically.

As with any delicate balancing act, and given the far-reaching challenges of the crisis, there was a price to pay for these ’good news’ stories. The bad news was that the average deficit rose twofold from 3.2% of GDP in 2008 to 6.6% of GDP in 2009 and public debt expanded to 41.4% of GDP in 2009, compared to 34.5% of GDP in 2008. There was also an increase in the costs of long-term debt in the CE countries and taking the lower yields on the EU-15, Swiss, US and Japanese long term bonds, borrowing from abroad for the region became cheaper than domestically. As a result, the foreign debt of the public sector in Central Europe increased by almost 19% year-on-year and made up 54% of the total public debt in 2009, compared to 47% in 2008. The nominal level of external foreign debt of the public sector significantly exceeded the foreign currency reserves of the CE central banks, which remained almost unchanged during 2008-2009.

Making sense of the situation: Deloitte’s analysis of economies in Central Europe

In last year’s edition of the Deloitte Central Europe Top 500 Main Report, we analyzed perspectives of both economies and companies in the region. We aggregated 18 countries into three groups (See Table 1A). The first group comprised countries facing particular challenges in combating the recession: Croatia, Estonia, Lithuania, Latvia, Macedonia, Serbia, Ukraine and Hungary. The second group consisted of countries capable of experiencing the recession in relatively good shape: Albania, Bosnia-Herzegovina, Bulgaria, Montenegro, the Czech Republic, Moldova, Romania, Slovenia and Slovakia. Finally, the third was a group of one — the special case of Poland, which did not experience a recession and had actually shown GDP growth in 2009 (1.8% year-on-year).

Our analysis shows that in the majority of cases, we were right to group the countries as we did. However, there were a few exceptions: Albania and Moldova, for example, eventually registered positive GDP growth in 2009 (2.8% and 2.7% respectively) and therefore have since joined Poland in the third group. At the other end of the spectrum, results in Romania and Slovenia were a bit of a disappointment, as they showed a decline in GDP of more than 7% in 2009. They should have been moved to the first group of countries facing challenges in combating recession, to be replaced by Macedonia and Serbia. These two countries still registered negative GDP dynamics in 2009, but performed better than we had expected.

This year, we used the same five criteria as a year ago to forecasts developments in CE countries during 2010-2011, with GDP dynamics and fiscal developments having the biggest weight*.

GDP dynamics and behaviour of GDP components (consumption, investments, net exports), may provide clues to the future behaviour of households (whether they maintain consumption levels or cut spending) and companies (whether they forecast good or bad sales levels)
General government balances and levels of public debt as governments (and fiscal policies) respond to the crisis in the long-term
Exchange rate behaviour, levels of foreign reserves, inflation and interest rates as central banks (and monetary policies) make a short-term response
Trade balances and balances of payments, with an emphasis on changing exports and imports
Levels of unemployment as companies respond to changes in demand by optimizing their costs
This approach produced two groups of countries. The first group included countries with positive GDP dynamics during 2010-2011, declining fiscal deficits and stabilisation of public debt levels and improving current account deficits or positive dynamics of exports, resulting in high or growing levels of international reserves and lower volatility in foreign exchange rates. The improving situation in the labour market in the region also indicates growing demand for labour from enterprises and a more stable perspective of consumption demand. The first group includes (in alphabetic order): Albania, the Czech Republic, Estonia, Macedonia, Moldova, Poland, Serbia, Slovakia, and Ukraine.

The second group comprises countries still facing particular challenges in combating recession (their GDP dynamics would be negative in 2010): Croatia, Bosnia-Herzegovina, Bulgaria, Hungary, Latvia, Lithuania, Montenegro, Romania, and Slovenia.

Both groups included the same number of countries. However, four countries in the second group may switch to the first pending the outcome of the second half of 2010. Bosnia-Herzegovina, Slovenia, Bulgaria and Romania may still register positive GDP dynamics this year and in 2011. Bosnia-Herzegovina and Slovenia should almost certainly experience GDP growth in 2010, but they are small open economies and are therefore very dependent on external developments in their main trading partners, the EU countries (particularly Germany, Italy and Austria). Bosnia-Herzegovina and Slovenia are currently facing the consequences of some specific problems registered in 2009 such as very high level of unemployment in Bosnia-Herzegovina (of around 40%), and high negative investments in Slovenia (-21.6%).

Bulgariaand Romania are the most populous countries among the ones in the second group, with a relatively strong domestic consumption, but this alone does not indicate positive dynamics in 2010. These two countries, like Slovenia, faced significant decline in gross investments in 2009 (of over −25%) — to compare the figure with Slovakia and Poland in the first group that registered modest declines in investments of 10.5% and 0.4% respectively.

Two years after the global financial crisis hit, the CE region is maintaining its position relative to the EU-15 and strengthening its position over the so-called PIIGS countries (Portugal, Ireland, Italy, Greece, Spain). However, the crisis is not yet over for world and for the region. With governments worldwide withdrawing their fiscal stimulus by lowering general government deficits, and central banks beginning to reconsider hikes in interest rates, the global crisis is now entering its second phase. We can toss a coin and guess if it lands the world in a second dip (the so-called W-shaped recovery) or we end up back to normal (the U-shaped recovery), but it would be very unwise to call either way at the moment.