Crisis response: the next steps

by Erik Berglöf, Chief Economist, EBRD

The west has not turned its back

This year's EBRD Annual Meeting takes place at a time of unprecedented economic crisis in the EBRD region. Many economies will contract this year – some significantly – as will the region as a whole. There are signs that the situation has stabilised, but the outlook is for a slow recovery with risks on both sides.

But while the western credit crunch of 2007 and subsequent economic crisis last year severely impacted the region in October, it is important to stress that worst-case scenarios have been avoided. There have not been twin crises for financial sectors and currencies. Countries have not defaulted. Crucially the west has not turned its back on its neighbours in the east.

International response to the crisis

The decisive collective international response to the crisis is already bearing fruit.

• The major economies have pledged not to indulge in economic nationalism that could trigger a protectionist spiral.
  
  
• The International Monetary Fund’s resources are being increased to US$ 750 billion, allowing it to carry on its effective programmes to stabilise economies in the region.
  
  
• EU institutions have increased available finance and afforded an important safety net. The European Union has boosted funding for balance of payments support available for mainly eastern European member states from €25 billion to €50 billion.
  
  
• The G-20 process has held out a substantial rise in the funding of multilateral development banks active in the region.
  
  Western banks that own large parts of the eastern European financial sector, most of them now actively supported by their home governments, have pledged their continued commitment and engagement in the region.
  
  
• The international financial institutions have responded strongly to the crisis, offering significant resources through the Joint IFI Action Plan and a critical coordination process within the context of the Vienna Initiative, bringing together the large banking groups active in central and eastern Europe, as well home and host authorities for these banks.

Emerging Europe less affected than others

But this is not enough. We are not yet out of the woods. My own experience from discussions with the international banks and recent statistics from the Bank of International Settlements show that capital is being withdrawn from the region. However, in relative terms “emerging Europe” is less affected than other emerging markets. In our view the response from the international financial institutions has helped. But most of all it is a testament to the quality of financial integration and the maturity of the policy environment in central and eastern Europe.

Some net outflows are probably unavoidable as the region adjusts to more accurate assessments of risks and to the global trend to decrease leverage. But what is critical is that the adjustment takes place in an orderly manner and without leaving major vulnerabilities on the balance sheets of the banks.

A relevant agenda

Beyond providing finance, the current agenda must also support enterprise restructuring and help reduce the large exposures in foreign currency in both the household and corporate sectors.

• At the top of the current agenda is support for enterprises as they restructure to adjust to a new environment where credit is more expensive and some sources of funding are unlikely to return for quite some time.
  
  
• Banks can also be supported by the provision of swap lines from international financial institutions. The extensions of such lines from the European Central Bank could help central banks in a few countries to improve the liquidity of foreign exchange markets.

Furthermore, the private sector crisis is rapidly turning into a public sector crisis. The large output declines and adjustment of current accounts are leading to large fiscal deficits. In the absence of capital market access, filling these gaps requires international assistance.

The long-term future

Once the immediate challenges of the crisis have been addressed, it is important to prepare economies for their longer-term futures.

• EU candidates must be encouraged to continue preparing for accession. This is not the time to let “accession fatigue” take hold.
  
  
• There must be a clear timetable to the euro for EU countries. The crisis has underlined only too sharply the dangers of being a small currency on the fringe of the larger bloc.
  
  
• Domestic capital markets must be strengthened to promote the benefits of domestic financing and to reduce the dependence on foreign markets and the attendant foreign exchange risks.
  
  
• Financial supervision and regulation needs to be further improved to enhance the stability of the regional banking sectors and in a way which is better coordinated with the rest of Europe.
  
  
• Investments need to continue to ensure economic diversification away from an over-dependence on raw materials or a small number of industrial products. Skills need to be improved via spending on education and vocational training to develop a knowledge-based economy with higher value-added products.