Press release

18 May 2008

EBRD sees moderation in 2008 economic growth as the global economy deteriorates

Inflation seen as region’s most pressing problem

The EBRD sees economic growth in the transition region moderating in 2008, although most countries in eastern Europe and the former Soviet Union are proving to be surprisingly resilient in the face of disruptions on the international credit markets.

However, it added that any extended period of global economic slowdown is likely to take its toll on growth in then region over the medium term.

Inflation, now in double digits in many countries, is the region’s most pressing current problem. If left unaddressed, inflation could risk price-wage spirals, exchange rate re-alignments, or could force a belated and sharp response by monetary policy.

In its latest update of economic forecasts, the EBRD is predicting overall growth for the region of around 6 percent for this year, compared with 7.3 percent in 2007. The anticipated slowdown reflects very rapid increases in consumer prices, which are likely to impact household incomes and consumption, especially in the CIS. A more restrictive international funding environment, together with interest rate rises to combat inflation, could reduce domestic credit growth and limit growth in domestic investment. In addition, slowing global growth is expected to reduce import demand from key trading partners such as the countries in the eurozone.

The international credit crisis has so far only had a limited impact on the region as a whole. Banks in the region had little if any exposure to structured assets linked to U.S. mortgage markets. But greater risk aversion on the part of international investors has created some problems, evident for instance in the disruption of international bond funding to Kazakh banks.

Protracted stress in western financial markets could lead to a sharper than expected downturn in capital flows to the region, which could expose the substantial external financing requirements of some countries, especially in the Baltic and south-eastern European regions.

Persistently higher international prices for energy and agricultural commodities and risks to capital flows into region define fresh challenges at all levels of policy, including for market regulations. Specifically:

• greater public and private investment in energy efficiency projects should mitigate the impact of durably higher international energy prices, which should be passed on to consumers, if necessary alleviated by social income support to the most vulnerable groups;
• macroeconomic measures to contain resurgent inflation should be accompanied by supply side measures, in particular in agricultural markets. This could include reform of land markets, investment in storage facilities and infrastructure used by agricultural businesses, and liberalising domestic wholesale and retail chains. By contrast, price controls are unlikely to be effective. Keeping trade in agricultural commodities free from restrictions is in the collective interest of consumers and producers in all transition countries;
• risks to capital flows to the region should motivate improvements in the risk management capacity of banks, and re-invigorate efforts to develop local capital markets as alternative funding sources; and
• a renewed effort to improve business environments and simplify regulations should underpin sustained foreign direct investment into the region.

Overall, growth in the region will be more divergent, with better performance in the near term seen for commodity exporters or countries delaying the required anti-inflationary measures:

• The EBRD expects 2008 growth of 4.7 percent (5.9 percent in 2007) in Central Europe and the Baltics, down 0.5 percentage points from its last forecast in November last year. The revisions reflect anti-inflationary tightening of monetary policies and prudential regulations, and the expected slowdown in exports to the eurozone, with the sharpest changes seen for Hungary, Estonia and Latvia.
• Following 6.1 per cent average growth last year, the South Eastern Europe region is now seen as growing at 5 percent, compared with the 6 percent expected last November. Serbia is expected to show significantly lower growth of 5 percent this year, after 7.5 per cent last year, in part due the current political uncertainty. There are indication that this year’s agricultural harvest could be considerably better than average, which would benefit rural incomes and food prices across the region.
• The EBRD’s forecast for CIS growth in 2008 remains unchanged from the previous estimate at 7 percent, down from 8.4 percent in 2007. In Russia growth has exceeded previous expectations; this year’s expected rate of 7 per cent should be supportive of the entire CIS region, for instance through outflows of workers’ remittances or Russian direct investment. The outlook for growth has deteriorated substantially in Kazakhstan where credit to the private sector is expected to stagnate in real terms this year. In Ukraine, real GDP growth is expected to slow down to 5.5 per cent in 2008, given the impact of intense cost pressures on real household incomes and producers’ margins.