©1998 International Monetary Fund

Ordering Information

O C C A S I O N A L   P A P E R     
The Baltic Countries
From Economic Stabilization to EU Accession

Julian Berengaut, Augusto Lopez-Claros, Françoise Le Gall, Dennis Jones, Richard Stern, Ann-Margret Westin, Effie Psalida, and Pietro Garibaldi

List of Abbreviations
I    Introduction
Julian Berengaut
II Overview of Recent Macroeconomic and
   Structural Adjustment Policies

Julian Berengaut and Augusto Lopez-Claros
Fiscal Policy
Money and Banking
Energy Sector
III Exchange Rate Regimes in the Baltic Countries
Augusto Lopez-Claros and Pietro Garibaldi
Recent Experience
Limitations and Constraints
Policy Options Over the Medium Term
Appendix I. The CBA and an Exit Strategy
Appendix II. Monetary Policy Instruments During Transition
IV Fiscal Issues
Dennis Jones and Françoise Le Gall
Budget Processes
Fiscal Revenue Mobilization
How Can High Levels of Revenue Mobilization Be Sustained?
Expenditure Management and Rationalization
V Financial System Issues in the Postcrisis Era
Effie Psalida
Financial Deepening and Financial Intermediation
Development of the Money, Securities, and Capital Markets
Restructuring the Banking System
Looking Ahead
VI Private Sector Development
Richard Stern
Methodological Issues: Definitions and Measurement Biases
Progress in Private Sector Development
Necessary Conditions for Private Sector Development
Private Sector Development in the Baltics
Policies and Program Design to Remove Obstacles to
   Private Sector Development
VII The Baltic Countries and Accession to the European Union
Ann-Margret Westin
Pre-Accession Strategy for the Associated Countries of
   Central and Eastern Europe--the Baltics
EU Membership and Implications for Economic Policy in the Baltics
3.1   Selected Economic Indicators
4.1 Fiscal Revenues
4.2 General Government Expenditures in the Baltics and Selected EU Countries
4.3 General Government Wage Bill and Employment in the Baltics and Selected European Countries
5.1 Indicators of Financial Intermediation (End-1997)
5.2 Prudential Regulations and Deposit Protection
6.1 Measurement of Private Sector Development
7.1 Association Agreements and EU Membership Applications of Central and Eastern European Countries
7.2 EBRD Transition Indicators
7.3 Classification System for the EBRD Transition Indicators
7.4 Selected Economic Accession Indicators for the Baltics
7.5 Selected Economic Indicators for the Baltics and the EU
3.1 Real Effective Exchange Rates
5.1 Number of Banks
5.2 Indicators of Financial Intermediation I
5.3 Indicators of Financial Intermediation II
5.4 Money Multiplier
5.5 Credit and Deposit Growth
5.6 Interest Rates
5.7 Treasury Bill Rates


I   Introduction

Julian Berengaut

The process of adjustment and reforms in the Baltics deserves attention for three overarching reasons: (1) the extent and speed of transformation from the central plan and political repression to the market and democracy; from plummeting output and living standards and high inflation to high growth, low inflation, and rapidly rising real incomes; and from reliance on the central bank and bilateral and multilateral sources for financing to accessing domestic and international financial markets; (2) the policy challenges the countries have faced in choosing and maintaining exchange rate regimes; confronting weaknesses in the banking system; protecting public revenues while adjusting the pattern of expenditures; and resolving problems of interenterprise and energy arrears; and (3) an opportunity for a cross-country prospective based on similarities in size, starting positions, external shocks, and policy objectives, and differences in the choice of policies and their timing.

The linkage between the policy choices, their implementation, and the policy outcomes is the basic theme of the volume. Chapter II provides an overview of macroeconomic and structural adjustment policies mainly since 1994­95. By that time, financial stabilization had taken hold which allowed a critical mass of structural reforms to be put in place thereby creating the conditions for the revival of growth. Chapter III surveys issues regarding the choice of exchange rate regimes in the Baltic countries, including recent experience, current challenges, and medium-term policy options. Chapter IV covers three broad fiscal issues: the evolution of the budget processes into a rational tool for public resource management, revenue mobilization including the factors that explain the Baltic countries' success in preventing erosion of the tax-to-GDP ratio, and expenditure management and rationalization. Chapter V focuses on developments in the financial sector of the three countries, taking as a point of departure the banking crisis that occurred in Estonia (1992, 1994), Latvia (1995), and Lithuania (1995­96); it concentrates on the evolving structure of financial markets and the restructuring of the banking systems that subsequently took place. Chapter VI discusses private sector development in the Baltics, namely, problems in its measurement, recent trends, and the necessary conditions to foster it, and the policy agenda for removing remaining obstacles. Chapter VII examines the Baltic countries' relations with the European Union (EU), concentrating on pre-accession issues and the implications of membership in the EU for the three countries.

Rather than a comprehensive review of economic developments and policy issues in the Baltic countries, the volume represent a partial overview of those aspects that have stood out in the transition through 1997 as interesting challenges with potentially broader applicability. The selectivity of the papers is heightened by its methodological approach emphasizing the cross-country perspective rather then employing country-by-country descriptions; the cut-off point for describing developments is, in most cases, mid-1997.