Press Release: Growing and Deleveraging: the conflicting challenge of Central, Eastern, and Southeastern European Countries

May 10, 2015

Press Release No. 15/205
May 10, 2015

Growth patterns are increasingly divergent in Central, Eastern, and Southeastern Europe (CESEE), says a new report by the International Monetary Fund (IMF). The group of countries stretching from the Baltic states all the way to Turkey have been affected differently by external forces - oil prices, strength of the euro area recovery, and geopolitical tensions. Furthermore, some of the countries are still afflicted with debt overhang and are not likely to grow out of it without deep institutional reforms, in addition to supportive macroeconomic policies. These are the main conclusions of “Mind the Credit Gap,” the IMF’s new Regional Economic Issues report, launched today in Budapest at a conference hosted by the Central Bank of Hungary.

Weak investment is a common challenge in a very heterogeneous region. Investment is being held back by still low demand growth in much of Europe and uncertainty both at the global and the euro area level, but also by an incomplete private sector balance sheet clean-up. While credit deleveraging is necessary, it tends to be more protracted and a drag on growth when debt problems are pervasive, macroeconomic policies are not sufficiently supportive, and institutional frameworks are not flexible enough.

“CESEE countries face a challenging dilemma: strengthen private sector balance sheets that have been damaged by the slump in demand and employment caused by the financial crisis; and, at the same time, achieve again investment levels that will support the growth rates their economies need to catch up with the more advanced European countries,” said Jörg Decressin, Deputy Director in the IMF’s European Department.

Divergent performances

Cheaper oil and stronger euro area recovery are supporting faster growth in the Baltics (Estonia, Lithuania and Latvia), Central and Eastern Europe (CEE - Czech Republic, Hungary, Poland, Slovakia, Slovenia), and in Turkey. However, persistent structural weaknesses and an incomplete private sector balance-sheet clean-up have prevented Southeastern Europe (SEE - Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Kosovo, Macedonia FYR, Montenegro, Romania and Serbia) from fully benefitting from the same tailwinds.

In contrast, Commonwealth of Independent States (CIS - Belarus, Moldova, Russia and Ukraine) countries are expected to contract due to lower oil prices and sanctions (Russia) and the fallout from geopolitical tensions and ongoing macroeconomic adjustment (Ukraine).

According to the report, market volatility and geopolitical problems are the main risks that could negatively affect countries in emerging Europe. An increase in geopolitical tensions related to Russia and Ukraine, as well as a deterioration of the situation in Greece loom in the horizon. The beginning of rising of interest rates in the United States could increase funding costs and reduce capital flows to the region. On the upside, euro area growth may be stronger than expected on the back of the European Central Bank’s Quantitative Easing and lower oil prices.

Reviving investment remains a challenge for much of the region. Apart from global and regional uncertainties, pressures stemming from the deleveraging process have weighed down on growth and had a negative impact on GDP everywhere although less in CEE countries.

How can countries grow out of debt?

Support domestic demand; complete private sector balance sheet clean-up; and foster a pick-up in investment to ensure a robust recovery is the complex and often conflicting challenge ahead of policy makers in the CESEE countries. How to achieve that? The answer is a multi-front approach:

  • Macroeconomic policies should be mindful of the credit gaps: in countries where debt-related risks continue to weigh on demand, supportive macroeconomic policies are essential.

  • Fiscal consolidation is needed in many CESEE countries, but should not be too stringent, with the risk of derailing the recovery.

  • Monetary policy should remain accommodative particularly in countries facing deflationary risks.

  • Structural and institutional reforms are critical for lifting potential growth, especially for countries still facing private sector debt overhang: creating more efficient debt resolution frameworks; improving the business environment to raise productivity and reduce structural unemployment; making labor markets more flexible, so as to give companies more options to carry out necessary adjustments, other than only cutting back on investment.


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