Gazeta Wyborcza Interview with Reza Moghadam, Director, European Department, International Monetary Fund

October 18, 2013

Interview by Leszek Baj, published in Gazeta Wyborcza, October 18, 2013

The IMF just published the Regional Economic Issues report for Central, Eastern, and Southeastern Europe. How does our region do on the way out of crisis?

Central, Eastern, and Southeastern Europe have had a difficult five years. The region was hit hard by the global financial crisis in 2008-09 as the very large capital inflows of the boom years suddenly stopped and exports shrunk due to the collapse in global trade. Only two countries avoided recession (Albania and Poland) and the most-affected, Latvia, saw GDP decline by a quarter.

After a brief recovery, in 2012 there was a renewed slowdown as the region felt the effects of the euro area crisis and bad weather. The slowdown was far less dramatic than in 2009, but nine countries still experienced a contraction in their economies.

Things are starting to look better. Growth is picking up in both the euro area and in Central, Eastern, and Southeastern Europe. The euro area should grow by 1 percent next year, ending two years of negative growth. Growth in Central, Eastern, and Southeastern Europe will pick up to close to 3 percent in 2014—one percentage point more than this year.

But there are risks. One is that growth in the euro area will disappoint with inevitable knock-on effects for Central, Eastern, and Southeastern Europe. We are also keeping an eye on financial markets in emerging economies, for example, to see how factors such U.S. monetary policy decisions might affect the region.

Recently, the IMF increased the Polish GDP growth forecast for 2014 from 2.2 to 2.4 percent. But the potential GDP growth is much lower than it used to be before the crisis. What should we do to enable Polish economy to grow at 5 percent again?

2012 and 2013 were difficult for Poland, and growth is indeed lower than pre-crisis. The good news is that the economy appears to be recovering. It is also doing so at a slightly faster pace than we expected, which led us to revise up our growth forecast in 2014.

At the same time, Poland’s potential growth—or the rate at which the economy can grow in the longer term—has declined somewhat. But the decline is smaller than in many other countries in the region.

Economic reforms are needed to boost potential growth. There is scope to bring more people into the labor force, particularly women. Policies to help match people and jobs, including through better education and training programs for the jobless will help address unemployment. Continuing to improve the business climate and avoiding cuts to the public investment needed to meet Poland’s infrastructure needs are also important.

Does lower potential growth mean that the Polish economy will need more time to catch up with Western European economies?

Poland has made impressive strides in the past two decades to catch up to Western European economies, even after the crisis. And proximity to their markets and production centers continues to offer tremendous opportunities for convergence.

The challenge now is to ensure that Poland continues to take full advantage of these opportunities. The best approach is to continue the combination of good macroeconomic policies and economic reforms such as those described above. Poland is also lucky to have a talented population to help spur innovation to keep the country competitive and dynamic.

Do you think that the Polish authorities are doing enough to get the economy out of the slowdown?

Getting an economy out of a slowdown is always difficult, especially when growth is weak in the region or, in this case, the world. In Poland, macroeconomic policies have been appropriate. Monetary policy was eased substantially—policy interest rates were cut to 2.5 percent, a low level by Polish standards. Lower interest rates should help boost household spending and firms’ investment. Fiscal policy is more constrained. But the authorities appropriately allowed the deficit to widen as revenues declined to help avoid a drag on growth.

The conditions of the Central, Eastern, and Southeastern European economies are strongly correlated with the situation in the euro zone. What are the main threats and challenges for the recovery in Europe?

Growth in the euro area is picking up, but is fragile and many challenges remain. The banking sector is still recovering; and in many countries spending by households, firms and government is held back by too much debt.

Weak growth in Central, Eastern, and Southeastern Europe is not a recent issue. In the past five years, growth in the region has averaged only 0.5 percent a year. Part of the problem was cyclical, but more fundamental forces have been at work too. Firms invest much less than they used to. The result has been fewer factories and lower productivity growth, which has lowered the economy’s productive capacity.

At the same time, unemployment in many countries remains unacceptably high. In the Western Balkans, some countries have unemployment rates of 20-30 percent. And this is not a recent issue. So growth needs to be higher.

But how can we boost it?

The region needs to address the legacies of the 2008/09 crisis. Banks still have too many “nonperforming loans”—loans given during the boom years that went sour. This is holding back credit growth to households and firms, delaying the recovery. Government debt is much higher than before the 2009 crisis and in many countries is still rising. Strengthening public finances will reduce borrowing costs, with benefits for the private sector.

In addition to the reforms mentioned to boost potential growth, countries in the region can take other steps too, including better integrating with each other. More open economies tend to grow faster. The investment climate is also an issue in some countries—simplifying regulations and better protecting investments would help. In some countries, restructuring loss-making state-owned enterprises and enhancing governance and transparency are critical. Reforms could make labor markets work better in many countries so that wages adjust and help avoid high unemployment.

Politicians in Washington have just agreed to increase the debt ceiling. Meanwhile the policy of the U.S. Fed remains unclear going forward. Do you think that the possible U.S. Fed decision to scale back the stimulus program can harm recovery in Europe?

The U.S. Congress has taken an important and necessary step by ending the partial shutdown of the federal government and lifting the debt ceiling, which enables the government to continue its operations without disruption for the next few months.

As far as the U.S. policy is concerned, events in the United States will inevitably have wider repercussions, including for emerging Europe. Talk of scaling back the Fed’s bond-buying program has already had an impact. Emerging Europe has generally coped well, but countries that previously had large capital inflows and have weak fundamentals—such as large current account deficits—have come under considerable pressure and must prepare to minimize risks.

In recent years many European countries applied for financial assistance from the EU and the IMF. Were the remedies that were recommended proper or too harsh? What mistakes would you avoid if you had the second chance?

Since 2008 the IMF has had lending arrangements with 16 European countries, both in Central, Eastern, and Southeastern Europe, and in the euro zone, totaling over €130 billion. There are remarkable differences across all these countries and our country programs have reflected these differences.

For example, the pace of fiscal consolidation has varied markedly across programs, from more rapid tightening where initial imbalances were large and market pressures intense, to a more gradual pace where it could be afforded. And in our regular reviews of programs, we have made adjustments—including by relaxing fiscal targets—where conditions allowed. Finally, and most importantly, in our lending programs, we have always striven to protect the most vulnerable by encouraging spending on social safety net programs and improved targeting.

Of course, we do not claim that program design or implementation have always been perfect. But nor are programs static: as we learn lessons, we try to incorporate them. Over time, for example, we have increased the focus in the euro zone programs on structural measures to strengthen competitiveness, since reigniting growth and reducing unemployment are essential.


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