Convergence, Crisis, and Capacity Building in Emerging Europe

IMF Blog, July 27, 2012

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Convergence, Crisis, and Capacity Building in Emerging Europe

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Bibliographic details

• Authors: Nemat Shafik
• Published: July 27, 2012

Overview and historical context

• Central, Eastern and Southeastern Europe moved from a communist planned system to a market economy in "two short decades".
• Living standards in the region "have converged towards those in the West."
• The region experienced major crises: "the break-up of the old Soviet system in the early 1990s," "the Russian financial crisis in 1998," and "the recent global economic crisis."

Building blocks for stable economies

• IMF engagement in the early 1990s focused on "stable economies, price and trade liberalization, and privatization."
• IMF provided technical assistance and training that many countries "regarded ... as even more valuable than its lending and broader policy advice."
• Capacity building emphasized:
  • Creating new legal and regulatory tools.
  • Training qualified staff to "formulate policies and to execute them."
  • Developing skilled civil servants, many alumni of the Joint Vienna Institute, "a training center sponsored by the IMF, Austria, and other international institutions."

Lessons from the crisis

• The investment in human capital "paid off handsomely" when the global economic crisis hit in 2008.
• Effects of the 2008 shock: "growth, trade and employment collapsed and default threatened some governments and financial institutions."
• The region avoided meltdown due to "quick and well-executed policies supported by unprecedented international financial support."
• The "ongoing crisis in the eurozone" is identified as "the main threat to recovery" because of close ties to Western Europe.
• Countries with persistent vulnerabilities included those with:
  • "substantial financing needs,"
  • "widespread foreign-currency lending,"
  • "banks saddled with high non-performing loans."
• Key lessons highlighted:
  • "Every boom—no matter how unsustainable—has a good story at the time." Imbalances such as "huge current account deficits and double-digit credit growth" were misinterpreted as benign convergence.
  • "Counter-cyclical policies may be insufficient to fully prevent a bust, but they can dampen it." Examples:
  • Estonia’s "conservative pre-crisis fiscal policy" that kept its budget under control and allowed it "to join the euro in 2011."
  • The National Bank of Poland’s "far-sighted prudential policies that discouraged foreign exchange denominated borrowing," reducing vulnerability.
  • "A decisive and well-designed policy response can help overcome the crisis quickly." Illustrations:
  • IMF support for "Latvia’s ambitious consolidation based on maintaining its currency peg."
  • IMF support for "the more conventional adjustments in Hungary, Romania or Ukraine."
  • Poland "managed to avert a recession altogether, thanks to a flexible exchange rate and apt policy response, supported by a financial backstop from the IMF."
  • "Two decades of capacity building bore fruit"—strong institutions and skilled policymakers are "key to sustaining the success."
  • "Well-coordinated international support and close cooperation between the public and private sectors make a difference." Examples:
  • "joint IMF-EU financial support programs in the region,"
  • the "Vienna Initiative" that "brought together governments, regionally active banks and international institutions to maintain lending levels to the private sector in the region."

The look ahead — policy implications and recommended actions

• Country-level priorities:
  • "address vulnerabilities head-on" by:
  • "improving competitiveness,"
  • "reducing fiscal financing needs,"
  • "dealing with non-performing loans."
• International-level actions:
  • "reactivate the successful international cooperation of the recent past," including:
  • "the revival of the Vienna Initiative, taking into account the new circumstances for parent banks,"
  • potential financial support, "possibly precautionary, from the international community."
• The IMF commitment: "The IMF has stood by this region since the end of communism. We will continue to help whenever asked, with financing, policy advice, and capacity building."
• Confidence grounded in institutional capacity: "Given its institutional capacities, I am confident that the region will yet again be able to design and implement the policies necessary to meet these challenges."

Source: Nemat Shafik, July 27, 2012 — Convergence, Crisis, and Capacity Building in Emerging Europe

References

• https://www.imf.org/wp-content/uploads/2011/10/nemat-shafik-thumbnail.jpg
• region’s resilience and flexibility
• https://www.imf.org/wp-content/uploads/2012/07/minouche-blog-chart-july271.jpg
• technical assistance
• crisis in the eurozone
• non-performing loans
• Vienna Initiative
• new circumstances for parent banks