“The impact of the crisis on new EU member states†Role and Contribution of the Fund in the Crisis, Keynote remarks by Marek Belka,Director, European Department, Brussels, December 2, 2009
December 2, 2009
Speech
As Prepared for Delivery
• Vulnerabilities in CEE countries had built up for a long time, but it took an unusual combination of external shocks and domestic policy mistakes to lead to a crisis. Rapid capital inflows had lead to macroeconomic and structural vulnerabilities in most of the new member countries. The vulnerabilities were most pronounced in countries with fixed exchange rates, which had even fewer policy instruments than floaters to try and counteract.
○ When severe external shocks – the combination of the drying up of international interbank markets and faltering export demand – hit the region, all countries suffered, but still, fared better than others. Against this background it is clear that at least some countries were not “innocent bystanders” but that domestic policies had made them more vulnerable than others.
○ These “policy mistakes” – if we can call them so – include among others insufficient attention to the weaknesses in the domestic financial sector, years of inadequate fiscal responses to the capital inflows problem, and lack of institutional reforms necessary to support convergence with advanced Europe. Of course the outside world is also to blame. In the euphoria of rapid growth, most felt that the lessons learnt in earlier crises did not apply.
○ As we all know, in 2008 and 2009 three EU members—Hungary, Latvia, and Romania—faced balance of payments crisis so severe that they required external financial assistance. In each case assistance was provided in the context of joint IMF/EU balance support program. One country, Poland, while less vulnerable, decided to avail itself of the IMF’s new contingent credit line, the FCL, and thereby reassure international capital markets that its liquidity remained assured.
• The IMF’s initial crisis response for EU members has been fast and efficient, later developments reflected country specific issues. In October 2008 the Hungary crisis was – at the time—unexpected. Yet, the response was efficient: in the absence of a precedent the IMF and EU agreed in an unbureaucratic manner to undertake a joint program The program was agreed in “record time” and in an amount set to not only ensure bop sustainability but to avoid second round speculative attacks, and thereby to ensure instant credibility. Similar approaches led to rapid disbursements also for Latvia and Romania when these countries faced crises shortly thereafter, and, in particular in Latvia, helped prevent a major balance of payments crisis.
○ Following the initial disbursements, developments in the three crisis countries differed significantly. While initial developments in Hungary and mostly also in Romania tended toward stabilization, the most dramatic developments clearly occurred in Latvia. There, the first review of the program was delayed by several months as a result of the deepening economic crisis and a lack of full policy support for the necessary reform measures. The credibility of the program and the stability of the country was at stake. With a somewhat different appreciation of the risks involved, the coordination among program partners was also more difficult, but I would stress that open communication was at all times maintained.
○ Since the days of the “height of the crisis” much has changed. Most important, while the crisis is by far not over, none of the EU members with a program in place is facing an immediate bop crisis. At the same time, other countries remain vulnerable, and a “second wave” of programs may be yet to come.
• Much of the positive outcome to date reflect the IMF’s ability to “re-invent itself” in a manner necessary to operate in a new institutional environment. With the benefit of hindsight it is clear that the positive outcome was due to the Fund’s ability to act fast, while leveraging its resources with those of the EU and other program partners has helped to “tie” financial support packages that were sizeable enough, even in this day of very high capital flows.
• Equally critical was the concentration on macrocritical issues, which facilitated speed and political support. The IMF has learned some lessons from the past – one of them being that a crisis resolution program can not solve all problems a country faces. This recognition and the reform of conditionality initiated by the new Managing Director allowed us to tailor the recent programs, including those in the CEE, to macrocritical issues, while leaving structural reforms to “further down” in the reform process. I already mentioned the importance of speed – focused conditionality was clearly one of the elements that ensured speed. Another issue is important: While a Fund program is never politically easy, the concentration on critically important reform steps facilitated acceptance in the countries, and thereby made the process easier for the authorities to initiate and to pursue.
• The IMF also played a key role in the European Bank Coordination Initiative, together with the EU, the EBRD and others. The ECBI helped tie in the private sector, notably European parent banks, into the process to ensure bop sustainability in crises countries. It developed since into a forum to not only ensure that private sector debt is being rolled over and a credit crisis avoided, but also that more broader bank related issues can be discussed between home and host countries.
• The IMF has paid close attention to the social dimension of the programs. For example, the fiscal strategy in Hungary, Latvia and Romania aims at protecting the poor and low-income earners from the impact of the global crisis, through better targeting of expenditure (Hungary), strengthening the social safety net (Latvia), and higher social spending (Romania).
• We are now at a crossroads: Initial stabilization in crisis countries needs to be followed up with sufficient structural reforms to allow resumption of convergence, but avoid earlier vulnerabilities. Following the success to date, we now need to look forward to the steps that are needed to ensure longer-term success. Those steps differ by country. Some, including Latvia and Romania, have still a long period in their initial programs to go, and successful implementation and avoidance of “reform fatigue” will need to be at the top of their interest. For Hungary and Poland, there is a need to reflect on whether or not they should maintain the support and stability of a program or attempt to “graduate” – with good arguments for either way. For near crisis countries, the challenges are equally high. They need to decide whether they should get the protection of a program, or attempt to essentially follow the same reform agenda, but without the financial support.
• Going forward we can not allow old vulnerabilities to reemerge. With global liquidity now again in ample supply, there is a danger that the reform agenda may get disrupted. Yet, this outcome would be a disaster, as the costs of the current crisis are very high and avoiding a similar “trap” should be foremost on policy makers’ minds. Most important will be to put in place a policy framework that fosters the resumption of convergence, yet avoids imbalances and overheating.
• The main elements of such a policy framework are still being designed, and I see a key role for the IMF to draw on its broad experience in Europe and elsewhere in proposing the core elements. I see core elements to include prudential and regulatory rules that allow control of actual risks in a rapidly growing environment. Work is also needed in the areas of taxation to avoid procyclical bias in revenues. Finally, efforts are needed also in Western European countries to put in place safeguards to avoid banks and other market participants taking excessive risks in CEE countries.
• We at the IMF are cautiously optimistic that the “worst is over”, yet we do not underestimate the challenges of the “road ahead”
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