Challenges for Baltics as for the Eurozone countries having Advanced Economy status 4th European High-level Panel Discussion on Banking Vilnius, February 4, 216 Bas B. Bakker Senior Regional Resident Representative for Central and Eastern Europe
Outline Advanced vs. emerging country status, 26-15 Current advantages of advanced country status Current advantages of euro area membership Future challenges for Lithuania within the euro area 2
1. Advanced vs. emerging country status, 26-15
Advanced country vs. emerging market Wikipedia An emerging market is a country that has some characteristics of a developed market, but does not meet standards to be a developed market An advanced country is a sovereign state that has a highly developed economy and advanced technological infrastructure relative to other less industrialized nations. 4
View before 28: advanced countries more stable Emerging market country: volatile capital flows; prone to boom-busts and crises Policies not as good Advanced country: More stable Better policies 5
Therefore, advanced countries had lower borrowing costs 16 5-year CDS spreads in 26 (basis points) 14 12 1 8 6 4 2 Note: Emerging markets as of 26 in orange. 6
Real GDP growth, 29 This idea seemed to be confirmed in 29, when emerging Europe had a capital account crisis 6 4 2-2 -4-6 -8-1 -12-14 -16 Real Domestic Demand Growth and Real GDP Growth (Percent) Bulgaria Serbia Latvia Lithuania Romania Albania Bosnia and Herzegovina Estonia Hungary Macedonia, FYR Croatia Turkey Poland Czech Rep. Slovakia Slovenia -3-25 -2-15 -1-5 Current Account balance, 27 7
Interest rates rose 16 Long term interest rates (percent) 14 12 1 29 8 6 27 4 2 8
and GDP declined sharply GDP growth in 29 (percent) -2-4 -6-8 -1-12 -14-16 9
Crisis was deep, but by late 29, CDS spreads in Eastern Europe had come down sharply 12 1 5-year CDS spreads (basis points) Latvia 8 6 Estonia 4 Croatia Lithuania Romania Hungary 2 Poland Slovakia Czech Rep. Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Jul-1 Jan-11 1
Growth turned positive in 21 15 Real GDP growth (percent) 1 5 SEE non-eu Baltics CE5-5 SEE EU -1-15 -2 25 26 27 28 29 21 211 212 213 214 215 Note: Unweighted averages. 11
Idea that advanced countries were more stable was short-lived, as euro area crisis hit 2 18 16 14 12 1 8 6 4 2 1-year T-bond yields (percent) 37.1 Ireland Spain Italy Portugal Greece Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 12
Interest rate forecast error, 29-12 (pp.) And countries with weak fiscal positions saw large and unexpected interest rate increases Structural balance in 29 and WEO interest rate forecast errors 14 12 Greece 1 8 6 4 2 y = -.667x - 2.8596 R² =.7783 Ireland Spain Portugal Italy Slovenia Netherlands -2-4 Slovakia France Austria Germany Belgium Finland -2-18 -16-14 -12-1 -8-6 -4-2 Structural balance in 29 (percent of potential GDP) Note: Forecast error is difference between 212 and 29 WEO vintages estimates. 13
Rise in borrowing costs spilled over to private sector 2 5-year corporate CDS spreads (basis points) 3 Portugal 25 2 Greece 1 15 Ireland Spain 1 5 Germany Mar-1 Mar-11 Mar-12 Mar-13 Mar-1 Mar-11 Mar-12 Mar-13 14
GDP growth forecast error (pp.) The more interest rates exceeded projections, the more growth disappointed Spring 21 WEO Interest and growth forecast errors 5-5 -1 Belgium Finland Germany Slovakia Austria France Netherlands Italy Spain Ireland Portugal Slovenia y = -1.1356x - 1.98 R² =.7167-15 -2 Greece -4-2 2 4 6 8 1 12 14 Interest rate forecast error (pp.) 15 Note: Forecast errors are differences between 212 and 29 WEO vintages estimates.
Greece Ireland UK Spain Portugal Romania Poland Slovakia Lithuania France Czech Rep. Belgium Italy Slovenia Austria Netherlands Hungary Latvia Denmark Bulgaria Germany Sweden Finland Estonia* Fiscal positions in emerging Europe were better than in the euro area periphery Structural balance, 29 (percent of potential GDP) 5-5 -1-15 -2 * Cyclically adjusted balance (AMECO database) 16
And had also not deteriorated as much 5 Structural balance (percent of potential GDP) Latvia Estonia* -5 Lithuania Ireland -1 Spain Greece Portugal -15-2 26 27 28 29 21 211 212 213 214 215 * Cyclically adjusted balance (AMECO database) 17
Finland Germany Netherlands Estonia Czech Rep. Austria France Poland Russia Belgium Slovak Rep. Turkey Lithuania Latvia Bulgaria Romania Serbia Slovenia Italy Croatia Spain Hungary Ireland Ukraine Portugal Greece As a result, emerging Europe was less affected by the euro area crisis Risk premia in advanced countries were no longer lower than in emerging Europe 771 863 3536 6 5-year CDS spreads in 212 (basis points) 5 4 3 2 1 18
Euro area recovered in 214, after adjustment programs and QE had brought down interest rates in periphery 2 18 16 14 12 1 8 6 4 2 1-year T-bond yields (percent) 37.1 Ireland Spain Italy Portugal Greece Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 19
Overall, crisis in Baltics was deeper than in euro area periphery, but shorter 13 Real GDP per capita (index, 27=1) 13 12 Lithuania 12 11 Latvia 11 1 9 Estonia 1 9 Ireland Portugal Spain 8 8 Greece 7 27 29 211 213 215 7 27 29 211 213 215 2
Most notable difference was unemployment 3 Unemployment rate (percent) 3 Greece 25 2 25 2 Spain 15 Latvia 15 Portugal 1 5 Lithuania Estonia 1 5 Ireland 27 29 211 213 215 27 29 211 213 215 21
which may be related to more rapid adjustment of wages 2 Wage growth (percent) 2 15 15 1 5 Estonia 1 5 Spain Portugal -5 Lithuania -5 Ireland Greece -1 Latvia -1-15 28 29 21-15 28 29 21 22
Differences not the result of changes in emigration! 3 2 Working age population dynamics (percent) 3 2 Ireland 1 1 Spain -1 Estonia -1 Portugal Greece -2 Latvia -2-3 Lithuania 25 27 29 211 213-3 25 27 29 211 213 23
2. Current advantages of Advanced country status Advanced country label may no longer be a big advantage Large number of crises in advanced countries in past decade Investors care more about policies than about status 24
Germany Netherlands Finland Austria France Belgium Czech Rep. Slovak Rep. Ireland Estonia Poland Lithuania Latvia Spain Italy Romania Slovenia Hungary Portugal Bulgaria Serbia Croatia Russia Greece Weak advanced countries have higher risk premia than strong emerging market countries 3 5-year CDS spreads in 212 (basis points) Russia (377 bps) Greece (1739 bps) 25 2 15 1 5 Note: Emerging markets as of 212 in orange 25
3. Current advantages of Euro area membership More important may be euro area membership Removes any residual exchange rate risk Lender of last resort In future: banking union 26
Target 2 and ECB make liquidity shocks much less likely 75 65 55 45 35 25 15 5-5 -15-25 -35-45 Target2 Balances (euro billion) Ireland Netherlands Spain Germany 27 28 29 21 211 212 213 214 215 Italy Luxembourg 27
4. Challenges for Lithuania in euro area Lithuania has no independent monetary policy (of course, has not had it for long time) How do you prevent future boom-busts? 28
Wage growth in the Baltics is already high compared to rest of euro area 6 5 4 3 2 1-1 -2-3 Nominal wage and real productivity growth, 215 (percent) Productivity growth Wage growth 29
Unemployment is falling rapidly. How do you prevent renewed overheating? 25 Labor market in Lithuania 2 15 Unemployment rate (percent) 1 5-5 -1-15 Wage growth (percent y/y) 2 21 22 23 24 25 26 27 28 29 21 211 212 213 214 215 3
Decline of working age population does not help!.5 Population dynamics in Lithuania (percent). -.5-1. Population -1.5-2. Working age population -2.5-3. 1995 2 25 21 215 31
Working age decline to continue 9 Population in Lithuania by age (thousands) 8 7 6 65+ 5 4-14 3 1995 1997 1999 21 23 25 27 29 211 213 32
In future, fiscal policy may need to lean more against the wind not add to the boom -1 Structural balance in Lithuania (percent of potential GDP) Boom years Post-boom years -2-3 -4-5 -6-7 23 24 25 26 27 28 29 21 211 212 213 214 215 216 33
This would also help to rebuild buffers 45 4 35 3 25 2 15 1 5 Public debt (percent of GDP) Lithuania Latvia Estonia 24 25 26 27 28 29 21 211 212 213 214 215 34
Macro-prudential policy may also need to play a role With banking system largely foreign owned, close cooperation between home and hostsupervisors needed (Neglect home country supervisors during pre- 28 boom did not end well). 35
Employment rate (percent) Future catch-up will need to be driven by productivity increases 9 Labor utilization and productivity, 215 8 7 6 5 UKR BLR ALB MKD EST CZE RUS BGR ROU LAT LTU SVN HUN POL SVK HRV NLD DEU 4 3 2 MDA BIH MNE* SRB Note: Bubble color reflect regional groupings. Bubble size reflect GDP per capita level (PPP adjusted) 1 3 5 7 9 11 Labor productivity (PPP adjusted USD thousand) 36 *214 UKV*
There is less scope to increase employment rate than in the past 72 Employment rate in Lithuania (percent) 7 68 66 64 62 6 58 56 54 52 1995 2 25 21 215 37
Capital stock per worker is still low 2 Capital stock per worker (Thousands of 21 euro) 18 16 Germany 14 12 1 8 6 4 2 Estonia Lithuania Latvia 38
But growth of capital stock has slowed down 12 Lithuania: growth rate of capital stock per worker (percent) 1 8 6 4 2-2 1995 2 25 21 215 39
5. Conclusion Lithuania is now an advanced economy Nice recognition of the important changes that have been made since transition. However, it is unlikely to bring much changes either to financial markets or to economy Sports analogy: Champions are champions because they play so well It is not that champions play so well because they are champions 4
Euro area membership brings benefits but also constraints For a small open, and catching-up economy important to prevent future boom-busts With no independent monetary policy, fiscal policy main remaining instrument Macro-prudential policy may also help 41
Thank you