1 Regional macroeconomic processes in nutshell Mai 2010 OTP Bank Research Center

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Regional macroeconomic processes in nutshell

Mai 2010

OTP BankResearch Center

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How the crisis pushed the region into recession?

How OTP sees the future of the region?

What is happening right now? Which policy mix to follow?

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Five main factors pushed the region into recession at the beginning of the crisis and made the banking system vulnerable

Source: OTP Research

Fiscal adjustments• Fall in revenues (lower economic activity)• Rising expenditures (higher unemployment)

• Adjustment should be done ASAP!!!

Falling external demand for exports

• Demand for main export goods of the region - investment and durable consumer goods and tourism services - falls much sharply, than for non durable consumer goods.

Sudden stop in capital flows

• Convergence and the growth of CEE relies heavily on capital absorption.

• Sudden stop in capital flows & lending: domestic demand collapsed.

Labor adjustment• Lower output: lower employment• This may last for many years, and also pull

consumption back.

Depreciation• Where FX lending is strong, depreciation, higher

debt burden and lower bank lending also cut back consumption and investment

External factors Domestic factors

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With the sudden stop of capital flows regional capital absorption comes to an end, C/A deficits are down…

Source: Consensus Economics, Eurostat

Current account deficit to GDP (%)

RussiaUkraineBulgariaRomaniaCroatiaSlovakiaSerbiaMontenegroHungary

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Resulting also in a sharp drop in bank lending


Private sector loan flows (in % of GDP)

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And a drastic fall in domestic demand…


Domestic demand (in % of GDP)

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Subprime crisis & decoupling story

Subprime crisis & decoupling story

Fall of Lehman &

widespread credit crisis

Fall of Lehman &

widespread credit crisis

Consolidation, hope of V shaped

recovery

Consolidation, hope of V shaped

recovery

Sovereign defaults also in the developed

world???

Sovereign defaults also in the developed

world???

From: 2007 Q4. 2008. Q2. 2009 Q2. 2010 ???

Until: Q3. 2008. Q1. 2009. Q2. 2010 ??? ????

From: 2007 Q4. 2008. Q2. 2009 Q2. 2010 ???

Until: Q3. 2008. Q1. 2009. Q2. 2010 ??? ????

Only developed countriesOnly developed countries

Everyone, especially CEE

countries with high fiscal or C/A deficit

Everyone, especially CEE

countries with high fiscal or C/A deficit

EverywhereEverywhere Countries with unsustainable debtCountries with unsustainable debt

With Greece new phase of the crisis has started?

Who:Who:

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Why Greece? Debt sustainability in focus

Source: Eurostat, OTP Bank Estimations

Public debt to GDP (%)1. After Nov. 2009

it became very clear, that the debt path is not sustainable

2.Manipulated statistics

3. Nothing until January

4. Low adjustment, too optimistic conditions in January (rates, growth, spreads)

5. Eur 45 bn. was far from enough

1. After Nov. 2009 it became very clear, that the debt path is not sustainable

2.Manipulated statistics

3. Nothing until January

4. Low adjustment, too optimistic conditions in January (rates, growth, spreads)

5. Eur 45 bn. was far from enough

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Why Greece? II. After the EUR 110 bn package and a fiscal restriction of 11% the debt sustainability is still dubious


Public debt to GDP (%) 1. Too slow adjustment (nothing happens in 2011)

2. Debt ratio peak is too high

3. Low adjustment: below 100% only in 2050?

4. Package is not supported by residents

5. How will the budget be financed after 2013?

1. Too slow adjustment (nothing happens in 2011)

2. Debt ratio peak is too high

3. Low adjustment: below 100% only in 2050?

4. Package is not supported by residents

5. How will the budget be financed after 2013?

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Who’s next?

Source:, Eurostat

Public

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What to do?

Source: IMF, World Bank

Fiscal policy:• Debt sustainability is a must• Adjustment should be carried out as

soon as possible• In the lack of puffers (very low debt or

fiscal reserves) no room for counter cyclical policy

Monetary policy:• Textbook says to depreciate in the case

of an external demand shock• Depreciation is dangerous in the case of

debt euroisation• Effect of depreciation to growth, through:

• Exports: +, marginally decreasing• FX debt burden: -, linear• Precautionary savings: -, marg. incr. • Bank lending: -, marginally increasing

• So depreciation above 10-15% will have recessionary effects (contractional depreciation)

Thailand 1999

Korea 1999

Malaysia 1999

Ukraine 2009Indonesia 1999

Hong Kong

Sweden 1993

Bulgaria 2009Hungary 2009

0

10

20

30

40

50

60

0 25 50 75 100 125 150 175 200 225 250 275 300 325 350Depreciation (%)

Peak of Non performing loan rates (%)

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As it became clear that the developed world would fall into recession, expectations on divergence emerged…

Source: Consensus Economics

Evolution of expected GDP growth for developed and CEE countries, 2009 (%)

ConvergenceConvergence DivergenceDivergence

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Main drivers are intact: • Labor is still cheap (-40% even if we take into account productivity)• EU is still a unified market• Integrated banking system

Convergence will return in 2010 or 2011 latest as the main drivers of convergence are intact

The pace of convergence depends on growth in the core counties

Theory and empirical evidence:

• Convergence goes on until core countries do not fall into recession.

• During a crisis export demand falls, capital flows reverse, spreads rise resulting in a temporary divergence.

• After the core counties start to grow again, convergence process revives with some delay

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Debt to GDP, 2009 (in % of GDP)Debt to GDP, 2009 (in % of GDP)

Budget deficit 2010-2012 avergae (in % of GDP)Budget deficit 2010-2012 avergae (in % of GDP)

Change in public debt to GDP between 2010-2012 között (%-point) Change in public debt to GDP between 2010-2012 között (%-point)

Potential growth after the crisis (%)Potential growth after the crisis (%)

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60

55

8

34

35

23

78

38

16

76

73 35

70

84

68

66

France

110Greece

Ireland

UK

USA

Netherland

Denmark

Germany

Bulgaria

Croatia

Hungary

Romania

Slovakia

Ukraine

Russia

Brazil

India

China

source: EU Commission, Bloomberg, Focus Economics, IMF, IIF, OTP Bank

7.5

2.0

3.0

4.0

4.2

3.2

5.0

3.4

2.4

5.5

12.0

13.5

12.0

13.0

5.6

3.8

4.6

3.0

13.9

25.0

35.0

30.0

24.0

9.5

2.0

7.0

1.0

1.7

0.5

6.0

1.4

4.5

5.5

-3.0

0.4

-4.0

1.7

1.4

2.0

1.8

2.1

1.7

1.8

1.8

3

2.8

3.0

4.0

4.0

4.5

4.2

5.0

7.0

8.0

Countries facing structural problems due to the crisis

Countries facing structural problems due to the crisis

Balanced developed countries

Balanced developed countries

Commodity exportersCommodity exporters

Emerging countries with huge domestic markets

Emerging countries with huge domestic markets

Adjusted fiscal and external position, higher growth potential: CEE countries are likely to outperform developed countries again after the crisis

Small open economies in CEE

Small open economies in CEE

Trade effectsTrade effects

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But risks are still remarkable

What can be expected for the coming years:

• Root sign recovery: Modest growth after rebuilding stocks, construction will not be a driver any more

• Much lower capital and loan flows: risk aversion, higher, than the pre-crisis spreads, new banking regulation, fiscal policies should be built on lower employment numbers

• Rising unemployment for at least H2 2010, but negative risks are dominating

• Construction will fall everywhere

Main risks:

• External: Another wave of recession

• Fiscal adjustment will be forced out in many developed countries

• The role of quantitative easing in the fast recovery is not known

• How much funds were misallocated before the crisis? Are there any output gap?

• Country specific:

• Wrong economic policies

• Structural problems: high share of construction, rigid labor markets

What can be expected for the coming years:

• Root sign recovery: Modest growth after rebuilding stocks, construction will not be a driver any more

• Much lower capital and loan flows: risk aversion, higher, than the pre-crisis spreads, new banking regulation, fiscal policies should be built on lower employment numbers

• Rising unemployment for at least H2 2010, but negative risks are dominating

• Construction will fall everywhere

Main risks:

• External: Another wave of recession

• Fiscal adjustment will be forced out in many developed countries

• The role of quantitative easing in the fast recovery is not known

• How much funds were misallocated before the crisis? Are there any output gap?

• Country specific:

• Wrong economic policies

• Structural problems: high share of construction, rigid labor markets

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Thank you for your attention!

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1 Regional macroeconomic processes in nutshell Mai 2010 OTP Bank Research Center