Financial turmoil and Financial turmoil and Transition CountriesTransition Countries

Fabrizio CoricelliFabrizio Coricelli

University of Siena and EBRDUniversity of Siena and EBRD

Istanbul June 25, 2008Istanbul June 25, 2008

No decoupling, but transition countries No decoupling, but transition countries have weathered the storm…so farhave weathered the storm…so far

Spreads have increased, from extremely low levels

Stock markets have been hit

Growth forecast revised downward, but moderately

With a few exceptions foreign lending has continued

Some countries, Russia in primis is seen as a “safe heaven” by international investors and rating agencies (high commodity prices, large stock of foreign reserves main strength, large presence of the state in the economy)

CDS spreads significantly increased CDS spreads significantly increased (latest data for March 2008)(latest data for March 2008)

234

146

149163

173152

116105

163

74

3650

0

50

100

150

200

250

300

350

Slovak

Czech

Poland

Hungary

Russia

Croat

ia

Bulgaria

Romania

Ukrai

ne

Serbia

Latvia

Kazak

hstan

Jun-07 latest figures: difference in bps

Spread widening in bps

Equity markets fellEquity markets fell

MSCI Em. Europe equity index over the past year

0.8

0.9

1.0

1.1

1.2

1.3

1.4

Mar

-08

Jan-

08

Dec-0

7

Oct-07

Aug-0

7

Jul-0

7

May

-07

absolute terms

relative to all emerging markets

relative to world

But risks have increasedBut risks have increased

The transition region has benefited from the surge in capital flows to emerging markets in the past few years

Domestic credit has boomed, funded by foreign lending

In most countries, credit --and growth-- has been concentrated in real estate, construction and financial sector

Transition countries the only area in the emerging world with a current account deficit

Largest imbalances in the Baltic states, Bulgaria, Romania and Kazakhstan

Capital inflows: A large share to Capital inflows: A large share to transition countries transition countries (US$ bn(US$ bn))

0

100

200

300

400

500

600

2000 2001 2002 2003 2004 2005 2006 2007

Africa

Asia

Western Hem.

Transition Countries

Current account balance (% of GDP)Current account balance (% of GDP)

-10%

-5%

0%

5%

10%

15%

20%

2000 2001 2002 2003 2004 2005 2006 2007

AfricaAsiaWestern Hem.Transition Countries excl. Russia

Extremely rapid credit growth, though Extremely rapid credit growth, though from a low basefrom a low base

Key risks have not been sufficiently Key risks have not been sufficiently notednoted

We may have been looking at the wrong indicators (CA, borowing requirements)

Recycling of petrodollars, the cycle in commodity prices and associated inflationary pressure, are perhaps the key issues to look at.

Relevance of the Calvo-Talvi view for transition countries (for the commodity exporters of the CIS): they question the relevance relevance of aggregate current account and net capital flows for countries that experienced positive developments in the terms of trade

Recycling of petrodollarsRecycling of petrodollars

IMF estimates that 50% of foreign deposits of oil exporting countries have been channelled through credit to Central-Eastern Europe

Credit boom in transition countries funded through foreign borrowing

If commodity prices reverse their trend, CEE countries that absorbed large share of commodity surpluses will suffer

Commodity exporters in the CIS will suffer as well, if not more

Highest share of bank loans in transition countriesHighest share of bank loans in transition countriesShares in total capital inflows to each region (2007)Shares in total capital inflows to each region (2007)

0%

10%

20%

30%

40%

50%

60%

70%

80%

FDI Loans Portfolio

Africa AsiaCentral-Eastern Europe CISWestern Hem.

Sectoral imbalances and sudden stop Sectoral imbalances and sudden stop (Calvo-Talvi view)(Calvo-Talvi view)

Large surplus in the energy sector, combined with growing indebtedness of non-energy sectors, especially non tradables (financial sector, construction and real estate)

A sudden stop in capital inflows in these sectors may induce a sharp fall in output

Resources of surplus sectors may not be easily transferred to sectors starved with funds. One reason is that the surplus sector may invest abroad (capital outflows).

If surplus is in the hand of the state, the transfer may be easier. Example of Kazakhstan

Inflows and outflowsInflows and outflows

CIS

-15%

-10%

-5%

0%

5%

10%

15%

20%

2000 2001 2002 2003 2004 2005 2006 2007

net inflows current account

outflows inflows

Cent. & East. Europe

-10%

-5%

0%

5%

10%

15%

2000 2001 2002 2003 2004 2005 2006 2007

net inflows current account

outflows inflows

Inflation acceleratingInflation accelerating

Monetary expansion fuelled inflation, together with boom in commodity prices

Large share of food in CPI, especially in CIS countries

Inflation accelerated especially in countries with peg to the US$: see comparison between Russia and Ukraine

Response to inflation: tightening of monetary policy in several transition countries, which combined with possible stop in foreign financing could imply a sharp contraction in output

0%

10%

20%

30%

40%

50%

60%

Ukraine Romania Kazakhstan Bulgaria Russia Poland

Share of food and non-alcoholic Share of food and non-alcoholic beverages in CPI basketbeverages in CPI basket

Inflation (12-month changes)Inflation (12-month changes)

0

5

10

15

20

25

30

Jan-

04

Mar

-04

May

-04

Jul-0

4

Sep-0

4

Nov-0

4

Jan-

05

Mar

-05

May

-05

Jul-0

5

Sep-0

5

Nov-0

5

Jan-

06

Mar

-06

May

-06

Jul-0

6

Sep-0

6

Nov-0

6

Jan-

07

Mar

-07

May

-07

Jul-0

7

Sep-0

7

Nov-0

7

Jan-

08

Mar

-08

Russia Ukraine

A few comments on the episode of A few comments on the episode of sudden stop in Kazakhstansudden stop in Kazakhstan

Kazakhstan an interesting case, as it is the only country that experienced a sudden stop following the financial turmoil

Such sudden stop has induces a slowdown of the economy but not a deep crisis

Sudden stop in KazakhstanSudden stop in Kazakhstan

After the summer of 2007 foreign inflows stopped and domestic credit stopped as well

In real terms there was a decline in the stocks

Growth slowed down but there was no crisis

Sharp decline in growth rates, but no Sharp decline in growth rates, but no recession thanks to commodity productionrecession thanks to commodity production

No crisis yet, thanks to high No crisis yet, thanks to high commodity pricescommodity prices

High oil and gas prices have helped to avoid a deep crisis, in spite of a sudden stop in capital inflows

Role of the State: initial defence of the exchange rate followed by commitment to bail out banks, real estate companies and the construction sector

Government steps in Government steps in

Targeting of resources raised from the energy sector to other sectors in needs of financing

Pledge budgetary funds for construction sector

Announce readiness to use oil stabilization fund to support banking sector

Benefits in the short run, but risks in the longer run, as the reform process slows down.