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Klas EklundRiga, January 24, 2003

THE ROAD TO THE EU AND THE EURO:CONSEQUENCES FOR POLAND AND THE BALTIC ECONOMIES

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TOPICS

•General macro overview•Macroeconomic effects of EU

accession• Investment and migration •Policy challenges• The road to the euro• The company perspective• Institutional challenges

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GLOBAL UNCERTAINTY

• Lengthy hangover from the burst bubble - underestimated by most economists

•What potential US growth rate after the burst bubble?

•Deflation or reflation?•Will there be a war?•How long will Germany’s troubles

persist?

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THE GLOBAL ENVIRONMENT

•A wobbly international environment•Slow European growth - bleak

German performance•Volatile financial markets

•Bond yields up in 2003•Euro somewhat stronger

•Baltics and Poland must rely on own strength

- and impetus from EU convergence

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BALTICS & POLAND• Impressive shift to independence and

democracy• Credible fiscal policies, but external

vulnerability• Positive medium term growth outlook

•Potential growth rates 5-6% in Baltics, 4-5% in Poland

•Main constraints: Ageing populations in Baltics, weak public institutions, oversized public sector and imbalanced economic policy in Poland

• Fairly attractive to foreign investors• What impact of EU/EMU?

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THE EU

• Single market• Increasing trade within EU• Increasing investments• Utilising economies of scale• Higher productivity growth• Cross border transfers• But also increasing transformation

pressure and vulnerability for individual companies and sectors

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REAL CONVERGENCERatio of per capita GDP to EU average

0

25

50

75

100

125

1970 76 82 88 94 2000

SpainPortugalI relandEstoniaLatviaLithuania

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CONVERGENCE TO CONTINUE

2001 2005 2001 2005

Estonia 43 48 47 52

Latvia 33 37 54 56

Lithuania 38 42 48 49

Poland 40 42 54 58

GDP/cap level% of EU av.

Price level% of EU av.

Source: EU Commission, Nov 2002

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GROWTH PROJECTIONS FOR NEW MEMBERS 2005-2009

“Reference”No EU membershipNo changes

• “Central scenario”Integration into Internal MarketIncreasing FDISectoral shifts

• “Optimistic”Comprehensive reformsRapid sectoral shifts

2.9%

4.6%

6.1%

Source: EU Commission 2001

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FISCAL PRUDENCE - AND TRANSFERS

• Macroeconomic stability in EU presupposes strong public finances•Avoid crowding out, support low inflation and c/a

stability•Stability Pact: Balanced budgets or surpluses to

have room for stabilisation policies

• Challenge: Tax revenue •Political aim to cut taxes - while reaching

surpluses•EU harmonisation ahead - meant increasing taxes

in Club Med•EU transfers and common tariff

• Necessary: Strict budget procedures, institutional reform

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MAIN STRUCTURAL REFORMS NEEDED IN ENTERPRISE SECTORSAccording to EU Commission

Estonia

Latvia

Lithuania

Poland

• Strengthen SMEs

• Complete privatisation• Liberalise utilities• New bankruptcy law• Stamp out corruption

• Strengthen SMEs• Continue privatisation• Liberalisation of Energy• New bankruptcy law

• Strengthen SMEs• Continue privatisation• Restructure industries• Promote entrepreneurship• Revise bankruptcy law

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EUROPEAN FDI TO SPAIN AND CANDIDATE COUNTRIESBn USD

0

2

4

6

8

10

12

14

92 93 94 95 96 97 98 99

SpainEast

Source:laCaixa

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0

0,1

0,2

0,3

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17

MIGRATION FROM NEW MEMBERS TO OLDAnnual migration from year 1 of membership, Per cent of home countries’ population

Source: EU Commission, 2001Note: Peak equals some 220,000 persons

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THE EMUStrengthens the single market:• Transparency, economies of scale, lower

costs• Means higher productivity and growthBut also:• Greater pressure on individual companies

through pricing• Greater difficulties in finding an optimal

stabilisation policy•Monetary policy decided in Frankfurt, fiscal policy

left on the national level

• And some risks along the road

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TIME TABLE FOR BALTICS AND POLAND• Referendum 2003• EU accession: May 2004• ERM: Autumn 2004? Maybe even spring?

•No great change for Estonia & Lithuania•But Latvia and Poland must peg to EUR

• 2005-2006: Assessment of Maastricht criteria

• EMU entry: January 2007?•Maybe 2006 if short ERM period is allowed?

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MAASTRICHT CRITERIAMembers-to-be 2001, Club Med 1994

Estonia +0.5 5 5.8 6.8Latvia -1.6 16 2.510.2Lithuania -1.9 23 1.3 6.3Poland -3.9 39 5.3 8.4Average -1.7 21 3.7 7.9Portugal -5.9 61 6.9 9.5Spain -6.7 59 5.3 10.1Italy -9.4 118 5.5 11.1Greece -10.5 109 8.9 n.aAverage -8.1 87 6.7 10.2

Budget Debt Inflation Bond deficit yields

Source: CEPS 2002

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VULNERABLE EXTERNAL POSITIONS• All four countries run c/a deficits• Dependence on FDI makes them vulnerable

to shifts in investor confidence

2000 2001 2002 2003Estonia -6.2 -6.4 -10.5 -9.5Latvia -6.9 -10.1 -9.0 -8.5Lithuania -6.0 -4.8 -6.5 -7.0Poland -6.3 -4.0 -3.7 -4.0

Source: SEB Baltic Outlook, Oct 2002

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POSSIBLE STRAINS DUE TO MAASTRICHT CRITERIA & ERM

• Criteria are nominal•Low inflation, low interest rates, low debt, low

budget deficit, stable exchange rate

• But a higher inflation is natural during the catch-up process•To fight it with appreciating currency is not

compatible with ERM - and to respond to stronger currency with low interest rates (Hungary!) may cause even higher inflation

•To fight it with tight budgets is politically difficult

• So: Nominal criteria can cause real problems

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EXCHANGE RATES

• Baltic states should not face severe problems

• Poland: A conflict between the need for a weak zloty and appreciation pressure

• Conclusion: Preserve flexibility as long as possible!

• Or persuade ECB to move straight from currency boards to the euro•Probable compromise: Keep currency boards

within ERM

• Or to adjust inflation target up

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THE NEED TO FIND THE RIGHT CONVERSION RATE

Strong currency• Slower exports - slower growth - lower

inflation - higher real rates - negative effect on asset markets - even slower growth

Weak currency• Stronger exports - stronger growth - higher

inflation - lower real rates - booming asset markets - even stronger growth

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STRATEGIC CHOICES FOR COMPANIES• Larger domestic market

•Single market and common currency will give economies of scale

• New procurement policy, aiming for the whole of EU

• Price transparency for comparable products• Sharper competition: More competitors and

pricing in common currency• Higher costs for consumer & environment

protection• Less graft & corruption. Insider contacts

less important

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WINNERS OR LOSERS?

• More joint ventures will come• Deeper integration of East European firms

into supply chains of leading Western manufacturers

• To make only operational preparations is a defensive policy for short-term survival

• An aggressive, long-term strategy means focusing on markets, competitors, products and prices

• The choice made can make the difference between survival or disaster

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CONSEQUENCES FOR BANKS

• Opportunities for cross-border business in EU

• Means also tightening competition• EU structural funds will support projects -

opportunities to participate as a co-financier

• EMU means smaller FX volume• Less volatile interest rates; devaluation

risks disappears• Potentially stronger demand for lending -

but watch out for changing credit risks!• Prepare new euro products!• Prepare systems updates!

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INSTITUTIONAL REFORMS

• More members mean today’s institutions must modernise

• The Nice treaty• The ECB• The Stability Pact• The need for institutional reform of

national fiscal policy• The Convention• The Nordic/Baltic fear of a superstate:

Let’s work together for openness!

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CONCLUSIONS

• EU membership is beneficial to growth• But a challenge to companies - and

individuals• Transformation pressure will sharpen• Prudent fiscal policy necessary• ERM is a risk• Several imbalances may result• Institutional reforms on EU and national

level will change economic policy-making• Companies face crucial strategic decisions• As do banks!