Development and crisis: the economies of former communist

countries turned EU members

Károly Attila SoósInstitute of Economics Budapest

soos@econ.core.hu

SloveniaSlovakia

RomaniaPoland

LithuaniaHungary

EstoniaCzech R.

BulgariaEuro Area

Latvia

0 2 4 6 8

(Data in percent)Average GDP Growth Rates between 1998-2007

Bulgaria Czech RepublicEstonia HungaryLatvia Lithuania

Non-CEE PolandRomania SlovakiaSlovenia

Non-CEE, 17 countries,88.5%

measured in GDP, at purchasing power paritiesThe share of Central and Eastern European countries in the EU

Bulgaria Czech RepublicEstonia HungaryLatvia Lithuania

Non-CEE PolandRomania SlovakiaSlovenia

Non-CEE, 17 countries, 79,3%

measured in populationThe share of Central and Eastern European countries in the EU

0 10,000 20,000 30,000 40,000

AustriaGreeceFrance

Euro AreaSpain

SloveniaCzech R.

EstoniaSlovakiaHungaryLithuania

LatviaPoland

RomaniaBulgaria

Euro Area

In 2005 US dollarsPer capita GDP in purchasing power parities, in 2007

0 5 10 15

HungaryEstonia

Slovak RepublicPoland

LithuaniaCzech Republic

RomaniaLatvia

BulgariaSlovenia

AustriaSpain

GreeceFrance

(In percent, calculated on the basisof goods and services exports data in constant 2000 US Dollars)

Average annual growth of exports between 1995 and 2006

Breakdown of exports by technological level, Central and Eastern Europe and „old

EU”Technological level 1999 2007

2007 to „old EU”

„Old EU” (EU-13)

High tech 15 14 12

Medium high tech 41 40 37

Medium low tech 11 13 14Low tech 33 34 37Total 100 100 100

CEE (EU-10)

High tech 7 11 11

Medium high tech 36 40 43

Medium low tech 15 16 15Low tech 42 32 31Total 100 100 100

02

04

06

08

0

Bulgar

ia

Czech

R.

Estonia

Hunga

ry

Latvi

a

Lithu

ania

Poland

Roman

ia

Slovak

ia

Sloven

ia

Austri

a

Franc

e

Greec

e

Spain

(IIT is measured with the Grubel - Lloyd index. Horizontal IIT: less than 15%difference in price/weight; HQ VIIT: export price/weight>import p/w by more than 15%)

(Horizontal + high-quality vertical IIT [in SITC 5 to 8 products])

The share of non-inferior intra-industry tradein the trade with EU-15 in 1999 and 2007

noninferior99 noninferior07

And the crisis came

Intensive participation in Intensive participation in the international economythe international economy

Main strength before the crisis

Main weakness in the crisis

old EU

new EU

0 50 100 150exports+imports in % of GDP

EstoniaSlovenia

Slovak RepublicHungary

Czech RepublicLithuania

LatviaBulgaria

PolandRomania

GreeceFranceSpain

Austria

(Exports+imports of goods and services in percent of GDP)Openness to trade in 2006

0 20 40 60 80 100ranking in FDI inflow/GDP among 158 countries

Slovenia

Romania

Lithuania

Poland

Latvia

Slovakia

Bulgaria

Czech R.

Hungary

Estonia

0 1 2 3 4FDI inflow in percent of GDP

Slovenia

Romania

Lithuania

Poland

Latvia

Slovakia

Bulgaria

Czech R.

Hungary

Estonia

Ranking according to FDI/GDP among 158 countries (left panel)and the share of FDI in GDP (right panel)

(average data 1994-2007)

0 20 40 60 80 100

Estonia

Slovakia

Czech R.

Lithuania

Hungary

Bulgaria

Poland

Romania

Latvia

Slovenia

Foreign ownership share of the banks in 2005, in percent

High share of foreign ownership of banks

Exposure to the probably most dangerous kind of protectionism: banks are under pressure to maintain a certain level of lending at home, and they control their total lending by lending less abroad

There is anecdotal evidence on such practices.

0 20 40 60 80

Latvia

Estonia

Hungary

Lithuania

Romania

Bulgaria

Poland

Slovakia

Czech R.

Slovenia

The share of foreign currency loans in 2007,in % of total loans

Flexible exchange rates

-10 0 10 20

Czech R.

Bulgaria

Poland

Slovakia

Romania

Hungary

Lithuania

Slovenia

Estonia

Latvia

Net foreign assets in percent of GDP in 2006

020

4060

80

2000 2002 2004 2006 2008year

Hungary Poland

020

4060

80

2000 2002 2004 2006 2008year

Bulgaria Romania

020

4060

80

2000 2002 2004 2006 2008year

Estonia Latvia

Lithuania

020

4060

80

2000 2002 2004 2006 2008year

Czech R. Slovakia

Slovenia

(In 2001-2007, percent of the GDP)Pulic debt in the 10 new menber states

-4 -2 0 2 4

Bulgaria

Czech R.

Poland

Slovakia

Slovenia

Hungary

Romania

Latvia

Lithuania

Estonia

(Data in percent of GDP, average 1994-2006)

Current account balance, FDI covered andnon-FDI-covered current account deficits

current account fdi-coverednon-fdi

Severe: Estonia, Latvia, Lithuania, Romania and Hungary

Estonia, Latvia, Lithuania: rapid economic growth, asset price bubble

Hungary, Estonia, Lithuania: High level of openness to trade and FDI, including to FDI in banks

Hungary, Romania: high share of loans in foreign currency, with flexible exchange rates

Estonia, Latvia, Lithuania: hard but not „bullet-proof” (remember Argentina) peg of currency to €.

Estonia, Latvia, Lithuania, Hungary: low level of net foreign assets

LatviaLatvia

EstoniaEstonia

LithuaniaLithuania

EU totalEU total

HungaryHungary

SloveniaSlovenia

Czech R.Czech R.

BulgariaBulgaria

RomaniaRomania

PolandPoland

SlovakiaSlovakia

-8 -6 -4 -2 0 2 4

EU total

(According to the January 2009 interimforecast of the European Commission)

Expected GDP growth in 2009 and 2010

EC GDP growth forecast 2009 EC GDP growth forecast 2010

100

110

120

130

140

150

01 A

ug 0

8

01 S

ep 0

8

01 O

ct 0

8

01 N

ov 0

8

01 D

ec 0

8

01 Ja

n 09

01 F

eb 0

9

date

SFR EUR

(31 July 2009=100)

The depreciation of the Hungarian forintagainst the Euro and the Swiss franc

0 1,000 2,000 3,000

January 09

July 08

(In Hungarian forint vs. in foreign currencies, data in billion forints)

Household mortgage debt composition

in HUF in FC

0 5,000 10,000

January 09

July 08

(In Hungarian forints vs. in foreign currencies, data in billion forints)

Public debt composition

in HUF in FC

The region impact„Because we are being included in

the same pack, it makes me fear that, in the end, we will need aid. We fear that. We would like to be in a different region”(Mirek Topolanek, Prime Minister of the Czech Republic, quoted in „Western investors panic over region's bad news”, The Prague Post, 26 February 2009).

A puzzle: why does the Polish zloty behave even worse than the HUF?

60

65

70

75

HU

F/P

LN

9.5

10

10.5

11

11.5

HU

F/C

ZK

Aug2008 Oct2008 Dec2008 Feb2009 Apr2009 Month

HUF/CZK HUF/PLN

to the Czech koruna and the Polish zlotyExchange rates of the Hungarian forint

Do we need the €?Should an EU member country at a more or less low

level of real convergence and thus with a high growth potential join the Euro area?

Yes (Spain) but then overheating, asset price bubble. And a hard peg of the currency to the € (Estonia, Latvia, Lithuania) leads to similar consequences.

No (Hungary) but then the floating currency will be exposed to such fluctuations that are rather harmful for a highly open economy.

Hungary’s extremely difficult situation suggests that keeping the national currency might be the worse one of the two bad options.

A part of the troubles caused by keeping the national currency was the leeway left for the government to pursue mistaken or outright mad policies: large public sector deficits and allowing massive borrowing by housebusinesses in foreign currencies: not only in €, but mostly in SFR (!) and to some extent even in Japanese Yen!!!!!

Do we need the €?

Now, at the edge of the precipice, the Hungarian government recognises that keeping the national currency for maintaining the possibility of irresponsable policies was dangerous, and the preparation for Euro Area accession has been announced.

At the same time, the actual economic policy of the government consists of trying to hold the budget deficit below 3% of the GDP and also to reduce wage taxes (supply-side rigidities).

Conclusion

ConclusionNot all economists agree with this policy but

changing it would require the approval of the IMF and the European Commission who prevented an unfolding currency crisis by granting a loan to Hungary in in last November.

Foreseeing any kind of outcome of any national policies in the given situation would be hard. Now, developments mostly depend on events going on outside of the region