Economic Update

New Growth Gradients, New RisksEurope and Central Asia RegionThe World Bank

Office of the Chief EconomistPoverty and Economic Management Sector Management UnitHuman Development Sector Management UnitPrivate and Financial Sector Management Unit

Annual MeetingsWashington DC, September 23, 2011

ECA was hit hardest

GDP Growth Projections, %

2

-6

-4

-2

0

2

4

6

8

102009 2010 2011 2012

Main points1. Economic recovery is underway, but it is slow

• Growth rates are about 2/3 of the pre-crisis rates

2. Job creation is lagging• 1 in 8 workers are jobless, 3 in 10 young adults are unemployed• The employed are working fewer hours

3. Public finance buffers have shrunk • Public debt to GDP ratios are over a third higher than 2007• Fiscal consolidation has become necessary

4. Private finance has stabilized• Credit is slowly picking up in most ECA countries• Banking flows have been stable in Central and Southeastern Europe, but not

among the oil and commodity exporters in the East

5. Risks are growing because of Southern Europe• The Eurozone is the region’s biggest trade partner• Greek and Italian banks operate in ECA, and Austrian, Swedish and French

banks both in ECA and in the Eurozone’s troubled periphery3

ECA Economic Update September 2011

Europe was hit harder in 2009

o Most countries had negative growth rateso And in some cases real GDP declines were in double digits

Real GDP growth in 2009, %

-20

-15

-10

-5

0

5

10

4

-2

0

2

4

6

8

10

Real GDP growth in 2010, %

5

Quicker pick-up in the East in 2010

2011 has been good, so far

o Growth projections are encouraging, even if lower than mid-yearo All ECA countries are expected to grow this year

Real GDP Growth in 2011 (projection), %

Croatia

Slove

nia

Monteneg

ro

Hungary

Azerbaij

an

FYR M

aced

onia

Albania

Poland

Ukraine

Moldova

Georgi

a

Lithuan

ia

Belarus

Turke

y

Uzbek

istan

0

2

4

6

8

10

6

2012 could be a good year too

Croatia

Belarus

Monteneg

roLa

tvia

Azerbaij

an

Bulgaria

Poland

Russia

Estonia

Armen

ia

Albania

Moldova

Ukraine

Kazakh

stan

Turkm

enist

an0

2

4

6

8

10

Real GDP Growth in 2012 (projection), %

7

2011 GDP compares well with 2007

GDP is below its 2007 level in only 8 out of 30 ECA countries The Eastern part of ECA has fared better than the West

-20

-10

0

10

20

30

40

% c

ha

ng

e fro

m 2

007

CH

NTK

MU

ZBIN

DA

ZE TJK

BLR

KSV

ALB

KA

ZBRA

KG

ZPO

LKO

RM

DA

TUR

GEO

MKD

SRB

MN

ERU

SBIH

MEX

CA

NBG

RSV

KD

EUC

ZERO

MU

SAFR

ASV

NH

UN

GBR

ARM

JPN

HRV

ITA

UKR

LTU

EST

LVA

Deviations of 2011 real GDP from the 2007 level

8

But the recovery signals a lower growth gradient

The loss of income relative to pre-crisis trends is striking There has been a noticeable reduction in growth prospects

-40

-30

-20

-10

0

10

% c

ha

ng

e re

lativ

e to

tre

nd

UZB

CH

NIN

DKSV

BRA

TKM

ALB

KG

ZTJ

KPO

LKO

RD

EU BLR

MKD

CA

NFR

AM

EXM

DA

USA ITA

KA

ZJP

NTU

RSR

BG

BRH

UN

BIH

MN

EA

ZEC

ZEG

EOBG

RRU

SRO

MSV

NSV

KH

RV

UKR

LTU

ARM EST

LVA

Deviations of 2011 real GDP from the 1997-2007 trend for 2011

9

Unemployment rates (percent, latest available) Youth unemployment rates in select ECA countries (percent, Q1 2011)

o Unemployment increased during the crisis; 1 in 8 are unemployedo Youth unemployment is a concern; 3 in 10 young adults are unemployed

Job loss remains a big concern

KAZ

RUS

CZE

SVN

MDA TU

RES

TRO

MPO

LH

UN

BGR

LVA

SVK

LTU

HRV SR

BM

KD

0

10

20

30

40

50

60

ECA average

BLR*

KAZ¹

CZE‡

MDA

‡

SVN

‡

TUR‡

BGR*

*

EST‡

ALB*

*

LVA*

*

MN

E*

MKD

**

0

10

20

30

40

50

ECA average

10Source: Employment Monitor-- http://go.worldbank.org/B8MMAI31I0

Percentage point change in unemployment rates in select ECA countries between Q1 2010 and Q1 2011 (or latest available quarter)

o Unemployment has dropped since the early 2010 peako Only a few exceptions: Bulgaria, Croatia, Slovenia, Moldova and Hungary

Some jobs are returning

EST

LVA

TUR

MKD SV

K

RUS

CZE

LTU

KAZ

POL

ALB

UKR BL

R

ROM

ARM HU

N

MD

A

SVN

HRV

BGR

-6

-5

-4

-3

-2

-1

0

1

2

3

% p

oint

cha

nge

in U

R fr

om Q

1 20

10 to

la

test

11Source: Employment Monitor-- http://go.worldbank.org/B8MMAI31I0

The crisis hit public finances

o Pre-crisis: structural fiscal imbalances masked by revenue over-performanceo During the crisis: sharp fiscal deterioration in most ECA countries

Fiscal balance in 2007 and 2010, percent of GDP

RUS

KAZ

POL

SVK

LVA

UKR

LTU

GEO

EU15 KY

RRO

MSV

NAR

MHR

VCZ

ESR

BHU

NBI

HM

NE

TAJ

TUR

BGR

ALB

MVA

MKD KO

SBE

LES

TUZ

BTK

M

-15

-10

-5

0

5

102007 2010

12

Fiscal consolidation is now a priority

o Public debt increased during crisis and buffers are in some cases exhausted. o In most other countries buffers are limited

EU15

HU

NAL

BKY

RPO

LSR

BLV

AM

NE

TUR

SVK

HRV UKR CZ

ELT

USV

NBI

HAR

M TAJ

GEO

ROM

MVA

MKD BE

LKA

ZBG

RU

ZB AZE

RUS

TKM EST

0

20

40

60

80

1002007 2010

Public debt in 2007 and 2010, percent of GDP

13

5-year credit default swap spreads and public debt (Eurozone and ECA countries)

Markets are now looking more closely at fiscal vulnerabilities

Average in 2008 August 2011

0

50

100

150

200

250

300

350

400

0 50 100 150

5Y C

DS

spre

ads,

AVG

200

8

Public debt as % of GDP, 2008

0

200

400

600

800

1000

1200

1400

1600

1800

2000

0 50 100 150

5Y C

DS

spre

ads,

Aug

201

1

Public debt as % of GDP, 2010

14

• Immediate challenge: Systematic fiscal consolidation, not ad hoc expenditure cuts• Markets are paying more attention to fiscal vulnerabilities now• Growth remains weak in emerging Europe• Oil rich countries better off, though fiscal reserves have fallen• Needed: pro-growth expenditure measures

• Long-term challenges: Aging will add to the fiscal pressures in health care and pension expenditures• Public service delivery, and public employment, and social security• Broader tax base in oil-rich countries• Restored ability to use automatic stabilizers• Needed: long-term fiscal sustainability, fiscal space for

investments and better quality of public services

Austerity ahead

15

Banking flows stable in the west, but declining towards the east

o Western European banks have maintained exposures in and near the EUo But developments in the East mimic those in Asia during the 1997-98 crisis

Source: BIS locational statistics. Note: The Asian crisis equals 100 in June 1997; based on exchange rate adjusted flows.

Banking claims in ECA (Quarterly data; September 2008 = 100)

20

30

40

50

60

70

80

90

100

110

t-12 t-9 t-6 t-3 t t+3 t+6 t+9 t+12

EU10 EU Candidates EU NeighborhoodCentral Asia Asian Crisis

16

BLR

TUR

ARM

RUS

GEO

MD

AAL

BAZ

ESR

BPO

LSV

KM

KD KAZ

UKR

HRV CZ

EBI

HBG

RRO

MSV

NLT

UES

TH

UN

LVA

MN

E

-20

-10

0

10

20

30

40

50

60

70

Perc

ent

Median pre-crisis credit growth rate (June 2008, y-on-y)

Credit slow to recover, but good signs before recent uncertainty

o Decline from pre-crisis levels was sharp—but necessaryo Some encouraging signs—now only five countries still in negative territory

Annual private sector credit growth, June 2011, year-on-year

17

Main risk? Spillovers

o Rescue packages have not assured markets and uncertainty has spread to other vulnerable countries (Spain and Italy)

Credit Default Spreads, as of September 5, 2011

18

Transmission channels are both financial and real

o Financial: Direct effect through parent banks in Greece and Italy and indirect effects through banks exposed to GIIPS (Austria, France, Germany)

o Trade: A cycle of declines in export demando Contagion: Policy coordination challenges in the Eurozone

ECA EU10 + 1 W. Balkans* MI CIS LMI CIS* Turkey*0

40

80

120

160

1526 25

617 15

51

68

39

49 29 31

14

21

1711

8 9

19

19

20

1913 19

Real sector foreign borrowingBanking sector foreign borrowingFDI and portfolio investment in equityGovernment and monetary authorities

Perc

ent o

f GD

P

Source: BOPS, WDI. *2009 data for Bosnia and Herzegovina, Macedonia and Turkey. 2008 data for Albania and Azerbaijan. EU10 + 1: Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. W. Balkans: Albania, Bosnia and Herzegovina, Macedonia and Serbia. MI CIS (middle-income CIS): Belarus, Kazakhstan, Russian Federation and Ukraine. LMI CIS (low-income and lower middle-income CIS): Armenia, Azerbaijan, Georgia, Kyrgyz Republic and Moldova.

Foreign Claims on ECA countries by sector and type, 2010

19

Financial channel—direct effects

o Greek banks are important in the Balkans; Italian banks in Central Europeo A fire sale of emerging Europe assets would compromise the recovery

Importance of GIIPS banks in ECA countries, 2010

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

Ass

ets

Dep

osits

BGR HRV CZE HUN

LVA LTU POL ROM

SVK SVN ALB BIH MKD

SRB KAZ RUS UKR KGZ MDA

TUR

EU10 + 1 W. Balkans MI CIS LMI CIS

0

10

20

30

40

50

60

Spain Portugal Italy

Ireland Greece

Perc

ent o

f ban

king

syst

em a

sset

s

Sources: Bankscope, Bankers almanac, Central Banks, Banks' Annual Reports. Note: Data only include banks with at least 50% ownership in the respective subsidiaries.

20

Financial channel—indirect effectso Some banks in emerging Europe have limited exposure in GIIPS (Sweden and

Austria), but interconnectedness in funding markets could trigger problemso As would be the case from weaker economic prospects in Europe

NL

B

Ers

te B

ank

Rai

ffei

sen

Ban

k

Dex

ia

KB

C B

ank

Mar

fin

Ban

k

Ban

k of

Cyp

rus

Dan

ske

Ban

k

BN

P P

arib

as

Soc

iete

Gen

eral

e

Deu

tsch

e B

ank

Com

mer

zban

k

Lan

desb

ank

DZ

Ban

k

Wes

t LB

EF

G

NB

G

Alp

ha

Pir

aeus

AT

Eba

nk

AIB

Inte

sa S

anpa

olo

Uni

cred

it

Ban

co P

opol

are

ING

Ban

k

Rab

oban

k

BC

P

San

tand

er

Nor

dea

Ban

k

SE

B

HS

BC

Bar

clay

s

SI AT BE CY DK

FR DE GR IE IT NL PT ES SE GB

0

10,000

20,000

30,000

40,000

50,000

60,000

Greece Ireland Italy Portugal Spain

Source: EBA. Note: Based on Stress test in 2011H1. SI: Slovenia, AT: Austria, BE: Belgium, CY: Cyprus, DK: Denmark, FR: France, DE: Germany, GR: Greece, IE: Ireland, IT: Italy, NL: Netherlands, PT: Portugal, ES: Spain, SE: Sweden, GB: United Kingdom.

Net direct positions in GIIPS sovereign debt for Europeanbanks with subsidiaries or branches in ECA

21

Trade channel

o 2011 was expected to result in export levels above those reached in 2008, but recovery of exports has so far been slow

o And now a slowdown in global activity has increased downside risks

0

20

40

60

80

100

120

140

HR

V

UK

R

SVN

MK

D

LTU

HU

N

CZE

TUR

LVA

SVK

BIH

PO

L

MD

A

RO

M

EST

AR

M

BG

R

ALB

GEO

2010 2011

Value of exports in 2010 and 2011 (2008 = 100)

22

Conclusion

23

ECA Economic Update September 2011

1. Economic recovery is slowing nearer the Eurozone• Growth rates are about 2/3 of the pre-crisis rates

2. Joblessness remains high• A slow recovery means that jobs will not return soon without reform

3. Treasuries are weaker now than they were in 2007• Public debt to GDP ratios are over a third higher than before the last crisis

4. Private financial flows are stable• Credit is slowly picking up in most ECA countries and banking flows were

recovering in Central and Southeastern Europe

5. Risks are growing again because of Southern Europe• The Eurozone is the region’s biggest trade partner, • Greek and Italian banks own banking assets in the region, and • Others (Austria, France and Sweden) active in the region also have exposure

in the Eurozone’s troubled periphery.