Transcript “Fixers”: mostly private sector / financial imbalances

Will catching-up continue smoothly in the
“new” EU Members?
Juergen Kroeger
Director
DG Economic and Financial Affairs
European Commission
13th Dubrovnik Economic Conference
June 27th to July 1st, 2007,
Disclaimer: The views expressed in this presentation are the author’s own and should
not be regarded as stating an official position of the European Commission.
Outline
1. “New” MS: successful catching-up but
imbalances
2. “Floaters”: mostly fiscal imbalances 
situation and policy;
3. “Fixers”: private sector / financial
imbalances  situation and policies;
4. Conclusions
2
STYLIZED FACTS OF SUCCESSFUL REAL
CATCHING-UP
Phase 1 : Upswing
 Initially real expected rate of upturn has to be high
 In order to avoid overheating monetary policy has to be
used, not fiscal policy
 Tight money in the upswing is necessary to
 Contain inflation
 Establish demand supply equilibrium
 Help establishing inter temporal equilibrium
 Appreciation reduces import costs
 Current account deficit, covered by FDI, is a counterpart to
fill the supply-demand gap.
3
STYLIZED FACTS OF SUCCESSFUL REAL
CATCHING-UP
Phase 2 : Consolidation
 Higher investment increases the capital stock : Potential
output rises
 Domestic supply approaches domestic demand
 The marginal real rate of return shrinks to the level of
partner countries
 Monetary policy is gradually easing
 Net exports rising as exchange rate depreciates
 Current account moving towards a sustainable level
4
1.“New” MS: successful catching-up but imbalances
Growth and per-capita income figures indicate that catchingup has been successful…
PER-CAPITA INCOME 1997-2006
(% of EU-15, PPS)
110
100
EU-15 average
90
80
70
1997
2006
LV
LT
60
50
40
30
20
10
0
BG
RO
PL
SK
HU
5
EE
CZ
SI
HR
1.“New” MS: successful catching-up but imbalances
…but other indicators, esp. current account deficits, suggest
potential problems ahead, in particular in “fixers”:
% of GDP
Current account balance
2
0
-2
-4
-6
-8
-10
-12
-14
-16
-18
-20
-22
-24
2004
BG
EE
LV
LT
CZ
HU
PL
RO
“Fixers”
6
2005
SI
2006
SK
2007 (f)
NMS
HR
2008 (f)
euro area
1.“New” MS: successful catching-up but imbalances
In some cases, FDI-financing of C/A-deficits is small and/or
decreasing:
Net FDI (% of current account deficit)
%
400
350
300
2003
2004
2005
2006
250
200
150
100
50
0
-50
-100
BG
“F I X E R S”
EE
LV
LT
CZ
HU
7
PL
RO
SI
SK
HR
1.“New” MS: successful catching-up but imbalances
C/A deficits are private sector-driven in “fixers”, while being
more public sector-driven in “floaters”:
Current account and domestic counterparts (2006)
10
(% of GDP)
5
0
0.1
-2.2
-5
-4.1
-5.9
-10
-7.7
-10.3
-10.7
-15
-20
Public sector (S-I)
Private sector (S-I)
CA - deficit
-13.9
-15.8
-21.1
-25
BG
EE
LV
“F I X E R S”
-8.8
LT
CZ
HU
PL
RO
SK
“F L O A T E R S”
8
HR
Euro
area
2. “Floaters”: mostly fiscal imbalances
• Room for fiscal consolidation and expenditure
rationalization:
Composition of general government expenditure in 2006
60
% GDP
Other
50
GFCF
40
Interest
30
Subsidies
20
Soc. benefits other
than in kind
10
Soc. transfers in
kind
Collective cons.
0
BG
EE
LV
LT
CZ
HU
PL
RO
9
SI
SK
HR
euro
area
3. “Fixers”: mostly private sector / financial imbalances
–
Against a backdrop of negative real interest rates…
Short term real interest rates
6
5
4
3
2
1
0
Euro area
LV
RO
BG
LT
SI
CZ
HU
SK
EE
PL
PL
LT
HU
HU
BG
CZ
PL
EE
LV
SI
RO
Euro area
RO
SI
CZ
SK
Euro area
LT
-1
EE
-2
LV
-3
SK
BG
-4
2003
2004
2005
10
2006
“F I X E R S”
3. “Fixers”: mostly private sector / financial imbalances
– …high growth in “fixers” predominantly driven by high
domestic consumption, while external contribution negative:
Contributions to GDP growth (2006)
(percentage points)
25
Net exports
Consumption
Inventories
Investment
GDP growth
20
15
10
11.4
11.9
7.5
6.1
7.7
6.1
4.0
5
8.3
5.8
4.8
2.7
0
-5
-10
BG
EE
“F I x e r s”
LV
LT
CZ
HU
PL
RO
“F l o a t e r s”
11
SK
CR
Euro
area
3. “Fixers”: mostly private sector / financial imbalances
– Although investment remains strong, it consists to a
substantial extent of construction:
% GDP
Share of construction in total investment, year 2005
35
Total investment
Construction (excl. Housing)
Housing
30
25
20
15
10
5
0
BG
EE
LV*
LT
CZ
HU
PL
* Data for Latvia (LV) are for 2004.
“Fixers”
12
RO
SI
SK
HR
euro
area
3. “Fixers”: mostly private sector / financial imbalances
– And the share of the construction sector in GDP is quite large
and growing:
Construction sector
% GDP
9
8
2004
2005
2006
7
6
5
4
3
2
1
0
BG
EE
LV
LT
CZ
HU
PL
“Fixers”
13
RO
SI
SK
HR
euro
area
3. “Fixers”: mostly private sector / financial imbalances
– Unit labour cost developments do not bode well for external
competitiveness:
% y-o-y
Nominal unit labour cost - Manufacturing
20
“Fixers”
LV
15
10
LT
5
0
-5
SK
EE
BG
HU
euro area
PL
SI
CZ
-10
-15
2003
2004
2005
14
RO
2006
3. “Fixers”: mostly private sector / financial imbalances
– Credit growth is reaching staggering levels…
Domestic Credit
80
70
% y-o-y
2003/2002
60
2004/2003
2005/2004
50
40
30
20
10
0
-10
-20
BG
EE
LV
LT
CZ
HU
PL
RO
“Fixers”
15
SI
SK
HR
NMS
euro
area
3. “Fixers”: mostly private sector / financial imbalances
– …with credits to households growing particularly fast…
(Y-o-y, end-2006)
90
Fixers
household sector
80
non-financial
corporations
70
60
50
40
Fixer
30
20
10
0
RO
LV
LT
EE
PL
16
SK
CZ
BG
HU
3. “Fixers”: mostly private sector / financial imbalances
– …and foreign currency lending often dominating:
Foreign currency lending as a % of total outstanding credit, 2005
80,0%
Fixers
Floaters
70,0%
60,0%
households
corporates
50,0%
40,0%
30,0%
20,0%
10,0%
0,0%
EE
LV
LT
BG
RO
17
HU
SK
PL
CZ
3. “Fixers”: mostly private sector / financial imbalances
– While real estate prices are high…
3.5
Appartements: ratio of price per m 2 in the capital to gross average
wage
3
2.4
2.2
2.2
2.1
1.6
1.5
1.5
1.5
1.3
LV
ES
FR
EE
PL
CZ
IT
SI
LT
IE
Source: Bank of Latvia
18
DK
1.2
FI
1.2
NL
0.7
0.7
0.6
0.6
LU
DE
AT
BE
4. Conclusions
•
Catching-up has been successful but there are signs of
overheating in the “fixers” (and RO), which could hamper the
efficient resource allocation and endanger smooth further real
convergence;
•
The remaining policy instruments of the “fixers” to cope with the
situation are limited to fiscal policy and structural policies (in
particular related to the financial sector);
•
This could be a lesson for the “floaters” (see e.g. RO) not to peg
their exchange rate too early or manage it too tightly and to
contain balance sheet exposures to exchange rate movements;
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