Economy & Trade, Europe, Financial Crisis, Headlines

EASTERN EUROPE: Good Old Ways Protecting the Economy

Claudia Ciobanu

BUCHAREST, Jan 9 2009 (IPS) - Fears about the impact of the global financial crisis in Eastern Europe may be overblown. While economic growth is likely to slow down in 2009, it is improbable that countries like Romania and Bulgaria will be hit as hard as Britain or the U.S.

“Among the most important factors to be taken into consideration if we are to evaluate the impact of the global financial crisis in any country are the strength of the banking sector, how export-oriented is the economy, the capital inflows coming to the country, and the state of public finances,” says Tomasz Mickiewicz, economist at the School of Slavonic and Eastern European Studies at the University College London.

Eastern European economies are structured differently from one another in relation to these parameters, although they are often grouped together as post-socialist states on their way to market liberalisation. This makes it harder to evaluate the impact of the global financial crisis on the region as a whole, but it also reveals that each of the economies has its strengths which might help it avoid a full-blown recession in 2009.

The banking sector across East Europe seems less exposed to the crisis than it is in some of the Western countries. This is because the ratio between private lending and Gross Domestic Product (GDP) is lower in Eastern Europe. Besides, “regulation in the banking sector is often tighter than in Western countries, and some obscure financial instruments which were among the causes of the financial collapse in the West are simply not permitted in Eastern Europe.”

Romanian banks started to take safeguard measures at the end of 2008, mainly by increasing interest rates for private lending in order to ensure stability and to prevent some of the negative effects of a possible devaluation of the national currency, the leu. At the end of 2008, the International Monetary Fund (IMF) estimated that the leu may be overvalued by as much as 19 percent.

But outside of the banking sector, all countries in the region are already being affected by the global crisis. Economic hardship in the European Union (EU), the U.S. and elsewhere has meant reduced investment in Eastern Europe and less appetite for imports from these countries.

Members of the EU since the beginning of 2007, both Romania and Bulgaria have the union as their main trading partner, sending most of their exports to countries such as Germany and Italy, which are experiencing slow-downs. Car producers like Renault and General Motors, which had opened factories in Central and Eastern Europe to take advantage of cheap skilled labour, have halted production at several plants.

Still, much of the foreign direct investment (FDI) will not be easily diverted away from the region. “The advantage of these countries is that most of their capital inflows did not come in the form of speculative capital, but rather in the form of FDI, which is less likely to move out,” said Mickiewicz. “The worst moment for the stock markets in the region probably already passed in 2008, when speculative capital shifted, so it is behind now.”

For countries like Romania and Bulgaria, “European funds can help to diminish the negative effects of the financial crisis,” says Dragos Jianu, a Romanian consultant for European finances. Romania is expected to receive close to 20 billion euros in the period 2007-2013, and Bulgaria 11 billion.

However, according to Jianu, benefits will come only if governments are able to “maximise the absorption of money,” and if EU structural funds are used to finance projects “which create and maintain employment – including in the rural areas, which help reintegrate the unemployed to the labour market, and which strengthen educational, health, transport and business infrastructures.”

The ability of the national governments to steer their economies through the crisis is crucial. While the EU and other external funding can prove crucial, the inability of the Bulgarian government to tackle high-level corruption and organised crime has already led the EU to withdraw hundreds of millions of euros in 2008. If the country were to need an injection of foreign capital in 2009, the willingness of external actors to grant such money remains under question.

On the other hand, unlike Romania and other countries in the region, Bulgaria has the benefit of coming out of 2008 with a budget surplus of around 7 percent of GDP. Given that the capital needed to bail out the banking system in a country is estimated at 10 percent of GDP, the outlook for Bulgaria in the face of the crisis does not look as dire. Furthermore, the budget surplus is a welcome safeguard for Bulgaria, whose financial system is governed by a currency board, meaning that the financial regulators are unable to play with lowering the reference interest rate to relax the economy, as has been done in the UK and the U.S.

“The fact that Romania and Bulgaria are now in the EU can be helpful in this crisis,” says Mickiewicz. “On the one hand, membership acts, to a certain extent, as a guarantee for foreign investors and it also forces the governments to keep a check on budget deficits. On the other hand, international financial organisations are more likely to step in if a bailout is needed, as with Hungary.”

The case of Hungary does serve as a warning sign for the entire region. In October 2008, the IMF, the World Bank and EU granted Hungary around 18 billion euros credit to help stabilise its financial sector. Hungarian banks had been left shaky after they had relied too much on popular credit for housing in Swiss francs. With government spending very high, the national authorities were unable to rely on the national budget for a bailout.

In light of the crisis, economists have been warning all governments in the region against too much public spending which stimulates consumption rather than production. Measures such as the increase by 50 percent of the salaries of all teachers, adopted at the end of 2008 by Romanian parliamentarians preparing for elections, are considered very risky in this period.

While the economic slowdown will certainly have negative impacts on employment and the ability of people to ensure their basic needs, economists point out that it might also help cool down Eastern European economies, whose growth was sometimes overheated and largely based on consumption.