“The joblessness created by the economic crisis translates into lower household incomes, remittances, and consumer demand,” said Kaspar Richter, Senior Economist in the World Bank’s Europe and Central Asia Region at the launch of the report in Warsaw. “Falling demand for industrial workforces and more return migration from the EU15 countries will strain labor markets and social safety nets. This then feeds back to the financial sector, including a rise in non-performing loans – becoming a vicious cycle. To break that cycle, Governments must protect priority spending that improves prospects for growth and target social assistance programs.”
According to the report, the EU10 countries are in recession, with economic activity projected to decline by 3 percent this year, and stagnate around zero percent next year. While the crisis has hit all countries in the region, its impact differs greatly across the EU10 c ountries. The variation is mostly related to two factors:
· differences in the magnitude of macroeconomic imbalances at the beginning of the crisis, where countries with the largest imbalances are experiencing now the largest contractions; and
· differences in the degree of market integration through trade, capital, and labor.
“Nowhere is the difference between countries in the region as stark as between the Baltic countries and Poland,” said Thomas Laursen, World Bank Country Manager for Poland and the Baltic Countries. “Reflecting their very large initial macroeconomic imbalances and reliance on foreign credit, the Baltic countries are suffering a severe downturn with output expected to contract by around 15 percent this year. Meanwhile, Poland, where macroeconomic fundamentals are much stronger, may still see positive growth this year.”
The contraction in global spending on capital goods and durables has hurt manufacturing exports, such as automobiles and electronics. Industrial production has contracted by over 20 percent over the last year across the EU10 region. The fall in export demand affects EU10 countries through trade linkages, which in turn depend on trade openness, the performance of export markets, and the composition of export goods.
And after years of high profitability, the soundness of the financial sector is threatened by the economic recession. Gross capital inflows declined by two-thirds from the third quarter 2008 to the first quarter in 2009 in emerging EU10 countries.
These shocks have led to the sharp downturn and steep rise in unemployment because of the region’s deep trade, capital, and labor market integration with the EU and the world economy. Workers in countries with fixed currency regimes face a larger risk of lay-offs, as job losses are likely to increase sharply with the stark decline in output, especially in the Baltic countries. In contrast, currency depreciations have lowered the purchasing power of households’ incomes in countries with floating exchange rates vis-à-vis the euro or dollar, and increased debt service burdens for households with foreign exchange debt.
According to the report, the economic outlook remains uncertain. Some countries may experience a stabilization process that is more protracted than anticipated. Other countries that have weathered the crisis better due to sound economic fundamentals may still be at risk from a worsening external environment.
So far, though, policy responses have been encouraging. The unprecedented actions by governments, central banks, and multilateral agencies have prevented a financial meltdown and stabilized financial markets to some degree, eased concerns about cross-border banking, reduced the size of the output gap, and limited unemployment increases.
“Going from slump to stabilization in the EU10 countries hinges critically on the success of policies to maintain strong trade, capital, and labor linkages. This requires policy coordination of the EU10 countries with other EU countries and advanced economies along three dimensions – fiscal, financial, and social,” said Richter.
Since the EU10 countries have in general little room for fiscal stimulus spending, embedding fiscal policy within a framework of medium-term fiscal consolidation will reassure markets. Trade linkages to high-income countries can channel some of the benefits of fiscal stimulus spending in high-income countries to the EU10 region. Economic stability in the region, as in the rest of the world, depends most of all on restoring financial confidence. This requires close coordination among parent banks active in the same country. Restructuring public finances can help to mitigate the social cost of the crisis through social assistance programs and protection of priority spending that improves prospects for jobs and growth.
“The World Bank, in cooperation with the International Monetary Fund, the European Commission, and other multilateral partners, continues to stand ready to support the economic recovery from the crisis and the protection of vulnerable households through financial support and policy advice as needed,” said Laursen.
* The EU10 countries include: Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia.
