The Greek debt crisis has shifted attention away from Central and Eastern Europe, a region that was haunted by the threat of complete regional collapse last year. Yet the region’s worries are not fully over and it is worthwhile assessing the role of the EU in supporting these crisis-hit countries. The EU coordinated various measures to assist Central and Eastern -European countries, but EU institutions and governments also contributed to the suffering of these countries in the crisis by some actions – or through failures to act.
Central and Eastern European countries were hit hard by the crisis. By October 2009, compared to October 2007, GDP forecasts for 2010 for 30 of these countries had been revised downwards by an average of 15.8% (Figure 1).1 However, as emphasised by commentators such as Mitra, Selowsky and Zalduendo (2009), the IMF (2009), and the EBRD (2009), the “worst problems from past crises”, such as currency overshooting, bank runs and banking system collapse, have so far been avoided.
Figure 1. Downward revision of GDP forecasts for 2010: Percentage difference of October 2009 forecast compared to October 2007 forecast
Source: Author’s calculations based on IMF and DG ECFIN forecasts published in October 2007 and October 2009
Note: Country group values are weighted averages (using GDP weights)
Central and Eastern European countries generally went into the crisis more vulnerable than other regions. EU integration, while being beneficial to growth in both Eastern and Western Europe (European Commission 2009), had also contributed to the build-up of huge credit, housing and consumption booms, and consequently high current-account deficits and external debt in many Central and Eastern European countries. Pre-crisis complacency, meanwhile, had been fuelled by the belief that the decoupling of saving and investment decisions was mostly a reflection of better use of resources, with EU integration serving as a shelter against shocks. The aggressive lending strategies of mostly Western-European-owned banks contributed to the vulnerability of these countries. But EU integration did not exempt Central and Eastern European countries from fundamental economic laws.
Coordinated response – most of the time
The crisis that so severely hit Central and Eastern Europe prompted the EU and international financial institutions to act in various ways (Darvas, 2009) and much good has come from it. One prime minister said that “reforms start when money ends,” and indeed the substantial granting of loans by the EU, as part of a coordinated international lending programme for Hungary, Latvia and Romania, helped these highly-vulnerable countries not just by substituting private capital flows, but also by prompting them to begin long-needed structural reforms, and to take steps toward fiscal sustainability. Coordination between the EU and other lenders, most notably the IMF, was done smoothly (with the exception of Latvia’s review in summer 2009, when there was approximately a one-month discrepancy between the EU and IMF decisions. This period was characterised by heightened uncertainty about what would happen in case the IMF declined to continue funding Latvia).
The banking system played a crucial crisis-response role. Pre-crisis, the region's financial sectors were relatively sound (compared with the Asian countries in the 1990s, for example), and Western European banks – which own the majority of banking systems in central- and eastern-European countries – have remained committed to the region. Calculations from the European Bank for Reconstruction and Development (EBRD 2009) suggest that foreign ownership of banks has reduced capital outflows from these countries. Efforts to coordinate parent-bank behaviour (the ‘Vienna Initiative’), European Central Bank support for parent banks and the EU’s political commitment to supporting subsidiaries, have certainly played important roles in this respect.
Other actions have included the frontloading of disbursement from structural and cohesion funds for EU member states, the expansion of European Investment Bank and EBRD activities in the broader region, the putting together of a small crisis-response package for south-eastern Europe and, last but not least, the commitment of European governments to boost IMF resources by €125 billion. This last was a key indirect support to Central and Eastern Europe, because this region is the largest recipient of IMF loans.
What might have been
But Central and Eastern Europe has suffered from shortcoming in support from the EU. Among these the non-establishment of a “mega-fund” is controversial. There were proposals to set up a fund of several hundred billion euros for various purposes, such as replacing the shortfall in private capital flows to the region and giving support to local banks. However, the issue of creating moral hazard, the lack of clarity in the various proposals, the existing facilities and the standard (non-crisis) EU support to new member states and other neighbourhood and developing countries, made EU and Western European policymakers understandably reluctant to set up such a fund.
The near-paralysis of the Eurozone interbank money market after the collapse of Lehman Brothers meant that (especially non-foreign owned) commercial banks in the Central and Eastern Europe were largely cut off from euro liquidity. The more the ECB (rightly) moved into new territory to remedy the shortage of liquidity in the Eurozone, the more it was inadvertently putting this region’s banks – at least those without access to a parent bank’s liquidity – at a disadvantage, while making their government bonds unattractive.
The ECB should have gone further in recognising the extent of its regional responsibilities by temporarily extending currency-swap agreements to at least some central- and eastern-European central banks, by accepting as collateral government bonds denominated in the currencies of non-Eurozone EU countries, and, even more radically, by offering to banks from non-Eurozone EU countries access to its euro-refinancing facilities. When accompanied with proper risk management, this would not have exposed the ECB to more risk than that presented by its other operations, such as the risk inherent in the expanded set of lower-quality and US dollar, British pound and Japanese yen securities (issued in the Eurozone) that became eligible for ECB refinancing in response to the crisis.
Operations with Central and Eastern European central banks would have helped directly and would have boosted market sentiment. As Table 1 shows, the ECB did offer swaps to Denmark and Sweden. It is difficult to understand why Poland, for example, was treated differently. The ECB may have wanted political backing for extending swaps, but no European body gave it. It is correct that the European Commission, Council and individual Eurozone governments do not comment on the ECB’s monetary-policy decisions. But the possible political support for extending swaps and other possible operations beyond Denmark and Sweden at a time of extraordinary circumstances is a completely different matter.
Table 1. Liquidity provision agreements between central banks in Europe (date of introduction in brackets)
Source: Central bank websites.
Note: The swap agreement between the ECB and the Sveriges Riksbank was announced retrospectively in the Annual Report of the Riksbank without indicating the date of introduction. Major European central banks (ECB and the central banks of Denmark, Norway, Sweden, Switzerland and the UK) have swap agreements with the Federal Reserve.
A change in attitudes towards euro introduction would have also boosted confidence. The economic foundations of the euro-entry criteria are fundamentally flawed, with Eurozone members continuing to violate them, while the EU's expansion to 27 members has made the criteria tougher for new member states to meet. During the crisis, European officials have not done anything to adapt the entry criteria, and this resistance to change has disadvantaged countries that were seeking the stability and credibility offered by eventual Eurozone membership.
Finally, crisis support for the neighbourhood countries was largely left to international financial institutions and western European banks with subsidiaries in those countries. Prompt and substantial direct EU support (in coordination with IMF programmes) would have had a strong signalling effect, and would have had far-reaching beneficial consequences for the EU's relationship with partner countries. The Commission's October 2009 proposals to extend loans to four neighbourhood countries (see details in Table 3 of Darvas 2009) were important and helpful, but came somewhat late, with only a relatively small proposed volume of lending.
1 The impact should be assessed against a benchmark. A frequently used measure of the crisis, the actual fall in GDP, assumes that the benchmark is zero which is not very intuitive. A better measurement of the impact of the crisis is a comparison of how the GDP level at a certain future date looks like now compared to how it looked like before the crisis.
Darvas, Zsolt (2009), “The EU’s role in supporting crisis-hit countries in Central and Eastern Europe”, Bruegel Policy Contribution 2009/17.
EBRD (2009), “Transition Report 2009”, EBRD, London.
European Commission (2009), “Five years of an enlarged EU. Economic achievements and challenges” European Commission, Directorate General for Economic and Financial Affairs, Brussels.
International Monetary Fund (2009), “Review of Recent Crisis Programs”, IMF, Washington DC.
Mitra, Pradeep, Marcelo Selowsky and Juan Zalduendo (2009), “Turmoil at Twenty: Recession, Recovery, and Reform in Central and Eastern Europe and the Former Soviet Union”, World Bank, Washington DC.