In One Boat, but in Stormy Weather
A Commentary by Marek Belka and Srobona Mitra, IMF’s European
Department*
Published in Gazeta Shqiptare, May 13, 2009
Hit by a twin storm of drying-out capital inflows and shrinking
exports, emerging Europe is going through a deep crisis. The illusion of
decoupling has vanished and it is clear now that recovery will not only
depend on making the right policy choices at home but also on
developments and decisions in the rest of Europe. The continent has
evolved rapidly during the last decade, with ever closer financial and
trade links bringing about much welcome growth and income convergence.
As a result, all of Europe now sits in one boat facing the same rough
weather—and emerging and advanced economies will have to jointly
coordinate a course out of it. Governments and central banks have taken
unprecedented actions to address the crisis, and there are efforts under
way to coordinate polices. But much more needs to be done on both
accounts.
The crisis has bruised some more than others, putting the spotlight
on glaring cross-country policy differences. As the IMF’s new Regional
Economic Outlook shows, the “halo effect” of EU membership disappeared
almost overnight and financial markets started to scrutinize countries
for their fundamentals. Countries with higher inflation and current
account deficits or those that funded a credit boom by taking
crossborder loans were hurt more. These strongly suggest that sound
macroeconomic and financial policies are again at a premium. Governments
will have to tread carefully when it comes to fiscal stimulus, and many
will be required to rein in deficits to regain the confidence in the
sustainability of their policies overall. This will also help to prevent
excess movements in the exchange rate, which is particularly important
in a region where many have borrowed heavily in euro, Swiss francs, and
other foreign currencies. Improving policy credibility, for instance by
strengthening policy-making institutions supporting fiscal
sustainability, is crucial in this regard. Another important item on the
to-do list remains structural reform. For instance, flexible labor
markets and a positive business environment will help to facilitate the
necessary shift of resources into the tradables sector and bolster
productivity growth during the adjustment to reduced capital inflows.
These policies are all the more important for countries committed to
fixed exchange rates which, lacking orderly exit options for now, have
little choice but to rein in fiscal policy and accelerate structural
change.
But the crisis also has made it clear that economic integration has
outpaced the coordination of macroeconomic and financial sector policies
in Europe. One area with an urgent need of coordination is the
macroprudential regulation of banks. Clearly, emerging Europe’s banks
were taking big risks when they fueled an exceptional credit and demand
boom without creating adequate buffers against downturns. But many of
these banks have parents in advanced European countries, and often host
supervisors by themselves did not have the means to secure a more
prudent behavior. Now, when these banks need to be recapitalized, better
supervisory home-host coordination is crucial. Sound bank balance sheets
are a precondition for upholding a healthy, sustainable flow of credits
to consumers and firms, which, in turn, is needed to underpin demand and
growth in most emerging economies. This is one of the reasons why
efforts to solve these matters are supported by the International
Monetary Fund working together with the European Commission. Another
area of coordination are monetary and exchange rate issues. For
instance, the ECB has been fairly selective in its currency support to
non-euro area countries, and discussions to clarify the euro roadmap for
countries with credible policies and sound fundamentals have just begun.
Given the strong feedback loops between emerging Europe and the euro
area, filling the coordination gap in all of these areas will help to
avoid unwanted volatility in currency and financial markets.
The convergence of Europe has been one of the world’s great success
stories since the fall of the iron curtain—but with this success also
came the pain of shared recessions. This is why the crisis is not only a
powerful reminder for a return to sound economic policies in emerging
economies. It is also an urgent call to establish a coordinated approach
to key policies across Europe, including the construction of the
much-needed financial stability framework enveloping advanced and
emerging economies alike, and a joint effort to prevent disruptive
exchange rate movements.
If there is a lasting lesson from the crisis for Europe, it is that a
tightly integrated region requires a regional perspective from policy
makers. In other words, to plot the course out of the current storm, we
will need more Europe and not less.
* Marek Belka is Director of the European Department
of the IMF, and Srobona Mitra is Economist in the same department. |