A Commentary by Marek Belka, Director of IMF’s European
Emerging Markets: Challenges and Rewards
Published in Ziarul Financiar, October 5, 2009
Emerging Europe has stepped back from the abyss.
For a region relying heavily on capital inflows made scarce by the
global financial crisis the worst could be expected. And indeed, several
economies have suffered a great deal and had to rely on help from their
friends. But global risk appetite has returned and the global recession
seems to be bottoming out. Does this mean that strong growth and renewed
convergence will return naturally to emerging Europe?
Not necessarily. Just as hopes of decoupling from
the epicenter of the crisis were dashed, so will the notion that all
emerging economies will automatically recover alongside the advanced
economies. Surely, some bounceback will occur, as trade has started to
resume. But it is already noticeable that the downturn is lingering
longer in a number of emerging market economies. Why? Many of these
countries were severely impacted by the slowdown in portfolio inflows
and the reduction in credit by troubled cross-border banks deleveraging
their balance sheets. As capital flows have started to resume, much more
differentiation is taking place as investors are more keen to scrutinize
external and internal vulnerabilities.
This change in investor attitude has caused a
dramatic shift in market risks. As the global factors that drove both
risks and attitudes to unprecedented levels recede, domestic factors and
policies surface as reasons for investors to differentiate among
countries. On the top of their list of worries seem to be the state of
private balance sheets and the financial system, as well as the closely
related issue of fiscal sustainability. The result is that investors
demand higher risk premiums, slowing down the recovery in the region.
But investors’ newfound scrutiny is also a chance
to get rewarded for sound policies. In fact, countries with better
policies fared much better already during the crisis. What should be the
priority now? Immediate action to plug holes in the banking system is
likely to pay off handsomely. In many cases these holes stem from the
combination of the economic slowdown and vulnerabilities associated with
foreign currency–denominated debt overhangs by corporations (as in the
Baltics, Hungary, Bulgaria, and Romania) and by households (as in the
Baltics, Hungary, Romania, and Poland).
Another priority should be to put in place policy
frameworks to ensure long-term fiscal sustainability and predictability.
Countries such as Hungary, Poland, and Romania have already begun the
process of setting credible medium-term targets. The benefits are fewer
surprises in fiscal policy and less volatile business cycles. Such
frameworks should therefore reduce sovereign risk premiums and speed up
However, even if the damage caused by the crisis
was quickly repaired, the overall level of risk premiums will probably
remain higher than before. This will drag down potential growth, posing
a major challenge for the emerging economies. Policies to foster
structural change would therefore be required to develop services and
industries less dependent on foreign capital, to improve export
performance, and reassure more fickle international investors. In many
emerging countries, just as much as elsewhere in continental Europe,
adjusting to the post-crisis world will necessitate increased labor
market flexibility and further liberalization of service and product
markets throughout the EU.
a recovery in emerging markets will therefore depend on government
action. It requires the combination of a resolute and proactive approach
to reduce uncertainly lingering in the financial system, efforts to
ensure a business-friendly environment and improved policy frameworks to
reduce uncertainty, and enhanced structural flexibility to ensure higher
potential growth. In the end, the market’s view of such reforms will
determine the speed at which Europe’s emerging economies will return to
a healthy level of capital inflows commensurate with the much-needed
continuation of convergence and economic integration processes. So while
the challenges for the emerging market economies have increased, so have
the rewards for sound policies.