Eastern Europe and Central Asia:

Economic Outlook and

Challenges Ahead

ISTANBUL CHAMBER OF INDUSTRY - 6th INDUSTY CONGRESS

November 26- 27, 2007

Klaus RohlandCountry Director

2

Main Messages• Strong growth, supported by:

o Domestic factors (policy reforms: macro, structural)o External factors (Trade, FDI)

• Short-term challenges:

o Macro vulnerabilitieso Financial sector vulnerabilities

• Medium-term challenges:

o Boost productivity to maintain competitiveness, spur innovation and sustain economic growth

o Unfinished structural reform agenda:

o Stronger investment climate; export sophistication (higher added value products); deeper financial markets

3

I. ECONOMIC OUTLOOK

4

Economic Expansion Continues…

GDP Per Capita (Constant 2000 USD) 2001-2006

0

1000

2000

3000

4000

5000

6000

7000

EU-10 SEE Middle Income CIS Low Income CIS Russia Turkey

2001

2004

2006

Real GDP growth(2001=100)

100

110

120

130

140

150

160

170

2001 2002 2003 2004 2005 2006

EU-10 SEE CIS MID CIS LOW Turkey Russian Federation

5

Poverty Has Fallen in most countries

Poverty Rate, $PPP 2.15 per day(Fraction of Individuals Below the Poverty Line)

0

10

20

30

40

50

60

EU-10 SEE Middle Income CIS Low Income CIS Russia Turkey

2001 or earliest available yearlatest available year

6

Strong Productivity Growth is Driving the Economic Expansion…

Labor Productivity Growth drives per capita

output growth in most countries

Sources of output per capita growth in ECA (1999-2004)

(3.7)

(7.3)

(6.5)(2.6)

(1.4)

(-2.8)

(3.1)(4.0)

(-5.9)

(-3.2)

-8

-6

-4

-2

0

2

4

6

8

10

1993-1998 1999-2004 1990-1998 1999-2004 1993-1998 1999-2004 1993-1998 1999-2004 1996-1998 1999-2004

EU-10 Turkey CIS-Mid CIS-Low SEE

Gro

wth

(%)

Output per Worker Employment to Working PopulationWorking population to Total Population Output per Capita Growth in Brackets

7

Output Growth Was Supported by Domestic Policies…

Fiscal Balance (Pct of GDP) 2001-2007

-10

-8

-6

-4

-2

0

2

4

6

8

EU-10 SEE Middle Income CIS Low Income CIS Russia Turkey2001

2004

2007

-18

Prudent Fiscal Policies Helped Improving Fiscal

Balances

8

… And Progress in Structural Reforms

Enterprises

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

EU-10 SEE CIS Mid CIS Low Russia

2001 2004 2007

Banking reform

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

EU-10 SEE CIS Mid CIS Low Russia

2001 2004 2007

Trade and Foreign Exchange

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

EU-10 SEE CIS Mid CIS Low Russia

2001 2004 2007

Overall infrastructure reform

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

EU-10 SEE CIS Mid CIS Low Russia

2001 2004 2007

Source: EBRD Transition reportsNote: The measurement scale for the indicators ranges from 1 to 4+, where 1 represents little or no change from a rigid centrally planned economy and 4+ represents the standards of an industrialized market economy. The infrastructure reform ratings are calculated as the average of five infrastructure reform indicators covering electric power, railways, roads, telecommunications, water and waste water. The enterprise ratings are calculated as the average of large and small scale privatization, and enterprise restructuring. The market and trade ratings are calculated as the average of price liberalization, trade&forex system and competition policy. The financial institutions ratings are calculated as the average of banking reform & interest rate liberalization and securities markets & non-bank financial institutions.

9

External Factors Also Contributed to the Economic Expansion

Total Trade (as % of GDP PPP)

0

5

10

15

20

25

30

35

40

45

50

EU-10 Turkey SEE CIS-middle CIS-low

% o

f GD

P PP

P

1994-1998

1999-2005

FDI Inflow (in % of GDP PPP)

0

0.5

1

1.5

2

2.5

3

EU-10 Turkey SEE CIS-middle CIS-low

% o

f GD

P PP

P

1994-1998

1999-2005

Source: Bank staff calculations; UN-Comtrade, 2007

Trade and FDI flows increased across the region, contributing to the economic expansion

10

Overall, Much Progress Achieved But Further Reform Efforts are Needed

II. CHALLENGES AHEAD

11

Short-term Challenges: Macro Vulnerabilities Remain…

Current Account Balance (Pct of GDP) 2001-2007

-15

-10

-5

0

5

10

15

EU-10 SEE Middle Income CIS Low Income CIS Russia Turkey

2001

2004

2007

Large current account deficits (except in resource-rich countries), inflationary pressures and real exchange rate appreciation are also an

issue of concern…

Source: IFS, Central Bank of Turkey, National Bank of KazakhstanNotes: *For Kazakstan, December 2000=100

Real Exchange Rates

Real Exchange Rates: June 2005 - May 2007

80

90

100

110

120

130

140

150

160

170

180

Jun-

05Ju

l-05

Aug

-05

Sep

-05

Oct

-05

Nov

-05

Dec

-05

Jan-

06Fe

b-06

Mar

-06

Apr

-06

May

-06

Jun-

06Ju

l-06

Aug

-06

Sep

-06

Oct

-06

Nov

-06

Dec

-06

Jan-

07Fe

b-07

Mar

-07

Apr

-07

May

-07

2000

ave

rage

=10

0*

Ukraine PolandRomania Russian FederationTurkey Kazakhstan

12

Short-term Challenges: Financial Sector Vulnerabilities

Domestic Credit to the Private Sector (Pct of GDP), 2001-2006

0

10

20

30

40

50

60

EU-10 SEE Middle Income CIS Low Income CIS Russia Turkey

2001

2004

2006

Rapid Credit Growth has led to Higher Exposure to Financial Risks: (risk (maturities shortened, portfolio risks increased, risk premia and interest rates

rose) calling for stronger financial supervision

13

Medium-Term Challenge: Boosting Productivity Growth

Income per capita, 1999-2005

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

9,000

10,000

11,000

12,000

Low-CIS Mid-CIS SEE Turkey EU-10

GDP

per

cap

ita, P

PP (c

urre

nt in

tl $)

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%

50%

Ratio to EU-15Even in the EU Accession countries income per capita is less than half the

EU-15 average. Productivity Growth can accelerate income convergence and improve competitiveness…..

14

Boosting Productivity Growth Calls for Further Progress on Structural Reforms

STRONGER INVESTMENT CLIMATE:Reduce barriers to firm entry, exit and expansion (reducing

regulatory burden, reforming tax systems, and increasing labor market flexibility)

Doing business, 2007

0

10

20

30

40

50

60

70

80

90

100

Procedures(number)

Time (days) Nonwage laborcost (% of

salary)

Firing costs(weeks of

wages)

Total tax rate(% profit)

Time (years)

Starting business Employing workers Closingbusiness

EU-10SEECIS MIDCIS LOWTurkeyRussian FederationEU-15

Share of Medium and High Tech Products in Total Exports (%)

0

5

10

15

20

25

30

35

40

EU-10 Turkey SEE CIS-mid CIS-low

1995-1998 1999-2005

Higher export sophistication (higher value added products) and deeper financial markets are needed to

spur innovation and boost productivity growth

15

Conclusions

• Strong economic growth, driven by domestic reforms and greater integration into global markets

• But further progress in structural reforms is needed to boost productivity growth, maintain competitiveness and spur innovation

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Thank you for your attention