Emerging markets in Europe:Emerging markets in Europe: Real and financialReal and financial integration integration

with the European Unionwith the European Union

IADB, Washington April 10, 2003

Fabrizio CoricelliUniversity of Siena, CEU and CEPR

Sudden stops in CEECs: Sudden stops in CEECs: exceptionexception

• Two cases of sudden stops. Czech Republic in 1997 and Bulgaria in 1996-97

• It would be interesting to compare with experience of LAC to highlight the causes and effects of sudden stops

Czech RepublicCzech Republic

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1995 1996 1997 1998 1999 2000 2001 2002

gdp growth current account

BulgariaBulgaria

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1995 1996 1997 1998 1999 2000 2001 2002

gdp growth current account

Other CEECsOther CEECs

• CEECs were able to ride smoothly through the Russian crisis and the current slowdown of major industrial economies.

• Gdp growth resumed rather quickly after 1998

• Current account deficit remained large• Foreign bank loans were cut also to

CEECs, but only temporarily, and less than for other EMs.

• FDIs remained strong

Growth and current account in Growth and current account in CEECsCEECs

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

1995 1996 1997 1998 1999 2000 2001 2002

Gdp growth Current account

The fall in bank loansThe fall in bank loans

Bank lending to emerging market countries

-50

-40

-30

-20

-10

0

10

20

30

40

1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002

(In bn US$)

Asia & Pacif ic Europe Latin America/Caribbean

Much smaller in CEECsMuch smaller in CEECs

-20000

-15000

-10000

-5000

0

5000

10000

15000

Q2

1995

Q4

1995

Q2

1996

Q4

1996

Q2

1997

Q4

1997

Q2

1998

Q4

1998

Q2

1999

Q4

1999

Q1

2000

Q2

2000

Q3

2000

Q4

2000

Q1

2001

Q2

2001

Q3

2001

Q4

2001

Q1

2002

Q2

2002

Q3

2002

Totale CEECs Russia e Ukraine

Czech RepublicCzech Republic

-2%

-1%

0%

1%

2%

3%

4%FDI/GDP Oher capital flows/GDP

PolandPoland

-3%

-2%

-1%

0%

1%

2%

3%

4%

5%

6%

Q4

1997

Q1

1998

Q2

1998

Q3

1998

Q4

1998

Q1

1999

Q2

1999

Q3

1999

Q4

1999

Q1

2000

Q2

2000

Q3

2000

Q4

2000

Q1

2001

Q2

2001

Q3

2001

Q4

2001

Q1

2002

Q2

2002

Q3

2002

Q4

2002

FDI/GDP Other capital flows/GDP

HungaryHungary

-6.0%

-4.0%

-2.0%

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

Q3 19

97

Q1 19

98

Q3 19

98

Q1 19

99

Q3 19

99

Q1 20

00

Q3 20

00

Q1 20

01

Q3 20

01

Q1 20

02

FDI/GDP Other capital flows/GDP

CEECs not very different from CEECs not very different from other EMsother EMs

• High volatility of main macroeconomic variables

• Debt to Gdp indicators• High share of foreign debt in total debt

Macroeconomic volatilityMacroeconomic volatility

V o la ti l i ty( s ta n d a rd d e v ia t io n )

GDP Terms of trade

Real effective exchange rate

Real interest rate

Gov’t revenue/GDP

CEECs 4,10 4,40 12,66 6,34 2,31

Latin America 3,74 8,70 18,00 13,18 2,19

Emerging Asia

4,11 5,92 8,65 2,52 1,82

Advanced countries

2,09 3,73 5,90 2,07 1,02

……..volatility..volatility

• Not due to terms of trade volatility (trade diversified)

• Real exchange rate more volatile: massive reallocation from tradable to non-tradable sectors

• Financial sector (still underdeveloped)?

Small capital markets (2001)Small capital markets (2001)

Stock Public Private Bond, equity B+E+BA

market debt debt Bank and bank excl.

capitalization securities securities assets assets public.

EU-15 86% 62% 88% 417% 652% 590%

Emerging ec. 27% 21% 11% 140% 243% 222%

LAC 22% 27% 10% 84% 157% 130%

Europe 9% 32% 3% 59% 119% 87%

Debt indicatorsDebt indicators

Public debtin % GDP

Public foreign% of total

Public debt % of revenues

Public foreign% of revenues

Bulgaria 80.6 91.4 185.3 39.8Czech Rep. 17.3 10.5 42.6 4.3Estonia 5.3 67.4 13.6 26.2Hungary 58.2 n.a. 126.8 n.a.Latvia 13.0 60.9 43.3 18.3Lithuania 28.3 77.8 93.7 23.5Poland 40.9 48.8 103.3 19.3Romania 31.6 44.9 100.3 14.1Slovakia 32.8 49.0 92.9 17.3Slovenia 25.8 48.8 60.3 20.9

avg. CEECs 33.4 55.5 86.2 20.4EU 64.2

Key favourable factorsKey favourable factors

• Parallel growth of trade and financial integration

• High degree of trade openness, and especially trade integration with the EU

• Relatively large tax base• “Anchor” of EU accession (political

economy factors as well)

Trade and financial opening Trade and financial opening hand in handhand in hand

0

10

20

30

40

50

60

70

80

90

0 20 40 60 80 100 120 140 160

trade openness

fin

anci

al o

pen

nes

s

Trade integration and financial Trade integration and financial flowsflows

• Parallel growth of trade and financial links with EU.

• Bulow and Rogoff (1989) channel: trade openness increases incentives of borrowers to service their debt.

• Plus, better information flows. • A recent paper by the Bundesbank finds

a significant effect on bank loans of German banks of the trade integration with Germany

Trade opennessTrade openness

0

20

40

60

80

100

120

140

160

Latin America Asia CEECs

Average

min

max

Integration with Eurozone Integration with Eurozone Trade with Eurozone/GDPTrade with Eurozone/GDP

0

10

20

30

40

50

60

70

Belgiu

m-L

ux.

Hunga

ry

Czech

Rep

.

Eston

ia

Slove

nia

Slova

k Rep

.

Hollan

d

Irelan

d

Bulga

ria

Portu

gal

Austri

a

Roman

ia

Latv

ia

Polan

d

Lith

uani

a

Spain

Franc

e

Ger

man

y

Finlan

dIta

ly

Gre

ece

Example: HungaryExample: Hungary

• Hungary, the country with the highest ratio of debt to GDP inherited from the pre-reform regime, that did not restructure the debt.

• Debt to GDP declined slightly, but debt to exports was sharply reduced.

• Spectacular increase in trade openness. Ratio of exports to GDP more than doubled in 7 years.

Hungary cont….Hungary cont….

0

50

100

150

200

250

300

1994 1995 1996 1997 1998 1999 2000 2001

External debt/GDP

External debt/Exports

Intra-industry trade

• Trade openness tends to increase specialization and output volatility.

• Much less true if trade is intra-industry (Smithian division of labor, and “external” economies of scale)

• Implication: dependence on the EU business cycle more and more important, but

• More diversified industrial structure

Intra-industry trade with Intra-industry trade with Eurozone/GDPEurozone/GDP

0

10

20

30

40

50

60

70

Belgiu

m-L

ux.

Hunga

ry

Czech

Rep

.

Eston

ia

Slove

nia

Slova

k Rep

.

Hollan

d

Irelan

d

Bulga

ria

Portu

gal

Austri

a

Roman

ia

Latv

ia

Polan

d

Lith

uani

a

Spain

Franc

e

Ger

man

y

Finlan

dIta

ly

Gre

ece

Output co-movement with EUOutput co-movement with EU

Industrial production annual changes 3month moving average

-10%

-5%

0%

5%

10%

15%

20%

25%

Jan-94 Feb-95 Mar-96 Apr-97 May-98 Jun-99 Jul-00 Aug-01 Sep-02

-4%

-2%

0%

2%

4%

6%

8%eu (right axis)hungaryPoland

Large tax base:Large tax base: Government revenue/GdpGovernment revenue/Gdp

0

10

20

30

40

50

1995 1996 1997 1998 1999 2000 2001

EU “anchor” and Institutional EU “anchor” and Institutional reformsreforms

• Importing institutions (against Rodrik’s view)

• May not be optimal, but more credible• “Credibility bonus”• Accession: anchor for market

expectations• Interest rate convergence• Expectations are of a fast entry in

Eurozone

Interest rate spreadsInterest rate spreadsshort-term rates CEECs-Euriborshort-term rates CEECs-Euribor

- 5

0

5

10

15

20

25

gen- 96 giu- 97 nov- 98 apr- 00 set- 01 feb- 03

Poland Hungary Czech Rep.

Risks ahead and open research Risks ahead and open research agendaagenda

• So far underdeveloped capital markets

• After entry in EU (next year):• Full liberalization of K-flows• Short term K-flows bound to

increase?• Exchange rate policy?• Fiscal rules?