OECD Journal on Budgeting Volume 2010/1 © OECD 2010
The Impact of the Crisis on Budget Policy in Central and Eastern Europe
by Zsolt Darvas*
This article describes the particular impacts of the financial and economic crisis on Central and Eastern European (CEE) countries; studies pro-cyclicality of fiscal policies; discusses the impact of the crisis on fiscal policy; and takes a look at the policy response of various governments. After drawing some lessons for fiscal policy from previous emerging market crises, the article concludes with some thoughts on the appropriate policy response from a more normative perspective. The key message of the article is that the crisis should be used as an opportunity to introduce reforms to avoid future pro-cyclical fiscal policies, to increase the quality of budgeting and to increase credibility. These reforms should include fiscal responsibility laws comprising medium-term fiscal frameworks, fiscal rules and independent fiscal councils. When fiscal consolidation is accompanied by fiscal reforms that increase credibility, non-Keynesian effects may offset the contraction caused by the consolidation to some extent. JEL classification: C32, E62, H60 Keywords: Crisis, budget policy, fiscal policy, Central and Eastern Europe, CEE, CESEE
* This article was prepared for the author’s keynote speech at the OECD’s 5th meeting of Senior Budget Officials from Central, Eastern and South-Eastern European Countries, held on 25-26 June 2009 in St. Petersburg, Russian Federation, hosted by the Russian Ministry of Finance. The author is grateful to Maite de Sola for her excellent research assistance, and to country delegates at the conference for their comments and additions to the table containing budget policy measures of CESEE countries. The author is a research fellow at Bruegel. He is also a research fellow at the Institute of Economics of the Hungarian Academy of Sciences, and Associate Professor at the Corvinus University of Budapest. He can be contacted at [email protected].
1 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE
The global economic and financial crisis is having a significant impact on all countries. However, central, eastern, and south-eastern Europe1 (CESEE) has been particularly hard hit. The crisis poses a significant challenge to budget policies world wide, and many countries, especially major economies, are relying not just on automatic stabilisers, but are responding to the crisis with discretionary fiscal stimuli and support for the financial sector. Indeed, the current economic environment would seem to call for Keynesian policies to counterbalance both domestic and foreign demand shortages. CESEE countries face significant budgetary challenges. Most have very limited fiscal policy options. Many of them face significant financing constraints, are small and open, have generally lower quality fiscal institutions than major economies and should respect investors’ confidence. Although public debt relative to gross domestic product (GDP) is considerably lower in most CESEE countries than in major economies, market tolerance for public debt in emerging and developing countries is also lower. The purpose of this article is to discuss the particular characteristics of the crisis in CESEE countries and the crisis’ impact on budget policy. We argue that financial linkages and, in particular, large current account deficits financed by external sources, as well as heavy reliance on foreign trade and, in some countries, inflows of remittances, were the major channels through which the crisis hit these countries. However, budgetary policy also played a role: according to our econometric estimates budget policy was pro-cyclical in many CESEE countries, reinforcing the business cycle both during the good years before the crisis and during the current crisis as well. While some bigger countries in the region have some space for discretionary stimulus, most countries do not; instead, many countries should embark on significant fiscal consolidation. A key message that emerges from this article is that the crisis should be used as an opportunity to accelerate the process of structural reform, including fiscal reforms. With proper fiscal consolidation and reforms, non-Keynesian effects may offset the contraction caused by fiscal consolidation to some extent, and CESEE countries may be better positioned for post-crisis growth than major economies, though it is unlikely that the pre- crisis fast growth rates will return. This article is organised as follows. Section 1 discusses the severity of the crisis for CESEE economies and the particular characteristics of these economies that made them vulnerable. Section 2 studies the direct role of budget policy in relation to the severity of the crisis by analysing the pre-crisis pro-cyclicality of budget policy using structural vector- autoregressions. This is followed, in Section 3, by a discussion of the main channels through which the crisis impacts budget policy. Section 4 presents the policy reactions of various governments. Section 5 draws some lessons for budget policy from previous emerging market crises. Finally, Section 6 concludes with some thoughts on the appropriate budget policy from a more normative perspective. Annex A details the budget measures taken in response to the crisis for all 26 CESEE countries.
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1. The crisis in CESEE countries 1.1. Severity of the crisis: more serious than in other regions CESEE countries have been severely hit by the crisis, though there are significant differences within the region. Before the crisis, i.e. up to 2007, CESEE countries seemed to be catching up with the EU15 quickly and reasonably smoothly; this was reflected in forecasts made at that time (Figure 1). For example, in October 2007, cumulative GDP growth from 2008 to 2010 was forecast to be 11.4% on average in the region, while, by comparison, the EU15 was predicted to grow by 4.3% during these two years. Some CESEE countries had built up various vulnerabilities, such as huge credit, housing and consumption booms and thus high current account deficits and external debt. It was widely expected that these vulnerabilities would have to be corrected at some point in time. However, the magnitude of the correction, as also reflected by the fall in GDP, was amplified by the global financial and economic crisis.
Figure 1. Revision of GDP growth forecasts, October 2007 and October 2009
GDP level change from 2008 to 2010 as seen in October 2007 (in per cent) GDP level change from 2008 to 2010 as seen in October 2009 (in per cent) Change in GDP level forecast for 2010 from October 2007 to October 2009 (in per cent) 40
30
20
10
0
-10
-20
-30
-40
Latvia EU15 Malta China Estonia Croatia Turkey Serbia Belarus Asia25 Poland Cyprus Albania Armenia Ukraine Georgia Bulgaria Moldova Romania Hungary Slovenia Africa48 Lithuania Azerbaijan CESEE26 LATAM32 Montenegro Slovak Republic United States Middle East13 Czech Republic Macedonia, FYR Russian Federation Bosnia/Herzegovina
Notes: Country group values are weighted averages (using GDP weights). CESEE26: 26 countries from central, eastern, and south-eastern Europe. Asia25: 25 countries from Asia excluding China. LATAM32: 32 countries from Latin America. Middle East13: 13 countries from the Middle East. Africa48: 48 countries from Africa. Country groups and non-CESEE countries are highlighted. Note that the sum of the first and the third column does not equal the second, partly because the sum of two percentages does not equal the total per cent effect, and partly because the October 2007 forecast level of the 2010 GDP also reflected forecasts for 2007-08, while the October 2009 forecast is based on actual data for 2007-08. Source: The source for the October 2007 forecast for EU member states was the European Commission Directorate General for Economic and Financial Affairs (DG ECFIN) 2007 autumn forecasts for 2007-09; the 2010 forecast was calculated by the author assuming that GDP growth in 2010 would be equal to the average growth during 2001-09 (including the forecasts for 2007-09). The source for the October 2007 forecast for non-EU countries was the International Monetary Fund (IMF) World Economic Outlook (WEO) October 2007 for 2007-09; the 2010 forecast was calculated by the author assuming that GDP growth in 2010 would be equal to the average growth during 2001-09 (including the forecasts for 2007-09). The source for the October 2009 forecast for all countries was the IMF WEO October 2009 for 2009-10.
OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010 3 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE
Figure 1 indicates that there were substantial downward revisions in economic growth forecasts from October 2007 to October 2009 in all countries. The 2010 GDP level of the CESEE country group was forecast in October 2009 to be 14.8% lower than was expected in October 2007.2 Downward revision in other emerging and developing country groups has been smaller, ranging from 3.3% (average of 48 African countries) to 6.9% (average of 25 Asian countries excluding China3). CESEE countries not only had to assume the largest downward revision of their forecast GDP level, but the actual fall in GDP is also expected to be the greatest among emerging and developing country groups. The average GDP change in the 26 CESEE countries from 2008 to 2010 was forecast in October 2009 to be –4.3%. Meanwhile the 25 Latin American countries were expected to maintain their GDP level, and the 25 Asian countries, and the 48 African countries and the 13 Middle East countries were expected to grow by between 5.2% and 6.0% during the same period. The three Baltic countries were hit the most seriously with GDP projected to fall between 16% and 22% from 2008 to 2010, according to October 2009 forecasts. Forecasts made in 2007 foresaw growth of about 15% during the same period. Furthermore, growth in 2008 was –4.6% in Latvia and –3.6% in Estonia and hence the total output fall experienced by these countries will be even larger than the forecasts for 2009 and 2010 would imply. The downward revision of the 2010 GDP level is between 34% and 39% for the three countries.
1.2. Why were CESEE countries the hardest hit among emerging/developing regions? The sensitivity of CESEE countries to the crisis is mainly due to three factors: 1. capital flows and financial integration, 2. dependence on foreign trade, 3. migration and remittances. Darvas and Veugelers (2009) demonstrate that foreign trade played a crucial role in the pre-crisis economic growth of CESEE countries, and that their dependence on foreign trade is greater than many other emerging and developing countries. Remittances are also very important for some countries: Moldova (34% of GDP in 2007), Bosnia/Herzegovina (17%), Armenia (14%), Albania (13%), Georgia (7%), Bulgaria and Romania (5%), and between 2% and 4% for eight further CESEE countries. In this section, however, we will focus on issues related to capital flows and financial integration. In general, CESEE countries entered the crisis more vulnerable than other emerging regions, although there are considerable differences within the region. A key feature of these countries is that their pre-crisis growth was associated with rising current account deficits (with the exception of commodity exporters), that is, the correlation between GDP growth and the current account was negative, as the left-hand panel of Figure 2 indicates. In contrast, correlation was positive in other emerging and developing countries as suggested by the right-hand panel of Figure 2. Why does the correlation between the current account (CA) and economic growth differ? As discussed by Prasad, Rajan and Subramanian (2006) and Collins (2006), the positive correlation in developing countries could be related to three main mechanisms: ● A demographic shift to reduce the old age dependency ratio increases the labour force, which increases both savings and output, leading to a positive correlation between CA and growth.
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Figure 2. GDP growth and the current account, 2003-07
26 CESEE countries 151 other countries of the world Current account/GDP (average 2003-07) Current account/GDP (average 2003-07) 10 40 Russian Federation
5 30 Ukraine 20 0 Azerbaijan Armenia 10 -5 Belarus 0 -10 -10
-15 -20
-20 -30 048121620-4 04 8 12 16 20 GDP growth (average 2003-07) GDP growth (average 2003-07)
Source: Author’s calculation, based on IMF data.
● A productivity shock leads to higher income, but financial impediments limit investment and consumption, which again could lead to a positive correlation. ● A policy shift to export promotion, for example the avoidance of exchange rate overvaluation, boosts exports and output leading to a better CA position and higher growth. On the other hand, the negative correlation observed for CESEE countries may be related to an institutional change (relaxation of previous constraints in accessing foreign capital) and a productivity shock: ● With the prospective and actual EU integration of ten former communist countries and with the better EU prospects of many other CESEE countries, the previous constraints in accessing foreign capital have relaxed or eased substantially. This has led to capital inflows, which in turn contributed to investment, but also to consumption booms and, eventually, current account deficits. ● At the same time, and also related to capital inflows, productivity increased rapidly in most CESEE countries, leading to higher income expectations. This in turn resulted in borrowing according to the textbook mechanism of intertemporal optimisation. Indeed, capital inflows and GDP growth were accompanied by a substantial growth in credit (Figure 3). For example, the private sector credit to GDP ratio was 20% in Latvia in 2000, rising to almost 100% of GDP by 2007. In the meantime, GDP also grew by about 10% per year in real terms on average.4 Since the banking system has a crucial role in financing CESEE economies, its stabilisation must be a high priority. The key question is the role played by the budget in the previous credit boom and in the stabilisation of the banking system now. The previous credit boom was mainly related to the private sector and the ratio of government debt to GDP was generally low in the region (Figure 4). Budget deficits varied, fiscal policy was pro- cyclical in many countries (see the next section), but in general the budget was not a serious problem (apart from some outliers like Hungary). Many authors even called for an active use of budget policy due to the large infrastructure investment needs of these countries, rather than for saving for rainy days. With the benefit of hindsight we of course
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Figure 3. Credit to private sector (% of GDP), 1995-2007
1995 2000 2007 100 200
80
150
60
100 40
50 20
0 0
Malta Latvia Cyprus Estonia Croatia Poland Serbia Albania TurkeyGeorgia Belarus Slovenia Bulgaria HungaryLithuania Ukraine Moldova Romania Armenia Azerbaijan Slovak Republic Czech Republic Macedonia, FYR Russian Federation Bosnia/Herzegovina
Source: Author’s calculation, based on IMF data.
Figure 4. General government gross debt (% of GDP), 1995-2010
1995 2001 2007 2010 120
100
80
60
40
20
0
EU15 Latvia Malta Albania Poland Asia25 Turkey Cyprus Croatia Serbia Belarus Estonia Hungary Georgia Africa48 Moldova Ukraine Slovenia Romania Armenia Bulgaria LATAM32 Lithuania CESEE26 Azerbaijan Montenegro United States Middle East13 Czech Republic Slovak Republic Macedonia, FYR Bosnia/Herzegovina Russian Federation
Notes: Countries are ordered according to their 2010 debt level. CESEE26: 26 countries from central, eastern, and south-eastern Europe. Asia25: 25 countries from Asia excluding China. LATAM32: 32 countries from Latin America. Middle East13: 13 countries from the Middle East. Africa48: 48 countries from Africa. Country groups and non-CESEE countries are highlighted. Source: Eurostat, European Bank for Reconstruction and Development (EBRD), DG ECFIN of the European Commission, IMF. 2010 forecasts are from the IMF (October 2009). The 2010 forecast for Armenia and Macedonia (FYR) is not available.
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know now that budget policy should have been more conservative during the good times in most countries to create fiscal space for counter-cyclical policy in the downturn. There is unpleasant asymmetry regarding the banking system: it was the private sector that incurred most of the debt, but the public sector has to adjust substantially and clean up the mess now.5 This asymmetry is similar to the Stability and Growth Pact’s failure (with its narrow focus on budgets) to preserve the euro area’s stability. These factors call for strengthened regulation and supervision, as well as creation of institutions for anti-cyclical budget policies. Despite the low level of government debt, credit-default swaps on government bonds (which is a measure of the cost of insurance against government default) have increased substantially (Figure 5). The huge rise in government-default probability on the one hand,
Figure 5. Credit-default swap on five-year government bonds, 2 January 2008-6 November 2009
Latvia Lithuania Bulgaria Hungary Romania Croatia Russian Federation Estonia Turkey 1 200 1 200
1 000 1 000
800 800
600 600
400 400
200 200
0 0
Jan. 08 May 08July 08 Nov. 08Jan. 09 May 09July 09 Nov. 09 Jan. 08 May 08July 08 Nov. 08Jan. 09 May 09July 09 Nov. 09 March 08 Sept. 08 March 09 Sept. 09 March 08 Sept. 08 March 09 Sept. 09
Poland Czech Republic Slovak Republic Slovenia Ukraine 500 5 500
450 5 000 4 500 400 4 000 350 3 500 300 3 000
250 2 500 2 000 200 1 500 150 1 000 50 500 0 0
Jan. 08 May 08July 08 Nov. 08Jan. 09 May 09July 09 Nov. 09 Jan. 08 May 08July 08 Nov. 08Jan. 09 May 09July 09 Nov. 09 March 08 Sept. 08 March 09 Sept. 09 March 08 Sept. 08 March 09 Sept. 09
Source: Datastream.
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Figure 6. The relation of credit-default swaps on government bonds to public debt and net foreign loan and debt liabilities
2007 2009 Credit default swap on five-year government bond Credit default swap on five-year government bond 800 800 Latvia Latvia
600 600
Lithuania Lithuania Estonia Estonia 400 Russian Fed. Romania 400 Romania Bulgaria Hungary Hungary Bulgaria Russian Fed. Croatia Croatia Turkey Turkey
Czech Lithuania Poland Poland 200 Romania 200 Rep. Czech Rep. Turkey Turkey Latvia Slovenia Slovak Rep. Russian Slovak Rep. Czech Rep. Slovenia Fed. Bulgaria Croatia Slovak Rep. Latvia Lithuania Romania Poland Russian Fed. Hungary Poland Croatia Bulgaria Czech 0 Estonia Slovenia 0 Hungary Estonia Slovak Rep. Slovenia Rep. 020406080-80 -60-40 -20 0 Public debt over GDP Net foreign loan and debt liabilities over GDP
Note: 2009 credit-default swap (CDS) refers to the average between 2 January and 27 October 2009. Public debt refers to general government gross debt. Net foreign loan and debt liabilities refer to the whole economy. Data on net foreign loan and debt liabilities (NFDL) are available only for 2007 and therefore both the 2007 and 2009 CDS are plotted against the 2007 value of NFDL. Source: Author’s calculation, based on IMF and Datastream data.
and the low level of government debt on the other, are puzzling. Furthermore, credit- default swaps on government bonds do not relate to the general government debt/GDP ratio (left-hand side panel of Figure 6). The most likely solution to this puzzle could be related to the risk inherent in private sector debt in many countries, which is (in some countries) held mostly in foreign currencies. The magnitude of the eventual bank losses is still highly uncertain, and in countries where foreign banks are prevalent, burden sharing is an issue. Should the economic outlook deteriorate further, and/or the exchange rate collapse (e.g. Baltics), or fall further (e.g. Hungary, Ukraine), then even deeper economic crises may emerge that could lead to more bankruptcies, unmanageable bank losses and the complete drying up of foreign capital. These factors may end in a government default, despite the low level of government debt. Indeed, government default risk is now related to external indebtedness defined as net foreign loan and debt liabilities (right-hand side panel of Figure 6). It is noteworthy that before the crisis the cost of insurance against government default was not related to external indebtedness. This suggests that risk pricing was done incorrectly before the crisis.
2. Cyclicality of budget policy in CESEE countries A growing empirical literature demonstrates that fiscal policy in emerging and developing countries tends to be pro-cyclical, while it is a-cyclical or counter-cyclical in most developed countries. A pro-cyclical budget policy amplifies both the boom and the bust phases of the economic cycle. During the boom period, the amplifying effect contributes to the build-up of vulnerabilities both directly and indirectly. It also has an impact if the faster economic growth that results from the pro-cyclical budget policy induces agents to expect a brighter future and consequently to borrow against their expected future income. During the bust period, the pro-cyclical fiscal policy required by,
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e.g. the external financial constraints, amplifies again the effect of the downturn. Kaminsky, Reinhart and Vegh (2004) have coined this phenomenon as “when it rains, it pours”. It cannot be optimal from any theoretical perspective to reinforce the business cycle by expanding budget policy in good times and contracting it in bad times (see Ilzetzki and Vegh, 2008, for further discussion). Consequently, analysing the cyclical nature of budget policy may shed light on whether or not budget policy in CESEE countries also contributed to the severity of the crisis by amplifying the economic cycle during good times. It is instructive to start the analysis with some simple correlation measures that may hint at pro-cyclicality, and then to continue with a structural analysis.
2.1. Correlation of output and government consumption using annual data Table 1 reports the correlation coefficient between annual real GDP and real government consumption6 growth in four different time periods. The sample starts either in 1995 or in 2001 and ends either in 2007 or in 2010, where available. Extending the sample to 2010 (with available forecasts) provides an indication of how the current crisis affects the correlation. Starting the sample in 2001 instead of 1995 eliminates the period of the Russian
Table 1. Correlation of annual real GDP and real government consumption growth
1995-2007 1995-2010 2001-07 2001-10
Bulgaria 0.81 0.77 –0.25 0.29 Cyprus –0.54 –0.35 –0.37 –0.20 Czech Republic –0.21 –0.08 –0.59 –0.11 Estonia –0.18 0.14 –0.23 0.54 Hungary 0.81 0.62 0.92 0.62 Latvia 0.30 0.45 0.84 0.91 Lithuania 0.69 0.83 0.13 0.90 Malta n.a. n.a. –0.01 0.24 Poland 0.27 0.56 0.59 0.78 Romania 0.09 0.24 –0.65 0.28 Slovenia –0.26 0.03 0.04 0.23 Slovak Republic 0.43 0.40 –0.10 0.12 Albania 0.40 n.a. 0.41 n.a. Croatia –0.03 0.04 0.67 0.27 Macedonia, FYR n.a. n.a. –0.64 –0.55 Turkey 0.17 0.24 0.56 0.50 Russian Federation 0.24 n.a. 0.57 n.a. Armenia 0.57 n.a. 0.40 n.a. Azerbaijan –0.15 n.a. –0.29 n.a. Belarus 0.76 n.a. –0.29 n.a. Georgia –0.04 n.a. –0.35 n.a. Moldova 0.76 n.a. 0.71 n.a. Ukraine 0.78 n.a. –0.37 n.a. Euro area 12 0.04 –0.08 –0.06 –0.03 Denmark 0.23 0.20 0.18 –0.08 Sweden 0.05 0.02 0.03 0.07 United Kingdom –0.09 –0.38 –0.03 –0.46 Switzerland –0.26 –0.17 –0.55 –0.21 Norway –0.12 –0.55 –0.21 –0.63 Japan –0.01 0.24 –0.62 0.13 United States –0.34 –0.69 –0.70 –0.77
Note: Data for Bosnia and Herzegovina, Montenegro, and Serbia are not available. Source: Author’s calculation.
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crisis that affected many other CESEE countries. Some earlier country-specific crises are also eliminated (e.g. Bulgaria, Czech Republic, Romania, and Slovak Republic). Furthermore, the transitional recession lasted till the late 1990s in the case of many CIS countries and hence the 2001 sample starting point implies a more homogenous time period. The general result for developed countries shown in the last eight rows of the table is a close to zero or negative correlation, regardless of the sample period considered. Hence, the simple correlation coefficient confirms the a-cyclical or counter-cyclical budget policy finding that is found as a result of more structural analysis in the literature. In contrast, the general result for many CESEE countries is a positive correlation suggesting pro-cyclicality, though there are exceptions. Results for some CESEE countries are different for different time periods, which make us cautious when interpreting the results. Considering the 1995-2007 period, a negative or positive but close to zero correlation was found for the following countries: Cyprus, Czech Republic, Estonia, Romania, Slovenia, Croatia, Azerbaijan, and Georgia. The correlation for Turkey, the Russian Federation, Poland, Latvia, Albania, and the Slovak Republic was positive but not large. Large positive correlations were observed for Bulgaria, Hungary, Lithuania, Armenia, Belarus, Moldova and Ukraine. If only the “good times” of 2001-07 are considered, the results change for several CESEE countries. Correlation increases substantially compared to the 1995-2007 period in Latvia, Croatia, Poland, Turkey and the Russian Federation. There are also countries in which correlation in 2001-07 is substantially lower than in 1995-2007: Bulgaria, Lithuania, Romania, the Slovak Republic, Belarus and Ukraine. Data for Malta are available for 2001-07 which indicate a zero correlation. Including the recent crisis in the sample period generally increases the finding of positive correlation for CESEE countries. For example, among the EU member states for which forecasts up to 2010 are available, the correlation coefficient rises substantially in the cases of Lithuania and Estonia, and to a lesser extent for Bulgaria, Malta, Romania and Slovenia, leaving only Cyprus and the Czech Republic with negative correlations, and the Slovak Republic with a small positive correlation. To sum up, although there are important country-specific differences (e.g. Cyprus and the Czech Republic were found to have negative correlations in all sample periods), many CESEE countries indicate a positive correlation between GDP and government consumption growth, in at least one of the sample periods we studied. In contrast, the correlation is close to zero or negative in developed countries, irrespective of the time period studied.
2.2. Structural vector-autoregressions using quarterly data As highlighted by Ilzetzki and Vegh (2008), a positive correlation between GDP and government consumption does not imply causality. Pro-cyclicality would require a causal effect from GDP growth to government consumption growth. However, a positive correlation between the two variables may be the result of a causal effect from government consumption to GDP, i.e. the expansionary effect of government consumption. Following Blanchard and Perotti (2002) and Ilzetzki and Vegh (2008), we employ structural vector- autoregressions (SVAR) to identify the effects of output shocks on government consumption using quarterly data. The model has the following form:
p q A0 yt Ai yt i Bj xt j t i1 j 0
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where yt is the vector of output and government consumption, which are assumed to be endogenous, xt is the vector of exogenous variables, t is the vector of orthogonal structural shocks, A0 is the contemporaneous impact matrix, Ai and Bj are parameter matrices. Our sample period covers quarterly data between the first quarter of 1995 and the first quarter of 2009, where available (Box 1 details data availabilities).7 A few key assumptions have to be made for the use of the SVAR: ● Identification of shocks: Following Blanchard and Perotti (2002) and Ilzetzki and Vegh (2008), we assumed that an unexpected shock8 to GDP does not have a contemporaneous effect on government consumption, but an unexpected shock to government consumption may affect GDP contemporaneously. ● Measurement of variables: In contrast to Ilzetzki and Vegh (2008) who de-trended GDP and government consumption using linear and quadratic trends before making estimates, we included the variables in log-levels. There are various de-trending methods adopted in the literature, and empirical results might depend on the specific filter adopted, as demonstrated in Canova (1998). Estimates for the levels, however, is consistent irrespective of whether or not there is a co-integrating relationship among the variables, though in small samples the estimate may be biased. ● Exogenous variable(s): We include only one exogenous variable, the weighted average of EU15, US, Russian and Japanese GDP. The weights are proportional to trade weights. We did not include all trading partners in the weighted foreign GDP for reasons of endogeneity. For example, the Czech Republic and the Slovak Republic have substantial bilateral trade relations, but, e.g. GDP development in the Slovak Republic is likely not exogenous to GDP movements in the Czech Republic. In contrast, GDP developments in EU15, United States, Russian Federation and Japan can be regarded as exogenous with respect to economic developments in CESEE countries. These four main economic regions represent, on average, 67% of total trade of the 26 CESEE countries, and hence the bulk of external demand is captured. ● Lag length: We used Schwarz information criterion to determine the lag length.9 Figure 7 shows the response of government consumption to an unanticipated GDP shock for the 20 CESEE countries for which quarterly data are available. The results are broadly consistent with our earlier findings shown in Table 1. With a few exceptions, government consumption reacted positively to unexpected GDP shocks. The most pro- cyclical budget policy was observed in Hungary: a 1% positive GDP shock caused a more than three percentage point rise in government consumption at the two-year horizon, according to the point estimate, though the confidence band is very wide. The positive effect is sizable in many other countries as well. The key exceptions are Croatia (which is found to be a-cyclical), the Czech Republic and Estonia (in which the point estimates of the impulse responses are very close to zero with a wide confidence band), Cyprus (which shows an initial counter-cyclical reaction followed by a delayed pro-cyclicality at about 1.5 years after the shock10), and Romania (in which a contemporaneous pro-cyclical impact is followed by a small and insignificant counter-cyclical response).
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Box 1. Data sources and availability for the empirical estimates We aimed to collect seasonally and working-day adjusted quarterly GDP and government consumption figures at constant prices for the 1995Q1-2009Q1 period. The table below details our data.
Country Availability Source Note
Bulgaria 1995Q1-2009Q1 Eurostat (only raw data – not seasonally and We calculated the seasonal adjustment by using working-day adjusted – are available) the Census X12 method. Cyprus 1995Q1-2009Q1 Eurostat Czech Republic 1996Q1-2009Q1 Eurostat Estonia 1995Q1-2009Q1 Eurostat Hungary 1995Q1-2009Q1 Eurostat Latvia 1995Q1-2009Q1 Eurostat Lithuania 1995Q1-2009Q1 Eurostat Malta 2000Q1-2009Q1 Eurostat Poland 1995Q1-2009Q1 Eurostat Romania 1998Q1-2009Q1 Eurostat (only raw data – not seasonally and We calculated the seasonal adjustment by using working-day adjusted – are available) the Census X12 method. Slovenia 1995Q1-2008Q4 Eurostat Slovak Republic 1995Q1-2009Q1 Eurostat Croatia 1997Q1-2009Q1 Eurostat (only raw data – not seasonally and Seasonal adjustment by using the working-day adjusted – are available) Census X12 method. Turkey 1995Q1-2009Q1 Central Statistical Office of Turkey (only raw data We first performed seasonal adjustment using the – not seasonally and working-day adjusted – are Census X12 method of the times series available available at different years’ prices: series at 1987 at 1987 and 1998 years’ prices and then prices is available for 1987-2007; series at 1998 combined them into single time series. prices is available for 1998-2009) Russian Federation 1995Q1-2009Q1 Federal State Statistics Service of the Russian We combined into single time series the data Federation (only raw data – not seasonally and available at different years’ prices and then working-day adjusted – are available at different adjusted seasonally with the Census X12 method. years’ prices) Armenia 1995Q1-2009Q1 IMF-IFS: unadjusted nominal national accounts We deflated nominal figures with the CPI and then figures and CPI adjusted seasonally with the Census X12 method. Belarus 1995Q1-2008Q4 IMF-IFS: unadjusted real GDP, nominal We deflated government consumption with the government consumption, and GDP deflator GDP deflator and then adjusted seasonally along with the GDP with the Census X12 method. Georgia 1996Q1-2008Q4 IMF-IFS: unadjusted real GDP, nominal We deflated government consumption with the government consumption, and CPI CPI and then adjusted seasonally along with the GDP with the Census X12 method. Moldova 2000Q1-2009Q1 IMF – IFS: unadjusted nominal national accounts We deflated nominal figures with the CPI and then figures and CPI adjusted seasonally with the Census X12 method. Ukraine 2001Q1-2009Q1 State Statistics Committee of Ukraine (only raw We calculated the seasonal adjustment by using data – not seasonally and working day adjusted – the Census X12 method. are available)
Data for the EU15, United States and Japan are from Eurostat and available for 1995Q1-2009Q1.
Why would most CESEE countries, in contrast to developed countries, pursue a pro- cyclical fiscal policy that might exacerbate the business cycle? Based on an extensive literature review concerning fiscal policy in developing countries, Ilzetzki and Vegh (2008) conclude that there are two main explanations: 1. Imperfections in international credit markets prevent developing countries from borrowing in bad times. 2. Political economy explanations typically based on the idea that good times encourage fiscal profligacy and/or rent-seeking activities.
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Figure 7. Response of government consumption to a one percentage point shock in GDP
Bulgaria Czech Republic Cyprus Estonia 2.0 2.0 2 0.8
1.5 1.5 1 0.6 1.0 1.0 0.4 0.5 0 0.5 0.2 0 -1 0 0 -0.5 -2 -0.5 -1.0 -0.2
-1.0 -1.5 -3 -0.4 5 10 15 20 5 10 15 20 5 10 15 20 5 10 15 20
Latvia Lithuania Hungary Malta 0.6 0.8 12 2.0
1.5 0.4 0.6 8 1.0 0.4 4 0.2 0.5 0.2 0 0 0 0 -4 -0.5 -0.2 -0.2 -8 -1.0
-0.4 -0.4 -12 -1.5 5 10 15 20 5 10 15 20 5 10 15 20 5 10 15 20
Poland Romania Slovenia Slovak Republic 1.0 2.0 0.6 0.7 0.5 0.6 0.8 1.5 0.4 0.5 0.6 1.0 0.3 0.4 0.4 0.2 0.5 0.3 0.2 0.1 0.2 0 0 0 -0.1 0.1 -0.5 -0.2 -0.2 0 -0.4 -1.0 -0.3 -0.1 5 10 15 20 5 10 15 20 5 10 15 20 5 10 15 20
Russian Federation Croatia Turkey Armenia 0.5 0.2 0.8 1.4
0.4 0.6 1.2 0.1 1.0 0.3 0.4 0.8 0 0.2 0.2 0.6 0.4 0.1 -0.1 0 0.2 0 -0.2 -0.2 0 -0.1 -0.4 -0.2 -0.2 -0.3 -0.6 -0.4 5 10 15 20 5 10 15 20 5 10 15 20 5 10 15 20
Belarus Georgia Moldova Ukraine 2.0 2.4 2.0 0.3
2.0 0.2 1.6 1.6 1.6 0.1 1.2 1.2 1.2 0 0.8 0.8 -0.1 0.8 0.4 0.4 -0.2 0 0.4 0 -0.4 -0.3 0 -0.8 -0.4 -0.4 5 10 15 20 5 10 15 20 5 10 15 20 5 10 15 20
Note: The panels show the response of government consumption to a one percentage point shock in GDP as a function of the time (measured in quarters) after the shock. Dashed lines represent +/- two standard deviations confidence band. The sample period for each country is detailed in Box 1. Data for Albania, Azerbaijan, Bosnia and Herzegovina, Macedonia, FYR, Montenegro, and Serbia are not available.
As far as imperfections in international credit markets are concerned, further integration of CESEE countries into the EU could ease this problem. However, as the cases of Greece and Hungary underline, it is euro-area membership that makes a difference. Both
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countries are members of the EU, but only Greece is a member of the euro area. While the main fundamentals were worse in Greece than in Hungary, Greece has fared much better than Hungary in the first year of the post-Lehman Brothers period of the current crisis.11 On the other hand, many CESEE countries also pursued pro-cyclical policies in good times when credit from foreign sources was abundant. Consequently, political economy factors may be highly relevant in explaining the pro-cyclical budgetary policies of these countries. We return to the issue of euro-area entry and the need for improvements in budgetary governance in the final section of this article.
3. The impact of the crisis on budget policy: main channels The crisis has, through various channels, had a significant impact on the budget policy of all countries, including CESEE countries. However the strength of certain channels varies across countries according to their specific circumstances. Figure 8 indicates the headline budget deficit numbers for CESEE countries in comparison with some major economies. Budget deficits outcomes are rather diverse and are related to a large number of factors, to be discussed later.
Figure 8. General government budget balance, 1997-2010 % of GDP
1997-2007 2008 2009 2010
20
15
10
5
0
-5
-10
-15
Latvia EU15 Malta Poland Cyprus Turkey Asia25 Albania Croatia Serbia Estonia Belarus Armenia Georgia Moldova Romania Slovenia Hungary Ukraine Africa48 Bulgaria Lithuania CESEE26 LATAM32 Azerbaijan Montenegro United States Slovak Republic Middle East13 Czech Republic Macedonia, FYR Bosnia/Herzegovina Russian Federation
Note: Countries are ordered according to their 2010 balance (except Macedonia, FYR). Source: Eurostat, EBRD, IMF WEO (October 2009). The 2009 forecast for Macedonia, FYR is from the EBRD (spring 2009); the 2010 forecast is not available.
From the perspective of most CESEE countries, the impact of the crisis can be summarised as: 1) a significant revenue shortfall; 2) changes in the global economic environment that have led to external financial constraints and less growth in main export destination markets; and 3) a significant change in the medium/long-term outlook.
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3.1. Direct fiscal impact The most serious impact of the crisis on budget policy has been felt on the revenue side. With declining economic activity, all kinds of tax revenues decline. Progressive income taxes and corporate taxes act as automatic stabilisers, as do unemployment and other welfare benefits. In addition, countries that have scope may engage in discretionary fiscal stimulus programmes to boost domestic demand. We believe that the current economic environment is a classical Keynesian situation that would in principle demand such discretionary policies. However, as we will discuss in more detail in Section 6, both the desirability of, and the scope for, such actions fundamentally depend on the circumstances of individual countries, such as their size and openness, the credibility and strength of fiscal institutions, and the level of government debt. Last, but not least, fiscal support for the financial sector (which is different from discretionary fiscal stimulus) has a crucial role, as the health of the banking system and its potential for credit expansion is crucial for the recovery.
3.2. Changes in the global economic environment Changes in the global economic environment have important impacts on all countries, but especially on open economies. The crisis affects capital flows, risk premia, trade, migration and also the outlook of major economies. These impacts in turn affect the economies of CESEE countries, thereby limiting their budgetary policies. First, as we have discussed in Section 1.2, countries in this region in general have relied heavily on capital inflows to finance investment (and also consumption in many cases). The global nature of the crisis, the ongoing de-leveraging process, and the general reduction in global liquidity have substantially reduced capital inflows and will even lead to capital outflows. For example, the October 2009 IMF World Economic Outlook includes a forecast for capital flows that foresees substantial decline. These factors pose significant constraints on the ability to raise capital. Second, the capital that is available will be more expensive, and risk premiums are expected to remain considerably higher than their pre-crisis levels, implying a higher cost of capital for all economic sectors, including the government. Indicators measuring the risk that emerging and developing countries represent for lenders, such as credit default swaps (Figure 5) or emerging market bond indices, have shown dramatic increases, suggesting a rise in risk perceptions. These indicators measure current risk perceptions, but it is unlikely that risk perception will decline to pre-crisis levels in the near future. Some authors argue that emerging market bond spreads and credit default swaps were unjustifiably low before the crisis and hence a return to that situation is unlikely. Third, the substantial fall in global trade, coupled with moves towards protectionism by major destination markets, have an impact on a key pillar for economic success in the generally small and open CESEE economies. Central and south-eastern European economies in particular heavily depend on trade with the EU, while eastern European countries are similarly reliant on the Russian Federation. Their previous success was partly based on the building up of (partly inter-company) trade relations. With the recession in western Europe and the Russian Federation, CESEE exports will be hit seriously, also reflecting the general finding that cyclical swings in small, open economies tend to be greater than in more advanced economies. Furthermore, many export destination countries are considering the adoption of various subsidies for certain sectors, which could
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further distort trade relations. Any undermining of the close integration of production networks within Europe, and the resulting job losses, would pose a challenge to eastern countries. While this effect is in some respects cyclical, if recession in western Europe and the Russian Federation is long-lasting and results in the rise of trade-distorting policies, the challenges for CESEE countries will also be long-lasting and serious. Commodity-exporting countries, including of course the Russian Federation, have also been hit by lower demand and revenues for an uncertain duration. Furthermore, in some of the countries there is a high level of specialisation/concentration of activities in a few sectors. Depending on which sectors these are (oil, cars, pharma, high-tech services, etc.), and how important foreign direct investment (FDI) is in these sectors, this might affect their sensitivity of those countries to cyclical downturns, and the sustainability of their long-term growth. Fourth, migration may also be affected. Some countries in the region have experienced very large outflows of workers to richer economies, with citizens from the new EU member states and western Balkan countries heading primarily to western Europe, and those of CIS countries heading to the Russian Federation. With the economic slowdown in western Europe and the Russian Federation, labour outflows may slow and even partially reverse. Remittances, which play a very significant role in some of these countries, could dwindle substantially. These developments would have additional adverse consequences. If some of the countries in the region experience very large economic contractions over extended periods, then migration outflows may speed up again, exacerbating the effects of the crisis and undermining the long term prospects of some countries.12 Finally, in addition to reduced capital flows, rising risk premia, declining trade, falling remittances and potential reverse migration, developments in the major economies may themselves have major impacts on CESEE countries. Major economies have accumulated huge budget deficits, as a consequence of automatic stabilisers, and also as a result of the huge support given to the financial sector, and discretionary fiscal stimulus in some cases. This has led to abrupt increases in government debt in major economies, which will require more countercyclical fiscal policy in the future to maintain credibility. However, prolonged budgetary adjustments in major economies run the risk of reducing growth for a prolonged period (perhaps after an initial rebound immediately after the crisis due to huge output gaps that will have likely emerged). Such a prolonged adjustment in major economies will significantly impact CESEE countries.
3.3. Reconsideration of the medium- and long-term economic outlook For all of the reasons discussed so far, the previous “growth model” of CESEE countries is at risk, and substantial downgrades in growth prospects compared to the pre-crisis outlook can be expected.13 Reconsideration of the medium- and long-term economic outlook for these countries will have consequences for future budgetary policies. In particular, budgetary expenditure planning must consider new revenue realities. Furthermore, the crisis will likely have lasting negative wealth effects on these countries. The fall in the price of certain assets, and their future outlook, should be evaluated in the light of pre-crisis expectations for these prices. While asset prices will likely bottom out, if they have not yet done so, their future outlook is not just uncertain, it is also likely that there will be a downward shift in price levels compared to the pre-crisis outlook.14
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The fall in housing prices impacts especially those countries that had huge housing booms in previous years.15 The fall in commodity prices impacts commodity exporter countries.16 Wherever foreign currency loans were granted and the exchange rate has depreciated, a wealth effect operates because of the increased debt/income ratio. Increases in the interest rate, both for domestic and foreign currency denominated loans, increases the debt service/income ratio. Many of the countries have funded pension systems, and the losses assumed directly challenge those who are to retire in the coming years. The downgraded prospects compared to pre-crisis outlooks will also have an effect. The consequence of all of these wealth effects is a downward shift in consumption patterns. The current crisis is different from a “regular” bust in a business cycle. Consumption smoothing, if any, will work to a much lesser extent. Instead, heightened falls in consumption are likely due to changed expectations about the future, to wealth effects and also to the difficulties in obtaining credit (supply plus higher real interest rates).
4. Budget policy reactions in CESEE countries Budget policy reactions can be understood only in the broader context of other macroeconomic policies and constraints. Due to the substantial revenue shortfall and external financing constraints, most countries simply do not have scope for discretionary fiscal stimulus. In addition, many countries face significant confidence constraints as well. Eight countries (Armenia, Belarus, Bosnia-Herzegovina, Hungary, Latvia, Romania, Serbia, and Ukraine) have standby agreements with the IMF,17 and Turkey is in talks. The loans granted under these agreements are conditional on the implementation of a comprehensive economic programme aimed at ensuring fiscal consolidation, structural reform and support for the financial system.18 On the other hand, the Russian Federation, a large and not-so-open economy with huge fiscal reserves (and low gross government debt, see Figure 4) has scope for fiscal stimulus, and indeed has rightly embarked on a significant fiscal stimulus programme. However, as also highlighted by, e.g. World Bank (2009a), the scope for further fiscal stimulus in 2009 and 2010 appears limited due to the remaining downside risks in the global and Russian economies, and the exhaustion of a large part of Russia’s Reserve Fund. Because of its low government debt, the Russian Federation has room to borrow externally, which is indeed planned for 2010. But while that is being done, longer term fiscal sustainability should be prioritised, which will require reforms to broaden the revenue base and ensure greater efficiency in public and social programmes. In parallel with budget constraints, monetary policy reactions were varied across countries. Three-month interbank interest rates also reflected this (Figure 9). Some countries (e.g. Czech Republic, Poland and Slovak Republic) cautiously cut interest rates, while others had to raise them substantially (e.g. Hungary and Romania). Monetary policy actions were determined by pressures on exchange rates, currency composition of debt, and of course by the credibility of economic policies and inflation prospects. The Russian Federation and Ukraine aimed for exchange rate stabilisation. The Russian Federation has lost one-third of its reserves in defending the exchange rate. A recent IMF staff position note (IMF, 2009) assessed fiscal stimuli in G20 countries and in a few CESEE countries, while the European Commission (2009) presents assessment for all 27 EU countries. In this section, we first report the IMF (2009) and European Commission
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Figure 9. Three-month interbank interest rates, 2 January 2008-6 November 2009
Lithuania Estonia Bulgaria Poland Latvia Moldova Czech Republic Slovak Republic Romania Turkey Euro area Hungary Euro area
10 28 9 8 24 LTU MDA 7 20
6 EST TUR BGR 16 5 POL 4 12 ROU HUN 3 8 CZE LVA 2 4 1 SVK 0 0 2008:012008:07 2009:01 2009:07 2008:012008:07 2009:01 2009:07
Note: The Romanian rate peaked at 49.81% on 20 October 2008, but for better readability of the right-hand side panel, the vertical axis has a 30% cut-off. Source: Datastream and National Bank of Moldova.
(2009) results for CESEE countries in comparison to some G20 countries. In Annex A, we report our own data collected from various sources, which cover all 26 CESEE countries. Table 2 shows that the Russian Federation adopted the largest stimulus among G20 countries in 2009, and the sixth largest for the three-year period from 2008 to 2010. In particular, the Russian Federation’s stimulus is larger than that of the United States, and of any single European country (as a percentage of GDP), both in 2009 and the three-year 2008-10 period. Turkey’s discretionary fiscal stimulus is the second lowest among G20 countries. The June 2009 stimulus, which is not included in IMF (2009) and hence Table 2, is estimated to be 0.3% of GDP. Table 3 indicates that most of the EU member CESEE countries have not implemented discretionary stimulus measures. Using a different methodology, Saha and von Weizsäcker (2009) estimate that discretionary fiscal measures amount to 0.5% of GDP in Poland in 2009. Annex A details the various measures adopted in response to the crisis for all 26 CESEE countries. Budget policy reactions vary substantially across countries. The less vulnerable countries (e.g. the Czech Republic, Malta, Poland, Slovenia) implemented discretionary stimulus measures, but most countries instead engaged in fiscal consolidation. Direct measures for supporting the financial sector were generally low or zero in CESEE countries (see Tables 4 and 5 and Annex A). Four CESEE countries (Hungary, Poland, the Russian Federation and Turkey) are included in IMF (2009) in this respect (reported in Table 4). As an integral part of its IMF programme, Hungary gave the largest (among these four countries, in terms of GDP) support to the financial sector that required upfront government financing. Still, measures in all four countries have been dwarfed by the measures that have taken in advanced G20 countries, which are reported in the last row of Table 4. Table 5 highlights that among the EU member CESEE countries only Hungary and Latvia provided support for the financial sector.
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Table 2. Estimated cost of discretionary measures in G20 countries % of GDP, relative to 2007 baseline
2008 2009 2010 All three years
Saudi Arabia 2.4 3.3 3.5 9.2 South Africa 2.3 3.0 2.1 7.4 China 0.4 3.1 2.7 6.2 Korea 1.1 3.7 1.2 6.0 Australia 1.2 2.5 2.1 5.8 Russian Federation 0.0 4.1 1.3 5.4 United States 1.1 2.0 1.8 4.9 Japan 0.3 2.4 1.8 4.5 Spain 1.9 2.3 .. 4.2 Germany 0.0 1.6 2.0 3.6 Canada 0.0 1.9 1.7 3.6 Indonesia 0.0 1.4 0.6 2.0 India 0.6 0.6 0.6 1.8 United Kingdom 0.2 1.5 0.0 1.7 Argentina 0.0 1.5 .. 1.5 France 0.0 0.7 0.8 1.5 Mexico 0.0 1.5 .. 1.5 Brazil 0.0 0.6 0.5 1.1 Turkey 0.0 0.8 0.3 1.1 Italy 0.0 0.2 0.1 0.3
Note: Countries are ordered according to the sum of the stimulus over 2008-10. Source: Extracted from Table 3.4 of IMF (2009), “Fiscal Implications of the Global Economic and Financial Crisis”, IMF Staff Position Note, June, Washington DC. See detailed notes to the table in IMF (2009).
Table 3. Fiscal stimulus measures in EU countries, 2009 and 2010 % of GDP, relative to 2008 baseline
2009 2010
Increased Measures Measures Increased Of which spending on Total Expenditure Revenue aimed at aimed at public public Total labour market households businesses investment infrastructure measures
Bulgaria 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Cyprus 0.1 0.1 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Czech Republic 1.0 0.5 0.5 0.0 0.5 0.1 0.4 0.4 0.5 Estonia 0.2 0.2 0.0 0.0 0.2 0.0 0.0 0.0 0.3 Hungary 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Latvia 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Lithuania 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Malta 1.6 1.3 0.3 0.3 0.0 0.1 1.3 0.7 1.6 Poland 1.0 0.3 0.7 0.6 0.0 0.1 0.3 0.3 1.5 Romania 0.0 0.0 0.0 0.0 0.0 0 0.0 0.0 0.0 Slovak Republic 0.1 0.1 0.0 0.0 0.0 0.1 0.0 0.0 0.0 Slovenia 0.6 0.5 0.1 0.0 0.1 0.3 0.2 0.0 0.5 Total euro area 1.1 0.5 0.5 0.4 0.1 0.2 0.3 0.1 0.8 United Kingdom 1.4 0.4 1.0 1.2 0.0 0.0 0.2 0.0 0.0
Source: Extracted from Table I.1.1 of European Commission (2009), “Public Finances in EMU”, European Economy, 5/2009 (provisional version), Directorate-General Economic and Financial Affairs of the European Commission.
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Table 4. Headline support for the financial sector and upfront financing need % of 2008 GDP
Purchase of Central bank Liquidity Guarantees Capital injection assets and support provided provision and (excluding Total Upfront (A) lending by with treasury other support by deposit (A+B+C+D+E) treasury (B) backing (C) central bank (D) insurance) (E)
Hungary 1.1 2.2 0.0 4.8 1.1 9.2 3.3 Poland 0.0 0.0 0.0 0.0 3.2 3.2 0.0 Russian Federation 0.6 0.5 0.4 7.6 0.5 9.6 1.7 Turkey 0.0 0.3 0.0 0.0 0.0 0.3 0.0 G20 advanced economies 3.2 4.4 1.2 18.7 22.9 50.4 5.8
Source: Extracted from Table 2.1 of IMF (2009), “Fiscal Implications of the Global Economic and Financial Crisis”, IMF Staff Position Note, June, Washington DC. See detailed notes to the table in IMF (2009).
Table 5. Public interventions in the banking sector % of projected 2009 GDP
Guarantees on bank Liquidity and bank Capital injections Relief of impaired asset Total liabilities funding support Total for all Deposit effective Total Effective Total Total Total Effective approved guarantee Guarantees Effective for all approved capital approved approved approved liquidity measures scheme granted asset relief measures measures injections measures measures measures interventions
Bulgaria 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EUR 50 000 Cyprus 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EUR 100 000 Czech Republic 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EUR 50 000 Estonia 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EUR 50 000 Hungary 1.1 0.1 5.9 0.0 0.0 0.0 0.0 0.0 7.0 0.1 100% Latvia 1.4 0.0 10.9 2.8 0.0 0.0 10.9 6.1 23.1 8.9 EUR 50 000 Lithuania 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EUR 100 000 Malta 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EUR 100 000 Poland 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EUR 50 000 Romania 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 EUR 50 000 Slovak Republic 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 100% Slovenia 0.0 0.0 32.8 0.0 0.0 0.0 0.0 0.0 32.8 0.0 100% Total euro area 2.6 1.4 20.6 8.3 12.0 0.7 1.3 0.7 36.5 11.1 United Kingdom 3.5 2.6 21.7 9.5 0.0 0.0 25.1 18.7 50.3 30.8 ca. EUR 57 000
Source: Extracted from Table III.6.1 of European Commission (2009), “Public Finances in EMU”, European Economy, 5/2009 (provisional version), Directorate-General Economic and Financial Affairs of the European Commission.
The key reason for this discrepancy is that CESEE countries did not hold US-related toxic assets. However, domestic losses due to falling income, rising unemployment, the bursting housing booms, currency depreciation and increases in retail interest rates, increase the ratio of non-performing loans and lead to risks of huge losses in some countries. Again, there are substantial differences across the 26 CESEE countries. The banking system plays a crucial role in financing CESEE economies. Furthermore, due to the substantial foreign ownership of the banking system in many CESEE countries, the behaviour of foreign banks is decisive for these countries. In recognition of these factors, there has been strong international backing for stabilisation of financial systems in CESEE countries, thereby easing the pressure on their budget policies (see Box 2).
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Box 2. External support for the CESEE financial sector The EU’s commitment not to let any systemically important bank fail in the euro area, or in Sweden (whose banks own most of the banking system in the Baltic countries), the commitment that packages designed to help international banking groups can also benefit their subsidiaries, and the European Central Bank’s liquidity support to euro-area banking groups, have also helped their subsidiaries in the CESEE region. Efforts to stabilise the financial system in CESEE countries (irrespective of the ownership structure) are supported by the joint action plan of the EBRD, EIB Group and World Bank Group, unveiled on 27 February 2009. This initiative aims to support the CESEE banking sectors and bank lending to businesses, in particular to small and medium-sized firms, up to a level of EUR 24.5 billion over two years in the form of equity and debt finance, credit lines, and political risk insurance. The so-called “Vienna Initiative”, which is a multilateral effort to secure financial sector stability in those CESEE countries with substantial foreign bank ownership, aims to stimulate coordination between all relevant stakeholders, including international banking groups, home and host country authorities, international financial institutions and the EU. The aim of the initiative is to develop a common understanding on key issues, to secure the commitments made by both international banking groups and home and host country authorities, and to coordinate a fair burden-sharing. Furthermore, agreements between central banks, most notably the euro/lats swap offered to Latvia by the Danish and Swedish central banks and the Swedish krona/Estonian kroon swap offered by Sweden to Estonia, are also helpful for the stability of the banking sector. The option of getting foreign exchange liquidity in exchange for domestic currency alleviates the pressure on domestic currency markets.
5. Lessons from previous emerging market crises to budget policy Previous economic crises were a major cause of structural reforms in general, and of the budget in particular. For example, Henriksson (2007) presents an excellent essay about fiscal reforms in Sweden, which were prompted by the deep Swedish economic and financial crisis of the early 1990s. Kopits (2008) lists some examples from CESEE countries. Baksay and Kiss (2009) describe and analyse the new Hungarian fiscal responsibility law that was adopted by the Parliament in December 2009. The law was initiated well before the crisis but the crisis has sped up its finalisation and passing. Let us highlight two other cases: the Russian Federation and Brazil after 1998. Both countries experienced serious crises in 1998/99; furthermore, Brazil’s economic history since the oil shocks was a tale of crises, instability, hyper-inflation, temporary economic booms followed by serious busts, and serious fiscal tensions between the central and regional governments. However, despite the global nature of the current crisis, instead of asking for help from the IMF, both countries intend to invest USD 10 billion in notes to be issued by the IMF to support the Fund’s activities elsewhere. The fiscal consolidation and reform, as well as changes in monetary and exchange rate policies prompted by the 1998/99 crises, changed the position of these countries from potential and actual recipients of IMF loans to suppliers. The Russian Federation’s fiscal policy was characterised by very high deficits before the 1998 crisis, averaging 8.5% of GDP between 1993 and 1997 (Figure 10).19 Business subsidies amounted to about 16% of GDP, with little social benefit. The external financial constraints posed by the crisis forced substantial budget consolidation and vital fiscal reforms.
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Figure 10. General government budget data in the Russian Federation and Brazil % of GDP
BalancePrimary balance Balance Primary balance Gross debt Expenditures Gross debt Net debt Revenues Russian Federation Brazil 100 80
70 80 60
60 50
40 40 30
20 20
10 0 0
-20 -10 9294 96 9800 02 0406 08 10 96 9800 02 0406 08 10
Note: Gross debt for Brazil is based on the official method used until 2007 (this is still in use, though it has now been supplemented with another method). The new method indicates that gross debt was between two and nine percentage of GDP lower between 2006 and 2009, in comparison to the former method, when data from both methodologies are compared side by side. Sources: Russian Federation: EBRD (for 1992-2006) and IMF (for 2007-10) except the primary balance, which is from the IMF in the full period; Brazil: Banco Central do Brasil (1995-2008) and IMF (2009-10).
Consolidated general government expenditures were cut substantially from a peak value of 48% of GDP in 1997 to 34% of GDP in 2000. The average expenditure ratio over 1999-2007 was also 34% of GDP and hence the consolidation turned out to be permanent with little time variation (Figure 10).20 The largest declines in non-interest spending, compared to the pre-crisis years, have been in transfers to regions and in capital expenditures. However, wages, social transfers, and defence spending have also been cut. Many inefficient subsidies were abolished, levelling the playing field. Interest costs, measured in rubles, rose with the exchange rate depreciation following the 1998 crisis, but after rescheduling the debt, cash interest spending also decreased from over 4.5% of GDP in 1995-97 to about 3% in 2000. The government continued its tax crusade against the oligarchs, launched in 1997-98, with success. The government started applying the tax laws to big enterprises, especially the oil and gas companies, which had previously enjoyed individually negotiated tax rates. Substantial progress was also made in monetisation and rollback of barter, which had risen to 54% of all inter-company payments in 1998, but fell back below 15% by 2001, and continued to fall in subsequent years. At the same time, revenues were centralised away from the regions to the central government through statutory increases in federal shares of value-added tax (VAT) and income tax in 1999, and through the introduction of new tax-sharing rules in 2000. The reintroduction of export taxes in early 1999 and their subsequent expansion were major sources of higher revenue. A new aggressive bankruptcy law tightened the budget constraints. Later, in 2001-02, a radical tax reform was implemented,21 measures were taken to make doing business easier and to secure property rights, and progress was also
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made with financial sector reform. Starting in 2004, most of the windfall oil revenues were saved in a Stabilisation Fund that was later divided into a Reserve Fund and a National Welfare Fund (of which the former was indeed used in 2009 to cover the budget deficit). All of these factors and the related financial stabilisation of the economy have contributed to the Russian Federation’s excellent budget performance in the post-crisis period, and to strong economic growth.22 Still, the reforms implemented in response to the 1998 crisis are not the end of the story. The Russian Federation still faces significant fiscal challenges and there is much room for further improvement (see, e.g. OECD, 2009, and World Bank, 2009a). Furthermore, as we shall demonstrate in the next section, the Russian Federation is one of the lowest ranking of the 26 CESEE countries in terms of preventing corruption and maintaining the rule of law. The government has a crucial role in making improvements in these areas. Brazil also implemented very ambitious fiscal reforms after the 1998-99 crises.23 In 1998, the federal government announced its first Fiscal Stabilisation Programme, comprising four initiatives: 1) fiscal adjustment to increase the primary surplus of the consolidated public sector (in contrast to the pre-crisis close-to-zero and small negative primary balances, a primary balance target of plus 3.75% of GDP was introduced, which was later raised to 4.25%); 2) institutional reform, including the social security system and administrative reform; 3) redesign of fiscal federalism based on a comprehensive debt financing and restructuring agreement with federal states and local governments; 4) reform of the budgetary process and the introduction of fiscal rules. The primary balance targets were generally reached (Figure 10). The debt-restructuring agreement with federal states and local governments was the basis for the change in sub-national governments’ fiscal performances after 1998. The improvements were further consolidated after the approval of the May 2000 Fiscal Responsibility Law, which set out a general framework for budgetary planning, execution and reporting for the three levels of government. The law called for sustaining the structural adjustment of public finances and constraining public indebtedness. It comprised three types of fiscal rules: general targets and limits for selected fiscal indicators; corrective institutional mechanisms in case of non-compliance; and institutional sanctions for non-compliance. Brazil’s public sector had substantial foreign currency liabilities before the 1998 crisis, but it could gradually reduce the foreign exchange exposure to less than 10% of GDP. Fiscal policy was accompanied by strict monetary policy with inflation targeting under floating exchange rates, which was again a fundamental revision of pre-1999 policies. Fiscal reforms played a crucial role in Brazil’s good growth performance after 1999 and in Brazil’s resistance to the current global crisis.
6. Budget policy options in CESEE countries In principle, the current global economic environment calls for Keynesian policies. Although potential output is also likely to be falling in all countries of the world, actual output is falling to a much greater extent. As a result, in many countries large negative output gaps are expected, and hence the fall in actual output is not just a case of correcting pre-crisis positive output gaps that existed in many countries, including the CESEE region. Furthermore, the development of large negative output gaps is not just the result of domestic factors. The current crisis is likely to be a once-in-a-generation event, affecting all countries world wide. The falls in external demand and remittances are clearly external factors, as well as disturbances in international financial markets and the resulting global changes in liquidity and capital flows to emerging and developing countries.
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Temporary discretionary fiscal actions, as well as monetary policy easing, are precisely suitable for overcoming the demand shortage. Many countries, most notably major economies but also many emerging economies, are rightly adopting various fiscal stimulus measures (see Table 2). In CESEE countries, government debt is generally low in most (but not all) cases (see Figure 4). In principle, this would provide even more room for discretionary fiscal stimulus. Having said that, the viability of discretionary fiscal stimulus in CESEE countries has to be looked at from the angle of country-specific circumstances. First, financial constraints pose unavoidable limitations to such policies. Even countries with low government debt levels and substantial fiscal reserves, such as Estonia, are seriously constrained by the revenue shortfall resulting from the unexpected depth of the recession. Contingent liabilities should also be taken into account when deciding on discretionary measures. The crisis has substantially increased the risk of further government intervention in the banking system. Furthermore, the debt level tolerance of markets is lower for emerging and developing countries than it is for major economies. Government debt defaults occurred at reasonably low debt levels (see, for example, Sturzenegger and Zettelmeyer, 2006). For example, among recent cases of government default, the public debt-to-GDP ratio was 37% in Ukraine, 45% in Argentina, 54% in the Russian Federation and 66% in Ecuador, in the year before the government default. Second, the impact of the fiscal stimulus on the domestic economy crucially depends on whether a country is large and closed, or small and open. In small and open economies, the effect of the stimulus can easily show up in increased imports. The Great Depression taught us that protectionism can prolong the recession and hence this is not the path small and open countries (and of course all other countries) should follow. On the other hand, small and open economies can benefit from the stimulus implemented in their main destination markets through trade and migration links. Third, the results of the fiscal stimulus very much depend on the strength and credibility of fiscal institutions. Figure 11 presents the four out of the six World Bank governance indicators on which governments have the greatest impact. Although large variation is evident, in many countries government effectiveness, regulatory quality, control of corruption and the rule of law still lags substantially behind the EU15 and the United States.24 Fourth, related to the previous point, the potential effect of stimulus programmes on investors’ confidence should be considered. The weaker the credibility of the stimulus programme is, the more likely it will result in increased risk perception and, eventually, higher interest rates and capital outflows. Fifth, as capital is becoming scarce, the potential for private investment to be crowded out is also an important factor for countries facing external financing constraints. Regarding the above list of issues, there is a key dividing line between CESEE countries. On the one hand, the Russian Federation is big, has low debt and substantial fiscal reserves and hence may be less exposed to the risk of loss of investors’ confidence, especially since the rouble has been allowed to depreciate significantly. Discretionary fiscal stimulus was the right decision for the Russian Federation. Azerbaijan also has substantial reserves and its economy is still expected to grow by about 7.5%, both in 2009 and 2010 (see Figure 1).
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Figure 11. World Bank Governance indicators, 2008
Government effectiveness Regulatory quality Control of corruption Rule of law
2.0
1.5
1.0
0.5
0
-0.5
-1.0
-1.5
EU15 Malta Latvia China Estonia Cyprus Poland Asia25 Croatia Turkey Serbia Albania Belarus Slovenia Hungary Bulgaria Romania Georgia Armenia Africa48 Moldova Ukraine Lithuania CESEE26 LATAM32 Azerbaijan Montenegro United States Slovak Republic Middle East13 Czech Republic Macedonia, FYR Bosnia/Herzegovina Russian Federation
Note: The average score of all countries of the world is zero. Countries are ordered according to the average of the four indicators. Source: World Bank (2009), Governance Matters 2008, The World Bank, Washington DC.
On the other hand, all other countries have much narrower or even zero scope for discretionary measures, though there are important differences between countries. Poland and Turkey, for example, are larger countries than most of the CESEE, and their debt levels are around 50% of GDP. Such a debt level is higher than in many other CESEE countries, but still at a level that does not itself pose a risk of a loss of credibility, provided that the stimulus package is implemented in a credible and timely way. The Czech Republic, Slovak Republic and Slovenia, the latter two of which enjoy the sheltering effect of the euro area, also have greater scope for fiscal stimulus, as they did not accumulate significant vulnerabilities before the crisis. However, their small and open economy characteristics certainly limit the effectiveness of Keynesian policies on their domestic economies. Countries that have had to rely on IMF programmes have no scope at all for stimulus, and other CESEE countries should be very cautious as well. The limited scope for fiscal stimulus leads us to ask if the crisis can be used as an opportunity to reform fiscal institutions, improve their quality and embark on a necessary budgetary consolidation. As we discussed in Section 5, many previous crises prompted substantial fiscal reforms and serious budget cuts, despite earlier arguments that challenging interest groups and reducing public expenditures would be impossible. External financial constraints, while costly in the short run, help to expose the weaknesses of fiscal institutions, and prompt reforms that have the potential of paving the way to much better macroeconomic outcomes. The crisis is certainly very painful in many respects. Unemployment has increased dramatically in many countries; many people have lost their homes; many corporations have gone bankrupt, etc. However, the crisis, and especially its global nature, also helps in communicating to the general public the need for budgetary adjustment and structural reforms, including fiscal reforms.
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Still, there are limits, and highly pro-cyclical budget cuts during a severe recession should be avoided. For example, the latest forecasts for GDP falls in Latvia in 2009 are in the 15-20% range. The Latvian authorities decided to maintain the exchange rate peg and had no other choice but to rely on the international community for emergency financing. As the recession became much deeper than what had been seen up to the point when the programme was designed, the budget deficit widened even more, requiring additional and substantial fiscal efforts to limit it, so that Latvia could receive the subsequent tranches provided by the financing programmes. This happened even though international financial institutions agreed to somewhat higher deficit levels. In June 2009, the Latvian Parliament passed a new budget law with additional cuts. While much blame can be laid on the Latvian side for past behaviour (in particular, fiscal expenditures were increased substantially before the crisis and little was done to limit the credit boom and the huge current account deficit) the EU should be more flexible with regard to Baltic aspirations to join the euro area.25 Regarding budget policy options for the future, some general principles could be laid down: ● As a priority that is relevant both for the very short run and the longer term, the good functioning of the financial system should be maintained. At the same time, so-called “zombie lending” should be avoided.26 ● The crisis should be used as an opportunity for structural reforms to enhance growth in general and fiscal frameworks in particular. Reforms to avoid future pro-cyclical policies, and to increase credibility and the quality of budgeting, such as fiscal responsibility laws comprising medium-term fiscal frameworks, fiscal rules27 and independent fiscal councils, should be considered where such institutions do not exist. When fiscal consolidation is accompanied by fiscal reforms that increase credibility, non-Keynesian effects28 may offset the contraction caused by the consolidation to some extent. ● Protection of the most vulnerable should be prioritised. Unemployment has different social consequences in rich and poor countries. In poor countries, household saving is typically lower and the risk of poverty is larger. ● Debates over healthcare and pension reforms should be re-opened, especially in countries facing serious demographic pressures. ● Spending on pro-growth policies, such as education and innovation, should be maintained but rationalised so as not to destroy the longer term post-crisis growth prospects of these countries. ● Long-term fiscal sustainability should be highly prioritised. All of the above recommendations would contribute to this. How to do all of these at the same time when significant fiscal consolidation is needed in many countries? There are some countries that did manage this during crisis episodes. Let us quote a sentence from Henriksson’s (2007) excellent essay on “Ten Lessons About Budget Consolidation”, which was inspired by his active involvement in the dramatic Swedish budgetary measures that were taken after the crisis of the early 1990s:29 “The bottom line may thus be: if you have to consolidate, wait for a deep crisis to occur, and it will be easy to do, easy to communicate and easy to be re-elected.” The crisis is here now and the opportunity should not be missed.
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Notes 1. This article analyses 26 countries of central, eastern, and south-eastern Europe: 12 central European and Baltic members of the EU (Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Romania, Slovak Republic, Slovenia); the 7 European Commonwealth of Independent States (CIS) countries (Armenia, Azerbaijan, Belarus, Georgia, Moldova, Russian Federation, Ukraine); 5 non-EU countries of former Yugoslavia (Bosnia and Herzegovina, Croatia, FYR Macedonia, Montenegro, Serbia; data for Kosovo are not available), and Turkey and Albania. The information in this article with reference to “Cyprus” relates to the southern part of the Island. There is no single authority representing both Turkish and Greek Cypriot people on the Island. Turkey recognises the Turkish Republic of Northern Cyprus (TRNC). Until a lasting and equitable solution is found within the context of the United Nations, Turkey will preserve its position concerning the “Cyprus issue”. 2. In our view, comparison to a benchmark, i.e. the downward revision of the forecast level of GDP at a future date, is a better measure of the severity of the crisis than the actual fall in GDP. For example, zero growth has a different meaning for a country that has been used to growing and was expected to continue to grow in the future by 2% per year, than for a country in which these numbers are 6% per year. Nevertheless, we also show and discuss actual changes in GDP. 3. China is included separately in Figure 1. 4. See Darvas and Szapáry (2008) for further details on capital inflows and credit growth in the EU member CESEE countries. 5. For example, Latvia is trying to implement heroic efforts to cut the budget deficit in the context of a GDP fall of about 15-20% in a single year. 6. It is preferable to use government consumption rather than, e.g. government expenditures or balance, for studying the pro-cyclical nature of budget policy, because these latter indicators are strongly influenced by the business cycle (e.g. through transfers, debt service and tax revenues), while government consumption is a more direct policy tool. See Kaminsky, Reinhart and Vegh (2004) for a detailed discussion. 7. Quarterly data before 1995 are generally not available for CESEE countries, but even if available, they are likely burdened with substantial structural changes. Still, our sample starting in 1995 may also include structural breaks due to, for example, changes in fiscal policy regimes, which would necessitate time-varying parameter SVARs. This issue is left for further research. 8. Note that impulse response functions in SVARs measure the effects of unanticipated shocks. 9. In the case of Poland, the Schwarz information criterion suggested two lags. However, with two lags the estimated model turned out to have an unstable root, and the impulse response functions became explosive. We therefore used only one lag for Poland. 10. Using a panel of developed countries, Ilzetzki and Vegh (2008) also found such a pattern. 11. For example, Greece has had much higher government debt and a much higher current account deficit (as a percentage of GDP) than Hungary in the past few years. Immediately after the collapse of Lehman Brothers, Hungary experienced serious speculative attacks on its currency and government bond markets, and had to rely on a multilateral financial assistance programme, while tensions in Greece were milder, at least till the finalisation of the article (November 2009). Hungary’s current account deficit is expected to shrink from 6% of GDP in 2007 to 3% of GDP in 2009 and 2010, while Greece is still expected to have a current account deficit in excess of 11% of GDP both in 2009 and in 2010, according to the October 2009 forecasts of the IMF. The government debt- to-GDP ratio is also expected to remain much higher in Greece than in Hungary. In June 2009 the spread over German ten-year government bond was 186 basis points for Greece and 668 basis points for Hungary. While macroeconomic indicators were in many cases better for Hungary than Greece, Hungary was still one of the weakest among the new EU member states, and hence it was not surprising that Hungary was the first to turn to the IMF for emergency financing. Our calculations indicate that Hungarian fiscal policy was the most pro-cyclical among the 26 CESEE countries, and government debt was also the highest in 2007 (Figure 4). Government expenditure (as a percentage of GDP) was also the highest in Hungary and not just because of higher interest spending. By using a proper method to compare government expenditures in four new EU member states, Kiss and Szemere (2009) conclude that the Hungarian government spends considerably more than its neighbours.
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12. Ahearne et al. (2009) estimate the potential migration impacts of the crisis for new EU member states. They found that in the short run, the crisis is likely to lead to a lower stock of migrants from the new member states in the EU15 than would have been the case without the crisis, on account of diminished job opportunities for migrants. By contrast, in the longer run, the crisis is set to lead to an increase in migration from the new member states, compared to what would have happened without the crisis. This is because the crisis has undermined the economic growth model of those new member states that relied heavily on external financing to fuel their growth. 13. See Darvas and Veugelers (2009) for a detailed analysis of growth prospects of CESEE countries. 14. At time of finalising this article, November 2009, stock indices have increased substantially from their bottom in February/March 2009 and currencies also have strengthened in most countries. The future outlook of asset prices is uncertain. Still, the current levels of, e.g. stock prices, are still just a fraction of their pre-crisis values. 15. See Égert and Mihaljek (2007) on housing prices and their determinants in some CESEE countries during the boom years. 16. At the same time, the fall in commodity prices improves the terms of trade of commodity importers. 17. The IMF programme for the three EU countries (Hungary, Latvia, and Romania) was part of a coordinated international lending programme. The EU and the World Bank contribute to all three programmes; the Czech Republic, Denmark, Estonia, Finland, Norway, Poland, Sweden and the EBRD have contributed to the Latvian programme; the EBRD and the European Investment Bank (EIB) have contributed to the Romanian programme. 18. As a precautionary measure, Poland has applied for, and received, the IMF’s new Flexible Credit Line, which is granted to countries that adopted sound policies in the past. 19. Main sources for the Russian summary are IMF (2000, 2001) and Åslund (2007). 20. By studying 85 fiscal consolidation episodes in 24 OECD countries since 1978, OECD (2007) finds that consolidations based on expenditure cuts, including social spending cuts, tended to be larger and longer-lasting than consolidations based on revenue increases. 21. Key elements include reduction in, and consolidation of, social fund contributions, improvements to VAT, sharp reduction in turnover taxes, the introduction of a flat personal income tax at a reduced average rate, strengthened excise taxes, amendments to the profit tax that reduce the rate while eliminating most exemptions, and a new simplified system for the taxation of mineral resources. 22. As OECD (2009) emphasises, temporary factors have also contributed to the strong recovery after the Russian crisis of 1998, including the undervaluation of the rouble, low capacity utilisation and spare labour resources. 23. The main source for the Brazilian summary is Goldfajn and Guardia (2004). 24. A direct measure of the quality of fiscal institutions is presented in, e.g. Fabrizio and Mody (2008), for EU member countries (for which data are available). The index shows that some EU member CESEE countries lag behind the EU15. 25. There are serious concerns with the euro accession criteria. Two decades after the designing of the criteria and one decade since the launch of the euro, it is time to reform the criteria and to strengthen their economic rationale. There is a straightforward way to do that: the EU treaty itself specifies an obligation on the Council to lay down the details of the convergence criteria and the excessive deficit procedure. See the economic and legal aspects of reforming the criteria in Darvas (2009). 26. On zombies see, for example, Ahearne and Shinada (2005) and Caballero, Hoshi and Kashyap (2006). 27. Kopits (2004) argues that fiscal policy rules (if well designed and properly implemented) can be useful commitment tools for emerging market economies exposed to macroeconomic volatility and high capital mobility. They can be instrumental in avoiding myopic policies that result from dynamic inconsistency and or/political distortions, and in a broader sense they can help to depoliticise the macroeconomic policy framework. Regarding the interaction of fiscal rules and fiscal consolidations, OECD (2007) finds that countries with fiscal rules achieved better results in consolidating public finances. Furthermore, fiscal rules can also contribute to better performance in a monetary union. As Darvas, Rose and Szapáry (2007) have shown, when a country has a chance to run a substantially and persistently higher budget deficit than other countries, it likely creates idiosyncratic shocks that result in the business cycle deviating from that in the rest of the
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currency union. This would violate one of the most important criteria of the optimality of currency areas: the synchronisation of business cycles. 28. The “non-Keynesian effects of fiscal consolidation” refers to increased private sector demand in response to cuts in government spending. If fiscal adjustment credibly signals fiscal sustainability and reduces the expected tax burden on the private sector, private sector demand may start again to compensate for the fall in government demand. Rzońca and Ciżkowicz (2005) present evidence that non-Keynesian effects were indeed in force in new EU member states. Giudice and Turrini (2007) study fiscal consolidations that have been undertaken in the EU in the last 30 years and conclude that roughly half of these episodes have been followed by higher growth. Their results indicate that the consolidations that turned out to be expansionary were more likely to have started in periods with output below potential, and to have been based on expenditure cuts rather than on tax increases. 29. As a result of the budget consolidation measures, government debt in Sweden turned out to be 53% of GDP in 2000 instead of increasing to 128% of GDP, as was projected by the OECD in 1994 (OECD Economic Outlook).
References Ahearne, Alan, et al. (2009), “Cyclical Dimensions of Labour Mobility after EU Enlargement”, Bruegel Working Paper, No. 2009/2. Ahearne, Alan and H. Shinada (2005), “Zombie Firms and Economic Stagnation in Japan”, Hi-Stat Discussion Paper Series 95. Åslund, Anders (2007), Russia’s Capitalist Revolution: Why Market Reform Succeeded and Democracy Failed, Peterson Institute for International Economics, Washington DC. Baksay, Gergely and Gábor P. Kiss (2009), “Act One, Act First – The Law on Fiscal Responsibility”, Magyar Nemzeti Bank Bulletin, May, pp. 15-23. Blanchard, Oliver and Roberto Perotti (2002), “An Empirical Characterization of the Dynamic Effects of Changes in Government Spending on Taxes and Output”, The Quarterly Journal of Economics, Vol. 117, pp. 1329-1368. Caballero, R., T. Hoshi and A. Kashyap (2006), “Zombie Lending and Depressed Restructuring in Japan”, NBER Working Paper, No. 12129. Canova, Fabio (1998), “Detrending and Business Cycle Facts”, Journal of Monetary Economics 41, pp. 475-512. Collins, Susan M. (2006), “Commentary: Patterns of International Capital Flows and Their Implications for Economic Development by Prasad, Rajan, and Subramanian”, proceedings, Federal Reserve Bank of Kansas City, pp. 159-167. Darvas, Zsolt (2009), “The Baltic Challenge and Euro Area Entry”, Bruegel Policy Contribution, 2009/13. Darvas, Zsolt and György Szapáry (2008), “Euro Area Enlargement and Euro Adoption Strategies”, European Economy – Economic Papers 304, Directorate-General for Economic and Financial Affairs, European Commission, Brussels; also published as a chapter in Marco Buti et al. (eds.) (2010), The Euro: The First Decade, Cambridge University Press. Darvas, Zsolt and Reinhilde Veugelers (2009), “Beyond the Crisis: Prospects for Transition Economies”, mimeo, Bruegel. Darvas, Zsolt, Andrew K. Rose and György Szapáry (2007), “Fiscal Divergence and Business Cycle Synchronization: Irresponsibility is Idiosyncratic”, in Jeffrey A. Frankel and Christopher A. Pissarides (eds.), NBER International Seminar on Macroeconomics 2005, MIT Press, Cambridge, MA, United States, pp. 261-298. Égert, Balázs and Dubravko Mihaljek (2007), “Determinants of House Prices in Central and Eastern Europe”, Bank of International Settlements Working Paper, No. 236. European Commission (2009), “Public Finances in EMU”, European Economy, 5/2009 (provisional version), Directorate-General Economic and Financial Affairs of the European Commission. Fabrizio, Stefania and Ashoka Mody (2008), “Breaking the Impediments to Budgetary Reforms: Evidence from Europe”, IMF Working Paper, No. 08/82, International Monetary Fund, Washington DC. Giudice, Gabriele and Alessandro Turrini (2007), “Non-Keynesian Fiscal Adjustments? A Close Look at Expansionary Fiscal Consolidations in the EU”, Open Economies Review 18(5), pp. 613-630.
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Goldfajn, Ilan and Eduardo Refinetti Guardia (2004), “Fiscal Rules and Debt Sustainability in Brazil”, in George Kopits (ed.), Rules-Based Fiscal Policy in Emerging Markets: Background, Analysis and Prospects, Macmillan Publishers Limited, pp. 114-130. Henriksson, Jens (2007), “Ten Lessons About Budget Consolidation”, Bruegel Essay and Lecture Series. Ilzetzki, Ethan and Carlos A. Vegh (2008), “Procyclical Fiscal Policy in Developing Countries: Truth or Fiction?”, NBER Working Paper, No. 14191. IMF (International Monetary Fund) (2000), “Russian Federation: Staff Report for the 2000 Article IV Consultation”, International Monetary Fund, Washington DC. IMF (2001), “Russian Federation: Staff Report for the 2001 Article IV Consultation”, International Monetary Fund, Washington DC. IMF (2009), “Fiscal Implications of the Global Economic and Financial Crisis”, IMF Staff Position Note, June, International Monetary Fund, Washington DC. Kaminsky, Graciela, Carmen Reinhart and Carlos A. Vegh (2004), “When it Rains it Pours: Procyclical Capital Flows and Macroeconomic Policies”, in Mark Gertler and Kenneth Rogoff (eds.), NBER Macroeconomics Annual, MIT Press, Cambridge, MA, United States. Kiss, Gábor P. and Róbert Szemere (2009), “Apples and Oranges? A Comparison of the Public Expenditure of the Visegrád Countries”, Magyar Nemzeti Bank Bulletin, May, pp. 35-47. Kopits, George (2004), “Overview of Fiscal Policy Rules in Emerging Markets”, in George Kopits (ed.), Rules-Based Fiscal Policy in Emerging Markets: Background, Analysis and Prospects, Macmillan Publishers Limited, pp. 1-11. Kopits, George (2008), “The Political Economy of Fiscal Reform in Central and Eastern Europe”, OECD Journal on Budgeting 8(3), pp. 127-137. OECD (2007), “Fiscal Consolidation: Lessons from Past Experience”, in OECD Economic Outlook, Volume 2007 Issue 1, doi: http://dx.doi.org/10.1787/eco_outlook-v2007-1-40-en. OECD (2009), OECD Economic Surveys: Russian Federation 2009, OECD Publishing, Paris, doi: http:// dx.doi.org/10.1787/eco_surveys-rus-2009-en. Prasad, Eswar, Raghuram G. Rajan and Arvind Subramanian (2006), “Patterns of International Capital Flows and their Implications for Economic Development”, proceedings, Federal Reserve Bank of Kansas City, Kansas, United States, pp. 119-158. Rzońca, Andrzej and Piotr Ciżkowicz (2005), “Non-Keynesian Effects of Fiscal Contraction in New Member States”, ECB Working Paper, No. 519. Saha, David and Jakob von Weizsäcker (2009), “EU Stimulus Packages”, Bruegel Policy Contribution 2009/2. Sturzenegger, Federico and Jeromin Zettelmeyer (2006), Debt Defaults and Lessons from a Decade of Crises, MIT Press, Cambridge, MA, United States. World Bank (2009a), “Russian Economic Report No. 19”, June, The World Bank, Washington DC. World Bank (2009b), Governance Matters 2008, The World Bank, Washington DC.
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ANNEX A
Budget policy measures in CESEE countries
OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010 31 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE
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32 OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE
e n g r n t cy u ci gh n atio n nsur e u s t a o s d p lti-yea n r n urr u ’ the to e to m path, s a r r d-By r t m al fi s ability; s n s de de itie n rn e ce r ta r r d capitali n i m (to 40% of d the c d the un S m-te o tai n a r r u u n n tho a m to the la the m to ce u u eq t exte u sus r n amme (3% of GDP n d eallocated th r IMF m te r n n u idity a m blic fi r m to the la afeg e og u ce. r u s u fficie n ur amme). amme) i amme) d r r able medi n g-te to su dit n n itive bala s og og cal p cal fide n e ate liq r r s s n tai D 1.57 b u the Adde the ur the medi S t (IMF). The a n n olidate p ce lo n ec ce P ce P sus g po n e co s n n ns r a et i n g expe adeq i , the Adde a s n dget Act of 2008 n
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io n n ns e by 10% r n fe atio ide t s a n ce). The e with the s J lt of 3.3% of d expe dgeta 1J io s co [FT]). n sur n n rn n i ns n ns u n e 2009, Latvia n s ea a evi ed capital n su a ded tme li te ns r i r will be will r n e n s u ced, a n n un s r opea co t Commi dget, th dget, m a u d r ns cl May 2009 with a ce o r , i olidatio n ve n u g n r ur n n ded leadi y of Fi g mea s oved i n d will be p ed efit n t de r i r n n ns r d i t n n efo u ctio , i s y of Fi s n r t , 18 J eco s i r un u e (E ns cial Time opea to fo t t a avi s u tate-ow n tate b ce). Admi , a e n s s n s app n ur i s
r ur ame s a n s 2009 –, pe 2009 –, olidati e c n et by the i by et t n s tal be tal ly ( ctio a d n a dit dget c dget s u me amme. New b n n dec will dget u u n (E s wage eviewed i eviewed will be ur ns r ). Red n u ive tax tax ive e u r r s un d s J r
rn n t ed (Mi t). e c e , wa r f off n dit r og ns n r t b s io un n r Les Echos n n ur ur 2009 (Mi ns g ie al co ns d i dget) withco ecto of 4% of GDP. The of 4% of GDP. 2009 b idated i idated the io ss o pa y of Fi me n n n s n u s t expe ehe n epo r wage bill to fall by 20% – fo wage bill to fall u itial 2009 gove g p e to come i s dit dit d time i d time r ce: ity f t r r ur g n di ns n n rn n n n n ctio ifica m s e f n i n ditio ur un ur u n u di s blic n t n d al o e liq J n pe ig u urr r u tate b tate ec avi eco n ecto S ed n c p The expe a compa expe 4% of GDP (Fi withi a GDP, a GDP, GDP. Package of of Package GDP. additio expe s wa Mi s gove Commi to pe s S S ( The i comp co EMU r le i s a s The whole b
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n t , s o r t). s g e n t s d r g to n ss s m to m to n gh i e of n e r ove ove g u n wa sur ti r n t (EMU n y of epo omote omote i o us n om the g a owi r r r r u r d t t n un g-te rr i t adopted us r f s c n (Mi r i omic n th n have al have s mea s r n n s ated ated ns blic blic s g ee g b r e g of ppo u n n me n s (IMF). n , amo i d to imp (EMU to impleme i to bo s ology r gi n ecto , tax exemptio , tax su s rn . The pla eco s n e by 1.5% of om lo
ildi t k (Mi n p s s n r idity, to p idity, s s ate wa ate s r ns ss r doi a u n n r f u r well a well age s t of loa s m wage a m wage te ea t s r accele b r d 2009, movi r y Pla d/o edit u n s n atio n fo r hift of p r n c . Thi tech ce, ea n t Ba oject cial e s ivate ivate s e acce s i n r n r ), a n n ee im able n r a ns ppo n to liq r s s d a ce i n s tme ss ta e g i t p e amme n n n s fo e s su r r ga ss n n i n tme l s r n come tax tax come g job i g to i ti ditio , a s ve 2008 a u the p n og ss fo ma n oject s n n n n r i r r r ocial payme ocial n n us of fi of ve tme tive n t v di s ve al i the mi the n n
s fo d i n s t p n y 2009, the gove oved (tax c oved (tax n r n n n I atio g to o g to n tai r r n g fo g b package g co m p i ve o omic Recove omic cial a cial s ce n n a n r pe i n n n omy). s y pla a e i n n e i ctio n n s r rs us s di n s s to EU/OECD ave a ru u l rn t m t). ce). ce). tme r n r app n r u ovi r t-te oximately 5 % of GDP with the aim of gy pe owi s n e ea ea r r r r n opea od r r a s fi the mo the r rr -le i blic e d mai r r c Feb ve c t n amed withthe ome i tim ocial ur n u n ho n epo ecove r n n n n n r e of Eco The pe s i E EU fi i expo fo mode f r to facilitate acce facilitate to bee i fo I Fi S bo o p a S S GDP betwee I facilitati clo the Eco app imp ia y n r t a u un Co Latvia Lith
36 OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE s Note r ecto s cial n a n the fi the r t fo r ppo Su e nu eve r of n tatio n gme u A e e: t n ur nu dit with with d 2009 n itme eve s n r e of e ru s ur ly capital ly capital e, til e ec ea n ced r r t expe ur dit u , c u un n
s n dit ed n r n il) c t (mai r ed i n atio expe e r wage n t nn n n i s t expe t i n ns n n e atio r ctio dget (Ap t ctio urr t of pla s u u u i ). compo n c s n s ed t ed n e r r r i ed b ur the admi d n eme g s n n n n dit evi di n ctio r n tpo u blic admi s eeze i pe u ed r (EIU) a p f expe r by 7% to match expected expected match to 7% by po high impo S The
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n r u a i su itial pla itial rs r ib r r r
dget; c n n r s ct n e n r ly di di cl p t u p , co-fi ofit i n ch 2009, adopted n u to th to n n n r ru : i r g a s tio r t n t impo , altho s cl ow , i n d/o u s i s s e d othe t of the a
n n s n r ed b ate r idity p ib r n d impo r -yea Ma tem. Howeve well a r , i s able ie a u et of meaet of t la r if eve n s t s n n s sur n s ce). s r , a n e u y s a n with good fi ie evi oject s ocial co ocial s n (122% of e e d r r l s a s ot pa n r r s eve eg n t
u y 2009, p n n r r s ie tee
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t : a : a e p n s a ity co i n n n t v s u 2008 offe with liq with s a t us ce. The mo (EIU) a s of mea of ur t r amme will will amme ur s nu r wage b n s n r package u a rs ct ed i ed. Thi s e ie y of Fi ec ted to capital ow u e wa et s ss t compa t to compa r n n n og us s ru u t s r r ma il 2009, divided i l o r t ,etc. ,etc. r s r r idi de c i u ib s sur s the cha the th EUR 8 b s r tpo t u a n ee fo t r the mo the s r s r ppo r ppo b s ambitio to compa to edit g r cl s f Ap om 1 Ja ocial ocial tim r n s r n n n facilitate expo facilitate su mea c employe the g S i pe su su that p co Novembe fo wa f di i adopted package wo i a yea 17.5% a GDP, po (Mi package EUR 300 m (4.6% GDP) i S Th i a compo compa ia, n y r t un FYR Co Macedo
OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010 37 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE
n d n a t it bee n u g will be s n ctio di t ha u n n le ed r r me ty rn the r May 2009 b ur n y f n pove ed i r r ew gove n ee-yea til a til a r un th likely that that a likely s un
s s oved r med (EIU). med owth facility expi r r eem g fo s app Note The IMF’
al to to y r s ate ate t r n of r a om . n n r s ce, g e n r k io n n r (f take dato n a a r s ed ci n ns n atio s k s n cheme to r k de n a s ecto badly hit n 2008 to ea edit flow to n s r s r teg r un
exte c d ma cial ba n efi r tee tee r n n n y of Fi r i n r i ot a cial a t a cial ba cial s ic n n rn r s s r cial ba o fa
i s a r a t the c i s s capital. The Ce The capital. te n r n u s p to EUR 100 000 s n e k eptembe u
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sur tem i tem s r it n ly 2009) a ced ba ced s k). the fi the by comme su s u r u y n s s J e of comme ed ee comme n r s t fo r depo t the ba t the e little we e little
ly mea ss r r s s depo e n al Ba al cial cial ve r us r n r n t k of Moldova ha i idity to idity e a ly th ppo n n ppo om 21% i u s n n r us e cove (EIU). Malta’ well a well su beca O (f 22% to 16%) (Mi Ce b liq Su The o Fi by fo backed Ba 11.5% i r
t s u e i li, b y of sur elated elated u r r t e s i tim ur . n s mea n s dit d n n (0.4% of GDP) cal (Mi e atio s s s r e t nu ty a s gh thi i u u sur n eve r of expe e d itiative n s n of i r n elated to fi to elated tal mea r t), altho ate policy objective objective policy ate ectio exci r r n r n tatio othe me e i epa edi epo n s ectly r r n s ced tax admi s r d ce). n o r n r ea r a gme ha vi c n u ot di n n n to the the to had a towa Fi e (EMU n A I E
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n n cal t s d u n evi (1.4% s u t s s r ed n i o s the fi the dit t n r ew wage tit s n y of n n n e a t. The n y of r r blic blic n t r ns t i y idie t u maki epa s n urr idie i gh thi s n s r eeze; eeze; dget c dget n i s al i n u r b u n ec b io n effective r t f g admi d p s liame su highe n n
the p the n r of vaca of n su of expe elated to fi t of a t of liame r n (Mi n r n r n (Mi ate policy objective objective policy ate of di s n i ted b r t i catio s u of the abolitio s of i n t n ns u s itme t), altho tate n cl u ctio r s g pa ew pa epa n ed deci eme m
ectio u ru tio ns ectly ectly r d othe s r n n r ibility a ibility n r n u atio n itiative ec ed i olme epo r de ati r te r de: c ivilege n ns tit r n edi ctio r r n tpo n i u nr r the u r s ot di i ns g; g; teg po r cl pecial ed pecial d a n n s n d p n t impleme ctio
n ed s i n t had a e ope i r n n fo s u al i i s of e r r u y a n (EIU) a
s s a n r n g othe g; po g by 20%, i s s e i e ea ed s latio al s me n ns n n r r e e o s ct da s it d li, b c ce). ce). di r r rn di di u n p ctio u sur sur n n n n r catio itio n n u sur a a nus s de u od opo n n pe ha r r tim eco pe pe ed elated to the to the elated Fi towa r r of legi bo ed clo Fi of GDP) (EMU mea s po p gove half ofhalf 2009 hi bill i bill s S S Lack of a s p un mea s
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n n s t, i g, g, io r a s k of g t n d the r i g mp i mp n ’ u t ss rs ced a a ced n mp, e p to p to n u s ld be g hit e i l r ur ppo of u u us u n e ba l n s
t s r olli un ized e a a r r k). s s r will be ted omy omy o su s t s n ea s s of n fact ur t e n r r bei amewo ehold nn s s c m- mbe s ct r ve ppo g to j Commi ity co nu . m fo n u n n e 2009, us s n omic po ru u r nu g a su al Ba i ur ti om the t ei
mbe n r r r n r e-by-ca s r amme package, b package, t ur
r ec s ME a the f un n t a t a g ma nu n r g f s d ho ce of co of ce S us n opea f ato to hotel ow s t p n l
i d/o n befo og n r n n r i d medi n ti r u n of the eco n e ur r ns r i t havi n y, which i y, ss r a ca a n able ome mode r a n n ), a r t p t n t fo s (E ffe g the s ocial ce, Ce fe tim s tme e r n t mo t i r r e aimed at at i e aimed s o tax o o tax n s n ppo s t, withi n us r n r n atio me k loa su l a r te
ci d ade, amo , to a d s n a ME u n mall a mall su ve r s n d by the eco d by u rn n n ppo tme cal s r s S n ns ali s om VAT. om VAT. tme s t, t, e m t v . r ba i ppo ( ed r r t). d su s al t ty, ze ty, n r s r m i n s r g powe ve eceived eceived , albeit o , albeit n s n ns s package e r su applied eve ed, a n sur n ve i o e i latio epayme y of Fi fo s ed rs r me s g the i n n i libe r n r o s tic fi s u by us t r r epo ur mal fi mal n g n ced. t l s atio m a s s r r nu r s p o n tai ity i ity n i s u ato ci i eg r r i r ti rn r n al r n cha the u pectio the mo the geted n blic i blic e yea e te vi ha s io pecially ha pecially rn ur r te r tim r u ur n n s ur n n ed n ns p p EMU i (Mi (EIU). The mea e EUR 3.7 m (0.06% GDP). The to e dome ope exempted f exempted F ta capital capital o with the gove e to ea EU fo r Tax am Tax S No fo P e i Co ha bodie mai Impo y r t un Co Malta Moldova
38 OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE
s n
ss of d i n e a d r blic blic n n n k of ns n n u s tio i ocial dby oce r u a r s n ctio ptio s e the e the e we ib r hip a d u ta ditio e r r s g p o t g a s n n d ivate ivate s n ified p ss n ed n r ea n urs implify implify r e r
d EBRD e s c r n a un goi . The n i n ly. n n d s n d e DR 13.69 b n r e n us the n blic-p S a g the co g the u b t o p the ab p the ss ep ur ocial co capital a capital s r n r catio e (MoF).flexible IMF d, implyi d, n u s n t tially i tially s u n n t of i i n k, EIB a n fo d ovi s le me n n r ded f ded ta e un age p us ed oject ns g e ru s s r u ru peed n t n ur t b s i cl de ea om the EU, IMF ( n s ibility law a ibility law d beyo n r r ld Ba ns co su tax a tax blic debt (IMF).blic debt ew b r lati ur n i c to f m n n u n ns u s n n r y i n by imp i e r eme i p s , e s r a the amo the po t May 2009. g p u s tim efo ur s n n u loa e will e will n r n d s tem. sur e i take t), Wo g
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p r t).
n n u r gh gh r p to p to e u io u ppo ,
fo o will ss s epo us s have s s opea r r r su s , ve ur s tee eg ). tee tee to to y of r t), tho s n r n s n n r e ecto t a k a a s idity idity s s te r r r i n e tee u a n a a y bill (EMU r Commi n epo n u u u s n r a y g the E cial r r al g k liabilitie , liq sur n n a o s it g s it g n a u s s s cial ba cial ea ns l n r opea r u ba k of Mo opo it g ur idity (Mi idity n n r s u dicate p p to EUR 50 000 (EMU jectio n e of t the fi the n u n r s oved (EMU , of depo of depo tee o tee al Ba io r g liq r s n n n t g the E g the n t fo a i ss cha al d depo d n n io io r r s s n ce). t). a ur app r ns ns n u ea n r a ppo g opo c n r r epo n (beyo IMF(2009) i bee the p i o Fi followi r i No capital p to 20% of comp Commi Su The Ce Exte Exte allow the comme the allow EUR 50 000, followi
r s d of of n ie n n e fo s d VAT d VAT n ctio ate a ate r u
n od compa r r tio t u n m” tax tax m” (0.2% of GDP) e t i ib ofit a tax s total, 1% of r r su u t n nu tie n tax) fo tax) (i u r d p s mp eve n t). r u r e d ged, b ove s n of epo ocial co ocial . Update of the tax. Update of the ba n ial “l urn r ty taxe s t). s cha r r exci come a rs n n tie un ive t ive tatio u ope e of e i epo e n ove r r r s s r ss t ate i ate e d e r n r ea ea s r r gme c c eg u r n n (EMU tax we tax (EIU). I exci local p GDP) (EMU A I Flat- ( a co
t g) g r n n the the t of the the n e n n n di di n g i t ecto n urr –2.2% idge s n n tate r i pe n pe de s s n il 2009 to s u ated o ated r
me of c r . dget blic blic t n cl r n ed to the ed to the rn u ome u n ce). n tly “b r the the eplaceme Ap s will have have will i n s r ocial n n s (MoF). ce s atio a s ctio d p
r d n n e n ie timated i t r u n co n r s s gove cal tighte cal tate b tate ed i t g to i a s n s s ed n ss sur n i
r s e co i nn ti e n n r , r n t). mptio of the yea i y of Fi s r ns un a r idie t rs pla we ns s able fi able s modified i ctio s s nsu ns r i te t b epo except fo except t s ctio u withle r r n s 2009 – compa u u a (all mi t bill a wage amo ctio su un ide blic admi blic ed ns r
u n n u ctio s u blic job r u 2009. Mea ed e c n i e u io r u ns r i n ed ”, y c ur ur al q r n g e p r g) (Mi ecto ns
n n s dget wa dget s n ns mptio dit dit al amo al u ew p us di io di de co n n ea ctio n mediate co mediate n n r r n u io u ly pe ly ee fi ee dget fo dgeta blic r ns nsu r igi o r cl te pe r u u u pe ed n n n pe ea r o PLN 21 b b expe S Dec ( Va The b i s i (EIU). Red of GDP (EMU th Expe b p co
s s ,
d n e of s ch d n
n al iod r the the y of n elf- n , r s ME r n r
s g of ced. t n sur o ea cial cial S , fee amme amme
s n n ) a catio gh fo cial d s i r oved n ss s r n cial cial ed, rs the s r e u u n n n a e n di t r n n r ha ctio a o g, r n n ed pe og n tai a i aimed at r n u r n well a n r n n s s ce fo pe us di te g the g the ed ce). th t of . (Mi e, ed t app package i package hip a g taxe n edemptio s ppo m fi r r e n s n s r n n amme al fi eamli n r b n ity e ity et at 18% a at et i otectio r i ur r k a ted p ted us n al su n s r t ur l s ho r t by 1% of GDP oject pe ly urs
elated mea elated n ate of pe n ur ur n tate fi ct s t of ce , r r r r s r u hip, a me s e n og o will be s s g-te n ea r dit d n s s ec p ru d atio r rn n tgage g to 0.05%GDP)g to of t n s r e ppo s allowa eatme r n d/o tim urs r s n de p r employed fo employed n rn tme y 2009 (EIU). The g p s e n tic ba a ocial p ocial a ti u u (EIU, IMF). su r s dget- y of Fi hme r n have have s n te ep able s s acket i come tax r a taxe a f o un u s r cl s r e t mo r additio r n r e s t n ve n un n r r amme r e n ocial ocial s urn i t (R&D) t r n n i nu come, ea ai s i n t ss . r l n n r ove n ovide lo ep s oximately EUR 18 m (0.5% ced a al i n eciatio e s r r r u d r og r e u n Ja t g e n d dgeted fo acket ed to r (t fo n i r r able tax t o n n et i et n able g u withi s t. The gove s blic i blic t). t). t v (Mi r od 2008. B n r r un d RON 500 m (0.1% of GDP) n n s t p u sur us rs ly two b capital expe capital ur r oom fo oom b e t of thei aimed at dec to p r t n r n lati g n of the top 40% package ef s ns n
s n ed a ce to dome n l r u n us of b n s e ss e p n i ed dep epo epo t offe t to e t to atio n r u g job us r r tio r e s r s r s l g o al debt, aboli d i ew b ew amme n mea ce [MoF]) [MoF]) ce tme ta u n tai omic dow de pe r r u tim n n t v n sur s e favo n s ea 2009, app ea ea n rn n u s i r s r r tit r a
the mo the VAT VAT mbe 2009 a 2010 to imp d health. The IMF- d developme ppo d r ppo ovide og r eati r r ve c c c come tax i tax come te cl n tim r r n ss n r n eadi epayme n n n n n ns n n n n i p RON 250 m (amo i i employme mea i a coope fo a a i su p r c fo a mo (EMU r Othe fo Fi Abolitio i Ambitio GDP) wa S Fo i Pola Novembe i leavi I mai su 32%. (MoF) Lowe (EMU mo eco I nu o r eg ia y n r n d t te n n un Co Mo Pola Roma
OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010 39 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE
s
s n s ed ed s n r e r d i d ed n ve to s r eig uss a un s sur t wa tatio k fo r e c to e n ea n n n s
s r r ket ket e n c ovide r ns r (EIU). GDP). that the r di n r mea s s s ns i d of fo eeme d i m r r s oved the the r n i o pla bia’ wealth f wealth d ma t a t a decade. r oved i D 100 b r n r t with the EU led EU the t with s d the Ba n n u r followedby two e S n t. Afte n t 20%. efo n o will p S s r e-thi s al impleme g o u ti-c U eig ce 1999. The deficit r r n r ia al ia n n k a . abo app n al bo r i s n collectio s celled celled – to be t al e lo . Pla n eeme s t a r s e n s n r dget dget ded imp ove awi uss ilate ove n r d u s u ce: o s ch 2011) a n atio t with the IMF sur r May, the ag May, we cl un t R al Ba al tom un
e ca me ted fo r s n n n (10% of u r t s rn n age ch b n rn us t’ n two ve n ade ag te package n r r s c y deficit mea ), b we n un e til Ma til r r n s n Ce us eeme s ia’ ced by d l eciated by abo by eciated me r n ate defe 2008 i e le of EU f n r im t un ito e i u gove r r r a r n r ia rn n n pla ru uss n te e tola y 2009). I dgeta ge ge ge tim r n us u to the i l n s uss n ptio a cal ded (
ot impleme omic Developme r u s ey fo ey dby ag r s . n n t b n r o ssur ble dep n d, which ma n nu urn t e of R 2010 (EIU). s e u rs r ta tim u p to EURp to 2.9 b n o et un n mo late P b othe (EIU). (EIU). Fi Novembe Note The R Eco S S u The gove All fi All r o f will be fi be will ab (Ja of the i to a decli (RGE Mo exte r excha Excha i
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actio s o n r s rn s temically A s n tee nsu tlook). tlook). t n uss s it 2008, wa ve ve s n t till fa till dicato n ie u n al Ba ns s r (EIU). (EIU). , i y ecto r r s d i n eig a n EU a
n e pecially by pecially s s s s r r e the c e the r n O n phy s s s k k r t, which wa which t, a r e mitted to joi Commi i n gh R gh e n n n a r u r r n n u r e a eme otectio g to co t, e t, cial r r idity i t capital ha capital t i n n idity of ba 2008, i n ba t to the ba the gove de it g un u n r u a u eme n opea Octobe atio s e pe r s , mo di ce). r , 100 of them r n r J to ba to it p opea i n u un n n a eq s ur e to 2.5% i s n me u it r a eig s . Altho k ur ppo s with a with ge ns y 2009, fo s r i ome catego s k t n limited fo r n r s rn r t le ce a eq s ew liq ew ageme n n r a blic blic e su ie r n e of the Natio e of the n n r the liq the the fi the t of 8% befo 90% of the t un u n d ta r r ge n n nu ( n of depo s ve jectio of fo of t 0.5% i that accept depo accept that o the n t ba ). s i r sur e n cial cial s gove ) (IMFE a s s n y of Fi g the E g the n s r r e t fo t fo led to n al r t n us n io of a ily to la to ily g lice r t s . a s eme ta u s r ns ns r n s e lovak depo lovak r r ia n i un i che che 1 000 ba to o o r ns ns compa e ted, S idity ma idity ed to 1.5% i ki r n mal (EIU). mal s u n r n s r ppo s r d compa rs u t toj n rs opo a ima a om 1 Ja ie uss om 15 Novembe lovak Rep lovak lovakia o lovakia r r r o r n ta ecto u ched r eq ai r r acco ove a followi p t Exte s r impo (Mi mea b S R p No fi s pe liq Thi r c s The mea S ba pe mo The n the Su i Capital F b f (Moody d
t n s n d d n un d tme a s n f n ns ve eco n tobacco a tio s atio ejected by the by ejected n u r s e
o ib n r s t nu n tie tabili om the i om the s u om the eve r r r f f e d n s rs of (total: 0.6% GDP) (EMU have bee n r ocial co ocial ed by fe s s t (EIU). t e
rn n s jectio ns n a n i tatio pilla r ea y 2009) (EIU). ed exci s n me r r n s c a t). io ge rn r n ea n r nu e-off i gme ns c come ea n u epo n n (Ja capital t capital pe r i cha A O Tax i I gove
, n n n d g o oad atio r n n r g take t a n s – i s tate s n s ie
r cal ly falli n t s o bei 2009-10 have n s i o s tate r n s s amme al fi g r fo al admi e al n al n r r s n og e (EIU). –mai g mi r s avi s n n get s e r gi t p ns egio g– a g– r r n : ge n sur s t additio t di ctio e by office u u n u tme , me n ur s ome n pe s ed e c t mea r dit s ve atio n ed, b g n r ur n t g s t n i n n g (EIU). s cal deficit ta deficit cal ai i e mptio dit hi s n r tme di us n
s n n n urr io us t expe t ildi nsu r pe u u ec (IMF). adj bee r b va aboli S Expe The fi C co admi
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us ur ked g to . The that t s n r e of r s a ci , a s n n wa e r e s e rs n s
n ie bee di blic blic ew t a ma ity, ity, s r tax-f n u n n ovide oced r me n us sur sur cha the labo the l r r n tate to d (Mi ur nsur vice o beca u n le othe ru s n r ur s ce). t g p r t a ew ca ew e i ppo n e ec a cheap a e ea n n n s n i s r s s g o a tim ns mea a get ha s su (al atic p t r e mea n
s s r n ea ati ivate fi ivate d fo i r 2008 pla g compa i
r s r r n r de ed with the r ocial i ocial t r gy n c s come employee n n r r the p the c . s i u e of eed to p r n r late 2008. us u n r by the s n s g dema (EIU). e e ta n dget (EIU). dget cl d/o , a n g p s e avi s n n bia u t ea n i n n o d to g r y i ur s rs ti y of Fi ti-c n tme welfa e fo r s able e n ial cha a r s ur di t of EIB i s n r sur ns a r n t n d e S s ke dit low-i r n a n e ily foc s i b ur n r r a i io n r s ve n s r g to the t fi l n a n r ss boo n n u ns fo s e ge ily at accele ily at mea n ced by ced by i s edit li g ima mate g employme r ci e i n s n ceme s r r n t). Novembe i i t v n n n t may al may t the p the n (Mi r p payme pe r i package i package s s r ur (4.1% of GDP) a a n c s i d o : tempo u n n al expe , p us r fo r n package e ltie ima n n s avi r ct us s r ce). n g l y 2009: two othe ctio bala u b e s e i ed by 7% compa epo me r r n r ss n us u ru r s ei me g facility to g facility s l ti-c al level of the b t a late expo a ru e r gthe te t rn idy fo n u n s ced taxe ced n ot off wolay u gy gy n sur n ea ket a ket n ea s i ru r a u tim n r r di r a the mo the e r dget fi ns b un nsu e igi s r r c r f come, cha come, c n tim u us r t peedi imple tim n ed n n n n of diffic s s e co legal legal i gove aimed p (EMU s b r su (EIU). Feb fo co fo A le do co i Mea b RUB 1.6t o i S The fede I 0.5% of GDP fo s package ma of Fi n
y n r atio blic t ia r u bia un r uss e lovak Co R Fede S S Rep
40 OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE t) e s s tem, tem, t
ea s r n n y c e s r n g the g the
n s ity e the mo eached, will eached, m r ur ). r
ur r dby loa dby s o appa ec amo n dit t i efo s s n 2010. ta n r n t ecto s n u ia i s al n ocial ur le i le ible s eeme ct blic , r ru love ss u ru blic expe blic S ns t that will have to i u cal s s io d p
s , if ag ie n n a po r ns n t n o o un ns ket a ket elated p elated r tatio e, pe t with the IMF, b t with the IMF, ns r r . New fi . New n n io ss ma ltatio e p of co p of r s age- uss ur r u c eeme nsu r o s og ot be immediate ( r r thei n labo Impleme (EIU). g Note Co (healthca Di ag p
k s n y r g a tee r n n a ki r r n a etail ba etail r u ecto g tempo s s all n r the ba . n cial fo s s n g a well a n n tee s t will make available available will make t n avi n a , a oblem i r s r a ns d the fi the me u p (30% GDP) i r n n rn a us t fo s k loa io r it n r s e s tem. ba ppo limited g s r y depo un fo s Su The gove EUR 12 b No (0.9% of GDP) e s nu tie u eve r e d s of n t). r exci n tatio e i epo n r s ea r gme c u n (EMU A I the wage bill n ns ai r t s ctio e u r t). ed r r to s g e epo n r di sur n pe (EMU S Mea
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s a o t). Total t). Total epo s s s ki egio . ovi s r n r t r ie rs s u wo n (EIU, tme e r r r t n , t r
e g ctio n us s (EIU). (EIU). n ed b s i n ke n u idie s s rs ss , VAT , VAT r ed p to elimi urs s sur epo , b al al ve g p rs g diffe sur s s
o ie r ecto ocial ocial ppo n ew s p compa ed b oject n n t ea n r n n n r fe s r s r i tme n u n
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c s ecto s su payi su r r n have bee have s u t-
u n ac ifyi ns s n s ate tax c tax ate r r c d additio i s compa e p ome of the mea s egio te a r ve me blic i blic r ew wo ew have bee t i s n n blic ie s r , i r r ss ed ta t n u s n ur n u s n us s rn s
, i u d/o po e d r al ed al et divid tive r ho ct s oll tax, p n n io d al i g the mea g the s n ea s n r n d impo r n
ce fo ce ME (cla r able n n d c n i ru a tme fo gh p sur r ate, a ate, n pecific pecific r t r c t a n n S e 2009 with a s ce). n s r s ce a of a deci a of u idie s ” i e s ce). n n a n s n s package n o omic activity by by activity omic io s n (1% GDP) (EMU a pecific t pecific d R&D (EMU fo m de co n ve , a l a r un compa r s b n egio s s i a n u f u d i ns r n u n
rs r t idity to compa ns mea J 12 rs s . n of pay ME itie n n i idy fo i a n cl r su u u idy i n r t th r r n s tatio S t). t v s fo i n g, us s
edit to edit ns n r 2008: Off l emi eco g i , a b n s ate tax s t allowa r me ieto i n r egio fo b ted. Amo r pa of vocatio r i fo u r n n r e ns r n s ate package to local gove s ti-c s r n
s tio n y package adopted i adopted y package g liq ns atio r s su y of Fi tax c tax su ced i ced n r e c epo y of Fi u t fo r po n rs n op t nsu io us ur al dime t r r hi r tim r s r l ea d taki s ologie ity p t tive r tive ib s tme us n fe s r un t employme r idie i u n e ctio tfall i tfall r s n n ns s n c i s ea o s t r r n ur ee a io u ce May 2008, va r the mo the ns n r n de r b n ppo d co timated: 0.9% of GDP. timated: 0.9% of GDP. ovidi r ce n te to fo to ve ce c a tim i r s nn n ec ecto ole p ho egio ed n r n n n n n – Impleme r tech e a su – Elimi the co co New i su (Mi p impleme a – I (EMU s fo – Wage – Wage Th “wage di “wage exemptio i a tax s exte Mi boo S Recove Decembe i S s developme un r Va I i s t i y ia r n t key un love ur Co S T
OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010 41 THE IMPACT OF THE CRISIS ON BUDGET POLICY IN CENTRAL AND EASTERN EUROPE y r ive ive of of a omy eta ss n n n g ”, g by n s
ctio n n u 9.1% of agi g mo r n od ur eeded (IMF). r t , o k-taki n co n n s oved i oved i s r r , if objective n n , di d allowi ive s n t app ss n , a D 16.4 b flatio n S eciatio ate, to “help theate, eco to “help hock y to avoid policy exce rs eed to the i to the eed r r r i s r n eeme al r d exce ge ge eta ag o owe n n n s rn rr a us n 2008 (U ate dep ate itie r r r g mo dby ag n n atio ge ge i tho g excha s n i n ta t to exte to t u n r s s us hedged bo hedged dolla un policy to foc adj floati GDP) (IMF). GDP) (IMF). The a Novembe Note IMF tighte excha the the r r amme: the the amme: ol ove ecto r r s t og n r cial p n n ll co a u n YR, Malta, Moldova, Poland, Romania, Slovak Republic, Romania, Slovak Poland, Malta, Moldova, YR, k. atio n s peanCountries, held on 25-26 June 2009 in St. Petersburg, the fi the y by Maite de Sola, whose contribution is greatly appreciated. is greatly contribution whose Sola, de Maite by y r eceive f eceive ed ba r s for Croatia, is which also appreciated. greatly t fo r ecapitali r k ppo n tate will ecapitali r s Su Ba me icity icity r by nsu ns elect r tio u ib e r e that co that e t s nu ; highe n co urs eve tho r n e r n io e Eastern and South-Eastern Euro South-Eastern and Eastern fo of r s ns n ep iff r r t n tatio public, Estonia, Lithuania, Macedonia, F Lithuania, Estonia, public, ta ed pe n s s e (EIU). ea r r gme d ga ivate e ivate c u r n n mo p a A I
n
gh s u o e tha
tead of of tead r d s rs ch of the n ns u a s (EIU). s e to wo e to ea u r good gh the IMF ha IMF gh the cal policy i cal n u s e (IMF). M e (IMF). n Budget Central, Officials from ity a ity e o information. The first version of this table was compiled mostl compiled was table this of version first The information. r ur ns likely to come th io r s g of fi g of ed 4%, d the Institute of Public Financeadditional provided information dit n i t decli -p n g i ctio nn n u n n u i o 2009, altho tp n n ed
u n r n expe i g n s n p tighte g i r itially pla itially di n n i n eed to of a deficit 6% of GDP i ha vice n cal tighte r r s pe s e ei bania, Bulgaria, Croatia, Cyprus, Czech Re bania, Bulgaria, Cyprus, Croatia, Czech expected o expected fi the i r ag s expected i expected S A
d n n
t
s n s ocial ocial g a e s of two s n i n t otectio y of ea r r io us r r amme t r g of c s of the of ns n i n ppo n og n r d ho employme k (IMF). su n
dexi n ice i ice amme amme un r r de: 1) p n r u i p iff a otectio n r cl s d/o og r afety p afety r d 3) expa ld Ba n n s r n i able a e ta s gh the r t ga s e flatio n e u ted p ted n n o ns l r r ocial ocial u sur ce; 2) p s tem; a tem; n s t v ppo y agai s s r su package ed the i g (0.8% of GDP) (Mi geted ce ce n r n us n l gh the life-li ce). Mea ce). a tai di u tified by the Wo u n n n n a o the mo the employed th r r n tim tility allowa tility pe nsur un ide u th well-ta fo s Fi of the poo mai S The IMF- i y e Empty cells in the indicate table either no measures or of lack r t n ai un r Co Uk Note: Comments and additions from delegates from Al from delegates from additions and Comments Slovenia, Turkey, and Ukraine at the OECD’s 5th Meeting and Ukraine at of the Senior OECD’s Turkey, Slovenia, Russian Anto Bajo from appreciated. highly also are Federation,
42 OECD JOURNAL ON BUDGETING – VOLUME 2010/1 © OECD 2010