Turmoil at Twenty: Recession, Recovery and Reform in Central and Eastern Europe and the Former Soviet Union (Europe and Central Asia Studies)

Two decades since the fall of the Berlin wall, Central and Eastern Europe and the former Soviet Union, is experiencing the deepest contraction and is expected to see the weakest recovery in output among all emerging and developing economy regions a result of the global financial and economic crisis. Their commitment to open trade and financial integration as part of the transition from plan to market has brought many gains, but a combination of large global imbalances during this period and policy weaknesses in a number of countries made them vulnerable to the crisis. The global recession is expected to be deeper and more protracted than any in recent memory and will test the international community's commitment to both the middle income countries of emerging Europe with access to capital markets as well as the poorest countries of the former Soviet Union. Recovery from the crisis will require domestic policy reform in the countries and coordinated and sustained international collective action. After two decades, the business environment in transition countries increasingly resembles that of market economies at similar levels of per capita income. Strong private sector growth preceding 2008-2009 led to firms reporting infrastructure and skilled labor as being among the most important barriers to doing business for the first time since transition began. But rapid growth has also increased the costs to firms of weak market economy institutions, in part the product of legacy, especially in respect of the legal environment and corruption. Preparing for the recovery from crisis will require attention to these weaknesses in the enabling environment. Table of contents......Page 6 Acknowledgments......Page 14 Overview......Page 16 1 Prelude to the crisis......Page 40 Figure 1.5 Capital flows in developing East Asia......Page 44 Transition meets global finance......Page 51 Would different macroeconomic policies have lessened vulnerability?......Page 69 Opening the toolkit......Page 75 Annex 1.1 Separating wheat from chaff —evidence of market differentiation from EMBI spreads......Page 84 Figure 1.1.1 Country-specific components of EMBI spreads......Page 85 2 How much adjustment? How much financing?......Page 90 Different shocks for different countries......Page 91 Figure 2.1 Mean private capital flows during the East Asian capital account crisis......Page 93 Crisis, adjustment, and financing in low-income and lower middle-income CIS countries......Page 106 Of parents and offspring: understanding rollover risks in ECA......Page 110 Three concluding arguments—three caveats......Page 128 Table 2.1.1 Comparison of information on claims in BIS data......Page 130 3 Restructuring bank, corporate, and household debt......Page 132 Financial systems need to be fixed......Page 133 For the lenders: bank restructuring......Page 137 For the borrowers: corporate and household debt restructuring......Page 142 Lessons on restructuring from previous banking and capital account crises......Page 157 Lessons for strengthening bank regulation and supervision......Page 163 4 Scaling up social safety nets......Page 178 Existing social assistance programs......Page 179 Figure 4.3 Targeting accuracy of overall safety-net benefits, by country, various years......Page 182 Figure 4.6 Coverage of means-tested programs, by country, 2004–08......Page 186 Cost of expanding means-tested programs......Page 188 An opportunity for further reform......Page 190 5 Prioritizing structural reform......Page 194 Interpreting business environment surveys......Page 195 Overview of results......Page 198 Growth bottlenecks......Page 200 The persistence of legacy in shaping the business environment......Page 211 Annex 5.1 Conceptual framework......Page 221 Annex 5.2 Moving away from the benchmark: firm characteristics and constraints......Page 225 Annex 5.3 Tables......Page 228 6 The day after......Page 234 Bottlenecks in electricity—an agenda for reform......Page 235 The education and skills agenda—making the grade......Page 252 Bibliography......Page 268 Box 1.1 Shades of vulnerability—a cluster analysis approach to classifying countries......Page 50 Box 1.2 Playing cat and mouse—staying ahead of regulation arbitrage in Southeastern Europe......Page 67 Box 1.3 Why foreign currency lending did not take off in the Czech Republic......Page 81 Box 2.1 Sticking together through thick and thin: the European Bank Coordination (Vienna) Initiative......Page 95 Box 2.2 From Bangkok to Budapest: ECA’s adjustment compared with East Asia’s......Page 101 Box 2.3 Countercyclical fiscal policy in financially integrated countries: Kazakhstan and the Russian Federation......Page 103 Box 2.4 Tajikistan’s declining remittances can hurt the poor disproportionately......Page 108 Box 2.5 Foreign ownership and funding sources......Page 122 Box 3.1 ECA’s growth prospects—green shoots? Maybe. High growth rates? Unlikely......Page 136 Box 3.3 An agenda for modern banking sector institutions in ECA countries......Page 166 Box 3.4 Capital—what is it and why require it?......Page 170 Box 3.5 Taking the rough with the smooth—dynamic provisioning in Spain......Page 173 Box 4.1 Aiming high to serve the poor: Georgia’s new Targeted Social Assistance Program......Page 183 Box 4.2 Enough bang for the buck? Safety nets in the Russian Federation......Page 187 Box 5.1 Transition economies converge in structure to market economies......Page 213 Box 5.2 Comparing constraints in transition (BEEPS 1999–2005) and nontransition (ICA) countries......Page 218 Box 6.1 Electricity tariff increases and poverty impacts......Page 242 Table 6.6 Students tutored by their own teachers......Page 264 Figure 1 Means-tested safety nets: targeting accuracy, coverage, and transfers to the poorest quintile......Page 29 Figure 1.2 Trade integration, by region, 1994–2008......Page 41 Figure 1.4 Labor integration, by country, 2007 and 2008......Page 42 Figure 1.7 Capital flows in Latin America and the Caribbean......Page 45 Figure 1.9 Real GDP growth, median values, 2000–08......Page 46 Figure 1.11 Inflation, median values, 2000–08......Page 47 Figure 1.13 External debt to GDP, median values, 2000–08......Page 48 Figure 1.14 Ratio of short-term debt to foreign exchange, median values, 2000–08......Page 49 Figure 1.16 Fiscal balance, median per group, 2000–08......Page 53 Figure 1.18 Short-term debt to foreign exchange reserves, median per group, 2000–08......Page 54 Figure 1.19 Bank ownership patterns in Europe and Central Asia transition economies, 1997 and 2005......Page 55 Figure 1.20 Banking crises in transition economies, 1990–2002......Page 56 Figure 1.22 Average return on assets, parent banks and competition, 2004–08......Page 57 Figure 1.24 Loans to deposits, median value, 2000–08......Page 59 Figure 1.25 Foreign exchange assets to liabilities, median value, 2000–08......Page 60 Figure 1.26 Liabilities to equity, median value, 2000–08......Page 61 Figure 1.27 Private sector credit developments in 2005–08: catch-up or excess?......Page 62 Figure 1.28 Real housing price developments......Page 64 Figure 1.29 Exchange rate regimes......Page 70 Figure 1.31 Average policy outcome/stance: fiscal policy, by group and period......Page 71 Figure 1.33 Average policy outcome/stance: nominal exchange rate volatility, by group and period......Page 72 Figure 1.35 Policy response to balance-of-payment pressures: fiscal policy, by group and period......Page 73 Figure 1.37 Policy response to changes in net foreign assets: sterilization of foreign exchange, by group and period......Page 74 Figure 1.39 Median current account balance, by group and period......Page 79 Figure 1.41 Policy response to balance-of-payment pressures: real eff ective exchange rate, by group and period......Page 80 Figure 1.2.2 Bank efficiency in ECA’s transition economies, median values, 1995–2007......Page 86 Table 1.2.1 Comparing ECA’s transition economies with other regions......Page 87 Figure 2.2 Crisis, adjustment, and financing in financially integrated Europe and Central Asia economies......Page 98 Figure 2.3 Crisis, adjustment, and financing in financially integrated oil-exporting Europe and Central Asia economies......Page 99 Figure 2.4 Public and private sector balances in low-income and lower middle-income CIS countries, 2008–10......Page 109 Figure 2.5 Banking sector credit—national and domestic sources......Page 111 Figure 2.6 International claims, end-2008......Page 114 Figure 2.7 Foreign claims, end-2008......Page 115 Figure 2.8b Foreign exchange liabilities, Republic of Korea and financially integrated ECA countries......Page 117 Figure 2.10 Resident retail deposits, by country, 2007–09......Page 120 Figure 2.11 Parent bank funding, by country, 2007–09......Page 121 Figure 2.13 Loans with a maturity of five years or more, by country, 2007–09......Page 123 Figure 2.15 Currency composition, by country, March 2009......Page 124 Figure 3.1a Average duration and change in output of recessions, by type......Page 134 Figure 3.1b Average duration and change in output of recoveries, by type......Page 135 Figure 3.3 Household debt, earlier EU members, 1995–2004......Page 148 Figure 3.5 Foreign currency-denominated loans, by country, 2008......Page 149 Figure 3.6 Mortgage loans with adjustable interest rates, by country, 2006......Page 150 Figure 3.7 Mortgage interest service and interest rate shock, by income quintile......Page 151 Figure 3.8a Total debt service under shocks......Page 152 Figure 3.8b Total debt service under shocks......Page 153 Figure 3.9a Ratio of actual to minimum required capital-asset ratio......Page 164 Figure 3.9b Supervisory agency can legally declare a bank insolvent......Page 165 Figure 4.1 Spending on overall safety nets, by country, 2006–08......Page 180 Figure 4.2 Coverage of overall safety nets, by country, various years......Page 181 Figure 4.4 How ready are ECA’s safety nets for rapid crisis response? A typology of countries......Page 184 Figure 4.5 Targeting accuracy of means-tested programs, by country, 2004–08......Page 185 Figure 5.1 Average business environment constraint: transition economies in 1999, 2002, 2005, 2008, and nontransition economies......Page 196 Figure 5.3 Infrastructure bottlenecks—electricity, 1999–2008......Page 202 Figure 5.5 Access to land, 1999–2008......Page 203 Figure 5.6 Skills bottlenecks, 1999–2008......Page 204 Figure 5.7 Corruption, priority measure, 1999–2008......Page 206 Figure 5.9 Tax administration: priority measure, 1999–2008......Page 207 Figure 5.10 Customs regulations: priority measure, 1999–2008......Page 208 Figure 5.11 Financing expansion—internal finance......Page 209 Figure 5.13 Financing expansion—external financing, constraint priority......Page 210 Figure 5.15 Skills: priority measure, 1999–2005......Page 215 Figure 5.16 Legal environment: priority measure, 1999–2005......Page 216 Figure 5.17 Labor regulation: priority measure, 1999–2005......Page 217 Figure 5.1.1 Demand and supply of public goods—one country, two firms......Page 222 Figure 5.1.2 Demand and supply of public goods......Page 223 Figure 5.1.3 Two transition economies, two nontransition economies (and many firms)......Page 224 Figure 6.1 Relative importance of constraints, by country groups......Page 236 Figure 6.2 Investment commitments in electricity with private participation, 1993–2007......Page 237 Figure 6.3 Evolution of average collection rates in ECA countries......Page 238 Figure 6.4 Weighted average electricity tariffs, 2008 (US cents per kilowatt-hour, excluding taxes)......Page 241 Figure 6.5 Present structure of ECA electricity markets......Page 244 Figure 6.7 Worker education: change in the frequency of satisfied firms between 2005 and 2008......Page 253 Figure 6.8c 2007 TIMSS—mean content scores in grade 4 science......Page 255 Figure 6.9b 2007 TIMSS—mean cognitive scores in grade 8 math......Page 256 Figure 6.10a PISA math scores......Page 257 Figure 6.10b PISA science scores......Page 258 Figure 6.11b PISA math scores—difference between quintile 5 and quintile 1......Page 259 Figure 6.12 Positive and negative shifts in employment participation in 1995–2006, by occupation......Page 260 Figure 6.13 Kazakhstan survey of fi rms, 2008: importance of general competencies and technical skills......Page 262 Map 1 Income convergence to the EU15 average income, 2000–09......Page 18 Table 1 Credit market characteristics in financially integrated countries......Page 25 Table 1.1 Savings–investments balance......Page 52 Table 1.2 Evolution of banking sector indicators, by country, 1999–2008......Page 58 Table 1.3 Growth and composition of credit to the private sector......Page 65 Table 2.1 Savings–investment balances, adjustment without official financing......Page 97 Table 2.2 Savings–investment balances, adjustment with official financing......Page 105 Table 2.3 Direct lending as a share of total national credit, by country, 2005–09......Page 113 Table 2.4 International claims, by country, 2000–09......Page 116 Table 2.5 Stability of funding sources......Page 118 Table 2.6 Index of home country concentration of parent bank exposure, international claims......Page 126 Table 2.7 Importance of lending in foreign exchange among parent-subsidiary banks......Page 127 Table 2.1.2 Sectoral breakdown in BIS data......Page 131 Table 3.1 Countries with banking and currency crises and nonperforming loans as a share of total loans......Page 141 Table 3.2 Credit losses—extrapolating from past crisis events......Page 143 Table 3.3 Median nonfinancial corporate leverage, Europe and Central Asia countries and EU cohesion countries, 1999–2008, and comparator countries for years of crisis......Page 144 Table 3.4 Median nonfinancial corporate leverage, by country, 2008......Page 145 Table 3.5 Median interest coverage in nonfinancial firms, Europe and Central Asia countries and EU Cohesion countries, 1999–2008, and comparator countries for years of crisis......Page 146 Table 3.6 Median interest coverage ratio in nonfinancial firms, by country, 2008......Page 147 Table 4.1 Transfer to beneficiaries in the poorest quintile, by country, various years......Page 189 Table 4.2 Percentage of transfers through means-tested programs to overall safety net transfers, by country, various years......Page 191 Table 5.1 Levels and priorities of constraints on business in BEEPS 4 and other surveys......Page 197 Table 6.1 Total technical and commercial losses in ECA countries......Page 240 Table 6.2 Regulatory institutions in ECA countries......Page 246 Table 6.3 Implementation of the directive 2003/54/EC in the contracting parties to the treaty establishing the energy community, December 2008......Page 250 Table 6.4 Features of electricity systems in Central Asia......Page 251 Table 6.5 Russian Federation—wage premia for additional schooling......Page 261 The transition economies of Central and Eastern Europe and the former Soviet Union, among all emerging- and developing-economy regions, have been hardest hit by the global economic crisis of 2008-09. This is partly due to the region’s deep integration into the global economy across many dimensions—trade, financial, and labor flows. Attempts by countries that came later to the transition to catch up rapidly to Western European living standards at a time when global liquidity was unusually abundant, together with some policy weaknesses, made them vulnerable to reversals in market sentiment. Written on the eve of the twentieth anniversary of the fall of the Berlin Wall, 'Turmoil at Twenty' analyzes the run-up to the current crisis and addresses a number of key questions related to vulnerability to the recession, expected recovery, and necessary reforms in the region: • Did the transition from command to market economies, and the period during which this took place, plant the seeds of vulnerability that made transition countries more prone to crisis than other developing countries? • Did the choices made on the road from plan to market shape the ability of crisis-hit countries to recover? What combination of domestic policy reform and international collective action is needed to bring about a recovery and minimize the humanitarian cost of the crisis? • What structural reforms are needed today to address the most binding constraints on growth in a world where capital fl ows to transition and developing countries are expected to be considerably lower than before the crisis? 'Turmoil at Twenty' will be of interest to policy makers and their advisers, researchers, and students of economics who seek lessons from the current economic crisis, as well as scholars of the transition. Annotation The transition economies of Central and Eastern Europe and the former Soviet Union, among all emerging- and developing-economy regions, have been hardest hit by the global economic crisis of 2008-09. This is partly due to the region€™s deep integration into the global economy across many dimensions€”trade, financial, and labor flows. Attempts by countries that came later to the transition to catch up rapidly to Western European living standards at a time when global liquidity was unusually abundant, together with some policy weaknesses, made them vulnerable to reversals in market sentiment.Written on the eve of the twentieth anniversary of the fall of the Berlin Wall, 'Turmoil at Twenty' analyzes the run-up to the current crisis and addresses a number of key questions related to vulnerability to the recession, expected recovery, and necessary reforms in the region:€ Did the transition from command to market economies, and the period during which this took place, plant the seeds of vulnerability that made transition countries more prone to crisis than other developing countries?€ Did the choices made on the road from plan to market shape the ability of crisis-hit countries to recover? What combination of domestic policy reform and international collective action is needed to bring about a recovery and minimize the humanitarian cost of the crisis?€ What structural reforms are needed today to address the most binding constraints on growth in a world where capital fl ows to transition and developing countries are expected to be considerably lower than before the crisis?'Turmoil at Twenty' will be of interest to policy makers and their advisers, researchers, and students of economics who seek lessons from the current economic crisis, as well as scholars of the transition

This book, written on the eve of the 20th anniversary of the fall of the Berlin wall in 1989, addresses three questions that relate to recession, recovery, and reform, respectively, in Europe and Central Asia (ECA) transition countries. Did the transition from a command to a market economy and the period when it took place, plant the seeds of vulnerability that made transition countries (the region excluding Turkey) more prone to crisis than developing countries generally? Did choices made on the road from plan to market shape the ability of affected countries to recover from the crisis? What structural reforms do transition countries need to undertake to address the most binding constraints to growth in a world where financial markets have become more discriminating and where capital flows to transition and developing countries are likely to be considerably lower than before the crisis? This report is structured as follows: chapter one of the book analyses how countries fell into recession and crisis, why not all of them were equally affected, and whether different policies could have positioned them better to face the crisis. Chapter two discusses rescue and stabilization and the role of international collective action. The next two chapters focus on policies for recovery, chapter three on restructuring bank, corporate and household debt and chapter four on scaling up social safety nets. Chapters five and six focus on reform, examining the binding constraints to growth and the policy agenda in the most important sectors identified by that analysis.

This book, written on the eve of the 20th anniversary of the fall of the Berlin wall in 1989, addresses three questions that relate to recession, recovery, and reform, respectively, in Europe and Central Asia's (ECA's) transition countries. Did the transition from a command to a market economy and the period when it took place, plant the seeds of vulnerability that made transition countries (the region excluding Turkey) more prone to crisis than developing countries generally? Did choices made on the road from plan to market shape the ability of affected countries to recover from the crisis? What structural reforms do transition countries need to undertake to address the most binding constraints to growth in a world where financial markets have become more discriminating and where capital flows to transition and developing countries are likely to be considerably lower than before the crisis? This report is structured as follows: chapter one of the book analyses how countries fell into recession and crisis, why not all of them were equally affected, and whether different policies could have positioned them better to face the crisis. Chapter two discusses rescue and stabilization and the role of international collective action. The next two chapters focus on policies for recovery, chapter three on restructuring bank, corporate and household debt and chapter four on scaling up social safety nets. Chapters five and six focus on reform, examining the binding constraints to growth and the policy agenda in the most important sectors identified by that analysis