Macroeconomic Imbalances and Catchingup Growth of the EU

Macroeconomic Imbalances and Catching-up Growth of the EU Candidate Countries PROFESSOR, DR. DANIELA BOBEVA BULGARIAN ACADEMY OF SCIENCES

High growth without imbalances? Academic and political challenges q What macroeconomic imbalances mean? q Persistent or temporary macroeconomic imbalances? q Excessive or healthy macroeconomic imbalances? q What drives imbalances? q Policy responses: encouraging growth or/and diminishing excessive imbalances?

Methodology q We focus on candidate and potential candidate countries: Albania, Bosnia and Herzegovina, North Macedonia, Serbia, Montenegro and Kosovo. q Comparison of macroeconomic imbalances with the group of catching-up economies in the EU -10 (Bulgaria, Czech Republic, Slovakia, Slovenia, Lithuania, Latvia, Estonia, Romania, Hungary, Poland) and also with euro area macroeconomic indicators. q Two periods: before and after the recent crisis. q Qualitative and quantitative analysis of the impact of macroeconomic imbalances on the economic growth of both groups of countries. q. Political economy of imbalances

Macroeconomic imbalances: the concepts q Concepts focusing on external imbalances/current account q Concepts based on the combination of external and internal imbalances q A broad concept based on large number of macroeconomic indicators with thresholds (MIP) q We test macroeconomic framework in both groups of countries and select the potentially disruptive indicators that sustainably exceed the thresholds (MIP) for the majority of countries

Economic Growth of catching-up economies

E-10 GDP growth (annual %) 15 10 5 0 q Convergence of economic growth dynamics q High economic growth before the crisis and severe drop during the crisis (except Poland) q Slow and less volatile economic growth in postcrisis recovery q Smaller economies larger growth volatility -5 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 -10 -15 -20 Bulgaria Estonia Lithuania Latvia 15 10 5 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 -5 -10 Hungary Poland Romania Slovakia Slovenia Czehc R.

Candidate and potential candidate countries: GDP growth (annual %) 12 10 q Similar trends of growth q High economic growth before the crisis: Bosnia and Herzegovina 8. 7% (2005), Serbia 9. 7% (2006) , Kosovo 7. 2% (2007), Montenegro 8. 6% (2006), North Macedonia 6. 4% (2006), Albania 7. 5% (2008) q During the crisis: GDP substantially decreased; Albania and Kosovo’s economies continued growing q Post-crisis recovery: Economic growth slowed down (no country reached the pre-crisis GDP growth rates). Recessions in some countries 8 6 4 2 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 -2 -4 -6 -8 Kosovo North Macedonia Albania Serbia Bosnia and Herzegovina Montenegro

Catching-up economic growth q Different patterns of economic growth before and after the crisis q. More volatile economic growth in the candidate countries and less convergence of economic cycles q Several small recessions in post-crisis period q The high economic growth is driven by FDI, real estate markets and non-tradable sectors q Convergence of economic cycles less pronounced in candidate countries

FDI and capital inflows role in growing faster q The FDI role in the economies varies across both groups of economies q Large inflows before the crisis (in some countries exceeding 30% of GDP) q After the crisis the economies grow with less foreign investment q In general, FDIs play more important role in boosting the economic growth in smaller economies (the model suggests significant relation between FDI and economic growth) q Substantial and sustainable remittances inflows in candidate and potential candidate countries

Foreign direct investment, net inflows (% of GDP) 40 40 30 35 30 20 25 10 20 0 15 10 19992000200120022003200420052006200720082009201020112012201320142015201620172018 -10 5 -20 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 North Macedonia Albania Serbia Montenegro Bulgaria Estonia Lithuania Poland Romania Czech R.

Macroeconomic Imbalances

EU-10, Current account balance, % of GDP q Identical dynamics of current account balances q Before the crisis: Deficits enlarge since 2003 in all countries and reach historically highest levels. q After the crisis: Relatively quick correction of current account deficits. Small deficits (Romania, Czech Republic, Poland, Latvia and Lithuania); small surpluses (Bulgaria, Estonia, Hungary). q The smaller the economy the larger the current account deficits: Bulgaria (-25. 8% in 2007), Estonia (-15. 8% in 2007), Lithuania (-15. 5% in 2007), Latvia ( -21. 1% in 2006). 10 5 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 -5 -10 -15 -20 -25 -30 Bulgaria Hungary Estonia Poland Romania Czehia Slovakia Slovenia Lithuania Latvia

Current account deficits in candidate and potential candidate countries q Similar dynamics of current account balances q Persistent and excessive deficits before and after the crisis q Before the crisis: Highest levels of deficits in all countries in 2008: Bosnia and Herzegovina 13. 8%, Serbia -20. 2%, Albania 15. 6%, Kosovo -16. 3%, Montenegro -27. 7%, North Macedonia -12. 5% q Slower and smaller reduction of deficits in post-crisis period (no country in surplus) q More volatile current account deficits 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 -5 -10 -15 -20 -25 -30 Bosnia and Hercegovina Kososvo Albania Serbia North Macedonia Montenegro 2016 2017 2018

Drivers of current account deficits q Large FDI inflows q Strong relation FDI/Current account deficit in countries with higher FDI to GDP ratio (stronger relation between the FDI and current account deficit than that between the FDI and economic growth) q Substantial part of capital inflows channelled into real estate. (Moderate relation in G-10 countries; data limitations make it difficult to assess the impact for the candidate countries) q Credit growth (strong relation) q Incomes growth (moderate relation)

Is current account excessively imbalanced in the catching-up economies? q Catching-up economies experienced before the crisis demand booms fuelled by large financial inflows (the G-10 countries as well as candidate countries borrow heavily from the EU), strong credit growth and moderate income growth q High current account deficits exposed those economies to sudden stop but did not produce widespread distortions or market failures (if distortion defined as substantial increase of debt to GDP ratio) q Current account deficits were broadly covered by FDI q EU catching-up economies: Large deficits before the crisis and around a balance after the crisis; Candidate and potential candidate countries: Persistent and volatile deficits q Current account deficits were reduced and self-corrected (no particular policies applied) rather quickly but on the expense of decreasing FDI and slowing economic growth

Current account deficits and economic growth q Stronger relation between current account and economic growth before the crisis and within periods of high economic growth q Stronger relation between growth and current account deficits in the countries with higher current account deficits

Credit growth q Credit to the economy and household rapidly increased in pre-crisis period due to the development of financial sector intermediation and high internal demand q Still large room for catching-up developed economies q Application of the new EU regulations for financial sector in the EU candidate and potential candidate countries contribute to the stability of the financial sector but the stressed financial institutions could hardly achieve financial sector development benchmarks q Historically highest levels of non-performing loans before the crisis and rapid reduction in the last years. In June 2019 non-performing loans from all the loans: Albania 11%, Bosnia and Herzegovina 8%, North Macedonia 5. 1%, Kosovo 3. 1%, Montenegro 4. 7%, Serbia 6. 4%

Domestic credit provided by financial sector (% of GDP) q Before the crisis domestic credit grew fast (in average from 23. 2% in of GDP in 2002 to 53% of GDP in 2018) q Deceleration of credit growth in the last four years (except Kosovo) q Convergence of domestic credit to GDP ratios q Large (and sustainable) difference between the Euro area domestic credit to GDP and that of the candidate countries 180 160 140 120 100 80 60 40 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 -20 Montenegro Serbia Kosovo N. Macedonia Albania Euroarea 2017 2018

Public debt q No excessive government debt imbalances experienced by the candidate and potential candidate countries q Excessive public debt increase constrained by the monetary regimes in most of the candidate and potential candidate countries q In spite of significant macroeconomic imbalances, accumulated before the crisis, public debt remained in average around the 60% of GDP

General Government Debt (Percent of GDP) q Cyclical general government debt dynamics q Reduction of public debt before the crisis and moderate increase in post -crisis period (slightly exceeding the pre-crisis levels) q Relatively low level of public debt and large discrepancies between the countries: Kosovo around 21. 2% (2017), Bosnia and Herzegovina 39. 5%, Albania 71. 8% 120 100 80 60 40 2001 2002 2003 2004 2005 Bosnia and Herzegovina 2006 2007 Montenegro 2008 2009 Serbia 2010 2011 N. Macedonia 2012 2013 Kosovo 2014 2015 Albania 2016 2017

Inflation q The theory suggests that transition and emerging economies are exposed to high inflation q Fixed exchange rate regimes are believed to live in higher inflation environment q Small open economies are vulnerable to external price shocks q Highly volatile inflation in the last 15 years in candidate and potential candidate countries q Higher economic growth occurred in high inflation environment

Inflation, consumer prices (annual %) q. Hyper inflation in the pre-crisis period q. Disinflation during crisis q. Moderate inflation in the last three years q. Higher than the Euro area average inflation but there is tendency of a convergence 20 15 10 5 0 2003 2004 Bosnia and Her -5 2006 2007 Montenegro 2008 2009 Serbia 2010 2011 2012 N. Macedonia 2013 Kosovo 2014 2015 Albania 2016 2017 2018 Euroarea

Conclusions q Macroeconomic imbalances accumulated before the crisis were driven by the very fast catching-up process but those economies got closer to their EU peer economies q Factors that has driven the high economic growth have contributed to the widening of major macroeconomic imbalances q Obvious and sustainable reduction of the main macroeconomic imbalances after the crisis q New balanced model of growth: low inflation, low current account deficits, low public debt q Potentially disruptive imbalances: most of them outside macroeconomic conventional thinking q Potentially disruptive “balances“: slow economic growth, slow credit growth to corporate sector, small FDI inflows, limited borrowing

Conclusions § Before the crisis the EU and EU candidate catching-up economies exhibit a highly imbalanced economic growth and speedy convergence. § In the post-crisis recovery period the external imbalances to a large extend self-corrected and internally diminished but the economic growth decelerated as well as the convergence. § The policies should address the slower than needed growth in the candidate and potential candidate countries in order to achieve smooth convergence. § High attention is given to the macroeconomic imbalances and the policies that correct them. but § Such policies may slow down the economic growth and decelerate the convergence process.

Prospects q The expected worsening of external environment will further darken the growth prospects of candidate and potential candidate countries. q Slower growth will help accumulation of imbalances in the fiscal and financial sector. q There is a need for structural adjustment and growth encouragement policies.