IMF Urges Eastern Europe to Boost Exports, Cut Deficits

Governments in Eastern Europe must quickly focus their efforts on reducing budget deficit and on stimulating exports as a means of growth, according to the International Monetary Fund.

In its twice-yearly Regional Economic Outlook for Europe, the IMF has warned that "emerging", i.e. Central and Eastern Europe, will face substantial challenges to their economic recovery.

"The main downside risk for emerging Europe is the revival of sovereign stress in advanced Europe, which could depress growth in the euro area and lead to adverse spillovers for the region. To prevent the emergence of market concerns, countries with high fiscal vulnerabilities may need to proceed with fiscal consolidation at a faster rate," says the IMF.

According to its Europe Outlook, Eastern Europe's combined economies will grow by 3.9% 2010 and 3.8% in 2011, after a 6% decline in 2009.

The estimates of the Bulgarian government for Bulgaria's economic growth in 2011 of 3.6%, roughly the same figure, have seen much criticism for being unrealistic. The IMF Outlook projects a 0% growth for Bulgaria in 2010 and a 2% growth in 2011.

In 'advanced Europe' - defined as the Euro Area countries plus Britain, Denmark, Sweden and the Czech Republic - growth is projected at 1.7% in 2010 and 1.6% in 2011, the IMF said in its Regional Economic Outlook for Europe. That follows a contraction of 4% in 2009.

Germany, Europe's biggest economy, is expected to grow by 3.3% in 2010 and 2.0% in 2011, after contracting by 4.7% in 2009.

The IMF has warned that emerging Europe's fortunes depend primarily on the developments in the Euro Area, i.e. "advanced" or Western Europe, which is the major market for Eastern European exports.

The Fund said that emerging Europe should find new sources of growth, relying more on exports than on domestic demand. Before the economic crisis in 2008, the region of Eastern Europe saw boosted economic growth that resulted from surge in capital inflows funding strong growth in domestic demand, the IMF reminds pointing out that this is unlikely to happen again.

"Capital inflows are unlikely to return to pre-crisis levels, and domestic demand is likely to remain depressed. Future growth must rely more on the tradable sector and less on the nontradable sector—especially in countries that had built up large imbalances during the boom," the Fund said.

Domestic demand growth, however, has remained weak in most countries. Domestic demand continues to fall in Croatia, Estonia, and Hungary, and, following only a mild recovery in the last few quarters, remains some 20–30% below precrisis levels in the Baltics and Bulgaria. Only in Poland and Turkey has domestic demand recovered to precrisis levels. 

Private consumption shows signs of recovery in the first half of 2010 in a number of countries, but continued to decline on a quarter-onquarter basis in the Baltics, Bulgaria, Croatia, and Hungary... Net foreign direct investment (FDI) inflows are well below precrisis levels, and other investment flows are negative in many countries, notably in Bulgaria, Estonia, and Lithuania... Stock exchanges in the Baltics and Romania have lost about half their value (up to 80% in Bulgaria, since end-2007), and real estate prices are down some 30% from their peak.

The Fund believes that Eastern European states must reduce their budget deficits to avoid a "Greek" scenario in which investors may start to worry about the government's ability to repay their debts.

"Financial sectors would be particularly affected, especially in those countries where banks hold a large portion of their assets in the form of government securities—Albania, Hungary, Poland, and Turkey. In such countries, bank capitalization could be significantly impacted if the value of government securities declined. This in turn could curtail the supply of bank credit," the Europe Outlook of the IMF states.

"Now that the region is finally recovering, it would be a good time to start with fiscal consolidation and in the next few years get deficits back to more sustainable levels," Bas Bakker, chief of the IMF's emerging Europe division, said, as cited by BusinessWeek.

Budget deficits across emerging Europe averaged 6% of GDP last year compared with zero in 2008, the IMF said. Average public debt levels swelled to 30% of GDP from 24%. The average deficit will narrow to 5.2% this year and 4.1% in 2011, with debt climbing to 30.8% and 32.1%, respectively, the IMF forecasts.

"With deficits still at very high levels, and a permanent loss in revenues resulting from the end of the demand boom, it is clear that substantial fiscal consolidation is needed over the next few years," even if it hurts growth in the short term, according to the report.

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