Central and Eastern Europe is one of the worst hit regions. Except Poland, its economies have tumbled at a very quick pace while budget deficits have been soaring. The trade and financial shocks have compounded internal difficulties (and previous policy mistakes) and made budget revenues collapse in NMSs (new member states). For most of the EU economies which do not belong to the euro zone, the forex constraint has returned as an overwhelming concern of policy-makers. This state of affairs has brought back the IMF and other IFIs [Ed. n. – international financial institutions], on a grand scale, into the picture –stabilization programs, which are based on their financial support, has become almost a must in several NMSs for the sake of averting worst case scenarios (such as a sovereign default).
There are significant differences among EU new member states. Some of these differences are rooted in dissimilar exchange rate and monetary policy arrangements; some countries (Latvia, Lithuania, Estonia, Bulgaria) peg their currencies (via currency boards), while others float. Likewise, different histories of economic/budget policy also matter in the architecture of stabilization programs, which is illustrated by the room of policy maneuver. But, though pain is unevenly distributed among NMSs, all of them do suffer considerably.
Currency boards raise a huge challenge when it comes to the capacity for absorbing shocks and undertaking adjustments. Unless markets (labor market included) are very flexible, shocks can hardly be absorbed and the exchange rate and monetary policy arrangements become untenable. The policy dilemma in the Baltic countries (and not least Bulgaria) relates to their capacity to adjust to the new international context by improving competitiveness fast enough. This is why some argue that devaluation is an option not to be discarded, though others point at the ubiquitous wealth effect of such a move (because of heavy euroization) and the further erosion of banks’ balance-sheets. All in all, peggers are under extreme strain. Floaters are also facing major challenges for their budget revenues have also come down dramatically. Much hope is pinned down on economic recovery in France, Germany and other old EU member countries. But unless that recovery gets real, not much traction should be expected. The economic downturn adds new pressure on banks, which face a real conundrum. They are in a process of deleveraging (driven by parent banks from outside the Region), which limits their propensity to lend. At the same time, not caring about their clients would make the economic recession worse. The Vienna initiative (which has brought together banks, governments, the EC [Ed. n. – European Commission] and IFIs) has tried to induce banks to roll over debts of their clients so that a total breakdown of financial intermediation be averted. But the problem remains, for credit markets are functioning quite precariously, which suffocates many local companies.
The freeze of credit markets in the NMSs and their collapsing budget revenues have reduced the ability to use EU funds. At the start of this year the European Commission simplified procedures for the absorption of EU funds. But this is not sufficient in view of the intensity of the economic downturn. Moreover, the IFIs based programs have not escaped being pro-cyclical albeit the IMF has shown a substantial amount of flexibility in their design. The stark fact is that these programs are pro-cyclical at a time when international markets have been on a downward spiral and private sector activity is compressing; and this is happening when governments in many EU countries, in the US and Asia use budget instruments and monetary policy counter-cyclically in order to mitigate the effects of the crisis. Pro-cyclicality is a disturbing feature of these programs.
In this context EU structural and cohesion funds can make a hell of a difference, for they can go up to 4-5 percent of GDP [Ed. n. – gross domestic product] in the NMSs –but only if their absorption coefficient is high. EU funds would be the equivalent of the budget policy activism which is practiced in the US and EU big economies without entailing higher deficits, and they could offset the pro-cyclical feature of IMF-based programs. How these coefficients can be improved is, should be a more than critical issue for policy makers in NMSs and, I would emphasize, for the Economic Commission too. Herein it pays to consider also that this economic downturn can have highly deleterious social effects, which have to be accounted for by the current programs. Just think about the nominal cuts of wages and pensions in Latvia and Hungary.
The public budget is a big issue for NMSs. Even Poland, which boasts of avoiding recession, is likely to incur a budget deficit of over 5 percent this year. And a large deficit is expected for next year too. I reiterate a hypothesis highlighted above: economic growth in the Region will be sharply reduced in the years to come, though differences will exist among countries. One has to come also to grips with the reality of EU rules, of the single market logic, against the backdrop of unstable financial flows. This combination of premises makes it plausible that budget revenues will not start to climb again as they would be needed -- in view of the size of current deficits and the goal of joining the euro zone. All this makes more urgent finding ways to increase the use of EU funds in the NMSs and, why not, lend them a new mission! By the latter I have in mind the situation created by the deepest economic crisis after the Second World War.
The Commission has to be more imaginative and take the lead in enhancing EU funds absorption as means to combat the economic crisis – apart from the traditional objectives of enhancing convergence and implementing CAP [Ed. n. – Common Agricultural Policy]. A speed up of disbursement, a further rise in pre-financing, giving up co-financing in the case of unquestionably useful and of national importance projects have to be a major focus of the Commission. EU funds may be needed to buttress the capital of local banks as well, or to set up financial institutions dedicated to promoting rural modernization. In Romania such a vehicle would make a lot of a sense considering the almost total neglect of agriculture by commercial banks. The EC may also set a number of projects of regional importance, which should be funded in totality by EU funds. After the Second World War, institutions were devised in Western Europe to tackle reconstructions and sectorial needs. This crisis demands a corresponding vision and policy imaginative devices. There is corruption and institutions are weak in not a few NMSs. But this is not an argument for inaction and procrastination, for bashing those at the economic periphery of the EU. As this crisis has triggered exceptional responses in the euro zone and the US the same policy thrust should apply to the use of EU funds in NMSs. The stakes are too high for vacillating and being more catholic than the Pope.
The bottom line is that more capital has to flow into the NMSs for funding the production of capital goods in a period when national budgets are extremely strained. And this period may last for a number of years. I am pretty sure that the reconfirmed President Barroso, as well as the expected to be reappointed commissioner Almunia, realize that a change in the vision and the approach is badly needed because of the severity of this financial and economic crisis. I would mention here that both served as high officials in countries that have benefitted enormously from EU funds. EU funds can help avoid the emergence of a new divide inside the EU, in Europe.
Daniel Daianu is currently Professor of Economics and Finance at the National School of Administrative and Political Studies (SNSPA) Bucharest. He is former Minister of Finance, former Chief Economist of the National Bank of Romania (BNR), and former member of the European Parliament.
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