“A human crisis is looming in the Europe and Central Asia Region,” said Shigeo Katsu, World Bank Vice President for the Europe and Central Asia Region. “Within 10 months of the crisis, countries have started to lose the poverty gains made over the last 10 years. By end-2010, we may unfortunately see 35 million more people fall back into the poverty and vulnerability trap. This is a human crisis that is going largely unnoticed in the talk of the ‘global financial and economic crisis’.”
Europe and Central Asia hit hard
Many Europe and Central Asia countries entered the crisis in a vulnerable position. Relatively high current account deficits, elevated external debt levels, very rapid credit growth, and a consumption boom financed by foreign currency borrowing created vulnerabilities in Central and Eastern Europe (CEE), the Baltics, and some Commonwealth of Independent States (CIS) countries. On the other hand, sharp drops in commodity prices brought growth in economic powerhouses of the eastern part of the Region (e.g., Russia and Kazakhstan) to an abrupt halt and hit the less well-off parts of the CIS very hard.
For these reasons, ECA countries for now have been hit relatively early and with greater severity than other developing regions. In particular, the effects of the crisis are being felt through three key transmission mechanisms – financial, product, and labor markets. In the financial sector, rollover risks for countries with high current account deficits and volatility in foreign exchange markets have created a highly uncertain environment. Industrial output is down with some countries experiencing double-digit declines in early 2009 compared to a year ago. Unemployment is on the rise with unprecedented job losses in some countries and others poised for double-digit unemployment in the near future. This is particularly bad news for countries that are dependent on remittances (e.g., Albania, Moldova, Tajikistan). For instance, current simulations for Tajikistan suggest that an anticipated 30 percent decline in remittances could result in a 5 percentage point increase in the number of people living in poverty.
What the Region can expect
The past decade was a good one for the Region. Helped by international trade and financial and labor flows, regional GDP grew by two-thirds of its level in 2000. But this growth has now proven to be unsustainable. The fall in output has taken on catastrophic proportions. Forecasts for global economic growth in 2009 have come down significantly, with the sharpest adjustments in growth for ECA. But based on experience, these forecasts may still be too rosy. And, using reasonable assumptions on foreign credit and investment flows, the potential financing gap in the Region could be around $300 billion.
“This will be a deeper crisis than expected, and the forecasts for Eastern Europe and Central Asia may still be too optimistic,” said Indermit Gill, Chief Economist for the Europe and Central Asia, World Bank. “Past crises indicate that capital flows do not quickly recover to pre-crisis levels – so adjustments required are now much larger than anticipated. And we can expect that this is a crisis that will leave the Region changed – post-crisis growth is likely to be lower than pre-crisis growth rates.”
What should be done
“By focusing on preserving jobs, protecting people, and stabilizing the financial sector, countries can mitigate the impact of the crisis and ensure they are in a better position to rebound afterward,” said Katsu.
Social policy actions should be a priority for the Region. In many countries in Eastern Europe and Central Asia, two years of rising food prices, high energy costs, and the global economic downturn have combined with other shocks like natural disasters and political instability. The impacts of these crises are reducing government revenues and affect social spending and pension systems, even as the need for unemployment and benefits increases.
Keeping labor market channels open is necessary, but not sufficient. Most ECA countries spend large sums on social protection, and have the mechanisms necessary to better target assistance to the poor and vulnerable. Social assistance and unemployment programs in ECA can act as integral parts of a crisis response mechanism, by expanding to help low-income families to smooth consumption and mitigate the adverse impacts of the shocks. Their budgets, along with those for basic education and health services, should be protected and increased to leverage this potential.
“It is obviously imperative for the governments of the Region to meet the urgent and immediate needs of their citizens,” said Katsu. “Safety net programs – school feeding programs, nutrition, conditional cash transfer projects, cash for work – are important not only in times of crisis, but in the long-run they help to protect the poor and allow governments to avoid other more costly or inefficient policies. And if programs are well targeted, you do not need exorbitant amounts to protect the poor. Their cost – at less than one percent of GDP – can go a long way and is a small price to pay.”
While fiscal stimulus spending may be possible in some economies, fiscal policy options for ECA during the crisis are limited. Keeping trade pathways open, which channeled prosperity to the Region over the last decade, is the most promising way for ECA countries to benefit from fiscal stimulus programs taking place in the developed economies.
And finally, a key challenge remains the stabilization of the financial sector – the original source of the global crisis. Keeping capital market linkages strong is the only way for ECA countries to finance some of their financing needs. Banking systems must be stabilized. While the scope of the problem remains large, the World Bank Group in partnership with the European Bank for Reconstruction and Development (EBRD) and the European Investment Bank (EIB) has launched a $31 billion initiative to support bank recapitalization and restructuring in order to provide resources to institutions hit by the global economic crisis, complement national crisis responses, and deploy rapid, large-scale and coordinated financial assistance to support lending to the real economy through private banking groups, in particular to small- and medium-sized enterprises.
