Economic Outlook

GDP growth remains strong in the Europe and Central Asia (ECA) Region, but is expected to slow from 7.6 percent in 2007 to 6.1 percent in 2008. External demand is expected to weaken in the Region overall this year, due to slower growth in the OECD and the Euro Area, and slower domestic demand growth in some countries because of projected lower private consumption and investment growth.

With a stable population in the region, GDP per capita continued to increase at rates of more than 6 percent over 1999 – 2006 which drove up living standards and reduced poverty. The efficiency of labor and capital rose rapidly in the Region, especially in the middle-income countries of the Former Soviet Union. As a result, the Region’s income per capita, in constant PPP dollars, rose from US$5,592 in 1998 to US$8,605 in 2006, lifting 50 million people out of poverty within a population of nearly 460 million. In fact, per capita GDP in the Commonwealth of Independent States (CIS) was about 50 percent higher in 2005 than in 1998, and in the EU-10 countries (Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic, and Slovenia), it was 15 percent higher than in 1993.

High growth has been made possible by technology diffusion, double-digit growth in investment supported by rapid credit expansion through lending by domestic and foreign banks, high energy prices for hydrocarbon exporters, and large remittance inflows from workers overseas. These same factors have boosted private consumption and consistently raised import growth 3 or more percentage points above the already robust expansion of exports.

However, these developments, which have helped to rapidly increase standards of living, are not without risks. Capital inflows have created challenges for macroeconomic management; inflation remains high relative to that in the Euro Area, making it more difficult to maintain real effective exchange rates; and current account deficits in many oil-importing countries have become unsustainably high.

Major Gains in Poverty and Living Standards

Rising incomes have halved poverty in the Region since 1998-99, with about 45 million fewer poor. Poverty – defined as people with incomes below $2.15 in 2005 PPPs – fell from about 102 million in 1998-99, to 57 million in 2005-06. Vulnerability – defined as people with incomes between $2.15 and $4.30 in 2005 PPPs – fell from 161 million in 1998-99 to 123 million in 2005-06. However, by the end of 2006, about 180 million people – or more than a third of the Region’s population – were either poor or vulnerable. On average, poverty levels have fallen for all groups – the working people, unemployed, pensioners, and children – but the poverty risk is higher for the unemployed. Overall consumption inequality has continued its moderating trend, given broad-based growth, but intra-country regional inequality has grown in some countries. In particular, there is a growing ruralization of poverty as urban areas have grown and reduced poverty faster than rural areas. Labor market gains are important for the poor and vulnerable. Many have benefited from the real wage increases. But net job creation has been scarce and may have limited income growth opportunities for the poor. However, public transfers have grown in real terms in most countries and is likely to have improved the incomes of the poor.

Financial Market Instability & Food/Energy Price Increases

ECA countries may be more vulnerable to ongoing global financial turmoil than the rest of world due to large current account deficits in many countries. Current account deficits are partly financed by credit from commercial banks that could dry up. But the extent of vulnerability varies a great deal from country to country and depends on many factors including currency regime, composition of capital inflows, importance of remittances, level of foreign direct investments, etc. Structural reforms carried out over the past years across the Region have helped in reducing its vulnerability to shocks.

Food and energy prices have surged in recent months, which in turn have driven inflation upwards. Food price inflation has varied across countries, rising between 2006 and 2007 from 5.6 to 13.8 percent in the new EU member states and from 6.5 to 20.3 percent in the middle income CIS countries. The increases were smaller but still large in the low income CIS countries – from 10.7 to 17.1 percent. The distributional implications may be significant for low income countries since spending on food is a larger percentage of their consumption. In the EU10, food accounts for an average of only 21 percent of the Consumer Price Index (CPI) basket; in the poorer countries in Central Asia, it accounts for 50-60 percent of the CPI (50 percent for low-income CIS, on average). Simulations suggest that for some of these countries, even a 5 percent relative increase in food prices can increase poverty rates by 2-3 percentage points. ECA Governments have tried to soften the impact of food prices by topping up existing social assistance and other transfers.

Energy price increases were, on average, significantly higher for the low-income CIS (33 percent increase in 2007) and middle-income CIS (18 percent), versus 8-10 percent for the EU10. In general, the increase in food prices is likely to have a larger impact in low income countries while the energy price increase is likely to affect the middle income countries more.

Doing Business in ECA

The EBRD-World Bank Business Environment and Enterprise Performance Survey (BEEPS), developed jointly by the World Bank and the European Bank for Reconstruction and Development, is a survey of managers and owners of more than 20,000 firms across 26 countries of the ECA Region. The latest version, conducted in 2005, shows that firms across the region are benefiting from greater stability, both in the macroeconomic environment and with regard to regulatory policies, as well as general improvements in the tax environment. According to firms in the survey, tax administration is less onerous than three years ago, and in 2005 they even complained less about tax rates, the bane of firms everywhere. A side-benefit to this is that tax evasion has eased, and unofficial payments related to taxes have become less frequent. As a whole, firms complain less about both access to finance and the cost of finance than three years earlier. Although firms still use their own funds as the primary source of financing new investments, they are increasingly using formal borrowing and the capital markets and relying less on informal borrowing. Firms also say that crime and corruption, as well as the burden of red tape, have eased.

Structural reforms in most countries have driven ECA’s ongoing success. According to the 2008 Doing Business report, ECA countries are reforming the most rapidly, surpassing even East Asia on the ease of doing business, and four ECA countries (Croatia, FYR Macedonia, Georgia, and Bulgaria) were among the top 10 performers worldwide. Integration with the European Union (EU) has been key to the reform process in many ECA countries. Bulgaria and Romania joined the EU in January 2007, bringing the number of member countries to 27. Slovenia joined the Euro currency area as the bloc’s 13th member state.

Despite strong growth, ECA countries still face significant challenges, including large sub-national disparities, rapidly aging and declining populations, persistent youth unemployment, and, especially in the low-income countries, weak public and corporate governance. Countries must also work to mitigate the threats posed by HIV/AIDS, drug addiction, human trafficking, natural disasters, and environmental degradation.

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