Outlook

The aftershocks from the initial crisis in global financial and product markets will continue to exact a painful toll on the growth outlook across Europe and Central Asia.
As many countries are facing large balance-of-payments difficulties and in some cases unavoidable adjustments to the real side of their economies, the region will see the sharpest contraction among all developing regions (see table below).

Aggregate GDP is expected to contract by 4.7 percent in 2009 but recover to reach still-subdued growth of 1.6 percent as markets begin to thaw by 2010.

In Central and Eastern Europe, GDP is expected to decline by 1.6 percent and remain almost flat through 2010 as many economies in the region recover slowly from the crisis.
The sharpest downturn will be felt in the Baltic states, as Latvia struggles to weather its sharp decline in GDP during 2008 and as the falloff in private consumption widens in Lithuania.

Latvia’s GDP is projected to fall 13 percent in 2009, while Lithuania’s GDP appears set to contract by 10 percent.
Despite relatively strong fundamentals, Poland will not remain unscathed.

GDP is anticipated to grow by just 0.5 percent in 2009 as the country continues to be exposed to spillover effects through trade flows and financial vulnerabilities given the large presence of foreign-owned institutions in its banking system.

The CIS area is expected to face a deep recession in 2009, with real GDP contracting by 6.2 percent from growth of 8.6 percent in 2007 and 5.6 percent in 2008.
The slowdown stems to a considerable extent from the projected 42 percent decline in international energy prices in 2009 (relative to the 2008 average).

For the group of CIS oil-exporting countries, the decline in terms of trade Forecast represents a loss of some 7.9 percent of their 2008 GDP.

In Russia, the combination of declines in industrial output, soaring unemployment, and flight of foreign capital is expected to reduce GDP by 7.5 percent, sending damaging waves throughout the whole of the CIS through intraregional trade flows and transfers.
Remittances from Russia to the broader CIS region are expected to decline for the first time in a decade, by 25 percent.

The small oil-importing countries in the CIS will be the most affected owing to their close economic ties with Russia. GDP is expected to fall by 6 percent in Armenia, by 3.3 percent in Belarus, and by 3 in Moldova. 

Financing requirements across the region are projected to remain substantial, due in part to large current-account deficits.
The prolonged credit crunch, untamed recession in the Euro Area, and sharp contraction in Russia will continue to put pressure on current accounts in a number of countries.

Two economies that are likely to maintain large surpluses are Azerbaijan and Uzbekistan, which in 2008 generated record double-digit surpluses in net exports of 38 percent of GDP and 16.2 percent of GDP, respectively.
In 2009, Azerbaijan’s current account surplus is projected to shrink to 10.3 percent of GDP, and Uzbekistan’s to 11.8 percent of GDP.

Russia is also expected to post a current account surplus of 2.4 percent of GDP as the fast rate of ruble depreciation has slowed imports considerably.

In other countries, the sharp fall in exports of goods and services will be offset by contraction in imports through adjustments to the real side of the economy.
However, these offsetting effects will not be enough to reverse persistent deficits in current-account balances.

Overall in Europe and Central Asia, the current account deficit will widen from 0.4 percent of GDP in 2008 to 1.2 percent in 2009.

The region’s large external financing requirements in 2009 also reflect the more than $283 billion in short-term debt coming due.⁴ 
Among the countries with high short-term debt levels, only Russia could foot the bill from reserves or its current-account surplus if external finance were not forthcoming.

As of February 2009, Belarus, Bulgaria, and Latvia held insufficient international reserves to cover debt coming due in 2009 (see figure on previous page).
Kazakhstan, the Former Yugoslav Republic of Macedonia, Moldova, Poland, Romania, and Bulgaria had short-term debt levels above 50 percent of their reserves.

So far, rollover of short-term debt has not proved to be the problem initially feared—in part because of moral suasion exercised by domestic and international authorities on lending banks.

With the sharp fall-off in capital flows, tight capital markets, and large borrowing requirements, financing gaps⁵ in the region could be as high as $102 billion, or 3.7 percent of GDP in 2009.
For those countries that lack large foreign currency reserves, the gap will have to be bridged either through capital flows from official sources or through internal adjustment.

Between September 2008 and May 2009, nine countries reached agreements with the IMF for a total of $55.8 billion in assistance,⁶ with additional funds being channeled through the World Bank, the European Commission, and several other donors.
Lithuania and Turkey are exploring similar options and might contract stabilization packages from the IMF in 2009. 

Although the surge in international official flows has offered some temporary relief, international assistance alone cannot make up for the sharp contraction in private capital flows, and many countries in the region are undergoing painful cuts in domestic demand as part of the adjustment process.
Current account deficits in five countries in the region are projected to fall by 5 percent of GDP or more.

In countries with floating exchange rates, some of the adjustment will occur through depreciation but at the cost of higher debt for private firms and households with loans denominated in foreign currency.

The currencies of several countries are expected to depreciate further during 2009.
In countries with more rigid exchange rate and/or monetary policy response, the adjustment will have to take place through a sharp contraction in imports and, thus, in domestic demand.

In the second half of 2008, inflationary trends across the region were gradually replaced by disinflationary pressures from fast-declining international energy and commodity prices (see figure on previous page).
Lower agricultural prices favored by improved weather conditions and weaker domestic demand also contributed to this development.

Projections for 2009 indicate that the region as a whole will see a widening in the output gap, from output exceeding long-term potential by 8.4 percent in 2008 to output below potential by 2.4 percent in 2009, which will put downward pressure on prices.⁷ 

The most affected will be countries in the CIS, where output exceeded sustainable levels by 1.2 percent in 2008 but is projected to be below potential by 11.1 percent in 2009.
However, in a number of countries the effect of slowing activity on domestic prices will be offset by downward pressures on local currencies.

This is particularly the case for net oil exporters and for those countries that face large current account imbalances.

Econometric estimation of the behavior of headline inflation in response to changes in internationally traded dollar-denominated commodity prices also suggests that the median inflation rate for the region will stabilize within a 5.4 percent to 6.3 percent band through 2010.
Overall, average fiscal positions across the region are expected to deteriorate further in 2009, to an average deficit of 5.9 percent of GDP, compared to surpluses of 1.6 percent in 2007 and 0.7 percent in 2008.

⁴ Short-term debt due in 2009 is calculated based on the Bank of International Settlements reporting system and data released in May 2009.
⁵ In consistency with the methodology explained in chapter 3, the financing gap is defined as the difference between total external financing requirements (current-account deficit plus scheduled principal payments on both short-term and long-term private debt coming due in the year) and private capital flows (new loans on private debt, net equity flows, and net unidentified capital outflows).
⁶ Georgia, which signed a $740 million stand-by agreement in September 2008, is excluded from this total because the package was mainly targeted at helping economic recovery after the Russian war.
⁷ The output gap is defined as the difference between the actual and potential GDP as a share of the potential GDP in a given year.