Financial markets

Unlike Latin America and the Caribbean and East Asia and Pacific, Europe and Central Asia entered the global financial crisis highly dependent on foreign capital inflows.
For example, Hungary had been sustaining twin deficits (on the current account and the government budget) for several years, while Romania had been accumulating alarming levels of private sector foreign debt to finance booming domestic demand.

As the financial crisis took hold in September 2008, key growth determinants for the region started to deteriorate rapidly, unveiling deep vulnerabilities.
Surging commodity prices, which had spurred growth among commodity exporters in the first half of 2008 spiraled downward, external markets, began to collapse, and capital flows reversed owing to heightened investor risk aversion.

As a consequence, growth rates between 2007 and 2008 decelerated from 8.8 percent to 6 percent in private consumption and from 19.3 percent to 7.7 percent in investment activity.
Weak domestic demand and investment contributed to a slowing in import growth to 9 percent in 2008 from 18.8 percent in 2007, while stress in the external markets reduced growth in exports of goods and services to 3.8 percent from 7.7 percent.

The most vulnerable group of countries within the broader region, Central and Eastern Europe (CEE), received shocks through several channels simultaneously.
In the capital markets, external financing continued to decline, with total gross capital inflows (syndicated bank lending, bond issuance, and equity initial public offerings) plummeting from $56.6 billion in the second quarter of 2008 to a meager $3.9 billion in the first quarter of 2009.

At the same time, spreads for government borrowing on international markets, a key measure of credit risk, widened to unprecedented levels.
Between September 2008 and March 2009, spreads on sovereign five-year credit-default swaps increased from a range of 68 to 270 basis points to 381 to 1,100 basis points.

Vulnerabilities in the banking sector and a general increase in the risk aversion toward emerging markets affected to different degrees each of the countries in the region.
In Bulgaria and Romania spreads almost tripled, while in Croatia, Lithuania, and Poland spreads widened by five times or more their levels in mid-2008 (see figure on previous page).

As market sentiment started to improve, credit-default swap rates eased in April and May but continued to hover above pre-crisis levels.

The drying-up of capital was amplified by adverse developments in the product markets, where record growth prior to the financial crisis had been supported by large trade flows with the Euro Area.
Rapidly shrinking consumer demand and investment spending across major West European partners quickly resulted in a sharp contraction in trade.

In the last quarter of 2008, real exports contracted by 2 percent in Poland (year-on-year), by 3 percent in Croatia, and by 6 percent in Bulgaria and Latvia.
Turkish exports declined the most, by 8 percent, on the basis of falling demand for its manufactured goods.

The decline in both capital inflows and exports caused double-digit contractions in industrial production at the beginning of 2009 across a range of countries.
In the first quarter of 2009, industrial production fell by 10 percent in Croatia (year-on-year), by 11 percent in Poland, by 12 percent in Romania, by 18 percent in Bulgaria, by 22 percent in Turkey, and by 24 percent in Latvia.

In the first quarter of 2009, Turkey posted a contraction of 51 percent in the number of automobiles produced relative to the first quarter of 2008.
Poland’s industrial production of motor vehicles also fell by more than 25 percent, though fueled to a large extent by slack domestic demand.

The Romanian auto industry, regarded as one of the most vulnerable in the region, benefited from the scrap-car program that boosted sales of new cars in Germany.
Car exports rose by 62 percent in the first quarter of 2009 compensating for a 51 percent decrease in domestic sales of new cars during the first four months.

In the labor markets, the crisis has reduced personal income due to rising unemployment at home and abroad, with the latter leading to lower workers’ remittance inflows.
Over 10 percent of GDP in Albania and 5 percent in Romania and Bulgaria came from migrant remittances¹ in 2007.

With many migrant workers employed in the European sectors hardest hit by recession (such as household work, construction, and agriculture), receipts of remittances in the CEE region increased by only 5 percent in 2008, compared with 21 percent in the previous year.
Lagging the first signs of decline in the real economy, unemployment in the CEE region rose in February-March by one percentage point over the average rate prevailing in the first half of 2008.

Pressures on the current account and financial distress triggered a sequence of borrowing from the International Monetary Fund (IMF).
Hungary (which already had graduated from the group of middle-income countries) and Latvia were among the first to turn to the IMF in 2008, contracting loans of $18.1 billion.

Serbia followed soon after, with a $530 million standby agreement targeted at maintaining market confidence in its economy.

In March, Romania had to turn to the IMF for a loan of $17 billion after the national currency had lost about 20 percent of its value relative to the euro over the previous 12 months.
At the beginning of April, Poland took advantage of a $20.5 billion flexible credit line from the IMF—a precautionary facility for countries with sound economic fundamentals—to boost its foreign currency reserves.

Despite the initial resilience shown within the Commonwealth of Independent States (CIS), the group has not been spared by the global meltdown.
The sharp decline in international oil prices in the second half of 2008 adversely affected hydrocarbons producers, particularly the oil-exporting countries of Azerbaijan, Kazakhstan, and especially the Russian Federation.

In Russia, formerly the region’s engine of growth, the collapse of oil revenues caused GDP to decline at an annualized rate (saar) of 6.9 percent in the fourth quarter of 2008 and at a shocking 30.6 percent pace in the first quarter of 2009, bringing the level of GDP 9.4 percent lower than its level a year earlier.

In all CIS countries, dependence on external financing exacerbated the adverse impact of falling commodity prices.
A general deterioration in investor confidence toward emerging markets widened across the region, hitting Kazakhstan, Russia, and Ukraine particularly hard.

In Ukraine, spreads on five-year credit-default swaps increased from 443 basis points in September 2008 to a record high of 3,795 basis points in April 2009.
In addition to the economic slowdown and financial turmoil, investors’ concerns regarding Ukraine were increased by political difficulties in implementing a sequence of measures necessary to secure disbursements under an IMF stabilization loan agreement.

Gross capital inflows to the CIS area fell by 39 percent in 2008, after surging by 84 percent in the previous year.
In the first quarter of 2009, flows to all member countries fell to zero with the exception of Russia (which brought a $500 million bond to market and secured a syndicated bank loan of $1.35 billion) and Ukraine (which had a $7 million equity issuance) (see table below).

The CIS area also suffered a decline in remittances, a major source of revenue for the low-income economies in the group.
In 2007, international remittance receipts were the equivalent of 46 percent of GDP in Tajikistan, 28 percent in the Kyrgyz Republic, and 34 percent in Moldova.

In Moldova, more than 35 percent of the population lived in remittance-receiving households in 2008.² 

With oil revenue–driven growth slowing in Russia, the advance in total remittance receipts for the CIS region decelerated dramatically to 7 percent in 2008 compared with record growth of 75 percent in 2007.
Surging unemployment in Russia, which reached 10 percent in April 2009 (compared with 5.9 percent a year earlier), forced hundreds of migrant workers to return to their home countries.³ 

In an attempt to cushion severe external shocks from sharply falling remittances, Tajikistan, the region’s poorest country, turned to the IMF in April for a $116 million loan under the Poverty Reduction and Growth Facility.

¹ Migrant remittances are defined as the sum of workers’ remittances, compensation of employees, and migrant transfers.
² International Organization for Migration 2008 survey.
³ Migrants return home to Tajikistan, BBC, April 28, 2009.