Available in: Montenegrin Author: Jan-Peter Olters, World Bank Representative in Montenegro Published in Monitor, Vol. 19, No. 927 (July 25, 2008), “Crni oblaci iza planina,” pp. 32–33. A specter is haunting Europe (and not only Europe)—the specter of stagflation. The world has not seen this ominous combination of slow (or negative) growth and high inflation rates since the oil-price shocks of the 1970s and early 1980s. Several parallel developments now blend into a mix of factors that has policymakers shudder of the prospect of having to exorcise this specter again. Macroeconomic instruments only allow one of the two outcomes to be addressed, at the expense of the other. In the end, to allow markets to function properly, inflation will have to be brought under control first before the focus can be shifted towards ensuring higher growth rates again. Stabilization programs in the early 1980s involved very significant increases in the official interest rates. These were needed to rein in inflation expectations, but they caused recessions and high rates of unemployment (while preparing the ground for the period of rapid growth and low inflations in the subsequent periods). Thus far, Montenegro has been spared the effects from the deteriorating international environment. Foreign investors have kept on viewing Montenegro as an attractive site, growth has remained strong, and fiscal revenues remained buoyant. How serious, though, are the risks that the global crisis will bring the economic boom to a grinding halt? Having long been the locomotive of the world economy, the very significant depreciation of the US currency during the last seven years reflected widening macroeconomic imbalances and, as such, contributed to the increased fragility of the global economy. Since the summer of 2001, just preceding the attacks on the Twin Towers in New York and the Pentagon in Washington, oil prices increased by almost 450 percent, while the relative value of the US dollar vis-à-vis the euro has almost halved to US$1.60 per €1, from about US$0.85 per €1 exactly seven years ago. In the absence of an adjustment to fiscal and/or monetary policies, this is unlikely to change anytime soon. US economic data that influence the exchange rate all look weaker than those prevailing in the eurozone (EU member states, which have adopted the euro as their sole currency): The current-account deficit is higher (5.3 percent of GDP in the US in 2007 compared to a surplus of 0.3 percent in the eurozone); the fiscal deficit is higher (3 percent of GDP in 2007 compared to 0.6 percent), inflation is higher (5 percent in June 2008 relative to the 4 percent), while official interest rates are lower (2 percent versus 4.25 percent). Of these four indicators, the budget deficit and the policy rate are policy instruments under the direct control of the government and central bank, respectively. In addition, falling US house prices, particularly in less prestigious neighborhoods, have triggered the so-called “sub-prime” mortgage crisis. These debts have been included in various financial investment vehicles. The rapidly rising rates of mortgage default have thus caused liquidity shortages in the banking system worldwide. In April, the IMF estimated that global losses could have reached as much as €600 billion. A number of prestigious banks and mortgage lenders, including some in the most developed financial markets, had to be bailed out by governments. As a result, commercial banks worldwide have reined in their lending, which led to rising interest rates and widespread difficulty in maintaining credit lines. This affected even companies otherwise entirely unrelated to the crisis. Naturally, if banks extend fewer credits, this translates into lower expenditures for goods and services, leading to decelerating growth rates. One clear indicator tends to be the sharp contraction in home construction, which has brought not only the US to the brink of a recession. Many of the (transition) economies in Europe are currently viewed as being vulnerable to abrupt contractions. During previous years, countries as heterogeneous as the Baltic republics, Bulgaria, Iceland, or Ireland have benefited from easy access to credit, low (or even negative) real interest rates, and from the presence of foreign banks. These were able to borrow from their respective mother banks abroad. With high rates of investment and consumer spending, these economies experienced prolonged periods of above-trend growth. At the same time, the economies became increasingly more fragile, as wage and price pressures built, asset bubbles (especially house prices) burst, and current-account deficits widened. Some countries, especially the hitherto dynamic economies of Estonia, Iceland, Ireland, or Latvia, have recently experienced sharp declines in economic growth and face the prospect of negative growth in 2008. Does the same fate await Montenegro? Post-independence growth rates were largely fueled by three factors—foreign direct investments, tourism, and bank credits. In regards to investments, Montenegro appears more shielded from detrimental effects from the global crisis than many other countries in the region. The largest investors—including now for the large-scale tourism development projects along the southern coastline—come from countries that, as exporters of oil and gas, have immensely benefited from the high energy prices. Many firms in Russia or the Golf states are highly liquid and in search of attractive investment opportunities. As such, the overall economic effects in Montenegro from the record-high oil prices might be more ambivalent, as it appears to belong to the group of countries with some positive secondary effects. However, the tourism sector remains the primary destination of investments, and the inflow of revenues from tourism can easily be affected by the deteriorating international environment, as it entices households in the countries of origin to keep a tighter hold over their families’ expenditures. If the 2008 tourism season ends up disappointing, this will have an impact on investors’ expectations regarding the tourism sectors’ profitability over the medium- to long-term horizon. Currently planned investments might be reassessed on the basis of the experiences currently being made along the beaches of Montenegro. The global crisis will, in all likelihood, contribute to the faster-than-expected deceleration of private-sector credit growth rates in 2008. In late 2007, the central bank correctly reacted to the increasing macroeconomic and prudential risks and tightened regulations for banks to extend credits. This has already shown effects. But the first half of 2008 also saw an increase in foreign indebtedness by domestic banks and by activities to commission their foreign mother banks to provide credits to the private sector. The international credit crunch will affect the propensity of foreign banks to be thus engaged, even more so if anecdotal evidence of flattening real-estate prices gets corroborated in the official data to be released during the coming months. For reasons of internal macroeconomic management (including with a view to reducing the currently high rates of inflation), this may turn out to be a welcome side effect in efforts not only to avoid a full boom-bust cycle but also to ensure, as best as possible, high and sustainable rates of growth. But this is no time for complacency. |
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