Sustaining EU10 Recovery Requires Strong Policy Action

The report says that year-on-year output growth in the EU10 increased from 0.6 percent in the first quarter of 2010 to 2.2 percent in the second quarter of 2010. Growth improved not only due to the base effect — the second quarter of 2009 was the trough of the crisis — but also due to a strong dynamism of the economies, with quarter-on-quarter growth rising from 0.4 percent to 0.8 percent. The rebound in global trade and industrial production has lifted economic activity. European economies benefit from the upswing in trade, the return of confidence in financial markets in response to decisive policy action, low interest rates, and positive feedback effects between the real and financial sectors.

The upswing is taking root across the region. In 2010, Slovakia and Poland are leading in the region with growth of 3.5 percent or more, helped by modest adjustment needs during the crisis, a normalization of global trade and capital flows, and — in the case of Poland — solid consumption. Estonia and Lithuania, which undertook large adjustments during the crisis, are set for a turnaround from a contraction of around 15 percent in 2009 to an expansion of around 2 percent in 2010. Growth in the Czech Republic, Bulgaria, Hungary, and Slovenia is likely to be more modest, ranging from 0 to 2.0 percent, as domestic demand remains weak. Only Latvia and Romania are projected to contract in 2010, reflecting the large adjustment needs from unsustainable domestic booms in those countries in the run-up to the crisis. Growth is set to be positive in all EU10 countries in 2011.

“Not surprisingly Poland is leading the recovery in the region with GDP growth projected at 3.5 percent for 2010 and 4.1 percent for 2011,” said Kaspar Richter, Senior Economist in the World Bank’s Europe and Central Asia Region and lead author of the report. “However, there are still tough challenges that Poland will have to face in the near future to shore up growth prospects. They include reviving credit growth for companies, bringing about fiscal consolidation, and generating jobs, especially for the young and low-skilled.”

The rebound in the EU10 countries is still reliant on external demand and faces a number of risks, of which the main one is weak recovery in Europe, as prospects for exports, credit and jobs in the EU10 depend foremost on a strong recovery in the EU15^[2]. The EU15’s recovery from the global financial crisis could be sluggish and may still be followed by a relapse. Fiscal consolidation in a number of EU15 countries, the end of the inventory cycle and the recent appreciation of the Euro will dampen economic activity. And in most countries, private demand is not strong enough to take the lead and sustain the expansion. Another risk is the return of heightened financial strains in the euro area, in spite of the recent improvements in European financial markets. Renewed financial sector stress could spread quickly to the EU10 countries through cross-border linkages, as parent banks could shrink their subsidiaries’ balance sheets.

Addressing these challenges through policies to strengthen financial markets, fiscal frameworks and structural reforms remains essential for sustained growth in the EU10 region.

“There are three main issues crucial for policy makers in the EU10 region to sustain stable growth,” said Thomas Laursen, World Bank Country Manager for Poland and the Baltic Countries. “The first one, on monetary policy, is for central banks and financial authorities to pursue efforts to reinforce the resilience of the financial sector at the national and European levels. The second one is to implement credible medium-term fiscal strategies, which include rationalizing benefit entitlements and stabilizing age-related spending, strengthening broad-based taxes and tax compliance, and enhancing fiscal institutions. The third issue is to remove structural barriers which could strengthen growth without bringing back unsustainable domestic demand booms fuelled by excessive credit expansion.”

^[1]The EU10 countries include: Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia.
^[2]The EU15 countries include: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom

The report says that year-on-year output growth in the EU10 increased from 0.6 percent in the first quarter of 2010 to 2.2 percent in the second quarter of 2010. Growth improved not only due to the base effect — the second quarter of 2009 was the trough of the crisis — but also due to a strong dynamism of the economies, with quarter-on-quarter growth rising from 0.4 percent to 0.8 percent. The rebound in global trade and industrial production has lifted economic activity. European economies benefit from the upswing in trade, the return of confidence in financial markets in response to decisive policy action, low interest rates, and positive feedback effects between the real and financial sectors.

The upswing is taking root across the region. In 2010, Slovakia and Poland are leading in the region with growth of 3.5 percent or more, helped by modest adjustment needs during the crisis, a normalization of global trade and capital flows, and — in the case of Poland — solid consumption. Estonia and Lithuania, which undertook large adjustments during the crisis, are set for a turnaround from a contraction of around 15 percent in 2009 to an expansion of around 2 percent in 2010. Growth in the Czech Republic, Bulgaria, Hungary, and Slovenia is likely to be more modest, ranging from 0 to 2.0 percent, as domestic demand remains weak. Only Latvia and Romania are projected to contract in 2010, reflecting the large adjustment needs from unsustainable domestic booms in those countries in the run-up to the crisis. Growth is set to be positive in all EU10 countries in 2011.

“Not surprisingly Poland is leading the recovery in the region with GDP growth projected at 3.5 percent for 2010 and 4.1 percent for 2011,” said Kaspar Richter, Senior Economist in the World Bank’s Europe and Central Asia Region and lead author of the report. “However, there are still tough challenges that Poland will have to face in the near future to shore up growth prospects. They include reviving credit growth for companies, bringing about fiscal consolidation, and generating jobs, especially for the young and low-skilled.”

The rebound in the EU10 countries is still reliant on external demand and faces a number of risks, of which the main one is weak recovery in Europe, as prospects for exports, credit and jobs in the EU10 depend foremost on a strong recovery in the EU15^[2]. The EU15’s recovery from the global financial crisis could be sluggish and may still be followed by a relapse. Fiscal consolidation in a number of EU15 countries, the end of the inventory cycle and the recent appreciation of the Euro will dampen economic activity. And in most countries, private demand is not strong enough to take the lead and sustain the expansion. Another risk is the return of heightened financial strains in the euro area, in spite of the recent improvements in European financial markets. Renewed financial sector stress could spread quickly to the EU10 countries through cross-border linkages, as parent banks could shrink their subsidiaries’ balance sheets.

Addressing these challenges through policies to strengthen financial markets, fiscal frameworks and structural reforms remains essential for sustained growth in the EU10 region.

“There are three main issues crucial for policy makers in the EU10 region to sustain stable growth,” said Thomas Laursen, World Bank Country Manager for Poland and the Baltic Countries. “The first one, on monetary policy, is for central banks and financial authorities to pursue efforts to reinforce the resilience of the financial sector at the national and European levels. The second one is to implement credible medium-term fiscal strategies, which include rationalizing benefit entitlements and stabilizing age-related spending, strengthening broad-based taxes and tax compliance, and enhancing fiscal institutions. The third issue is to remove structural barriers which could strengthen growth without bringing back unsustainable domestic demand booms fuelled by excessive credit expansion.”

^[1]The EU10 countries include: Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia.
^[2]The EU15 countries include: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, the Netherlands, Portugal, Spain, Sweden, and the United Kingdom