Tipping into a new recession, or what else?

What lies ahead for Romania?

Daniel Daianu

COFACE conference, Bucharest, 28 September, 2011 1

contents

• Global context: the Great Shift

• A new recession (same crisis), or…?

• Euro-zone crisis; impact on NMSs

• Romania’s prospects

• The future of convergence

1.The Great Shift; black swans proliferate

• The Great Shift: the rise of Asia• A proliferation of black swans (tail risks, crises): financial/economic;

ecological; demographic,• Overstretched societies: economically; socially; militarily…political strain• Strain in the West (its decline)• Economic slowdown (quasi-stagnation?) in industrial societies

(Japanization?)• The struggle over limited resources: oil, food, water (Malthus again?) • A crisis of globalization (over-dependency on external supply chains; inter-

connectedness/ Financial markets and systemic risks• Financial markets as an in-built destabilizer• Governance bottlenecks (national; regional (EU); global)• Limits of openness• An age of uncertainty, insecurity and distributional struggle (volatility,

domino effects/contagion; back up systems…costs)

1.1 The Crisis impact State intervention to rescue financial institutions:

Massive costs of bail outs A huge sovereign debt problem (compounded by aging and effects of climate change) Sovereign debt crises (Reinhart and Rogoff) Fear and lack of confidence factors Global crowding out effect : impact on interest rates Getting out of an era of profligacy in an orderly way… Entering an age of diminished expectations and growing uncertainty (insecurity) Wrecked economies (Iceland, Ireland, Greece) in developed countries; Intensity of contagion effects Social strain (erosion of the middle class, but which has started in the early 90s)

1.2 Relapse into a new recession (same crisis)?

• Visible signs: flight to liquidity (drops on equity markets); bonds valuations; banks’ funding (do markets freeze again?); rising CDSs

• Economic slowdown: the IMF estimates for the EU in Q3 and Q4, and forecasts for 2012 revised downwards

• Dysfunctional politics• Political stalemate in the EU (EMU)• The specter of 1937…

1.3 Scenarios

• Tipping into a new recession, by sheer dynamics of market forces and inaction of policy-makers; worsening of bank balance-sheets (new bank recapitalization…)

• Avoiding a new recession by further intervention by the FED and the ECB; bigger firepower of the EFSF (leveraging it up), G20 coordination and IMF support…

• A new Lehman Brothers….disorderly default in the Euro-zone: fall of output (rise of unemployment) followed by quasi-stagnation for years; impact on the banking sector

• An orderly default of Greece; can contagion be avoided (is a firewall possible)?

• A long stagnation/contraction? Kondratiev cycles, but with the difference of the great shift in the global balance of economic power?

2. The euro-crisis Herman van Rompuy: “the EU model is under threat”; is

Europe 2020 a proper answer? The Crisis, recession, stagnation…jobs Rediscovering major cleavages in the EMU(EU) The crisis of the EMU (EU): the reform of governance “The Monti trade-off”:the single market may ask for intra-

Union fiscal transfers Lack of burden sharing arrangements in the EU; Renationalization of policies? Variable geometry on the rise? The future of convergence (the case of NMSs) More vs less Europe (integration vs. fragmentation):

(what does it mean for the EU budget?).

2.1 The EU budget framework• It seems to assume that we will get back to “business as usual” after the

crisis is over…• If this assumption is discarded the new framework looks like a relic, a

prisoner of the past…in spite of its pretense (Europe 2020, too); would its structure had been different in 2007/8?

• There is a sort of disconnect between this new framework and what the current crisis tells us…

• If the choice is for more Europe as a response to the Crisis, the EU budget should be bigger; the EP is right, philosophically, in this regard…

• De facto, there is an additional budget in the making for the euro-zone, EFSF; the latter could be raised to over 2,000 euro (the American proposal to leverage it up) –double the EU budget for 2014-2020

• It does not consider the need for drastic changes in the functioning of the EU institutions and policies

• Its own resources need to be bolstered

2.2 Rescuing the euro-zone

• Incrementalism does not work• Fiscal rules are necessary, but not sufficient• Eurobonds as a means for fiscal integration;

bolster the EFSF to over 2,000 billion• ECB operations • Bank recapitalization• Orderly restructuring of sovereign debts where

necessary• Fostering growth in the periphery

2.3 Fortune reversals? NMS vs EMU periphery

• Euro as shelter vs. euro as a major constraint on adjustment policy; the structural flaws of the EMU

• The Great Moderation as a Great Misperception; CDS reflect market myopia and overshooting (misperception); when euro-zone weak links did borrow very cheaply –resource misallocation

• NMS are better rated by markets than the EMU periphery (see CDSs)

CDS, 5y

11

0

100

200

300

400

500

600

700

800

Jan-09

Mar-09

May-09

Jul-09

Sep-09

Nov-09

Jan-10

Mar-10

May-10

Jul-10

Oct-10

Dec-10

Feb-11

Apr-11

Jun-11

Aug-11

RO

de

bg

hu

pl

cz

0

200

400

600

800

1000

1200

Jan-11 Mar-11 May-11 Jul-11 Sep-11

it

es

pt

ie

0

1000

2000

3000

4000

5000

6000

gr

GDP dynamics

Source: IMF-World Economic Outlook, Sep 2011, Eurostat 12

2008 2009 2010 2011p 2012p

Gr 1 -2 -4.5 -5 -2

Pt 0 -2.5 1.3 -2.2 -1.8

Es 0.9 -3.7 -0.1 0.8 1.1

It -1.3 -5.2 1.3 0.6 1.3

Ie -3 -7 -0.4 0.4 1.5

De 1.1 -5.1 3.7 2.7 1.3

-8-6-4-202468

% ch

ange

Gr

Pt

Es

It

Ie

De2008 2009 2010 2011p 2012p

RO 7.3 -7.1 -1.3 1.5 3.5

Bg 6.2 -5.5 0.2 2.5 3

Hu 0.8 -6.7 1.2 1.8 1.7

Pl 5.1 1.6 3.8 3.8 3

-8

-6

-4

-2

0

2

4

6

8

% ch

ange

RO

Bg

Hu

Pl

Current account dynamics

13Source: Eurostat, European Commission Spring Forecast 2011

2008 2009 2010 2011p 2012p

RO -11.6 -4.2 -4.1 -4.4 -4.8

Bg -23 -8.9 -1 -2 -2.6

Hu -7.3 0.4 2.1 1.6 1.9

Pl -4.8 -2.2 -3.4 -4.1 -4.1

-27

-22

-17

-12

-7

-2

3

8

%G

DP

RO

Bg

Hu

Pl

2008 2009 2010 2011p 2012p

Gr -14.7 -11 -10.5 -8.3 -6.1

Pt -12.6 -10.9 -9.9 -7.5 -5.2

Es -9.6 -5.2 -4.5 -4.1 -4.1

It -2.9 -2.1 -3.3 -3.5 -3.3

Ie -5.6 -3 -0.7 1.2 1.8

De 6.2 5.6 5.7 4.7 4.6

-17

-12

-7

-2

3

8

% G

DP

Gr

Pt

Es

It

Ie

De

Budget deficit

14Source: Eurostat, European Commission Spring Forecast 2011

2004 2005 2006 2007 2008 2009 20102011p

2012p

Gr -7.5 -5.2 -5.7 -6.4 -9.8 -15. -10. -9.5 -9.3

Pt -3.4 -5.9 -4.1 -3.1 -3.5 -10. -9.1 -5.9 -4.5

Es -0.3 1.0 2.0 1.9 -4.2 -11. -9.2 -6.3 -5.3

It -3.5 -4.3 -3.4 -1.5 -2.7 -5.4 -4.6 -4.0 -3.2

Ie 1.4 1.6 2.9 0.1 -7.3 -14. -32. -10. -8.8

De -3.8 -3.3 -1.6 0.3 0.1 -3.0 -3.3 -2.0 -1.2

-37.0-32.0-27.0-22.0-17.0-12.0-7.0-2.03.08.0

% G

DP

Gr

Pt

Es

It

Ie

De

2004 2005 2006 2007 2008 2009 20102011p

2012p

RO -2.3 -1.5 -1.4 -0.1 -1.8 -6.0 -5.6 -4.7 -3.6

Bg 1.8 1.0 1.9 1.1 1.7 -4.7 -3.2 -2.7 -1.6

Hu -6.4 -7.9 -9.3 -5.0 -3.7 -4.5 -4.2 1.6 -3.3

Pl -5.4 -4.1 -3.6 -1.9 -3.7 -7.3 -7.9 -5.8 -3.6

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

%G

DP RO

Bg

Hu

Pl

Gross public debt

15Source: Eurostat, European Commission Spring Forecast 2011

2004 2005 2006 2007 2008 2009 20102011p

2012p

RO 18.7 15.8 12.4 12.6 13.4 23.6 30.8 33.7 34.8

Bg 37 27.5 21.6 17.2 13.7 14.6 16.2 18 18.6

Hu 59.1 61.8 65.7 66.1 72.3 78.4 80.2 75.2 72.7

Pl 45.7 47.1 47.7 45.0 47.1 50.9 55.0 57.4 55.1

10

20

30

40

50

60

70

80

%G

DP

RO

Bg

Hu

Pl

2004 2005 2006 2007 2008 2009 20102011p

2012p

Gr 98.6 100.0 106.1 105.4 110.7 127.1 142.8 157.7 166.1

Pt 57.6 62.8 63.9 68.3 71.6 83.0 93.0 101.7 107.4

Es 46.2 43.0 39.6 36.1 39.8 53.3 60.1 68.1 71.0

It 103.9 105.9 106.6 103.6 106.3 116.1 119.0 120.3 119.8

Ie 29.6 27.4 24.8 25.0 44.4 65.6 96.2 112.0 117.9

De 65.8 68.0 67.6 64.9 66.3 73.5 83.2 82.4 81.1

30507090110130150170

% G

DP

Gr

Pt

Es

It

Ie

De

2.4 Pluses of NMS, but…no decoupling possible

• Low public debts

• Capacity to fiscal adjustment

• Being outside the euro-zone

• Some NMS are more compatible, competitiveness-wise, with the hard core of the EMU

3. Romania’s predicament

• It very much depends on EU wide dynamics

• Exports have been the driving force of its late feeble recovery

• Diminished consumption

• Fiscal correction underway

• EU funds absorption

3.1 Impact of the crisis in Romania

• Deep recession (why?)• Income per capita in Romania has gone down from cca 47% to 45%

of the EU average (PPS terms) since 2008; euro based the drop was from 26% to 23.4% (Eurostat data)

• It has, likely, reduced the level of potential output;• It has, likely, diminished the durable potential yearly economic

growth rate: from cca. 5-5,5%, before the crisis, to about 3-3,5%, but…

• Twin deficits syndrome since 2009• The computations on economic growth rates are optimistic were

Europe to revisit a recessionary period, and, moreover, lapse into a lasting quasi-stagnation (A “Japanized” dynamic…”the lost decade”);

• A double deep recession would heighten the strategic importance of EU funds

3.2 Pieces of good news

• Fiscal consolidation underway: see table (cca.4.5% in 2011 and, hopefully, cca 3.5% in 2012, though a double deep in Europe would make it quite hard to achieve)

• Strong reduction of the CA deficit (from double digit numbers before 2009 to around 4.5% during 2009-2011)

• Booming exports, though they are likely to slowdown; ULCs seem not to be the main issue

• Still low public debt• Restart of strong disinflation after the VAT shock of 2010• Not least: not being in the euro-zone (autonomous MP

and Ex rate policy)

3.3 Pieces of bad news• The big rise in public debt (speed of borrowing): from cca 18% end

2008 to 36% in 2011, with a big rise in external borrowing• Fiscal consolidation needs further major steps: the deficit of the

social security system; the inefficiency of the public sector• The rising cost of sovereign debt service (in spite of sovereign rating

improvement): CDS have climbed over 450 basis points lately (from around 250 basis points three months ago

• Low fiscal revenues (at 28% of GDP they cca 4% lower than NMSs average and about 10% below EU-27 average)

• High euroization• Low EU funds absorption capacity

Budget expenditures

21Source: European Commission Spring Forecast 2011

2006 2007 2008 2009 2010 2011p 2012p

RO 35.5 36.3 38.3 40.6 40.8 38.8 36.1

Bg 34.4 39.7 37.6 40.7 37.7 37.4 36.6

Hu 52.0 50.0 48.9 50.6 48.8 50.4 45.3

Pl 43.9 42.2 43.2 44.5 45.7 45.8 50.4

30

35

40

45

50

55

%G

DP

RO

Bg

Hu

Pl

2006 2007 2008 2009 2010 2011p 2012p

Gr 44.9 46.3 49.6 52.7 49.6 49.7 49.5

Pt 44.5 44.3 44.6 49.8 50.7 47.7 46.9

Es 38.4 39.2 41.3 45.8 45.0 42.9 42.0

It 48.7 47.9 48.9 51.9 50.6 49.9 49.2

Ie 34.5 36.7 42.8 48.2 67.0 45.5 43.9

De 48.6 48.4 50.1 54.0 53.0 53.1 53.6

303540455055606570

% G

DP

Gr

Pt

Es

It

Ie

De

Budget revenues

22Source: European Commission Spring Forecast 2011

2006 2007 2008 2009 2010 2011p 2012p

RO 33.3 33.7 32.6 32.1 34.3 34.1 34.5

Bg 36.2 40.8 39.3 36 34.5 34.7 35

Hu 42.6 45.0 45.2 46.1 44.6 52.0 42.0

Pl 40.2 40.3 39.5 37.2 37.8 40.0 40.1

30

35

40

45

50

55

%G

DP

RO

Bg

Hu

Pl

2006 2007 2008 2009 2010 2011p 2012p

Gr 39.2 40.0 39.9 37.3 39.1 40.2 40.2

Pt 40.5 41.1 41.1 39.7 41.5 41.8 42.4

Es 40.4 41.1 37.1 34.7 35.7 36.5 36.7

It 45.4 46.4 46.1 46.5 46.0 45.9 46.1

Ie 37.4 36.8 35.5 33.9 34.6 35.0 35.1

De 43.7 43.8 43.9 44.5 43.3 43.3 43.2

30

35

40

45

50

% G

DP

Gr

Pt

Es

It

Ie

De

Budget/Tax revenue: RO, NMSs and EU27

23Source: European Commission Taxation Trends, 2011, European Commission Spring Forecast 2011

2004 2005 2006 2007 2008 2009 20102011p

2012p

RO 32.3 32.4 33.3 33.7 32.6 32.1 34.3 34.1 34.5

NMSs 38.1 38.4 38.2 38.8 38.3 38.7 38.2 39.2 37.7

EU27 44.0 44.4 44.9 44.8 44.6 44.0 43.9 44.5 44.5

30.032.034.036.038.040.042.044.046.0

%G

DP

Budget revenue

RO NMSs EU27

2004 2005 2006 2007 2008 2009

RO 27.2 27.8 28.5 29.0 28.0 27.0

NMSs 38.8 39.1 39.6 39.6 39.3 38.4

EU27 33.1 33.4 33.5 34.1 33.9 33.41111

25.027.029.031.033.035.037.039.0

%G

DP

Tax revenue

RO NMSs EU27

3.4 Economic policy in Romania in the period to come

• NBR: provided inflation continues to go down, lower the policy rate;

• Do the utmost to increase EU funds absorption• Raise fiscal revenues (fight tax evasion;

increase royalties and tax land adequately, etc)• Continue structural reforms (labor markets; state

companies;)• Agriculture, infrastructure, education, industrial

rejuvenation; the role of EU funds• Trade links outer the EU

3.5 Estimates for 2012

• Provided there is no “black swan” engulfing the European economy, the GDP growth rate could be around 2.5% (it considers the economic slowdown in the EU)

• A new recession in the EU could reduce the GDP growth rate toward 1%

• The budget deficit: cca.3.5% of GDP (the lower the GDP growth rate the harder is to keep the budget deficit close to 3%)

• End of the year inflation: between 3.4-3.8% assuming an economic slowdown in Europe and no big pressure for depreciation of the exchange rate

• The CA deficit: around 4.5%

4. The convergence challenge in the EU

• It is of long vintage (structural and cohesion funds)• Only very partial success: the “mezzogiornification of the

southern fringe”/ fractures in the EMU (EU), which were obscured by the Great Moderation period (cheap credit and imports)….The Great Misperception

• The competitiveness challenge in the EMU (in the EU);• Weaknesses of the growth model in NMSs (big external

deficits and non-tradable sector overinvestment) • redesigning growth models in a new world context• What can EU policies do?• The role of the EU budget

4.1 The role of EU funds in NMSs

• A macroeconomic function; to help limit pro-cyclical policies in a a crisis

• A developmental function: infrastructure and rural modernization projects;

• A structural reform function: help improve the use of public funds, the reform of public administration

• A social function: the job issue (social strain)• Help reduce EU economic discrepancies• Planning for a double deep and mounting crisis

in the EMU

4.2 EU funds in Romania• Very poor absorption ratio until now• Raising the level of EU budget expenditure: an absorption ratio of

above 3% of GDP would increase budget revenues by 2% (cca 1% of Romania’s GDP is its contribution to the EU budget); nota bene: Romania has one of the lowest fiscal revenues ratio in the EU, 27- 28% of GDP during 2004-2010, as against an average of 39% in EU-27 and cca 33% in NMSs

• A net rise in budget revenues/expenditure of 2% of GDP could, ceteris paribus, increase the economic growth rate by 0,6-1%, and bring the durable economic growth rate above 4%; a net rise in budget revenues/expenditure of 3% could bring the economic growth around 4.5% of GDP.

• The estimates above do not factor in a new recession in Europe and, what would be worse, disorderly defaults in the euro-zone with ensuing lasting bad effects

• Should worst case scenario occur, EU funds could play a significant damage limitation function

4.3 EU funds in Romania (II)

• In the case of deeper euro-zone crisis, of defaults, Romania should be allowed to use EU funds in order to protect its banking sector (Greek banks hold cca 20% of Romania’s banking sector assets)

• Agriculture is a golden activity in view of rising world relative food prices; it should be seen as a priority for the EU as a whole;

• Infrastructure development• The scarcity of capital worldwide puts an additional

premium on EU funds;• The opportunity cost of not absorbing EU funds is

enormous: a/EU funds could be reoriented to other users; b/ the economic cost per se; c/ it could backfire by signaling fiscal indiscipline and resulting sanctions

4.4 Convergence prospects are dimmer

• By using PPS terms, an annual economic growth rate differential of 3%, as against the EU area, would permit to reach cca 80% of the EU average income level in about 18-20 years time (from the current level of about 45%); on euro based calculations the rise would be from around 23.5% in 2010 to cca 40% n 2030; a median value would give 60-65%.

• the lower the rate differential the longer the convergence period• These are back of the envelope calculations and based on uncertain

premises; but they provide a measure of challenges ahead. But consider the “Great Shift” and its impact, and not least, a new recession and long stagnation period in Europe…

• There is need for more tailor made policies –fitting Romanian circumstances, even if EU rules are constraining (see slide which follows)

4.5 Rethinking economic policies

• The Washington Consensus has been disputed since long

• Questionable IFIs policies (neglect of industrial policies; premature opening of the capital account, etc)

• Diversity of policy/ instruments (Dani Rodrik)

• Taming financial markets is a must for regaining financial stability