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WARSAW, February 20, 2009 — The World Bank urged European countries today to protect the hard-earned gains in boosting economic growth and fighting poverty that were made in Eastern Europe during the past two decades, gains that now are at risk during the global economic downturn.

“Eastern Europe is being hit especially hard in these trying times,” said Indermit Gill, World Bank Europe and Central Asia Chief Economist, who made his comments at a launch of the latest World Bank EU10 Regular Economic Report* in the Polish capital.  “In choosing EU membership, the EU10 countries committed themselves to openness and integration into the global economy. This path has paid dividends—spurring economic growth and reducing poverty.  If the world turns protectionist, developing countries will find it difficult to protect these hard-won gains. Fiscal stimulus programs in industrialized countries should be used to encourage production in ways that are broadly efficient, not narrowly nationalistic. During times of economic crisis, growing protectionism may be the greatest danger to economic recovery.”

The prospects for economic growth in the EU10 countries in 2009 continue to weaken—says the EU10 Regular Economic Report of the World Bank. The prospects for global recovery, for private capital flows, and for growth in the EU10 continue to deteriorate. Forecasts are subject to very high degrees of uncertainty, mostly on the downside.  The EU10 economies face the challenges of a dearth of international liquidity, exposure to vulnerable banks, and collapsing export markets. The impact will now be felt strongly in the real economy as defaults spread and foreclosures creep up, and as unemployment rises sharply.

The EU10 Regular Economic Report’s Special Topic: Reshaping Economic Geography concludes that the ongoing crisis should spur deeper European integration, rather than a return to the nationalism of the past. Taking a long-term view informed by the World Bank’s flagship World Development Report 2009 (http://www.worldbank.org/wdr2009), it recommends continued efforts to:

• Make economic borders ‘thinner’ – EU15 governments should resist temptations for protectionist policies that make their borders ‘thicker’ as they design economic stimulus programs;
• Welcome rising economic density – spatial concentration is an integral element of strategies for growth and competitiveness;
• Deepen institutional convergence – EU10 countries should continue efforts to harmonize financial and employment regulations, foster a sound macroeconomic environment, simplify customs regulations and rules of origin, and improve domestic governance.

“With the recent past in mind, it seems probable that 2009 will be a difficult year,” said Erika Jorgensen, World Bank Europe and Central Asia Economic Adviser and the author of the Report. “The global integration of finance, production, and labor was a good thing, although now, looking back, it is easier to see the dangerous buildup of vulnerabilities that came from, for example, mortgages in foreign currency with floating interest rates. With little or no room for fiscal stimulus, governments will need to focus on other measures to stabilize the financial sector and on better quality of spending to deliver core services and provide safety nets to the most vulnerable.”

The EU10 Regular Economic Report analyses stages of the crisis faced by different EU10 countries in four major areas:

• External financing risks in the banking sector;
• Interbank markets and spillover from the global crisis;
• Domestic credit developments;
• Fiscal policy as a stabilization mechanism.

As the international economic crisis continues to unfold, spreading from financial markets into the real economy, the EU10 economies find themselves especially vulnerable. External demand has collapsed, driven by recession in the region’s main trading partners. Foreign capital inflows to the EU10 states have dropped off, especially intrabank lending and foreign borrowing by companies. A credit crunch within the EU10 has further undermined production, as banks weather a crisis of confidence of lending to each other and to the private sector.

“Compared with emerging markets in East Asia and Latin America, EU new member states entered the crisis weak—with high public debt ratios, low foreign exchange reserves, rigid exchange rate regimes, and banks that depended more on foreign savings than domestic deposits,” said Gill.

The successful EU10 integration with the EU and globally, although differentiated across the 10 countries, has brought major benefits, including rapid convergence in incomes, improvements in living standards, and a sharp decline in poverty rates. But the easy flow of credit that made this possible was mirrored in rising private sector debt, growing exposure to foreign exchange risks, and easily-financed large current account deficits. The unprecedented series of external shocks have now revealed the financial sector in the EU10 as even more volatile than those in more advanced economies, while the extreme export dependence of some of the EU10, while supportive of high growth in the past, is now pulling the economies downward.

“Among the EU new member states, Poland is in better fiscal and financial shape,” said Thomas Laursen, World Bank Country Manager for Poland and the Baltic Countries. “Poland is affected by the ongoing crisis through the impact of falling external demand on Polish exports, a slowdown of credit activity, and lower FDI inflows.  Nonetheless, compared with the rest of the region, Poland demonstrates more balanced growth  and, with private consumption as the main driver, a positive GDP growth of up to 2 percent in 2009 is within reach. The Government remains committed to fiscal discipline, while exploring ways to cushion the effects of the crisis on the poor.”

* The EU10 Regular Economic Report is published three times a year. It monitors macroeconomic and reform developments in the EU10 countries, and provides in-depth analyses of key policy issues.  The EU10 countries include: Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia, and Slovenia. To obtain an online copy of the new report, click here. 

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