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Niamh Sheridan, Mr. Alfred Schipke, Ms. Susan M George, and Mr. Christian H. Beddies

Abstract

In just over a decade after independence, the three Baltic countries, Estonia, Latvia, and Lithuania, have transformed themselves into fully functioning, small open-market economies that will be joining the European Union. Capital Markets and Financial Intermediation in The Baltics analyzes the financial systems of the three countries and discusses some of their unique characteristics. The study also examines current distortions of the systems and discusses whether or not the Baltics should move from an almost exclusively bank-based system to one that relies more on capital markets. In the process, it addresses issues of corporate governance and regional integration.

Mr. Jerald A Schiff, Mr. Axel Schimmelpfennig, Mr. Niko A Hobdari, and Mr. Roman Zytek

Abstract

In recent years, the issue of pension reform has been high on the agenda of many countries. To a large extent, this reflects common concerns regarding demographic trends of declining birthrates and increasing life expectancies that have shed serious doubt on the sustainability of current pension systems. Most countries have attempted to shore up their pay-as-you-go (PAYG) systems through some combination of reduced lifetime benefits and higher social taxes.

Niamh Sheridan, Mr. Alfred Schipke, Ms. Susan M George, and Mr. Christian H. Beddies

Abstract

In only a decade after independence, the three Baltic states—Estonia, Latvia, and Lithuania—have transformed themselves into fully functioning, small open market economies that are on the verge of joining the European Union. The three Baltic states, jointly with the other seven accession countries of the first wave, will join the European Union in May 2004 and are expected to seek membership in the European Exchange Rate System (ERM2) shortly thereafter. Over the past decade, economic policies and developments in the three countries have been similar in many respects. All three have used the exchange rate as a nominal anchor to stabilize the economy and to impose fiscal discipline. Estonia and Lithuania chose a hard peg in the form of a currency board, while Latvia pegged its currency to a basket of currencies through an SDR peg. Although considered to be temporary arrangements until adoption of the euro, the respective exchange rate systems have served the countries well and withstood a number of shocks, the most extreme of which was the 1998 financial crisis in Russia.1

Mr. Jerald A Schiff, Mr. Axel Schimmelpfennig, Mr. Niko A Hobdari, and Mr. Roman Zytek

Abstract

The Baltic states inherited a PAYG pension system from the Soviet Union (Box 2.1). Economic developments of the early 1990s had a tremendous impact on the pension systems in ail transition economies, including the Baltic countries. Economic depression accompanied by growing unemployment (open and hidden) undercut the pension system’s financing while adding large numbers of new beneficiaries.1 At the same time, high inflation rates that were not immediately fully matched by nominal pension increases contributed to a sharp decline in the real value of pensions and flattening of benefits across different groups of beneficiaries.2

Niamh Sheridan, Mr. Alfred Schipke, Ms. Susan M George, and Mr. Christian H. Beddies

Abstract

In channeling savings to investment, the financial system contributes to economic performance through mobilizing savings and allocating them efficiently, mitigating market imperfections, and promoting good corporate governance control. In this vein, the following section focuses on the state of development of the financial systems in the Baltics and the role of both bank-based financial intermediation and that of capital markets in allocating financial resources and attempts to identify potential obstacles that may hamper the sound functioning of the financial system and its future growth. This section also provides the background for the discussion of issues related to small open economies more generally.

Niamh Sheridan, Mr. Alfred Schipke, Ms. Susan M George, and Mr. Christian H. Beddies

Abstract

There is a growing consensus in the literature20 that the development of a well-functioning financial system generally plays an important and positive role in the promotion of long-run economic growth and economic stability. This consensus has emerged relatively recently from a growing body of literature based on both theoretical considerations as well as empirical evidence that shows a positive correlation between various measures of financial development and economic growth. There is also some empirical evidence that suggests a causal relationship indicating that financial system development is conducive to economic growth. In addition, another wave of research has looked more closely at the channels through which the financial system enhances growth and has identified a number of specific features that seem to have a potential for enhancing economic growth. The goal of this section is to examine if and in what way the Baltics could develop financial systems with a view to promoting increased long-run growth.

Mr. Jerald A Schiff, Mr. Axel Schimmelpfennig, Mr. Niko A Hobdari, and Mr. Roman Zytek

Abstract

While the early reforms of the Baltic PAYG systems were oriented at preserving the financial solvency of these systems, demographic trends led policymakers in the Baltics, as elsewhere, to look for alternatives to their pensions systems. A PAYG system remains solvent as long as the working generation is able and willing to share sufficient income with the retired generation. However, given expected population trends, it was viewed as unrealistic to expect future working generations, dwindling in absolute numbers, to continue to support an ever larger population of retirees to the same extent as at present. To ensure sustainability via a PAYG system would require further increases in the already high payroll tax rates—which would overburden the working generation, complicate social tax collection, and have an increasingly negative impact on work incentives 21—or reductions in lifetime retirement benefits. As indicated in Table 3.1, maintaining a 40 percent replacement rate and a retirement age of 60 in the Baltics would eventually require that a payroll tax collect about 40 percent of gross wages, which would imply a tax rate well in excess of 40 percent.

International Monetary Fund. European Dept.
This 2018 Article IV Consultation highlights that the economy of Lithuania picked up steam in 2017, following two years of sluggish growth. Real GDP expanded by 3.9 percent largely because of the acceleration of investment, which benefited from credit growth and high capacity utilization. Private consumption remained the main engine of growth, though it was held back by decelerating real wages. The external current account swung to a modest surplus with exports benefiting from past investments in export capacity and improved external demand. Growth in 2018 is projected at 3.2 percent, mainly because of weaker exports after a very strong performance in 2017 and a slowdown of consumption driven by negative employment growth.
International Monetary Fund
Lithuania’s catch-up toward the European average has been impressive. This success has been coupled with the emergence of macroeconomic imbalances. The dominance of foreign-owned banks in the banking system constitutes both a source of strength and risk. Although stress tests indicate that the banking system is reasonably resilient to macroeconomic shocks, existing capital buffers might not be sufficient to cope with low probability extreme events, and strengthening the capital would be advisable. The government implemented a regulatory framework for Nonbank Financial Institution (NBFI) and a pension reform.
International Monetary Fund
Selected issues of Poland are studied in this paper. The global projection model used to prepare the baseline inflation forecast and risk assessment for Poland is also explained. Baseline forecast, risk assessment, and policy communication are discussed. The pension reform has been a cornerstone of fiscal policies in Central and Eastern Europe (CEE). Problems with the Stability and Growth Pact (SGP) rules, a brief discussion of reform reversals, and policy options for both individual countries and those at the EU level are also discussed. Fiscal implications of pre-funding future liabilities are also studied.