III. Policy Priorities
- International Monetary Fund. European Dept.
- Published Date:
- November 2015
Supporting domestic demand, addressing crisis legacies, rebuilding buffers against external shocks, and improving the business environment to boost investment and long-term growth are still the key policy challenges for CESEE countries.
The country-specific priorities depend on how far along these economies are in the postcrisis adjustment and their exposure to external risks:
Where the recovery is well advanced, the policy priorities need to increasingly shift toward the medium term, including rebuilding fiscal buffers and continuing with reforms to improve the business environment and address structural weaknesses. This is not to deny that there is still a lot of uncertainty about the strength of global recovery that, domestically, inflation is still too low in many CESEE economies, and that the key crisis legacies—high NPLs and debt overhangs—still need further work (notably in SEE).
For economies that are in recession (Russia and other CIS countries), the key challenge is to steer the adjustment to terms-of-trade and other shocks with a view to supporting weak internal demand and reducing high inflation.
Countries vulnerable to external shocks—such as those with large external financing needs, weak fiscal positions or high dependence on commodity exports—need to be prepared to deal with market pressures by using exchange rate flexibility as a shock absorber (Russia, Turkey) alongside macroprudential policies to contain the build-up of financial sector risks, and also gradually rebuilding FX-reserves buffers (Turkey).
In low-inflation economies, monetary policy should remain accommodative. Additional policy action may be necessary if inflation expectations continue to decline, or interest-rate differentials widen, resulting in unwarranted upward pressure on exchange rates that could prove disinflationary. Countries that do not have monetary autonomy – euro peggers or euro area members – have less scope for policy action (Figure 3.1). Where activity is still sluggish and fiscal space allows, countries could use discretionary, expansionary fiscal policies.
Figure 3.1.CESEE: Headline Inflation, 2015
Source: IMF estimates;
Note: Euro area countries and euro peggers are in RED.
For high-inflation economies, policies should aim to address excess demand pressures and external vulnerabilities to increase confidence in the currency.
Despite improvements in their budgetary structures, CESEE countries face significant fiscal challenges. Most CESEE countries still face sizable adjustment needs to stabilize debt levels and/or return to full compliance with the EU’s fiscal rules. The need for further consolidation tends to be larger in SEE. The analysis in this report offers some insights.
Countries with sizable fiscal adjustment needs (mostly in SEE; Figure 3.2) could achieve more growth-friendly fiscal consolidation via cutbacks in subsidies and tax incentives, reforms to entitlement programs, and the introduction or strengthening of modern property tax regimes. In a number of economies, tax compliance and administration need to be improved. At the same time, productive public investment should be shielded from cuts. EU member states should increase the absorption of EU funds and increase their focus on projects that could better enhance potential growth.
Figure 3.2.CESEE: Estimated Remaining Adjustment Needs
Note: The debt stabilizing primary balance uses current debt level as a benchmark; -1 percent of GDP is the European Commission’s Medium Term Objective for many CESEE countries. Neither metric gives a full account of fiscal consolidation needs.
Countries that do not have urgent consolidation needs could concentrate their efforts on improving their budgetary structures. This would involve reducing corporate income taxes in line with peers or replacing corporate income taxation with increased personal income taxation, especially for higher earners; financing a larger portion of social spending from general taxation, particularly the VAT, instead of social security contributions; and taking steps to enhance the amount and efficiency of health and capital spending, while limiting unproductive transfers and subsidies.
Addressing high NPLs and debt overhangs requires a comprehensive approach. A recent IMF study on the causes and consequences of persistently high NPLs in Europe (Aiyar and others 2015) finds that the weak economic recovery is only part of the story and that the underlying reasons are often deep rooted. A new survey of European country authorities and banks shows that deficiencies in the legal framework and underdeveloped distressed debt markets are, on average, seen as the most severe obstacles to distressed debt resolution in countries with high NPL levels across Europe.
For SEE countries, obstacles to NPL resolution related to information access, legal systems, and distressed debt market functioning are regarded as more severe than in other European countries with high NPLs (Figure 3.3). Furthermore, different obstacles tend to be interlinked, with difficulties in one area compounding challenges in others. Thus, resolving high NPLs requires a comprehensive strategy that includes tightened supervisory policies, insolvency reforms, and measures to develop distressed debt markets (see Aiyar and others 2015 for detailed recommendations).
Figure 3.3.IMF Survey-Based Scores on Obstacles to the Resolution of Nonperforming Loans
Source: IMF surveys of country authorities and banks.
Notes: The figure shows average obstacle scores based on the survey responses of European countries with high numbers (over 10 percent of gross loans at postcrisis peak) in each of five areas (information, supervisory framework, tax regime, legal framework, and distressed debt market). The scores range from 1 to 3, where 3 = high degree of concern, 2 = medium degree of concern; and 1 = no concern. CESEE = Central, Eastern, and Southeastern Europe.; SEE=Southeastern Europe.
Long-term growth challenges
Lifting potential growth is a key medium-term goal for CESEE countries. For much of the region, long-term growth forecasts are now substantially lower than before the crisis (Figure 3.4), largely due to lower total factor productivity. Capital flows to the region are and will likely remain significantly below pre-crisis levels. At the same time demographic dynamics are markedly negative in many countries across the region. In this context, sustained productivity gains can only materialize through structural reforms focused on expanding the role of the private sector, increasing labor and product market flexibility, accelerating the restructuring of loss-making state-owned enterprises, and improving the efficiency of public administrations and the judiciary.
Figure 3.4.CESEE: Long-Term Growth Forecasts in 2007 and 2015
Source: IMF, World Economic Outlook.
Note: CEE = Central and Eastern Europe; CESEE = Central, Eastern, and Southeastern Europe; CIS = Commonwealth of Independent States; SEE = Southeastern Europe.