Essential reforms for Central and Eastern Europe

Central and Eastern Europe has experienced incredible development over the past two decades in all aspects: politically, economically and socially. But the financial crisis has undermined much of this progress. Courageous and unpopular measures urgently need to be taken by governments in the region. If these choices are not made as a matter of urgency, the macroeconomic and social stability of the region will be threatened, the responsibility largely falling to local elected officials.

First, most Central and Eastern European countries (CEECs) vastly underestimate the problems they will face in 2009 and 2010 as their business models – built on foreign direct investment, foreign borrowing and, for members, EU regions, additional funds from Brussels – need a complete overhaul. Today’s problems cannot and should not be solved simply by relying on funding from the EU and other international financial institutions. Instead, we need a long overdue adjustment, with fiscal and structural reforms, including reform of pensions, health care and education.

Second, the banks that hold the majority of the CEEC banking sector underestimate the gravity of the economic situation, while worsening it by hesitating to accept even the limited aid offered by their governments, as in Austria and Hungary. The level of interest rates paid by the largest CEEC banks to governments as part of the 8-10% bailout is proof of the scale of the problems. In addition, some banks are turning to new investors – not always the most fit and appropriate – for financing.

Third, regulators in Central and Eastern European countries have limited tools as the majority of banks are owned by institutions headquartered in the EU. Mainly, they must sit idly by and wait for bank bailouts to be implemented in the countries where the banks’ headquarters are based.

Finally, national regulators are suddenly declaring what we have all known for a long time: that the framework for financial supervision in the EU, and beyond, needs to be fixed.

The only “positive point” is that the entire population shows a high level of realism in the face of the challenges. What is needed is that our politicians demonstrate the same degree of realism.

Urgent and bold action must be taken by the governments of the CEECs to ensure that things remain manageable, not only economically but socially. First, because of the drop in income, they must immediately revise the 2009 budgets and cut spending. It would be better to do it today voluntarily than under market pressure tomorrow.

Second, the EU should quickly provide transparent and tangible support to the countries of Central and Eastern Europe. Our local government initiatives should be complemented by EU funds, in coordination with the International Monetary Fund. I am willing to bet that the majority of Central and Eastern European countries will have an IMF program by the end of this year, as no other institution is so ready to provide the support we urgently need.

Third, other financial institutions, in particular the World Bank, the European Bank for Reconstruction and Development and the European Investment Bank, should demonstrate that a “friend in need is truly a friend”. In practice, this means that money is flowing quickly into the countries of Central and Eastern Europe – the time for promises and public statements is over. If this does not happen, we are facing a severe economic downturn, where declining income quickly consumes all capital investment. If, instead of making structural adjustments, Central and Eastern European countries chose to obtain additional financing from abroad, this could start a new circle of foreign borrowing that would be left to the next generation. We must avoid this.

While all the key players continue to bluff about the real economic situation – politicians blithely call this “general optimism” – the CEEC exchange rates are doing their job for them (at least in those with flexible exchange rates). It is to be hoped that before exchange rate depreciations lead to higher inflation, concrete results can be achieved. If the situation remains as it is today, all CEECs will be subject to varying degrees of political and economic tension.

We must learn from the courage of our predecessors twenty years ago, when they embarked on the uncertain path of economic transformation. Now is the time to stop pointing fingers and undertake economic reforms, first of all at home, in order to ensure that our macroeconomic development rests on a more sustainable basis in the long term.

The writer is governor of the National Bank of Serbia

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