Central, Eastern And Southeastern Europe: Mind The Credit Gap

- Countries in Central, Eastern, and Southeastern Europe (CESEE) were facing mixed economic fortunes, according to a new report on the region. In addition to the legacies of the crisis, external forces are at play: the oil price, the strength of the euro area recovery, and geopolitical tensions, said in the report.

Policies should aim to support the recovery and address excessive private sector debt, the International Monetary Fund's (IMF) new Regional Economic Issues report said. "Some countries need urgent progress on the structural reform agenda to escape the debt trap and sub-par medium-term growth."

Baltic countries, Central and Eastern Europe (CEE), and Turkey were faring best, supported by cheaper oil and a stronger euro area recovery, while Southeastern Europe (SEE) was getting a smaller boost from these factors, due to lingering structural weaknesses and private sector debt.

Commonwealth of Independent States (CIS) economies were expected to contract this year, with Russia affected by falling oil prices and sanctions and Ukraine in the midst of geopolitical tensions and macroeconomic adjustment, the report said.

A number of risk factors going both ways could come into play in the near future, warned in the report, reminding that there was a possibility of financial market volatility, such as the US Fed begins to normalize its monetary policy. "This could raise the cost of borrowing and reduce investment in the region" it said.

Any intensification of geopolitical tensions related to Ukraine or a prolonged period of turbulence in Greece could also weigh on the region’s prospects, while growth in the euro area could exceed expectations on the back of the ECB’s monetary policy and lower oil prices.

Since the global financial crisis, most countries in the region had significantly reduced investment and increased savings, while private debt-to-GDP ratios have declined only in a few countries. "This reflects a combination of deep recessions, low inflation, and the impact of currency devaluations on debt burdens" the report said.

CEE countries had seen less of a boom-and-bust cycle and hence, faced less of a deleveraging challenge than elsewhere in the region, while Baltic countries had made progress in reducing private debt and bad loans, a number of SEE countries needed further adjustment, said the report.

"While deleveraging is necessary, it tends to last longer and imply larger output losses if the debt problem is deeply-rooted, if macroeconomic policies are not sufficiently supportive, and if institutional frameworks are less flexible" it added.

"The strength of the financial sector and external environment also matters" it said, statin that a positive “credit gap” existed when private debt was high, compared to a country’s fundamentals, with its GDP and nominal interest rates.

"At the end of 2013, credit gaps were still wide in several SEE countries, Ukraine, Russia and Turkey. Firms in these countries are also typically more exposed to liquidity or solvency risks" it added.

While many CESEE countries need to cut their fiscal deficits, measures should be correctly dosed to avoid derailing the recovery. Monetary policy should remain accommodative in countries facing deflationary risks, according to the report.

"Finally, many SEE and CIS countries also face an extensive unfinished structural reform agenda to improve the investment environment, raise productivity and reduce long-term unemployment" the IMF report added.