1. South-eastern Europe -Effects of Crisis and The Way Forward Anita Angelovska-Bežoska National Bank of the Republic of Macedonia Belgrade, November 2012

2. Commonalities and differences among SEE countries before the crisis • Growth accelerated sharply in SEE-6 countries... • ...mostly driven by domestic demand (consumption) ... • ...supported by rapid credit growth... • ...fueled also by rising capital inflows

3. Commonalities and differences among SEE countries before the crisis Widening current account deficits... ...amidst growing external indebtedness in some of the countries

4. Commonalities and differences among SEE countries before the crisis (2) • Accumulation of external vulnerabilities (varying degrees) • Declining competitiveness, high current account deficits and rising external debt • Soundfinancial systems: well-capitalized and liquid banks in the run-up to the crisis, though rising reliance on external financing in some countries • Policy responses to contain accumulation of vulnerabilities • Monetary policy response (exchange-rate and euroisation limitations) • Macro prudential measures • Fiscal policy (budget deficit below 3% of GDP/government debt on a declining path)

5. Crisis spillover effects due to strong trade and financial linkages Massive fall in exports and lower capital inflows undermined the pre-crisis growth model

6. Sharp reversal in economic trends • Most severely hit countries with highest internal and external imbalances With both foreign trade and domestic demand channels in work

7. Overall, banking systems remained stable • Considerable second-round effects as the worsened economic outlook pushed credit markets into bust cycle and triggered a rise in NPLs • Sound initial conditions, traditional banking model and low exposure to riskier financial instruments contained direct spillovers during the early stage of the crisis (deposit withdrawal posed a challenge)

8. In the midstream of the crisis profitability eroded...

9. ...but financial stability was not under threat • Sound capitalization levels strongly contributed to banking sector’s resilience, despite the somewhat lower solvency ratio

10. Public finances under pressure... • Larger public deficits – automatic stabilizers’ effect and counter-cyclical expansionary spending • Rising public debt

11. ...contributing to external vulnerabilities build-up • External debt on a rising track, partly due to governments’ increased accumulation of foreign debt

12. Monetary Policy Response • Stronger countercyclical responses in countries with floating exchange rate only, where a currency depreciation was allowed in order to mitigate the impact of the crisis • Conventional and unconventional measures undertaken, balancing between the need for mitigating the crisis impact and maintaining stable currency • Interventions on the forex market, while bolstering foreign reserves level with external financing (IMF support to part of the region)

13. Looking ahead: A growth-enhancing model, with limited space for policy maneuver? • Pro-cyclical tightening in structural terms already in place • Fiscal rules, embedded within the legislation (Croatia and Serbia) • However, the SEE-6 fiscal outlook is still facing numerous challenges • Growth acceleration – a key priority for the region • The room for growth-oriented macro-policies is rather limited • Fiscal retrenchment – inevitable for medium-term fiscal sustainability

14. Looking ahead: A growth-enhancing model, with limited space for policy maneuver? • Buffers in foreign reserves need to be built further, or to be maintained in countries with fixed exchange rate, in order to counter external vulnerability risks – narrowed room for countercyclical monetary policy • At the current juncture, when inflation pressures in the region are building up, the room for accommodative monetary policy might be limited even in countries with a flexible exchange rate

15. Looking ahead: A growth-enhancing model: the role of the domestic banking system at the current juncture • How to cope with the weak bank’s portfolios, since they act as a potential drag on economic activity through: • currently high stock of NPLs which pose a constraint to credit • diminished investment incentives of the overextended borrowers - assets are kept instead of being used for more productive uses • Three years after crisis, credit growth remains subdued • reflecting low credit demand as well as weakened credit supply due to high NPLs • empirical evidence for CESEE shows a 5 % increase of NPL reduces credit growth by 2 p.p. through credit supply effects • De-leveraging of the foreign partner banks • no foreign capital available • imposing additional constraints to branches in the SEE countries • Vienna 2.0 initiative renewed from Jan.2012 as a response to renewed risks for the region from the eurozone crisis • Focus on fostering home and host authority coordination in support of stable cross-border banking and guarding against disorderly deleveraging

16. Looking ahead: A growth-enhancing model: the role of the domestic banking system at the current juncture • The role of foreign financing diminishing - more focus on domestic sources • Most countries have available space for additional financial support of the real economy • However, the deteriorated portfolio quality and the weak economy constrain a stronger credit growth

17. Looking ahead: A growth enhancing model: correcting past mistakes and dealing with structural rigidities • Redefining the economic growth model towards more balanced growth - Moving away from consumption-based towards investment and export led growth • Attracting non-debt capital inflows in the tradable sector – increasing competitiveness

18. Looking ahead: A growth enhancing model: correcting past mistakes and dealing with structural rigidities • The need for structural reforms and enhanced competiveness emphasized with the latest crisis – removing bottlenecks in the investment climate • The region lags behind OECD (Global Competitiveness Index - average of around 4 in SEE and around 5 in OECD) • Structural reforms necessary for income convergence and EU integration

19. Looking ahead: A growth enhancing model: correcting past mistakes and dealing with structural rigidities • Main issues to be addressed: infrastructure enhancement, increase of institutional quality, increase of efficiency and innovations...

20. Concluding Remarks • Growth acceleration amidst preserved macro stability – remains the main challenge for the region • The fiscal space for countercyclical response is rather limited, although there is room for maneuver in some countries • Constraints on conventional monetary policy for growth accommodation are present ... • ...but macro-prudential measures can be undertaken in a countercyclical manner • The soundness of the banking system – strength of the region • Existing space for the banking system to be used as a financial support for growth • Efforts for systemic NPL resolution can enhance banks’ role in growth support • Enhancing structural reforms and allocating capital in tradable sector – a key priority of the region in devising a sustainable new growth model

21. THANK YOU FOR YOUR ATTENTION http://www.nbrm.mk AngelovskaBA@nbrm.mk