Global Crisis ‘Highlights’ Imbalances in Transition, EBRD Says

By Agnes Lovasz

Nov. 2 (Bloomberg) -- The global financial crisis, which pushed some emerging European economies to the brink of collapse, revealed risky imbalances two decades after communism fell, the European Bank for Reconstruction and Development said.

The nations that joined the European Union, along with the southern Balkans, were driven into recession by the worldwide credit squeeze and lost investment. Commodity-rich nations including Russia and Kazakhstan, were punished for failing to diversify away from energy reliance, EBRD chief economist Erik Berglof said in the bank’s annual Transition Report. He warned the way back to prosperity needs more commitment.

“The crisis has highlighted the weaknesses,” he said, in the report, which will be presented today in a London conference on the 20th anniversary of the collapse of communism. “There are lessons to be learned. It is clear that the way to address these pitfalls is to extend the transition agenda and not to replace it.”

The 30 emerging European and central Asian nations in which the EBRD invests are struggling to escape the deepest recession since they adopted free-market policies. The bank, which helped limit the impact of the financial crisis by persuading western European banks to stay in the region, has said the recovery from the region’s worst recession since the early 1990s will be “patchy” and “fragile.”

Eastern Europe was the worst affected of all emerging markets by the worldwide financial turmoil because the level of financial integration they have reached with major economies has aggravated the impact, the EBRD said.

Boom to Bust

The effort to raise living standards to Western levels encouraged a credit boom, excess borrowing and a shift towards indebtedness in foreign currencies, the report said.

The International Monetary Fund needed to step in and finance rescue programs in Hungary, Latvia and Romania as the countries faced defaults and they struggled to refinance maturing debt and loans, many denominated in foreign currencies. The IMF has provided about $65 billion of loans to eastern Europe, which required more than $100 billion in bailout money.

As the recession deepened and unemployment soared, non- performing loans increased across the region as borrowers found it harder to make repayments. Declining currencies also pushed up the costs of loans taken out in euros or Swiss francs before the crisis to benefit from lower interest rates.

The EBRD warned the countries should learn from the crisis and build regulatory safeguards to prevent a similar crisis from occurring in the future.

No Turning Back

“The crisis has shown the need for urgent steps to help reduce dependency on foreign-exchange lending and to manage more effectively the demand for credit,” the EBRD said. It added that “attempting to reverse financial integration would be the wrong conclusion to draw from the crisis. The presence of foreign banks and the resultant depth of financial systems played a crucial stabilizing role.”

Resource-rich countries, such as Russia, Kazakhstan, Azerbaijan and Turkmenistan find conducting economic policy difficult as revenue and foreign-currency inflows fluctuate along with the global markets for commodities, the EBRD said. The lack of alternative sources of income presents a threat to their economies.

“The long-term goal of economic diversification remains elusive,” the report said. “Dependence on wealth from such resources and the very lack of diversification itself stands in the way of development of the sort of institutional framework that would support the creation of a more diverse industrial base.”

The crisis also meant a setback for efforts to further overhaul eastern European economies that would enable them to better compete with other emerging markets. Euro-aspirants are forced to delay the changeover as the recession cut tax receipts, spending increased on bank bailouts and unemployment benefits and currencies have become more volatile.

Euro Adoption

Estonia, which seeks to start using the euro in 2011, is struggling to stay within the EU deficit threshold this year to qualify. Poland’s ballooning deficit and rising state debt forced the country to abandon plans for adoption in 2012.

“The global crisis disrupted the pace of economic reform in eastern Europe, but there have been no significant reversals,” the report said.

The region’s economies will grow about 2.5 percent next year after contracting an average 6.3 percent this year, the EBRD said last month.

The recovery will be curtailed by continued tight lending conditions by western lenders.

Bulgaria, Latvia and Lithuania, which have fixed exchange rates, will contract further as they cut wages, prices and government spending. Albania, Poland, Slovakia and Slovenia will grow faster next year than their neighbors due to relatively unharmed banking systems, the EBRD said.

Recovery prospects in Russia and Kazakhstan depend on the ability of the authorities to clean up their financial industries, the EBRD said.

To contact the reporter on this story: Agnes Lovasz in London at alovasz@bloomberg.net