The economic and financial context we are going through is full of challenges, being marked by exceptional situations such as: the prolongation of the Covid-19 pandemic, the dysfunctions in the production and distribution chains, the increase of prices in the energy sector and the military aggression of the Russian Federation against Ukraine, with profound economic and social implications, which will remain a reference point for a very long time.
By Leonardo Badea, Deputy Governor of the National Bank of Romania
Despite the evolution of the pandemic situation, the global economy has recovered in 2021, amid broad monetary and fiscal support, backed by the launch of the vaccination process and the gradual easing of restrictions and the reopening of activities in the services sector. The speed of recovery is clearly uneven and there may be a slowdown in the process of global cooperation, given that the pandemic and geopolitical tensions have polarized societies and the efforts of states have focused mainly on crisis management.
Equally true, the return has been based on extensive government or international support programs, which are not enough without being accompanied by a gain in productivity, an increase in the quality of public services, and a strengthening of supply chains.
On the other hand, the pandemic has greatly accelerated some technologies, with visible advances in areas such as artificial intelligence, the medical or genetic field, the green sector, and the digital sector. Proper regulation of these developments and the implementation of policies to ensure the development of technologies is a major challenge, requiring, inter alia, access to high quality data related to sustainability, removal of subjectivity, transparency, strong decision-making, and acceleration towards a more sustainable economy.
The future course of the pandemic remains a factor of uncertainty, but the unpredictability of the evolution of the economy and the global financial system has been significantly amplified by the Russia-Ukraine war. It has created new obstacles to economic recovery. Rising prices and increased volatility for certain categories of goods, especially oil and gas, but also restricting access to some imports of agricultural products for which Russia and Ukraine accounted for a significant share of global exports, have caused a number of shocks in terms of supply, especially for some European economies, while affecting the level of confidence of consumers and investors. Among the most exposed states are Moldova, Poland, and the Baltic States, given their economic and geo-strategic ties, as well as their long history of strained relations with Russia. The complexity of the situation is accentuated by a number of other developments, such as: the transformations induced by new technologies, the integration of digital technology in multiple segments of society, the development of business models, which fundamentally change the way value is created.
So far, the difficulties posed by the new exogenous shock of Russia’s war in Ukraine have been managed at a reasonable level, even if they overlap with pre-existing vulnerabilities in many European economies, which have emerged or were amplified by the pandemic crisis, which no one can say with certainty that it is finally over. And these vulnerabilities are not insignificant at all, even if they differ in mix and intensity from one European economy to another: dependence on imports in key sectors of the economy such as energy, food, transport (fuels), and raw materials for the production of high technology goods and equipment, shrinking fiscal space and increasing public debt, inflation, growing impact of climate and demographic change. In the case of some economies, growing structural and current account deficits may be added to the list.
So far, government measures have been relatively effective in addressing the effects of these shocks on the economy and the population, but progress is still limited in addressing the causes or removing the vulnerabilities, which is understandable. These things usually take longer because they involve structural changes. Fortunately, some adaptation reactions from the business environment have been prompt and strategic opportunities have already been included in the priority lists of the states in the area. Imports of both oil and gas and agricultural products could be supplemented by the efforts of well-positioned EU countries to facilitate transit through or production of these resources. Also, accelerating the transition to green energy, a priority that seemed to lose importance during the pandemic, contributes not only to managing the effects on the environment but also to reducing these dependencies.
The impact of the mentioned factors, which act in the sense of the deterioration of the macro-financial imbalances, could be counteracted for the time being but it will continue to manifest itself during the next months. Their effects of discouraging consumption and investment are likely to intensify in the latter part of the year when household spending on heating returns, the effects of inflation on purchasing power will be perceived much more consistently, and public budgets will already be burdened by the effects of previous measures. Therefore, the real test of the resilience of the economy is expected to come in about 6-9 months from now and to be accompanied at some distance by a series of challenges, including for the financial system.
The financial system is undergoing major transformations in the context of the digitalization process which, on the one hand, creates the premises for cost reduction, efficiency gains, competitiveness, and financial inclusion, and, on the other hand, generates risks, some quite significant, such as cybernetic risks. Theft of data or information (especially in Central and Eastern Europe) and cyber attacks (most notably in Western Europe) are identified in the current context as some of the highest risks at European level.
Given that technology is leading to profound changes and that the digital assets and payments ecosystem is evolving at a rapid pace, its impact on the stability of the financial system must be assessed, not only as it exists today, but also as it could evolve in future. That is why it is important to understand the technological advances and consumer requirements that lead to these developments.
The impact of the pandemic and the war in Ukraine required a massive, substantial and, in some cases, unprecedented response to address the economic and social effects of these exceptional phenomena.
The main goal for the next period should not be to return to the situation before these crises, but to capitalize on initiatives that have proven effective in the short term and to develop them into long-term policy objectives. This process must involve changes in the functioning of the economy, funding mechanisms, the provision of public services, and the identification of solutions to some structural problems.
To achieve the best results, such an initiative must be linked to the energy strategy, the sustainable development strategy, and economic realities.
At EU level, the hydrogen strategy aims to make this potential a reality through investment, market creation, regulation, research, and innovation. Hydrogen could power sectors that cannot be electrified, while also providing storage to balance variable flows of renewable energy. According to the EU Strategy, the priority is to expand the production of renewable hydrogen through the use of solar and wind energy, but in the short and medium term, other forms of low-carbon hydrogen are needed to ensure a viable market and reduce pollutant emissions. Innovation and research thus become essential elements for the development of energy sources.
Continued management of short, medium, and long-term challenges involves implementing structural reforms, making investments, continuing the fiscal consolidation process, a coordinated effort to develop research and innovation, identifying measures to facilitate the green and digital transition and, last but not least, the revision of the governance framework focused on fundamental changes to ensure a sustainable economic recovery.
In the financial field, given the scale of the problems we face in the current context, such as geopolitical instability, structural changes in the economy, rising inflation, cyber risks, etc., the main challenge is to protect and consolidate a strong, competitive, and resilient financial system to support the real economy while avoiding volatility.
In this regard, more attention needs to be paid to strengthening the resilience of financial markets infrastructure, developing effective risk and vulnerability management mechanisms, and, last but not least, enhancing pan-European policy cooperation and coordination.
On the agenda, as we have seen in history, there is the existence of overlapping crises. Relatively recent examples would be the oil crisis of ‘73 and the Yom-Kippur war, the crisis of ‘80 –‘83 which was based on the energy crisis of ‘79 caused by the Iranian Revolution, or the recession of ‘90 –‘91 overlapping with the invasion of Kuwait by Iraq and the break-up of the Soviet bloc.
And this time, under the impact of the current overlapping crises, economic resilience will be seriously tested. But that is only half of the current landscape. The other half is our ability to stand in solidarity and use relatively new technologies to overcome these difficulties and strengthen the economy and society in the long run. It is time for human inventiveness and solidarity to speak once again in crisis situations.