High deficits normal for developing Europe, said IMF

“Over the last two decades, it has become clear that the growth potential in these economies is very large. Income levels have been catching up quickly, with the fastest progress observed in the Baltics, Bulgaria, and Romania, countries that started from low levels. Not surprisingly, these countries have also been experiencing the largest current account deficits in the region,” read the IMF's report.
Romania's own credit account deficit is nearing 14 percent according to latest estimates, but IMF analysts said there are at least five other European countries posting deficits above this figure. These imbalances are characteristic to growing economies and should not be a cause for concern as long as policy makers make sure there is a soft landing and effectively manage rapid financial deepening. “The blistering pace of credit growth and the rapid increase in private indebtedness in many of these economies have heightened risks and raised questions about sustainability. Policies have been unable to stem this tide, underscoring the importance of reducing vulnerabilities and building safety margins. These objectives can be achieved by removing fiscal and other distortions affecting bank lending, improving the implementation of prudential and supervisory measures, and promoting better disclosure and understanding of risks,” said the IMF.
Another finding of the report regards the effects of the US subprime crisis on European economies. “Emerging Europe has so far remained largely unscathed by the financial market turbulence, but growth is set to ease in 2008 in nearly all of Europe,” said the IMF.
Money market conditions initially tightened appreciably in a few countries, and floating currencies came under pressure, especially in Turkey, Hungary, and Romania, said researchers. However, these tensions eased quickly, except in Russia, where difficulties of some medium-sized banks in obtaining liquidity lingered for some time, and Romania, where exchange rate pressures continued, found the researchers.
Risks for emerging Europe have risen, especially for those countries that have been funding large current account imbalances with foreign bank borrowing, they said. “In this regard, the financial turbulence may herald a healthy correction to past exuberance, bringing risk spreads closer to fundamentals, improving credit discipline, and helping to reduce external imbalances in emerging countries,” said the IMF.
“If the turbulence recedes, the impact on growth should be manageable. A buoyant global economy, combined with generally sound macroeconomic policies and increasing trade and financial integration in Europe, have yielded a buoyant regional economy with clear growth dividends for advanced economies and convergence benefits for emerging Europe,” researchers added.
They expect the euro area to outpace the United States and the top-performing European emerging economies posting growth rates second only to developing Asia.Regarding second-round effects of the US crisis, IMF's forecast presumes that risks will dissipate gradually, and a further tightening may then be required.
“Such a stance would of course need to be reconsidered if the risks materialized and the slowdown became protracted. In the emerging economies, inflationary pressures and external vulnerabilities will then warrant further interest rate increases in the central scenario. In those cases where monetary policy tools are ineffective or unavailable, the tightening will need to be achieved through fiscal restraint. Strong banking supervision will be critical throughout emerging Europe,” said the IMF.For EU members, the integration process provides an opportunity to expedite financial development, as harmonization requirements, competition pressure, and supervisory risks make further comprehensive reforms more compelling.
“The emerging economies outside the European Union should focus on reinforcing the foundations of financial development: low and stable inflation, good institutional quality, and the rule of law. Creating a well-functioning government securities market, establishing strong corporate governance and creditor rights protection, and promoting the emergence of institutional investors would also be beneficial,” read the IMF Regional Outlook.

Ana-Maria David