Mugur Isărescu: Transformation of Central and Eastern European
economies - lessons learned and the way forward
Opening speech by Mr Mugur Isărescu, Governor of the National Bank of Romania, at the
Bucharest Security Conference, Bucharest, 4 October 2019.
* * *
Ladies and gentlemen,
I am honoured to speak at this conference about a highly topical issue in front of such a
distinguished audience. I believe it is a good opportunity to look back at the macroeconomic and
financial developments in Central and Eastern European countries and, based on the past
decades' experience, to look forward into the future of these economies, also from the
perspective of euro adoption.
Generally speaking, the transition from a centrally-planned to a market economy proved to be a
much more difficult task than it was first believed. The transition model was designed based on
the concepts prevailing in the western countries in the early '90s: free markets, globalisation and
ensuring security and development via NATO and EU membership. With the benefit of hindsight,
I can say now that not many knew exactly what the right thing to do was, relevant experience was
lacking, and every model - be it shock therapy or gradual reform strategy - proved to have its
limits, so it was rather learning by doing. It was a time of experiments and many reforms were
carried out in a sui generis manner. I dare say this as a veteran, serving also one year as a
Prime Minister in 2000.
In time, several aspects of transition differed from one country to another: smaller countries,
such as the Baltic states or Slovenia and Slovakia, opted for a fast track towards Eurozone entry,
inter alia because of geopolitical and security reasons, while states with larger and more
complex economies, such as Poland, Hungary, Czechia or Romania, focused their efforts more
on internal development. For instance, in Poland there is talk of "Polish-ization" and
"nationalisation" of development, the spotlight being on the requirement to increase the country's
power resources: "if you cannot stand on your own feet, no one will listen to you". In Romania,
we had a very difficult transition in the first post-communist decade, with half-hearted, gradual
reform, yet after 2000 our economy has evolved more coherently, having two important anchors:
the EU and NATO.
Events that were hard to foresee in the early '90s took place as well. For instance, who would
have thought that Slovakia, the less developed part of Czechoslovakia, would join the euro area
and Czechia would not? Under the circumstances, does euro adoption testify to a high
development level? Who would have thought that Balcerowicz, the initiator of shock therapy in
Poland, whose name will always be linked to its transition from a centrally-planned economy to a
market economy, considered a hero of reforms in the '90s and even before the global crisis,
would become now a sort of scapegoat for the less positive aspects of transition - the leader of
Law and Justice Party in Poland, Jaroslaw Kaczynski, committed to " finally reject the
1
unfortunate concepts of the pest Balcerowicz" .
I don't have now the time to discuss in detail these complex processes or the differences
between countries. I am sure that this conference will lay another brick to the better
understanding of these processes. My intervention aims at sharing with you a few lessons that I
am formulating from my present position as a central banker.
lesson I would like to mention refers precisely to real convergence. In almost two
The first
decades, all CEE economies have made significant progress - at various paces - in terms of
real convergence, with the catching-up process benefiting substantially from their EU accession.
In Romania's case, GDP per capita as a percentage of euro area average (based on PPS)
expanded almost threefold compared to the year 2000, reaching 61 percent in 2018. Poland and
Hungary stand at around 67 percent (both posting values of no more than 45 percent in 2000),
Czechia at 86 percent (from 61 percent in 2000) and Bulgaria at 47 percent (against 24 percent
in 2000).
As a matter of fact, Romania boasts the fastest growth rate in the group of peer countries with
similar trends. Can we, therefore, say that this is proof of a successful catching-up in real terms?
Furthermore, can we claim that having a flexible policy framework (including a managed floating
exchange rate) helped us in this respect? Allow me to assert that more time is needed in order
for these questions to be appropriately answered. However, a general remark can be made:
the
EU and NATO anchors helped us all make progress as concerns real convergence.
The second lesson derives from the answer to the following question: did the strategic
decisions on the exchange rate regime and monetary policy framework matter? It is known that
some countries in the region (Romania, Poland, Czechia, Hungary) opted for flexible exchange
rate arrangements and adopted inflation targeting, while others (Bulgaria and the Baltic states)
resorted to a fixed exchange rate regime under a currency board. At first sight, it seems that the
latter group of countries are better prepared in terms of euro adoption (the Baltic states have
already taken this step but they, being much smaller and more open economies, are a special
case), given the fiscal discipline pursued and the nominal convergence stage in those
economies. This has helped keep macroeconomic imbalances under control, yet the flipside of
the coin is that the pace of real convergence was slowed by these powerful constraints, at least
in the aforementioned case of Bulgaria.
Consequently, it can be said that
both approaches have benefits and drawbacks and that
the story of these economies on their catching-up journey is still far from over. I would
point out that there are resources for all these economies to continue to grow relatively fast.
While convergence will go on, it is unsure at what pace, how linear and how sustainable it will be,
and the surprises that the future has in store for us are difficult to foresee, just like the recent
past differed from what we could have forecasted two decades earlier, for instance.
The third lesson concerns the manner in which the global economic and financial crisis was
weathered. With only one exception (Poland, which has not seen a single year of recession
precisely because it managed to adequately combine exchange rate flexibility and fiscal
discipline), all CEE economies witnessed periods of economic decline - more or less severe,
shorter or longer - owing to the crisis, irrespective of their exchange rate or monetary policy
regimes. The steepest decline was in Romania, which had to undergo the most painful fiscal
adjustment. This occurred because the fiscal policy during the pre-crisis boom had been strongly
procyclical, so that the economic advance of over 9 percent in 2008 was followed by sharp falls
in the next two years: -5.5 percent in 2009 and -3.9 percent in 2010. The lesson learned here
is that there is no viable alternative to a predictable and coherent mix of economic
policies and structural reforms. Let me stress that this mix should remain in place even when
facing the challenges of election years, and there are several election rounds in Romania in 2019
and 2020.
The fourth lesson could deal with the issue of whether joining the euro area ensures faster
growth or not. I attended the celebrations marking the 10th anniversary of euro adoption in
Slovenia and Slovakia. While in the latter country euro area membership is considered a
success story, in Slovenia it is viewed as a necessary, yet painful, step. During my conversation
with a Slovenian expert, I argued that the difficulties faced after euro adoption were the
consequence of not cleaning up banks' balance sheets before euro area entry. He replied that
the people were not interested in these details, as what they cared about most was the standard
of living, which declined after the euro changeover.
While this could be in itself regarded as a lesson, I will go further and add that the recent views
expressed by policymakers in Hungary and Poland appear to favour the idea that euro area
membership contains the room for growth.
A number of public statements are relevant in this respect. The Hungarian Prime Minister, Viktor
Orbán, said in April 2013 that "Hungary cannot seriously consider joining the euro zone until the
country's average economic development reaches 90 percent of the level of euro states".
Poland's former central bank governor Marek Belka stated in 2015: "You shouldn't rush when
there is still smoke coming from a house that was burning... As long as the eurozone has
problems with some of its own members, don't expect us to be enthusiastic about joining". His
successor at the helm of the monetary authority in Poland, Adam Glapiński, said that - and I
quote - "We will not give up on the zloty (currency), because it will dramatically limit growth
opportunities for the Polish economy".
Back in 2001, Leszek Balcerowicz noted that structural reforms are those that harmonise
nominal and real convergence, as there are also unavoidable tensions between the two. The
more comprehensive the structural reforms, the less costly the disinflation and the more robust
the economic growth over the long term.
Benoît Coeuré, a member of the ECB's Executive Board, provided an overall view when pointing
out, in November 2018, that the Central, Eastern and South-Eastern economies were
characterised by an uneven level of convergence and that the smaller ones (from Slovenia to the
Baltic states) joined the euro area irrespective of their progress in this area. Larger economies
were in no hurry to adopt the euro, but rather focused in the first place on correcting some
structural issues as long as the economic policy framework still enjoyed a certain flexibility.
Let me now tell you how we addressed these issues in my country. Romania chose rather to
take the middle way in approaching euro adoption, envisaging a real convergence level of at least
70-75 percent prior to entering the euro area, as a lower level would cause us to be severely
affected by asymmetric shocks and therefore be unable to synchronise our business cycle with
that of other euro area economies. As for the Maastricht criteria, from July 2015 to November
2017, Romania fulfilled all the convergence criteria in the Treaty (yet without participating in the
Exchange Rate Mechanism). The fact that, at this moment, the reference values for the
longterm interest rate and inflation are no longer complied with is a warning that efforts should be
undertaken to attain nominal convergence in a lasting manner, not accidentally or temporarily.
This is feasible only when the two types of convergence reinforce each other.
The inherent flexibility of a managed float regime such as the one pursued by the NBR does,
however, have its clear limitations, which should not be overlooked - this does not imply, by any
means, that the central bank acts in a discretionary manner, taking the exchange rate wherever it
wants. The abuse of flexibility can be as harmful to the proper functioning of the economy as the
abuse of rigidity. In fact, the inflation-targeting regime implemented by the NBR is a mix of rules
and discretion with the aim of formulating a coherent and effective monetary policy.
As regards the current differences in the countries' approaches to euro adoption, for some it
might seem odd that Bulgaria, which lags behind in terms of real convergence, is considering
joining the euro area sooner than Romania. It is only natural for our neighbour to contemplate
euro adoption as the only sound exit from the present currency board. By contrast, in Romania,
as well as in other countries pursuing a floating exchange rate regime, the approach is different,
since euro adoption is more complex. This is by no means to say that Romania does not
envisage joining the euro area, but merely that a comprehensive preparation is of the essence to
cope with the related challenges.
The Latin dictum festina lente is, in my opinion, quite suitable in the case of euro adoption as
well. With respect to real convergence, many have been asking themselves "How fast is fast
enough?". Unlike others, I would not necessarily look for a certain figure (beyond the already
mentioned minimum level of roughly 70-75 percent); I would tackle this issue by approaching
real convergence not as a race where the fastest track is also the right one, but rather
as a complex process giving the steady runner (a marathoner rather than a sprinter) the
opportunity to reap most of the potential benefits, while avoiding excessive risks.
Speaking about risks, it is worth noting that relatively sizeable current account and fiscal deficits
may erode the very foundation of this edifice that is the national economy. It is therefore much
wiser to adjust them in a gradual manner than leave market forces to cause a sudden correction.
Fiscal discipline, consistent economic policies and an ambitious, yet viable, calendar should
make a successful euro adoption possible, so that the economy adequately withstand
competitive pressures within the euro area. Equally important is to reduce the still overly large
disparities across Romania's development regions, as it takes the entire country to join the euro
area, not only Bucharest and Ilfov county.
Economic growth is not enough, it should be
accompanied by lasting economic development.
Before ending my speech, instead of my personal view about the future, let me quote a recent
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column in Financial Times by Tony Barber relevant for the state of affairs in the region:
"Nevertheless all is not well in the region. Why? One reason lies in the model that western
governments in the 1990s prescribed for the east's transition to free-market democracy. As it
shed its communist past, the east was told to embrace not just liberal democracy but
globalisation, open borders and the lightly regulated financial capitalism that the west viewed as
the touchstone of its own economic success.
This model's flaws were exposed in the 2008 financial crisis and the European refugee and
migrant emergency of 2015-16. [...]
EU membership, too, has brought more pluses than minuses. Access to the single market,
regional aid and, from ordinary people's viewpoint, Europe-wide freedom of movement are
cherished gains. [...]
This resentment has much to do with the western model grafted on to the east. In 1989, as
during Europe's 1848 revolutions, the people wanted civic freedoms and, in many cases,
liberation from foreign overlords and their first independent states of modern times. But after
1989 the adoption of the western model - complete with EU membership, global capitalism and
a liberal political philosophy - created tensions between liberalism allied to internationalism and
the assertion of a newly acquired national sovereignty. [...]
Now central and eastern Europe is experiencing its own contest between populist nationalism
and liberal democracy. It would be brave to forecast a winner when some western societies are
caught up in much the same struggle."
This being said, let me thank you for your attention and wish you insightful discussions.
1
"Poland's wild ride out of communism remains election faultline", James Shotter, Financial Times, 2 October
2019.
2
"The legacy of 1989 has been complacency", Tony Barber, Financial Times, 2 October 2019.