George A Provopoulos: Economic policies, institutions, and the
politicalsocial environment that can increase and sustain potential growth
Welcome address by Mr George A Provopoulos, Governor of the Bank of Greece, at the
Bank of Greece - University of Oxford (South East European Studies at Oxford, SEESOX)
conference, Athens, 11 February 2011.
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I am pleased to welcome you to the Bank of Greece. This occasion marks the second
conference on South East Europe jointly organised by the Bank of Greece and Oxford
University. The first conference, held in October 2009, dealt with the effects of the global
financial crisis on this region and the policy challenges in the light of the crisis. The focus of
this conference is different. It is on the longer-term growth potential of the region.
Specifically, the conference will deal with the economic policies, institutions, and the
politicalsocial environment that can both increase and sustain potential growth. We are fortunate to
have with us a number of experts from the central-banking, academic and
commercialbanking communities. They will share with us their views about the growth potential of the
region and the policies that can help achieve that potential.
The global crisis, which halted more than a decade of sustained growth in most countries of
the region, has demonstrated that economic convergence in Europe is neither an inevitable
nor an automatic process. Prior to the crisis, most of South East Europe was characterized
by relatively high growth, based mainly on consumption spending, private and public. The
increased consumption expenditure typically reflected rapid growth in domestic credit, to a
significant extent financed through foreign-capital inflows. Rising public spending often
contributed to a widening of fiscal imbalances. These imbalances had adverse
consequences. Among other things, they added to domestic price pressures, reduced
competitiveness, and, along with rising private consumption, contributed to higher external
deficits. In some countries, inflation surged to double-digit levels, wage increases far
exceeded gains in labour productivity, and there were excessive increases in asset prices,
especially the price of housing. These external imbalances left the economies concerned
extremely vulnerable to an external shock. That shock came in the form of an eruption of a
crisis in the US subprime mortgage market in August 2007.
In its early stages, the crisis was confined to advanced economies. Local and foreign banks
in Central and Eastern Europe held only negligible amounts of so-called toxic assets.
However, as access to international capital markets was impaired, countries in this region
most in need of external financing experienced large declines in output. A number of
economies in Central and Eastern Europe were only moderately affected. Output contraction,
however, was especially severe in the Baltics and, to a somewhat lesser extent, in South
Eastern Europe. This circumstance suggests that countries with the more serious
imbalances and vulnerabilities were most at risk from external financial shocks. The lesson
from this recent experience is that convergence efforts should be accompanied by
stabilityoriented policies that contain the build-up of imbalances, both domestic and external.
Policy efforts at the national and international levels helped contain the impact of the crisis on
economic activity. The prevailing exchange-rate regimes were successfully defended and the
domestic banking sectors showed considerable resilience. In many instances, fiscal and
monetary policies were tightened. In some cases the tightening occurred within the context of
programs supported by the IMF and the EU. As a result, financial conditions have stabilized
and there are now clear signs of a recovery in economic activity in most countries in Central
and Eastern Europe.
Nevertheless, the global crisis has entailed large costs for the region. There has been a
sharp decline in economic activity and unemployment has risen sharply in many countries.
Moreover, the ongoing de-leveraging process, that is the need to repair household and
corporate balance sheets, tighter bank-credit standards, as well as rising long-term
unemployment, could slow the pace of economic recovery in many SEE countries. The
South East Europe economies, like most other economies in Central and Eastern Europe,
will likely experience reduced capital inflows, because investors have become more
riskaverse. Consequently, foreign investment may decline compared with pre-crisis levels,
leading to lower economic growth compared with the growth rates experienced in the years
leading up to the crisis.
In light of the above, there will be a need to formulate and implement economic policies
geared toward developing alternative sources of growth - policies that will render the
economies less vulnerable to external shocks and that will allow them to better navigate their
way through shocks should they occur. One such source of growth concerns the
tradedgoods sector. Growth based increasingly on exports will help avoid the boom-bust cycle and
asset-price bubbles that have in the past been associated with non-FDI capital inflows. Such
a growth will prove more sustainable. A more-diversified export base will also help protect
the economies concerned from sector-specific shocks, while providing an important
mechanism for limiting the build-up of external debt.
Fiscal consolidation will be an essential element for securing high growth, by crowding-in
private investment and making room for much needed infrastructure investment. Such
consolidation will need to be accompanied by improvements in the effectiveness and
efficiency of public spending as well as of the tax system and its administration. We look
forward to a discussion of issues related to fiscal consolidation and macroeconomic
adjustment in Session I of the Conference, which will be chaired by Mr. Yannis Costopoulos,
Chairman of Alpha Bank.
The desirability of establishing a more-diversified export-based growth in the region
highlights the importance of improving competitiveness. In this regard, policies that
encourage greater flexibility in the labour market, competitive product markets, and an
improved business environment will be critical. Issues addressing the necessary policies will
be discussed in Session II of the Conference, which will be chaired by Mr. George Tavlas,
Director General at the Bank of Greece.
Policies of stabilization and reform cannot be effectively implemented without public support.
In a period of falling incomes and rising unemployment, achieving that support may prove
challenging. It is especially important to try to ensure that the reforms are perceived by the
public to be fair and effective, so that the short-term sacrifices are considered worthwhile.
Issues related to the building of social and political support for reforms in South East Europe
will be addressed in Session III of the Conference, which will be chaired by Mr. Thanos
Veremis, Professor at the University of Athens.
With reference to the financial sector in South East Europe, the presence of foreign banks in
the region has increased both the efficiency of financial intermediation and the availability of
credit to the real economy. Yet, it has been argued that, in some cases, financial stress
originating in EU parent banks may have been transmitted to the Central and Eastern Europe
region in the early stages of the crisis. It has also been argued that euro area-based parent
banks helped fuel credit booms in the region and encouraged the use of unhedged
foreigncurrency borrowing. After the crisis erupted, the "Vienna Initiative" responded to those
criticisms. The Initiative promoted a dialogue among parent banks, home and host
supervisors, and governments under the umbrella of the IMF, the EBRD and the EU. It made
the countries in the region less vulnerable to shocks caused by sudden stops in capital
inflows by committing parent banks to maintain their exposure to these countries. However, a
number of challenges lie ahead, including the financial stability risks stemming form lending
in foreign currencies and the substantial build-up of currency mismatches in private sector
balance sheets.
Moreover, the Basel III framework, which has recently been released, sets stricter capital and
liquidity rules than those that presently exist. The new rules will encourage banks to rely
more on deposit-taking, thereby rendering the banking industry of the region more stable.
However, the new rules may also lead to slower credit growth, since commercial banks may
have to tighten their lending practices. The Basel III framework may, therefore, affect the
dynamics of the macroeconomy as well as the channels of credit that support economic
activity. Issues related to the role of the banking system in the region will be addressed by
fellow Central Bank Governors in Session IV of the Conference, which I will be honored to
chair.
Before concluding, I would like to touch briefly on the role of the ECB and the Eurosystem in
the crisis. The Governing Council of the ECB has moved quickly and forcibly to adapt the
ECB's tools of monetary policy to the challenges of the crisis, most importantly by protecting
euro area banks against liquidity shortfalls. We provided liquidity in unlimited volumes and
with longer maturities to banks at an early stage. In parallel, we reduced the interest rate at
which the banks can borrow from the Eurosystem to a historical low of 1%. We also launched
a programme to purchase euro-denominated "covered" bonds issued in the euro area. As a
result, concerns that a credit crunch might emerge have not been realised. Moreover,
confronted with a serious malfunctioning of the market for sovereign debt last spring, the
Governing Council of the ECB intervened in that market. This intervention was meant to
ensure a smoother transmission of monetary policy in all euro-area economies.
It is now a great pleasure for me to welcome our keynote speaker, Mr. Erik Berglöf, Chief
Economist of the EBRD.