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EBRD Transition Report 2014 – External conditions

TRANSITION REPORT 2014 Innovation in Transition

External conditions

Over the past year, modest improvements in the external economic environment have been more than offset by the crisis in Ukraine. The recovery in the eurozone took hold in the second half of 2013, with seasonally adjusted quarterly data suggesting that the single currency area returned to positive growth as early as the second quarter of that year, and by the first quarter of 2014 the crisis-hit economies of the eurozone’s periphery – including Portugal, Greece and Ireland – were able to return to the international bond markets, borrowing at relatively favourable interest rates.

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The recovery in the eurozone has benefited the transition region, particularly central Europe and the Baltic states (CEB) and south-eastern Europe. In most of these countries the recovery has been underpinned by renewed growth in exports (see Chart M.1), following a significant contraction in 2011-12 at the height of the eurozone crisis. Supported by an increase in exports, Bosnia and Herzegovina, FYR Macedonia, Hungary, Montenegro and Serbia all returned to positive growth in 2013. Growth remained negative in Slovenia, however, while in Croatia the recession continued into 2014.

An economic recovery has also taken hold in the United States, prompting the Federal Reserve to start tapering its quantitative easing programme by reducing its monthly asset purchases. The Federal Reserve first alluded to the increased likelihood of such tapering in May 2013. Expectations of tighter monetary policy led to a gradual increase in US long-term interest rates (see Chart M.2). This made risk-adjusted returns on emerging market assets less attractive in relative terms and led to a sharp decline in capital flows to emerging markets in the summer of 2013. As a result, the stock markets and currencies of those countries came under pressure (see Chart M.3).

In the second half of 2013 the CEB region and most SEE countries were less strongly affected by expectations of tapering than emerging markets in Asia and Latin America (see Chart M.3). In part, this reflected smaller inflows of capital prior to May 2013. It was also a sign of stronger investor confidence in the region, boosted by the news of a recovery in the eurozone. Improvements in economic fundamentals following the 2008-09 crisis – such as smaller current account deficits (or larger surpluses) and larger primary fiscal balances, particularly in the new EU member states – also helped to mitigate the impact that the tapering of quantitative easing had on capital flows to the region (see Chart M.4).

When the Federal Reserve actually started reducing its monthly purchases of assets in December 2013 (initially from US$ 85 billion to US$ 75 billion per month), emerging market currencies and interest rates in mature economies largely stabilised. By then, expectations of future monetary tightening had largely been priced in by the markets. Moreover, the low investment levels that have generally characterised the post-crisis recovery in mature markets gave indications that long-term interest rates could remain low for longer than had initially been anticipated. Although emerging markets may be negatively affected by higher interest rates in the United States, the strong growth in advanced economies which underpins that monetary tightening will translate into increased demand for emerging market exports and thus benefit their economies.1

By contrast with trends observed in the second half of 2013, the currencies of a number of countries in the EBRD region came under stronger pressure in the first few months of 2014, while emerging markets in Asia and Latin America saw their currencies stabilising and appreciating somewhat. In a number of countries – including Hungary, Mongolia, Russia and Ukraine (see Chart M.3) – this largely reflected country-specific developments.

CHART M.1
  CEB SEE   EEC   Central Asia SEMED

Source: National authorities via CEIC Data, and authors’ calculations.
Note: The chart shows average seasonally adjusted month-on-month growth in the 12 months to June 2014.

CHART M.2

Source: Bloomberg and authors’ calculations.
Note: The emerging market currency index is a simple average of currency movements against the US dollar for 121 developing countries and emerging markets.

CHART M.3
  Countries where the EBRD invests   Other emerging markets  
  • From May to December 2013
  • From January to July 2014
  • Total

Source: Bloomberg and authors’ calculations.
Note: Positive values indicate appreciation against the US dollar. ** denotes a country that uses the euro either as legal tender or as a reference currency for the exchange rate peg.

CHART M.4
  • EU countries
  • Non-EU countries

Source: IMF World Economic Outlook.
Note: Countries above the 45-degree line improved their external positions.