Eastern European Economies Contract More Than Expected in First Quarter

Sources: Wall Street Journal, CEE GDP Falls Are Even Worse Than They Seem; Reuters, E. Europe's Economies in Free Fall, Exports Hit; Bloomberg, East Europe Economies Shrank in First Quarter on Western Demand; Bloomberg, EBRD Board Says Ready to Consider Raising Capital

Across Eastern Europe, GDP declines were greater than expected for the first quarter of 2009. The year-on-year numbers released Friday by several national statistics offices show that Romania and Hungary were particularly hard hit, with 6.4% declines since this time in 2008. Slovakia's GDP also fell by 5.4%, despite growth in the last quarter of 2008. Czech GDP fell by 3.4%, the greatest decline in the country's history, while Bulgarian GDP fell for the first time in ten years, by 3.5%. Polish GDP is actually expected to have risen in the first quarter, by 1%, but those numbers will not be released until later in the month.

Some of the causes cited for poor performance in these countries including low demand for their exports in Western Europe, especially Germany; lack of foreign investment; frozen credit; low industrial production; low domestic consumption due to difficulty in accessing bank loans and government measures in some countries targeting budget deficits; low government spending; and stagnant wage growth. Companies are forced to lay off employees and cut back on production due to financial freezes and the lack of demand for their products in Western European countries.

A number of solutions have been suggested, ranging from the domestic to the international. Government infrastructure spending is one recommendation, as is central bank interest rate easing in areas where this is still possible, like the Czech Republic. However, the worst hit countries, Hungary and Romania, no longer have room for interest rate manipulation. The IMF already has loans out to Hungary, Latvia, Romania, and Serbia, but may also need to lend to Bulgaria and Lithuania. The EU, World Bank, European Investment Bank, and EBRD are also being targeted for financial assistance.

The EBRD, charged with support to the former communist countries in Europe, is considering raising capital in response to the impact of the global crisis on emerging East European economies. The bank's governors, however, have concerns about what a large lending effort to these countries would do to its capital position, and how much risk raising additional capital would expose the bank to. The EBRD's current focus is on lending to systemically important Western parent banks and larger local institutions, and it has lent $3.13 billion to the region so far this year.

Questions:

1) Do you think that the conditions placed on loans that require harsh measures to get budget deficits in control are harming Eastern European countries by limiting government spending?
2) Do you think that Western European institutions have a responsibility to help their neighbors in Eastern Europe, given that it is shrinking Western demand that in large part caused this decline in the East in the first place?
3) Do you think the EBRD should take the risk of raising additional capital and committing it to Eastern Europe, or should the bank take a more cautious position given the poor performance of these countries?