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EBRD urges further financial integration

The benefits of the integration of eastern Europe’s financial systems into the world economy outweigh the costs that have been highlighted during the global economic crisis, the EBRD has concluded in a new report.

The report also says that the global crisis has disrupted the pace of economic reform in eastern Europe, but there have been no significant reversals. Governments remain committed to the process of economic reform.

These findings appear in the EBRD’s Transition Report 2009 which addresses the implications of the crisis both for the transition region – the countries from central Europe to central Asia in which the EBRD invests - and for the whole transition process of economic transformation.

Entitled “Transition in Crisis?”, the 2009 report concludes that while the economies of the transition region have been dealt a severe blow, the transition process itself will survive the onslaught of the worst global economic downturn in generations.

 “The fundamental growth model for the region remains intact,” commented chief economist Erik Berglof. “However, the crisis has highlighted weaknesses. There are lessons to be learnt,” he added.

The report raises questions specifically about the growth model both for countries in central and southeastern Europe, where rapid expansion was fuelled by financial integration, and for commodity rich countries further east whose growth has depended on income from natural resources.

In the first instance, the EBRD economists concede that financial integration has brought disadvantages, by encouraging credit booms, over-borrowing and a trend toward foreign currency borrowing.

On the other hand, this region has benefited from high economic growth. More importantly, when the crisis was finally in full flow the presence of foreign banks and the resultant depth of the financial systems played a crucial stabilizing role.

“Based on these findings, it is clear that attempting to reverse financial integration would be the wrong conclusion to draw from the crisis. The region would deprive itself of a source of growth,” the report said.

Nevertheless, the report stresses that the crisis has shown the need urgent steps to help reduce dependency on foreign exchange lending and to manage more effectively the demand for credit.

Looking at the challenges to resource rich countries in the EBRD region, the EBRD report notes that they also face vulnerabilities, with policy management in such countries as Azerbaijan, Kazakhstan, Russia and Turkmenistan complicated by foreign currency inflows that fluctuate according to the price of commodities.

Some countries have successfully built up funds that help mitigate the impact of economic setbacks but the longer-term goal of economic diversification remains elusive.

This is partly because dependence on wealth from such resources and the very lack of diversification itself stands in the way of the development of the sort of institutional framework that would support the creation of a more diverse industrial base.

Nevertheless, the report concludes that: “Institution building in resource-rich countries is likely to be difficult and protracted, but by no means hopeless.”

Looking ahead to the impact of the crisis on further market reform in the transition region, the report says any new surge in reforms generally is unlikely, even though the financial sector will probably see both institutional change and policy adjustments, including initiatives to increase both the quality and the extent of government regulation.

In his foreword to the report, Chief Economist Berglof notes that the crisis has demonstrated the resilience of the reforms and the economic integration achieved over the last 15 to 20 years.

Even though the crisis has also uncovered some pitfalls in the economic models that have evolved, “It is clear that the way to address these pitfalls is to extend the transition agenda, not to replace it,” Berglof concludes. (press release)