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SUMMARY
Overall, the Central and Eastern European economies closed the year well behind 1995, with an average GDP growth of 3.4% for the seven countries, down from 5.5% a year ago. Only in Poland and Slovakia did GDP growth continue at previous levels. Modest growth was reported in the Czech Republic and Romania, with less impressive numbers from the republics of the former Yugoslavia and negligible growth in Hungary. The most troubling reports came from Russia and Ukraine, where the GDP continued its net decline, and from Bulgaria, where it slid precipitously, due largely to a crippling burden of debt.
Poland and Slovakia owe their stronger showing to a healthy rise in domestic demand, and particularly in gross fixed investment. The more cautious macroeconomic policies of Slovenia, the Czech Republic and especially Hungary resulted in lower rates of investment growth that led to lower growth in GDP. At the same time, net exports in Slovenia and the Czech Republic declined sharply. In Hungary, the level of net exports held quite firm, declining only slightly, so that the final level of GDP there primarily reflects very weak domestic demand. The country's austerity programme begun in early 1995 has placed a damper on growth that is proving hard to shake. In the Czech Republic, this has been primarily because of continuing problems over corporate governance. In Slovenia, delays in the privatization process have dampened investment activities and the overall dynamism of the economy.
In Romania and Bulgaria, progress has been slowed by a lack of integration of the economic infrastructure and its evolving legal context. Particularly in Bulgaria, problems have also been aggravated by a policy of high interest rates that have lasted far longer than advisable. This has also been true in Russia and Ukraine, where tight money policies aimed at lowering inflation and stabilizing nominal exchange rates have choked both investment and GDP growth.
Moderate disinflation continues in all of the more advanced CEE economies, although the low budget deficits and recent restrictive monetary policies have not brought about the rapid disinflation authorities had hoped for. Real appreciation of the domestic currencies, as well as rising competition, seem to have been important in the continuing reduction of inflation rates. Higher inflation did return to Romania and to Bulgaria, where the problem is verging on hyperinflation. In Croatia and FYR Macedonia, deflationary tendencies previously at work now seem to have been overcome. It remains to be seen, however, whether these two countries will manage the necessary reform of their banking systems which, as in Romania and Bulgaria, have accumulated large portfolios of bad loans.
In Russia and Ukraine, the severe inflation of the last few years has now successfully been brought under control. But even setting aside the significant costs to the GDP and a whole range of social programmes, it is not clear how durable this current price stability will be. To a large extent, it has been achieved in an artificial way, by depriving the economy of the normal supply of cash, and by allowing huge payment arrears (including wage, tax and budgetary transfers) to accumulate throughout the economy. The refuelling of the economy with cash -- a necessary condition for the resumption of normal market-oriented economic activity -- will be a delicate operation which can easily get out of control and bring on a new inflationary spiral.
Although current account deficits have been growing in Poland, Slovakia and the Czech Republic, they have not yet reached a dangerous level. In 1996, none of these countries had a problem achieving the necessary inflow of capital needed to compensate. And to the extent deficits primarily represent additional financing of an expanding business sector and its infrastructure, their long-run effects can be expected to be positive. High GDP and investment growth rates in Poland and Slovakia seem to have justified the deficit build-up. There are more grounds for scepticism about the Czech Republic, where the rapid deterioration of current accounts may have been a factor in last year's decline in foreign exchange reserves. In Romania, Bulgaria and Ukraine, the levels of foreign reserves are already dangerously low. None of these countries has been able to attract significant amounts of foreign capital, and they have thus felt compelled to limit their current account deficits, or as in the case of Bulgaria, to actually keep the account balanced.
Forces underlying recent performance will continue to be at work in 1997 and 1998. GDP growth in more advanced CEE countries will continue to be moderate, and lower still in the less advanced economies. Stabilization is at least a possibility in both Russia and Ukraine. Ukraine, however, also faces an essential task of coping with growing imbalances in foreign trade and current account deficits. Assuming only marginal improvement in the West European business climate, there will be little opportunity to boost exports. This must wait for pronounced structural changes -- rising volume of both skill-intensive and R&D-intensive products. For the countries that have made substantial investments in manufacturing technology in recent years, the payoff could be big, leading to improved export performance in 1997, even under conditions of strong appreciation.
The advanced CEE countries will probably try to prevent excessive increases in imports, probably through additional devaluations, but short of the drastic, Hungarian-style restrictions on domestic consumption and investment that seem likely in Romania and Bulgaria. In Slovakia, import levels could be cooled by slowing down the pace of government investments in infrastructure. Hungary and Slovenia -- with relatively good 1996 records on foreign trade and accounts -- will be less likely to need restrictions. Both may grow slightly faster than last year, though still at comparatively low rates, even by western standards. In Russia and Ukraine, the main concerns are falling production and low levels of investment. Maintaining relatively stable prices will undoubtedly remain a priority in both countries. Provided they achieve a certain flexibility in both monetary and fiscal policies, both may, with a dose of good luck, lower inflation further in 1997, while possibly finally bringing GDP decline to a halt.
WIIW Research Report No. 233, L. Podkaminer et al.: Year-End 1996:
Mixed Performance in the Transition Countries, February 1997, 63 pp.,
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