The Financial Effects of the Crisis in European Emerging Markets

Abstract

This chapter describes the evolution of financialization in Central, Eastern and Southeastern Europe (CESEE), the effects of the deleveraging period after the outbreak of the global financial crisis, the interactions of the financial market conditions with income distribution, the savings propensity, and the current account and economic development of CESEE before and after the outbreak of the global financial crisis. Financialization was particularly strong in the three small Baltic states, followed by the countries from Central and Eastern Europe (CEE) and, at a certain distance, by the economies of Southeastern Europe and the Commonwealth of Independent States (CIS). An important distinction can be made with regard to the structure of inward foreign direct investment (FDI) stocks in the region. Economies from CEE and, to a certain extent and with a lag, also economies from SEE were able to attract highly productive and export-oriented manufacturing FDI, while in the Baltics and in the CIS, import activities were supported by a much stronger focus on domestically oriented finance and retail trade services FDI. A major problem characterizing the deleveraging process after the outbreak of the global financial crisis has been the reversal of behavior by the main economic agents in CESEE. Especially the peripheral economies with large income inequality have experienced foreign-financed booms with households, corporations and the government being net borrowers in the aggregate. However, after the outbreak of the global financial crisis, the corporate sector became a net lender. Investments have been postponed and, hence, domestic demand dampened. As a consequence, earlier unsustainably high current account deficits often turned into surpluses. CEE economies that, during transition, received a larger chunk of export-oriented manufacturing FDI, that have lower levels of income inequality, and that experienced less dissaving in the boom phase were partly able to avoid more extreme real adjustments due to their stronger export bases and more stable current account positions.