Central and Eastern Europe: Structural Current Account Deficits and Increasing Foreign Debts (I)
Persistant current account deficits and increasing foreign debts are alarming though hardly discussed trends of East Central Europe's economic development. A series in five parts.
Rainer Tomassovits and Joachim Becker - Oct. 11, 2006
Central and Eastern Europe has been the region with the most rapid growth of foreign debt among the "developing and transition economies" over the last decade – it almost quadrupled between 1992 and 2004 (Fárek 2004: 8, tab.). The growth of foreign debt is closely related to the persistent current account deficits. Both trends are alarming, but are hardly publicly discussed. Many of the figures are worse than those of Latin America in the pre-crisis years of the 1990s.
Though current account deficits are persistent, significant shifts of the current account's composition have occurred over the last decade. These changes will be mapped in the first part of this paper while the debt situation will be summarised in the second part. Finally, the risks of a possible financial crisis are briefly discussed.
It is important to analyse how the composition of the balance of payments, and the current account in particular, has changed. The current account consists basically of the balance of trade, the balance of services, the balance of income, and the transfer balance. The balance of trade deals with the exports and imports of goods. In principle, it can be influenced by the government through a number of measures ranging from tariff policies to non-tariff measures (e.g. hygienic requirements) and currency devaluations and revaluations.
With the entry into the European Union (EU), East European states have lost the autonomy to formulate national foreign trade policies. These policies are now being formulated at the EU level. Imports of services can be restricted by appropriate national legislation. Free movement of services, however, is enshrined as a basic principle in the EU treaties. Presently, EU legislation is under way to further restrict national regulation of borderlands service provision. This leaves Central East European governments basically with the option to devalue or revalue their national currency.
In most cases a devaluation would favour exports and act as a break on imports. The accession process to the monetary union, however, limits the room to manoeuvre of policy-making in this arena, too. An eventual adoption of the Euro would eliminate the option of a national currency policy. Another import sub-balance of the current account is the balance of income. It includes profit remittances and interest payments. In principle, profit remittances can be restricted by national regulations.
Such regulations, however, are not compatible with present EU rules. Profitability might be affected by currency policies but a devaluation or revaluation does not directly affect profit remittances and therefore does not have any influence whatsoever on interest payments. Thus it is extremely difficult to reduce a negative balance of income. Usually a negative balance of income is the consequence of capital imports in the past. Insofar capital imports are short term solutions. Such imports may be needed to level out a negative current account.
Capital imports, however, have a negative impact on the current account at a later stage:A negative spiral of a deficit in the current account – capital imports – a growing deficit in the current account (as result of higher profit remittances and interest payments) – growing capital imports might emerge. Such a spiral cannot go on indefinitely.
As we shall see in more detail in the following parts of this series, the deficits of the sub-balances of the current account have shifted from strongly negative balances of trade to strongly negative balances of income. This is an alarming tendency since it is extremely difficult to revert.
Read in part II: statistical evidence for Poland, the Czech Republic, Slovenia, Hungary, and Slovakia.
Though current account deficits are persistent, significant shifts of the current account's composition have occurred over the last decade. These changes will be mapped in the first part of this paper while the debt situation will be summarised in the second part. Finally, the risks of a possible financial crisis are briefly discussed.
Changes and Continuities in the Balance of Payments
It is important to analyse how the composition of the balance of payments, and the current account in particular, has changed. The current account consists basically of the balance of trade, the balance of services, the balance of income, and the transfer balance. The balance of trade deals with the exports and imports of goods. In principle, it can be influenced by the government through a number of measures ranging from tariff policies to non-tariff measures (e.g. hygienic requirements) and currency devaluations and revaluations.
With the entry into the European Union (EU), East European states have lost the autonomy to formulate national foreign trade policies. These policies are now being formulated at the EU level. Imports of services can be restricted by appropriate national legislation. Free movement of services, however, is enshrined as a basic principle in the EU treaties. Presently, EU legislation is under way to further restrict national regulation of borderlands service provision. This leaves Central East European governments basically with the option to devalue or revalue their national currency.
In most cases a devaluation would favour exports and act as a break on imports. The accession process to the monetary union, however, limits the room to manoeuvre of policy-making in this arena, too. An eventual adoption of the Euro would eliminate the option of a national currency policy. Another import sub-balance of the current account is the balance of income. It includes profit remittances and interest payments. In principle, profit remittances can be restricted by national regulations.
Such regulations, however, are not compatible with present EU rules. Profitability might be affected by currency policies but a devaluation or revaluation does not directly affect profit remittances and therefore does not have any influence whatsoever on interest payments. Thus it is extremely difficult to reduce a negative balance of income. Usually a negative balance of income is the consequence of capital imports in the past. Insofar capital imports are short term solutions. Such imports may be needed to level out a negative current account.
Capital imports, however, have a negative impact on the current account at a later stage:A negative spiral of a deficit in the current account – capital imports – a growing deficit in the current account (as result of higher profit remittances and interest payments) – growing capital imports might emerge. Such a spiral cannot go on indefinitely.
As we shall see in more detail in the following parts of this series, the deficits of the sub-balances of the current account have shifted from strongly negative balances of trade to strongly negative balances of income. This is an alarming tendency since it is extremely difficult to revert.
Read in part II: statistical evidence for Poland, the Czech Republic, Slovenia, Hungary, and Slovakia.
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