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The East: EBRD Expects First Overall Economic Growth Since Communist Collapse

By Stuart Parrot

London, 3 November 1997 (RFE/RL) -- A report published today by the European Bank for Reconstruction and Development (EBRD) says that the collective GDP of the eastern region is expected to grow in 1997 for the first time since market reforms were launched after the collapse of communism.

The forecast comes despite anticipated declines this year in Bulgaria, Romania, Ukraine, Moldova, Albania, Tajikistan and Turkmenistan.

The EBRD's 244-page document, called "Transition Report 1997," assesses economic reforms across Eastern and Central Europe, the Baltics and the Commonwealth of Independent States (CIS).

The report says: "The general trend remains one of robust growth in Eastern Europe and the Baltic states and a gradual return to growth in the CIS, most importantly in Russia." It says most transitional economies are now expanding in contrast with the situation of a few years ago, when many were experiencing extreme economic dislocation and rapid falls of output.

On the whole, the EBRD expects GDP in the former communist world to increase by 1.7 percent in 1997. This follows seven years of continuous decline in the overall output of goods and services.

Prospects for next year are even better. Real growth in all Eastern countries has been forecast, with the overall GDP expected to increase by 4.3 percent in Eastern Europe and the Baltics, and by 4 percent in the CIS.

One of the report's most important conclusions is that the contraction of the Russian economy -- by far the region's largest -- has finally come to an end, with forecasters predicting "mildly positive growth" for this year. If they are right, the expansion of the Russian economy will act like a "locomotive" for other regional economies.

But growth in Eastern Europe and the Baltic states will be below the earlier expectations of many forecasters -- it is projected at a little over three percent in 1997. This is due to the sharp contractions in output in Albania and Bulgaria and slower growth in the Czech Republic due to a currency devaluation in May and heavy flooding during the summer.

In fact, growth in Eastern Europe has now slowed for three years in a row. But growth in Eastern Europe and the Baltic states is expected to strengthen to four percent in 1998. (This compares favorably with the 2.7 percent growth predicted for Western Europe next year).

In the CIS countries, growth is projected at 0.4 percent this year. That also is lower than the forecasts made by the EBRD a year ago. The bank blames this discrepancy on what it says was a slower than expected pace of enterprise restructuring in Russia, which accounts for 75 percent of GDP in the Commonwealth of Independent States.

The economies of the CIS countries are expected to expand in 1997 -- except for Moldova, Tajikistan and Ukraine. Forecasters say Russia (as well as several other countries in the CIS where output has fallen since reforms began) will also record positive growth in 1998. Growth for the CIS next year is put at 2.8 percent.

However, the growth performance is highly uneven across the 25 countries covered in the EBRD survey. In some countries, such as Poland, growth has been sustained for six years, whereas in others, such as Azerbaijan, it is only just beginning.

In the East European and Baltic states, the star performer is expected to be Poland with GDP growth projected at 5.7 percent. At the other end of the scale, Albania's output is expected to contract by 13.7 percent, and Bulgaria's by 6.3 percent.

In the CIS countries, the top performer was Georgia with growth this year projected at 10.1 percent. At the bottom of the list, Turkmenistan's GDP is expected to shrink by 14.5 percent.

The report says that 11 economies in the region, out of the 25 covered by the report, are now growing at rates of four percent or more. They include Croatia, Estonia, Lithuania, Poland, the Slovak Republic, Armenia, Azerbaijan, Belarus, Georgia and Kyrgyzstan.

The report says growth in the more advanced economies is being driven by domestic demand and especially by private consumption, whereas exports were the driving force when growth first resumed.

But countries such as Belarus, Moldova, Tajikistan, Turkmenistan, Ukraine and Uzbekistan are lagging behind. They have recorded low or negative growth, reflecting the slow pace of reform, and, in some cases, high rates of inflation. Their economic prospects are "uncertain."

The report says inflation has continued to fall in most transitional countries. Inflation is expected to be less than 10 percent in nine countries this year. The bank says prices will have climbed less than 20 percent in seven other countries. But five have seen a marked acceleration in inflation -- Bulgaria (1050 percent), Romania (137), Belarus (74), Albania (49 percent) and Tajikistan (46).

The report says that income disparities have increased across Eastern/Central Europe, the Baltic states and CIS countries in the 1990s. Social policies in Central Europe have mitigated their growth to some extent, but, in the CIS, inequality and poverty have risen very sharply.

Related social indicators, particularly life expectancy, have also deteriorated in many countries. (The life expectancy at birth of male Russians in 1995 was 58, the lowest in any transitional country).

The report says "dramatic increases" in deaths from heart disease, higher suicide rates, and the spread of infectious diseases appear related to higher stress and a deterioration in public health services.

The report says the transition economies have continued to make progress in market reforms over the past year, albeit at a slower pace than in the past. But the pattern of reforms differs across countries.

Azerbaijan, Bulgaria, Georgia, and Romania have made "particularly impressive advances" during the last year, but "back-tracking on reform" was evident in Belarus, the Slovak Republic and Uzbekistan. The report says reforms in Ukraine have been at a standstill.

The report says the commitment of Albania, Bulgaria, the Czech Republic, Romania and Russia to "deepen reforms in the face of political challenges or economic crisis" is particularly encouraging.

It says: "Crises and elections appear to have reinvigorated the reform process in some countries, renewing the mandate of governments to pursue long-delayed structural reforms."

The bank says that a new phase of transition has begun in the countries across the region. It says that after strong progress in liberalizing markets, privatizing state enterprises and stabilizing prices, the challenge ahead is to create the institutions, policies and practices that generate high, sustained growth.

Nick Stern, chief economist at the EBRD, said: "Fundamental tasks of institution-building remain and there are serious risks ahead. The challenge will be to create a well-functioning and stable market economy. Effective, market-oriented governance will be crucial."

One of the key messages of the report is that governments should establish policies, institutions and practices that allow competition to develop and market-oriented enterprises to flourish.

The report shows that countries which have reformed more vigorously have recovered from recession more rapidly and attracted greater private capital inflows. But it warns that rapid sustained growth depends on "reducing the legacy of bureaucratic interference and corruption that undermines investment and competition."

The report says in many countries, particularly in the CIS, "public corruption and arbitrary government behavior continue to be major impediments to private sector development." Problems such as corruption, unpredictable taxation and arbitrary bureaucracy are rated greater in the CIS than in any other region of the world.

The report says that large-scale privatization and banking reforms are expected to accelerate in 1997-98. But there are still serious weaknesses, even in more advanced countries, in the restructuring of enterprises, financial sector development and competition policy.

The report says external deficits have risen sharply in the past two years partly because of the recovery in household consumption. Almost half the countries now have current account deficits in excess of seven percent of GDP. These deficits have been financed by inflows of foreign private capital. Net flows into the region have surged over the past two years and are expected to reach $55 billion in 1997. (Half of all foreign investment is destined for Poland and Russia).

These inflows are a sign of growing investor confidence, but they can bring their own problems. They bring the danger of an economy overheating, of an excessive appreciation in the exchange rate, and of volatility, as the Czech Republic experienced earlier this year.

The report says the growth of foreign indebtedness in some countries (including Armenia, Georgia, Kyrgyzstan, Moldova and Tajikistan) will have to be "handled carefully."

In several countries, the combination of high wage increases and real exchange rate appreciation exceeded productivity growth for the first time in 1996. The report says the restructuring of enterprises, and the efficient provision of services, are crucial to maintaining future competitiveness on international markets in future.

The report says the introduction of market reforms has already brought about substantial change, bringing transition economies closer to the structure of western market economies.

But progress in restructuring is threatened by "hidden" government support, such as tax and energy payment arrears and soft bank lending. Governments, particularly in the CIS, continue to place barriers to the development of new businesses, including the payment of subsidies. This is said to be blocking growth of competition, which is vital to overall economic performance.

The report identifies reasons for both optimism and pessimism in the longer-term. The case for optimism: Genuine restructuring has the potential to generate large productivity gains that could fuel rapid growth, particularly if it takes advantage of the highly skilled workforces. The case for pessimism: The weakness of the institutions, policies and practices that are vital to market economies.

The report says governments across the region should take steps to improve the business climate. In particular, they should strengthen the institutions which support competition, investment and innovation. The potential for growth is large, but so is the possibility of reform being trapped by vested interests, monopolies and bureaucracy.

Still, the report sounds a positive note. It says with a combined GDP of $1 trillion (about three percent of the world economy), the region is rapidly establishing itself as a major "emerging" market. The report says it's possible that in 20 years' time, some of the world's "tiger" economies will be found in the region.