London, 23 November 1998 (RFE/RL) -- The European Bank for Reconstruction and Development (EBRD) predicts that, overall, the economies of Central and Eastern Europe and the former Soviet Union will shrink by one percent in 1998 and two percent in 1999, reflecting one of the most difficult years since the fall of the Berlin Wall.
The prediction is made by the EBRD's Transition Report 1998, released today in London. It is the fifth in an annual series of reports charting the progress of the transitional countries in building market economies.
The report says the eastern region's growth prospects have been diminished by the economic recession in Russia, turmoil in international financial markets, and a slowdown in the global economy.
The report predicts that gross domestic product (GDP) in Russia will fall by five percent this year and by over three percent in all CIS countries. It predicts that the economies of the Baltic states and of Central and Eastern Europe will continue to grow, but at less than the overall 3.6 percent of 1997.
The report says many of the 26 countries covered have performed robustly, with some achieving annual real growth rates of five percent or higher for more than two years. Some Central European economies are poised to achieve a higher output of goods and services than during the communist era, considerably higher if the unrecorded economy is included.
But there is a big difference between the performance and the prospects of the 26 countries, reflecting the fact that they are pursuing strikingly different paths of stabilization, privatization and structural reform.
A key message of the report, according to EBRD's chief economist Nick Stern, is that transitional economies cannot reach their full potential without evenly-balanced reforms. He said these include establishing competitive markets, financial discipline, private ownership, effective corporate governance and the rule-of-law.
The report says that "model" reformers like Poland and Hungary have maintained impressive growth, proving far less vulnerable to the external shocks of 1998 than countries where reform is unsound or only half-hearted.
The report predicts that after declining by five percent in 1998, the Russian economy will contract a further seven percent in 1999. This follows the August collapse of its financial system, sparked by a crisis of confidence in emerging markets and fears about the inadequacies of its reforms and economic governance.
This sharp downturn follows Russia's modest output recovery last year. It is a graphic illustration of the risk that progress in stabilization can be quickly reversed when underlying structural weaknesses, such as the workings of state enterprises and the banking sector, are not addressed.
The fall-out from the Russian crisis is affecting the performance in the rest of the region, particularly neighboring CIS countries with weak economic fundamentals and strong trade links to Russia.
The report says a number of CIS countries will record much lower growth than predicted earlier this year.
But the picture is mixed. The three Caucasus countries -- Armenia, Azerbaijan, Georgia -- are projected to continue growing at rates of five percent or more. The central Asian countries will grow unevenly. Growth in Kazakhstan (2.3 percent in 1998), Tajikistan (3.7 percent) and Uzbekistan (3.7 percent) is projected at between two and four percent for this year. Growth in Kyrgyzstan (6.3 percent) and Turkmenistan (6.9 percent) is projected to exceed six percent.
Growth in the Baltic states is expected to be lower than forecast earlier, particularly in Latvia and Lithuania, due to a significant amount of trade with Russia.
The report says a slowdown in western Europe and the Russian and east Asian financial crises will harm growth prospects in Central and Eastern Europe, but that the region's direct exposure to Russia through trade is now more limited.
The report says the momentum behind strong economic growth in the region evident during the first half of this year has slowed. It predicts that average growth will "fall considerably below its 1997 level of 3.6 percent."
Again, there are big contrasts across Central and Eastern Europe. Poland, where economic reforms are depicted by EBRD and World Bank economists as an example for the transition countries, is predicted to grow by six percent this year. The figure for Hungary is five percent. But the Czech Republic, which suffered a sharp slowdown in growth following a currency crisis last year, will grow only 0.9 percent.
Real GDP in Slovakia (predicted to grow by 4.6 percent in 1998) and Slovenia (3.9 percent) are projected to reach 1989 communist-era levels, joining Poland, which cleared this key psychological hurdle in 1996. In contrast, official GDP levels in most CIS countries remain below 60 percent of 1989 levels, although growth has returned to most of them.
The report predicts that there will be a significant rebound of growth in Bulgaria (3.1 percent in 1998) and Albania (7.9 percent), but Romania (minus 2.8 percent) remains mired in a macro-economic crisis.
EBRD economists say the contrasting performance of Central and East European countries underlines the considerable costs of delaying structural reforms.
Looking forward to economic prospects for 1999, the report says the CIS countries will remain the most affected by the Russian crisis. It says growth in Central and Eastern Europe will largely depend on the performance of the economies of the west European countries, who are increasingly important as trade partners.
The report says the CIS countries with the most advanced structural reforms will be most sheltered from adverse developments in Russia. Average projections for the CIS are largely driven by projections for Russia, with a majority of observers forecasting a further decline in Russian GDP by around 4-7 percent, reflecting the depth of the crisis gripping the country. The report says Ukraine and Uzbekistan will see their recovery further hindered by the Russian crisis as foreign investment dries up and the formation of businesses is impeded by government interference. It says Belarus and Moldova are likely to fall into recession due to their close trading links with Russia and unsustainable economic foundations.
The EBRD report says inflation continued to decline in a majority of transitional countries in 1997 and 1998. But in Russia, hard-won gains in the fight against inflation are in serious danger of being lost. Having reduced inflation to an end-year rate of 11 percent in 1997, the collapse of the ruble and crisis in the banking system means that "year-end inflation in 1998 will almost certainly exceed 100 percent."
The report says that if Moscow authorities are tempted to "print money" as a way out of the economic crisis, the result would be very high inflation leading to "great hardships of the type that occurred in Russia in 1993 and 1994."
In the CIS countries, inflation has slowed in much of the region but there have been significant setbacks. The average year-end inflation rate across the CIS was halved in 1997 to 32 percent. Single-digit or low double-digit levels in six of the 12 CIS countries are now projected to fall further in 1998. But the report predicts that Moldova's and Ukraine's annual inflation rates will rise to over 20 percent by the end of 1998, and will also soar in Turkmenistan.
The report says that, with the exception of Romania, inflation rates in all countries of Central and Eastern Europe for 1998 are expected to be in single-digit or low double-digit figures. The achievement of Bulgaria and Albania in cutting inflation from high levels in 1997 are said to be "particularly notable." Two of the former Yugoslav republics, Croatia and Macedonia, have the lowest rates in the region, coming closest to the EU average of 2.1 percent.
In summary, the report concludes that countries that have balanced privatization and liberalization programs with deep institutional reforms have been more resilient to the turmoil in Russia and financial markets.
But rapid progress in liberalization and privatization in some transition countries has not been supported by sufficient market-oriented institutional reforms, making them more vulnerable to the external pressures.
The report says enterprises and banks will only perform well when their managers are disciplined by competition and effective corporate oversight. Without this direction and discipline, enterprises are slow to restructure and banks will continue to make bad loans. The report lists barriers to the emergence of entrepreneurship and small and medium businesses as bureaucratic interference, inadequate law enforcement, and official corruption.
The report says that, in many transition countries, powerful groups with vested interests still pose big obstacles to reform, most strikingly in Russia.
Describing 1998 as a year of "stresses and contrasts," the report says whether the present situation leads to further reforms or backtracking depends "largely on the extent to which the influence of vested interests on policy makers is constrained by effective democratic institutions."