Macroeconomic Performance of ECA Countries
Macroeconomic situation plays an important role in the growth and performance of microfinance in the economy (see Box 1.3.). More than ever before microfinance depends on the overall economic situation: its performance is closely correlated with the macroeconomic indicators which shows that microfinance has been integrated into the financial system and the transmission channels between microfinance and the economy are more direct than when microfinance remained a niche phenomenon of the informal markets.
Box 1. Macroeconomy Matters for Microfinance Growth
The ECA countries have been heavily affected by the financial crisis but the macroeconomic performance varied substantially across the region. Aggregate GDP is estimated to have contracted 6.2% in 2009, nearly twice as much as the 3.3% estimated decline in high-income countries, and sharply more negative than the (2.2%) contraction for the remaining developing countries excluding China and India.
Figure 1.1. presents the GDP growth rates in 2009. Some countries largely escaped the crisis (for example Azerbaijan or Uzbekistan) while others were badly hit by the crisis and are far from recovery (e.g., Latvia or Ukraine).
Consumer prices have peaked in 2008 when the global food prices have noted the all time historic high levels, and declined since then. The most recent reports from the FAO and the World Bank indicate that the prices of foodstuffs are on the rise again and are approaching the levels of 2008, which creates a very difficult situation for the low income people whose household budgets are largely allocated to the basic goods. The rising prices also pose problems for microfinance.
The financial crisis has also impacted the exchange rates throughout the region (see Fig. 1.3). Weakening US dollar has been observed in most economies with a different impact in various countries.
With a few notable exceptions, such as Azerbaijan, Russia, the Baltics, and Uzbekistan, most countries experienced negative current account balances in 2009 and 2010 (see Fig.1.4). Reflecting the cut in capital inflows (and the associated cuts in domestic demand), regional current account deficits have narrowed, with Bulgaria, Latvia, and Lithuania posting double-digit improvements in current account positions measured as a share of GDP. As a result of the cuts in spending, the region’s ex-post financing needs declined, while at the same time external assistance and moral suasion helped prevent access to external finance from declining as sharply as had been initially expected.
Sharply reduced external demand for exports, a halving of foreign direct investment inflows, and falling remittances exacerbated the collapse in investor confidence and credit tightening, forcing a sharp contraction of 4.6% in regional private consumption, and a decline in gross fixed investment of 16.5% in 2009—down from expansions of 6.4% and 8.7%, respectively, in 2008. The impact of the crisis was most negative in countries where households and corporations held large foreign currency obligations (Armenia, Bulgaria, Croatia, Latvia, Lithuania, Romania, Turkey, and Ukraine), and where pre-crisis growth relied heavily on foreign capital inflows (Bulgaria, Georgia, Latvia, Lithuania, Macedonia, Moldova, Montenegro, and Romania are among the largest, with current account deficits equivalent to 10% or more of GDP in 2008). At the same time, petroleum exporters (Kazakhstan, the Russian Federation) were also hit hard by the plunge in international commodity prices.
Banking Sector and Lending
Banks in Eastern Europe and CIS countries have been badly affected by the crisis. The banking system was privatized in 1990’s and suffered substantial losses by the end of the last century, only to recover with the help of foreign capital. At present most banks in the CEE and SEE region and to a lesser degree in CA and Russia are foreign-owned. Many banks in Germany, Austria, Italy, Sweden and other states awarded loans amounting to several hundred billion Euros to Eastern European countries. These loans became overdue. Even the loss of just one of these loans could lead to the state bankruptcy of some countries.
The situation in other countries is equally gloomy. Many banks in Russia and Kazakhstan were exposed to toxic assets by participating in international financial operations which before the crisis was seen as a sign of progress and financial sophistication. The crisis left many banks insolvent forcing the government to offer substantial bailouts, including purchase of equity of some major banks (as was the case of Kazakhstan). To prevent runs on banks by the public trying to withdraw their deposits, many governments also introduced and enhanced the deposit insurance protection.
One of the salient features of the current crisis is the impact of financial integration on the spread of the crisis. The better financially integrated, the stronger the crisis was felt, but not all ECA countries have been equally hit by the crisis. There are notable examples. The year-on-year fall in Latvia’s GDP during 2009 of about 20% compared with the Czech Republic’s 4%. Both countries are deeply integrated into the global financial system and depend heavily on economic growth in Europe. 85% of the Czech banking sector is foreign-owned, compared with 65% of the Latvian banking sector. But the loan-to-deposit ratio at end-2008 was 280% in Latvia compared with 80% in the Czech Republic, implying that an extraordinarily large proportion of loan growth in Latvia was funded from abroad. This difference is due in part to the credible monetary policy in the Czech Republic and continued tight fiscal policy which kept interest rates lower than those in the euro area. Despite real exchange rate appreciation due to productivity growth, borrowing in local currency was more attractive than borrowing internationally. This removed a source of potential instability.
While these and other efforts may have helped to avert the collapse of the banking system, the immediate effect was a drastic reduction of credit to firms and households, which led to further contraction of the real economy (see Fig 1.7. and 1.8.).
The dynamics of annual changes in credit supply in the past three years is particularly telling. Overall, there is a clear tendency downwards indicating substantial decelerating of the speed at which domestic credit was growing recently with one notable exception of Uzbekistan where the volume of credit was on the increase during the crisis times (which may have not been felt that strong there). The country that placed the highest in 2009 was Belarus which showed a modest slow down yet overall a strong tendency in crediting in 2008 and 2009. This may be due to a low starting point of credit activities and the gradual opening of the Belarus economy for private entrepreneurship. Some countries registered dramatic changes in their credit activities: the fast growing Azerbaijan experienced sharp slow down and did Ukraine, Georgia and Moldova. Other countries, for example Tajikistan, also slowed down their credit activities but not as drastically.
