Semi-rational exuberance: Gaining speed on an old track? Vedran Šošić

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1 Semi-rational exuberance: Gaining speed on an old track? Vedran Šošić

2 Croatia at last out of the recession GD P growth event of the year Finally the best where it really matters! Croatian headlines after the last GDP data release, 3 Nov 216. With 2.9% year-on-year GDP growth in Q3.216 Croatia ranked in the upper half of EU members ranked by growth. At the same time, the quarter-on-quarter growth, 1.7%, was the highest among all 28 member states. 2/35

3 Croatia from leader to back of the pack 1, 8, 6, 4, 2,, -2, -4, Poland Slovakia Bulgaria Czech Republic Romania Hungary Slovenia Croatia Source: Eurostat

4 ... As income lags behind most peers Nominal GDP, EUR pc, 2 and Bulgaria Romania Slovakia Poland Hungary Croatia Czech Slovenia Republic Source: Eurostat

5 ... And than suddenly back ahead of the peers? QoQ GDP growth, SA YoY GDP growth 2, 7, 1,5 6, 1, 5,,5, 4, 3, 2, -,5 1, -1, Croatia Slovenia Bulgaria Slovakia Romania Hungary Poland Czech Republic, Romania Bulgaria Slovakia Croatia Slovenia Hungary Poland Czech Republic 216Q1 216Q2 216Q3 216Q1 216Q2 216Q3 Source: Eurostat Source: Eurostat

6 Time to rejoice and celebrate? Cyclical vs. Structural view: Is the Croatian economy growing due to closure of the output gap after a deep recession (train gaining speed on an old track), or Has economic growth arisen due to structural factors (the train has taken a structurally better track)? Extremely hard to tell in real time, even with a bit of a time-lag Estimates of potential output prone to major ex-post revisions

7 Structural view Growth is in large part driven by exports of goods and services Gains in non-price competitiveness Goods exports getting more diversified, more firms enter the ranks of exporters Sizeable CA surplus Also absorption of EU funds Growth not driven by excessive credit and debt Bank lending picking-up, but credit activity still muted H ousehold and corporate deleveraging facilitated by debt restructuring I mbalances correcting in general, and particularly external imbalances

8 Exports of goods and services major contributor to GDP growth Percentage points * % Personal consumption GFCF Exports of goods and services GDP growth rate - right Government consumption Changes in inventories Imports of goods and services Source: Eurostat

9 Relatively favourable developments in exports of goods and services compared to peers 15 1 % Croatia Average (Hungary and Slovenia) Average (Czech R., Poland, Slovak R.) Prosjek (Bulgaria and Romania) Average (Baltic countries) Source: AMECO

10 Sizeable current account surplus HR capital and current account balance Current account balance, % GDP Slovenia 4 Hungary bn. EUR 5 2 % GDP 5 Bulgaria Croatia Slovakia Poland Goods Services Primary income Secondary income Current account (right) excl. CHF conversion Current and capital account (right) excl. CHF conversion q2 Czech Republic Romania Source: CNB Source: Eurostat

11 Withdrawal of EU funds intensified EUR mn ,4 1,2 1,,8,6,4,2, -,2 -,4 in % of GDP -3 -, Allocated funds - capital (other) Allocated funds - current (other) Allocated funds - capital (government) Allocated funds - current (government) Payments to the EU budget Net allocated funds*-right *Sum of last four available quarters Source: HNB

12 Competitiveness effect on EU markets Croatia NM S EU15 NMS12 Total EU15 NMS12 Total Source: HNB Source: HNB

13 Credit activity picking-up, but stile muted Placements to households Placements to corporates % % Year-on-year rate of change (balance-based) Year-on-year rate of change (transaction-based) Year-on-year rate of change (balance-based) Year-on-year rate of change (transaction-based) Source: HNB Source: HNB

14 M acroeoconomic imbalances scoreboard some progress Reference Indicator value Current account balance - % of GDP, 3 years average ,4-6,4-7,6-7,2-5,2-2,4 -,7, 1, 2,7 Net international investment position - % of GDP ,6-89,1-73,8-86,9-94,3-91,7-9,8-88,9-86,8-77,7 Real effective exchange rate, 42 trading partners - 3 years % change ,8 1,8 5,3 5,8 2, -4,4-8,3-4, -1,,1 Export market shares - 5 years % change -6 18,8 12,9-5,7-5, -12,9-15,8-23,5-22,8-18,6-3,5 Export market shares - 1 year % change -2,8 1,9 1,5 -,7-12,7-6, -7,5 2,5 4,7 3,5 Nominal unit labour cost index - 3 years % change 12 6,1 18,7 22,2 27,8 12,5 7,6 -,6-3, -5,8-5, House price index, deflated - 1 year % change 6 13,9 8,8-2,5-8, -7,8-2,2-4,6-5,7-1,1-2,4 Private sector credit flow, consolidated - % of GDP 14 18, 16,7 16, 2,6 4,9-2,3-3, -,6,4-1,3 Private sector debt, consolidated - % of GDP ,1 1,7 11,3 118,6 125,2 122,6 119,7 118,4 119,5 115, General government sector debt - % of GDP 6 38,9 37,7 39,6 49, 58,3 65,2 7,7 82,2 86,6 86,7 Total financial sector liabilities, non-consolidated - 1 year % change 16,5 27,1 24,2-9,1 5, 3,3 2,4 1,7 2,8,9 2,1 Unemployment rate - 3 years average 1 12,8 11,5 1, 9,2 9,8 11,5 13,8 15,7 16,9 17, Source: Eurostat, CNB

15 Gaining speed on an old track? (i) Recession unusually deep cyclical recovery was due to take place Pick-up driven by optimism, both consumer and business Benign international financial environment Low oil price Supportive monetary and as of recently fiscal policy

16 Gaining speed on an old track? (ii) Recovery still heavily reliant on trade, transport and hospitality tourism windfall from geopolitical situation Little integration in cross-border production chains, economy not poised to take advantage of integration Hardly any reform effort taken crisis went into the waste All potential growth estimates low, TFP growth recently became non-existant Imbalances still elevated, public debt in particular

17 The fact Croatia was hit by the crisis which was deep and particularly long! Real GDP, 28 = 1 D uration of Recession 11, 13 Poland Slovakia Bulgaria 1, 9, Czech Republic Romania 8, 7, 95 9 Hungary Slovenia 6, Croatia 5, t+1 t+2 t+3 t+4 t+5 t+6 t+7 EU 28 HR 28 US 1929 GR 28 HR 1988 Source: Eurostat, CNB Source: Eurostat; The Maddison-Project, / maddison/ maddison-project/ home.htm, 213 version

18 Employment HR employment and quarterly contributions, SA Employment, national accounts, index, 28=1,8 1, Percentage points,4, -,4 -,8-1,2-1,6-2, -2,4 1,5 1,45 1, Public sector Other Industry Construction Trade Total employment, HZMO - right millions Hungary Czech Republic Poland Slovakia Slovenia Bulgaria Croatia Romania Source: Eurostat, CNB Source: Eurostat, CNB

19 I nterest rates developments 2,5 2, 1,5 1, %,5, -,5-1, ESB - left FED - left Euribor 3M - left EMBI for Croatia - right EMBI for European emerging markets - right basis points Source: Bloomberg, December 216

20 M onetary policy supportive, fiscal policy less of a drag on growth % GDP Liquidity surplus in Croatia and EA /16 HR - HRK liquidity surplus HR - EUR liquidity surplus EA - liquidity surplus Change in cyclically adjusted primary balance, pp. 5, Restrictive procyclical Restrictive countercyclical 4, , 2, , 216., , , -3, Expansionary countercyclical Expansionary procyclical -4, -5, -5, -4, -3, -2, -1,, 1, 2, 3, 4, 5, Output gap, % Source: Eurostat, CNB Source: European Commission

21 Still, public debt at the highest level amongst the CEE countries % GDP % GDP General government debt, % GDP Croatia Slovenia Hungary Slovakia Poland Nominal general government balance in % GDP-a (ESA 21) Czech Republic Romania Structural general government balance % GDP (ESA 21) General government debt % GDP (ESA 21) Bulgaria Source: Eurostat, CNB Source: Eurostat, CNB

22 Confidence indicators close to all-time high 13 HR consumer confidence and economic sentiment, standardised three-month moving average, SA 13 HR business confidence indicators, standardised three-month moving average, SA Consumer confidence indicator Long term average = 1 Economic sentiment indeks Construction Trade Industry Services Source: IPSOS, CNB Source: IPSOS, CNB

23 Drivers of growth similar to pre-crisis period Construction, Trade, Tourism! Source: Eurostat, CNB

24 ... And in relative terms even more important than before the crises 1% 8% 6% 4% 2% % -2% * Agriculture Construction Public sector Industry Trade, transport, hotels and restourants Other *Average gross value added in this period was negative ith negative contribution coming from all sectors 24/35

25 Although stock of FD I is relatively high, greenfield and FDI s in industry are modest in Croatia Greenfield investment projects, annual average FD I composition by sectors, inward FDI stock at the end of 214 as % of GDP Inward FDI stock / GDP BG RO SK LV EE HU LT PL CZ HR SI Source: UNCTAD, World Investment Report 216 Note: Data for Slovakia refer to the end 213. Industry includes mining and quarrying, manufacturing, electricity, gas and water supply. Source: WiiW BG EE HU CZ HR SK LV PL RO LT SI Real estate Financial interm. Trade Industry Transport, comm. Hotels Other

26 Potential GDP growth still significantly lower contribution of TFP compared to peers Bulgar ia Czech Republik Cr oatia H ungar y Poland Romania Potential output growth r ate TFP contributions to potential output growth rate ,36 2, ,82 -, ,66, ,6 2, ,15, ,89 1, ,12, ,74 -, ,15 -, ,53 1, ,4 -, ,83, ,2 1, ,1, ,77, ,92 3, ,83, ,46 2,2 Source: ESCB

27 Also dismal labour productivity performance Labour productivity growth, average of annual rates of change 6 5 5, ,2 4,1 4, 3,4 3,1 2,9 2,8 2,2 2 1,5 1,7 1,7 1,9,8,8,7,7,7,7,6,6,5,1,5-1 -,4 IE SE PT UK DK ES FR NL BE FI DE AT EL IT RO LV LT SK BG PL EE CZ SI HU HR Izvor: Eurostat EU14 EU CEE

28 Potential output growth modest even under acceleration of the TFP growth 5, 4, 3, 2, 1,, -1, -2, -3, TFP Capital Labour 28/35

29 Output gap isclosing volumes, bn HRK Output gap Potential output GDP 12, 1, 8, 6, 4, 2,, -2, -4, -6, 29/35

30 What to do to improve growth and resilience? First how come some countries recover soon and other are hit much more hard by the crisis? Second, H ow to increase medium-term growth prospects?

31 Why some countries recover sooner than others GIIPS 27 = 1 The fastest post-crises recovery in Ireland... Real GDP could be explained by a relatively good initial position Global Competitiveness Index Innovation Institutions 1 Business sophistication Market size 2 Technological readiness Infrastructure Macroeconomic environment Health and primary education Financial market development Labor market efficiency Higher education and training Goods market efficiency Portugal Italy Ireland Greece Spain Source: Eurostat Portugal Italy Ireland Greece Spain Note: Lower ranking indicates that country is more competitive. Source: World Economic Forum, Global Competitiveness Report

32 Global Competitiveness Report Note: H igh ease of Global Competitiveness Index (a low numerical rank) means higher degree of competitiveness. EU-15 stands for average of old EU member countries. CEE includes Bulgaria, Czech Republic, Estonia, H ungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia. Source: World Economic Forum, Global Competitiveness Report

33 D oing Business I ndicator 7 Ease of doing business Enforcing Contracts Resolving Insolvency Ease of Doing Business Rank Starting a Business Dealing with Construction Permits 6 5 Trading Across Borders Getting Electricity 4 3 CEE Paying Taxes Protecting Minority Investors Getting Credit Registering Property 2 EU15 1 Croatia CEE countries US DK UK SE FI DE IE AT PT FR NL ES BE IT EL LU EE LT LV PL SK SI CZ RO BG HR HU Note: A high ease of doing business (a low numerical rank) means that the regulatory environment is conducive to business operation. EU-15 stands for average of old EU member countries. Source: World Bank, Doing Business 216

34 Product market regulation Other barriers to trade and investment Explicit barriers to trade and investment PMR index components Public Ownership 3,5 3, 2,5 2, 1,5 1,,5, Invovlement in business operations Complexity of regulatory procedures 2,5 2, 1,5 1,,5 PMR index, 213 Regulatory protection of incumbents Croatia Administrative burdens on start-ups EU average, Greece Sweden France Luxembourg Ireland Spain Belgium Portugal Germany Finland Italy Denmark Austria UK Netherlands Croatia Slovenia Romania Cyprus Poland Latvia Bulgaria Malta Lithuania Czech Republic Slovakia Hungary Estonia Note: L ower value of the index means that the regulatory environment is more conducive to business operation. EU-15 stands for average of all EU member countries. Source: OECD, Indicators of Product M arket Regulation, 213

35 ... means low growth perspective How much would GDP grow with constant employment and historic productivity growth? 25 = Pre-crisis productivity growth - 2,9 Productivity growth during crisis - Historic productivity growth - 1,3 (22-214) Source: HNB

36 I M F and EC consider that Croatia is one of the top gainers from structural reforms Source: IMF, CEESEE Economic I ssues, May 216 Source: EC (214) The potential growth impact of structural reforms in the EU

37 If all it takes is more structural reforms, where is the problem? Implementation of structural reforms limited to those required by the EU? Even some low hanging fruits are not being picked. Who benefits from the non implementation of structural reforms (politicians, business)? What are the short run impacts of structural reforms?

38 Structural reforms that ease business operations example from OECD Competition Assessment Review of Greece (213)

39 Example of a structural reform in Croatia: Labour Act 3,5 3, 2,5 2, 1,5 1,,5, OECD Employment protection for regular openended contracts Germany Italy Austria Czech R. Latvia Croatia Croatia* Poland Slovenia Slovak R. Note: The value of 4 denotes extremely rigid and extremely flexible labour legislation. *Including new Labour Act (214) Note: Lower ranking indicates that country has a more flexible labour legislation. **Including only amendments to Labour Act (213) Source: CNB (214) Estonia Hungary ,5 3, 2,5 2, 1,5 1,,5, OECD Employment protection for temporary contracts Italy Austria Germany Estonia Luxembourg France Greece Portugal Spain Sweden Germany Finlad Netherlands Italy Belgium Austria Ireland UK Denmark Slovak R. Poland Slovenia Czech R. Hungary Croatia Croatia* Ease of employment index Latvia 4, 3, 2, 1,, Employment protection for collective dismisals OECD Croatia** Estonia Lithuania Slovenia Romania Poland Latvia Slovak R. Hungary Cyprus Malta Bulgaria Czech R. Italy Germany Austria BiH Srbia Macedonia, FYR Montenegro Latvia Hungary Slovak R. Slovenia Croatia Poland Estonia Croatia* Czech R.

40 Results of VAR analysis deviation from the long-term baseline projection Source: CNB

41 To recap Growth of the Croatian economy is accelerating after deep prolonged recession Something has changed in the performance of the Croatian economy, visible in export performance and correction of imbalances Cyclical factors also important, but it is yet hard to tell the exact magnitude How to escape low potential growth compounded by unfavourable economic structure and weak pre-crisis growth fundamentals 41/35

42 Thank you! 42/35