Speech

Convergence, Crisis, and Capacity Building: The Joint Vienna Institute in the Transition Process By Nemat Shafik, Deputy Managing Director of the International Monetary Fund

July 12, 2012

As prepared for delivery

Introduction

First of all, let me thank our Austrian hosts for organizing this conference, and Eddie Hochreiter and his team for the excellent organization of today’s celebration. I had heard about the Joint Vienna Institute’s (JVI) famed organizational efficiency, but to see it at work is really quite impressive. As some of you know, Eddie will soon be leaving us for retirement, so this is in some ways his last hurrah as director of the JVI. Eddie, on behalf of all of us here, let me express my appreciation for your outstanding service and wish you all the best for your future endeavors.

In my remarks today, I would like to offer a brief review of the Fund’s role in the Eastern European transition countries. In doing so, I want to particularly highlight the critical role of capacity building, and specifically the JVI.

This region has been through a lot in the last two decades. It has successfully transitioned from planned to market economy, and living standards have converged towards those in the West. But it also had to overcome three major crises: first the break-up of the old system in the early 1990s, then the Russian crisis in 1998, and finally the recent global financial crisis.

The strong institutions built over the last two decades have more than anything enhanced the region’s resilience and flexibility in dealing with the momentous challenges of the past, the present—and those to come.

The transition 1990-2008

The IMF’s role in the transition process is most often associated with the emergency financing and sometimes tough advice that we dispensed during this period. The focus in the early days was on getting the big picture right: macro stabilization, price and trade liberalization, and privatization. It wasn’t an easy ride, with the Russian crisis a major setback.

By the early 2000s this first, most visible, phase of IMF involvement came to an end. The region was able to stand on its own feet. Great strides were made especially in Central Europe and the Baltics, where aspirations for European Union (EU) membership had provided an important policy anchor. The crowning achievement was the EU accession of eight new members from the region in May 2004. Bulgaria and Romania followed soon thereafter.

Even after IMF programs had ended and most of our resident representative offices closed, we remained engaged in the region. Several new EU members sought our support in preparing for euro adoption, the next step in economic integration. In many Commonwealth of Independent States (CIS) and Balkan countries, we continued to assist in framing macro policies. In our surveillance work we had warned about the worrisome build-up of vulnerabilities during this period of rapid convergence, but we admittedly did not foresee the trigger and scale of the 2008-09 crisis.

While our program and later surveillance activities may have attracted most of the headlines, behind the scenes the long and arduous job of capacity building was underway. In fact, many of the countries emerging from Communism regarded the IMF’s technical assistance and training as more valuable than its lending and broader policy advice.

To understand the significance of the challenge, let’s remember that most countries emerging from Communism simply didn’t have the basic building blocks of a functioning market economy. Monetary policy had been conducted in Moscow (for the 15 new independent states of the former Soviet Union) or Belgrade (for the former Yugoslavia); revenues had been generated in state-owned enterprises rather than through taxes; international trade had been conducted on barter or bilateral settlement terms, with centralized decisions on production and the direction of trade; and bankruptcy procedures and market regulation simply did not exist.

The IMF’s Managing Director Michel Camdessus at a speech in May 1990 spelled out the key priority of the time, to “establish an institutional framework so that the market system can operate smoothly”. The IMF followed through on this task, both by coordinating the vast outpouring of help from Western countries and by providing technical assistance from its own resources (some 245 staff years in 1990-2000, a quarter of all its technical assistance during this time).

But capacity building isn’t just about setting up new agencies or dispatching foreign advisors. It is doomed to fail without qualified staff to use the new legal and regulatory tools, to formulate policies and to execute them. There was no lack of smart and educated people in Eastern Europe, many of them eager to learn—as I personally can attest from many encounters. What was needed, however, was a full-scale reset of skills and sometimes mindsets.

Nowhere was this basic fact better recognized than in Austria. From their unique vantage point during the Cold War, the authorities here understood from the beginning that well-trained officials are the backbone of effective economic management. This was the founding idea of the JVI in 1992, which soon became the international community’s premier venue for the provision of training and guidance. The recognition that learning is a continuous process was behind our subsequent joint decision to expand the JVI and put it on a permanent footing. None of this would have been possible without Austria’s generous support in supplying know-how, facilities and substantial funding.

Let me mention just two examples of the JVI’s early achievements in capacity building:

• One was the creation, from scratch, of monetary authorities in the 15 new states that emerged from the Soviet Union. These countries had not had their own currency and associated institutions for several generations, some never. In a short period of time, hundreds of officials needed to be trained in macroeconomic analysis, monetary and foreign currency operations, and financial supervision.
• Or take the creation of modern fiscal institutions including national treasury systems. This was essential to overcome the macroeconomic instability that characterized much of the 1990s, rooted in a combination of unrealistic budgets and poor governance. There was an urgent demand for staff trained in macroeconomic analysis and forecasting, tax administration, payment processing, accounting, fiscal reporting and financial management.

In both of these monumental endeavors, the JVI played a central role. It has trained staff at all levels of seniority, from Bulgaria to Belarus, Mongolia to Montenegro, and Uzbekistan to the Ukraine. Altogether, almost 30,000 officials have participated in JVI courses since its inception, about half of them offered by the IMF.

The crisis 2008-10

This investment in human capital paid off handsomely when the region was hit by its biggest shock since the fall of communism, the global financial crisis of 2008.

The collapse of Lehman Brothers and what followed profoundly shook the region: the post- EU accession boom abruptly came to an end and many economies in Eastern Europe went into a tailspin: growth, trade and employment collapsed and some governments and financial institutions were threatened by default. In March 2009, the Economist magazine asked in a leader “Can Eastern Europe avoid meltdown?” We now know that it did, due to quick and well-executed policy adjustment, supported by unprecedented international financial support.

Just a few words on the latter: altogether, the international community made available about € 100 billon. The IMF provided about 70 percent through various facilities, adapted to the circumstances. The European Commission (primarily through its Balance of Payments facility for EU member states), the World Bank and the European Bank for Reconstruction and Development contributed as well, both financially and with know-how. As the crisis abated, not all of the funds were drawn.

Financial support may have helped stabilize the situation, but the most interesting lessons from the boom-bust experience in Eastern Europe lie in the policies, both before and during the crisis.

• First, every boom—no matter how unsustainable—has a good story at the time. Many of us were misled by the perception that the imbalances, including huge current account deficits and double-digit credit growth, were a benign byproduct of inevitable convergence toward Western living standards. With the benefit of hindsight we all now know that the laws of economic gravity hold—in Eastern Europe just as now in the eurozone.
• Second, counter-cyclical policies may be insufficient to fully prevent a bust, but they can dampen it. Take Estonia’s conservative pre-crisis fiscal policy, which enabled it to keep its budget under control and to join the euro in the midst of the crisis. Or the National Bank of Poland’s far-sighted prudential policies that discouraged foreign exchange denominated borrowing, which made it less vulnerable to currency volatility.
• Third, a decisive and well-designed policy response can help overcome the crisis quickly. Every country needs to find its own path, there is no silver bullet. We at the IMF have stood by Latvia’s ambitious consolidation based on maintaining its currency peg, just as we have supported the more conventional adjustments in Hungary, Romania or Ukraine. Poland managed to avert a recession altogether, thanks to a flexible exchange rate and apt policy response, supported by a financial backstop from the IMF. What matters is that a country’s program is internally consistent and properly executed.
• Fourth, in meeting this challenge two decades of capacity building bore fruit. I firmly believe that the region’s able response to the crisis would not have been possible without well-trained civil servants, many of them JVI alumni.
• Finally, well-coordinated international support and close coordination between the public and private sectors can make a difference. This, in turn, requires the kind of trust and mutual understanding fostered by the JVI over the last two decades. It is no coincidence, therefore, that the Vienna Initiative—a key element in the crisis resolution—was brought to life at the JVI in January 2009.

The second stage of the crisis and the path ahead

In late 2009, the situation in Eastern Europe began to stabilize. The turmoil in the eurozone did not really affect the region until the middle of last year, attesting to the great strides made in the adjustment.

Nonetheless, close financial and economic ties to the West mean that the region is exposed to the eurozone crisis. This is particularly true for countries where vulnerabilities remain high—those with substantial financing needs, widespread foreign-currency lending, and banks saddled with high non-performing loans. No wonder that these were the economies most affected by spillovers when the crisis intensified in the second half of 2011.

On the country level, the answer is to address vulnerabilities head-on: by improving competitiveness, reducing fiscal financing needs or dealing with non-performing loans. Given its institutional capacities, I am confident that the region will yet again be able to design and implement the policies necessary to meet these challenges.

We also need to reactivate the successful international cooperation of the 2008-09 crisis. This includes the revival of the Vienna Initiative, taking into account the new circumstances for parent banks. It may also include financial support, possibly precautionary, from the international community.

The IMF has stood by this region since the end of communism. We will continue to help whenever asked, with financing, policy advice and, yes, capacity building.

So what is the JVI’s role in this new phase of transition? It is in fact already adapting to the region’s evolving training needs. Officials from the new EU member states no longer require courses on the basics of financial programming or budgeting. Their overall enrollment is necessarily declining and increasingly focused on specialized courses on subjects such as macro modeling or fiscal rules. At the same time, countries where convergence is still less advanced are taking increasingly advantage of the enlarged curriculum, often linked with IMF-provided technical assistance.

Conclusion

In concluding, let me draw your attention to the common theme that runs through this brief history of transition, crisis, and crisis resolution: institutional capacity. Underpinning the transition process with strong institutions—skilled policy makers and their staff—was key to sustaining the success.

Never was this more evident than in the 2008-9 crisis. Its resolution would have been much less effective if it hadn’t been for the institutional capacity, mutual trust and strong institutions built over the previous two decades. The JVI has created a group—maybe even a network—of officials who are open to the experience of others and self-confident to learn from each other.

The region’s institutional capacity, flexibility and resilience—so impressively demonstrated in the last years—gives me confidence that it is well positioned to meet the challenges ahead.

With this, let me say happy birthday JVI and congratulations on a job well done.