SAFEGUARDING THE RECOVERY AS THE GLOBAL LIQUIDITY TIDE stern and South - PDF document

SAFEGUARDING THE RECOVERY AS THE GLOBAL LIQUIDITY TIDE stern and South-Eastern Europe (CESEE) in the excluding the largest economies—Russia and Turkey—is projected to grow by 2.3 percent in 2014, marking a significant acceleration from last year’s 1.2 percent pace. However, e become more volatile since mid-2013. In addition to the ongoing reduction in foreign bank funding, portfolio flows to CESEE, excluding Russia and rst time since 2009. While flows rebounded in 2013:Q4, pressures may re-emerge if risks stemming from potential escalation of geopolitical tensions in the region, further bouts of financial normalization in advanced economies, and the possibility of protracted weak growth in the euro area were to materialize. The susceptibility of the region to external funding shocks stems principally from relatively high stocks of external debt, large refinancing needs, and sizable foreign currency exposures. While many CESEE countries have greatly improved their current account positions in recent years, vulnerabilities because of their relatively sector during the pre-global-crisis boom, linked to external borrowing is further compounded by a high degree of financial euroization in the region. The April 2014 Regional Economic Issues (REI) finds that CESEE countries’ sensitivity to changes in global financial conditions stems from a number of additional factors:Increased foreign investor participation in local bond marketstherefore exert pressure on borrowing costs and countries with stronger macroeconomic fundamentals and policy frameworks should be In this report, “CESEE” refers to the following countries: Albania, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Kosovo, Latvia, Lithuania, Macedonia, Moldova, Montenegro, Poland, Romania, Russia, Serbia, Slovak Rep., Slovenia, Turkey, and Ukraine. List of acronyms is at the end of the report. April 29, 2014 . While such flows are generally more resilient and differentiated across countries than retail investrongly and persistently to extreme shocks. Reliance on relatively few common creditors. In the case of foreign holdings of CESEE securities, investor concentration appears to be high, especially in smaller markets, making cation decisions of a few fund managers. Similarly, a large share of external bank funding to CESEE comes from a relatively few large euro area banks. volatility would have a net negative—but manageable—effect on most CESEE countriesThe analysis finds that while faster U.S. economcountries that would be more than offset by the contractionary impact of tighter global monetary conditions and financial market volatility that could accompany faster than anticipated monetary policy normalization in the U.S. Some CESEE countries may also face further reductions in cross-border bank flows. ading to selective cutbacks of exposures to some countries. Empirical evidence suggests that weaknesses in host-country macroeconomic and banking sector on non-deposit funding) increase the risk of a reduction in cross-border bank funding. Stronger policies and buffers would help mitigate external shocks and also unlock higher as evidenced by the experience ofCESEE countries that have faced more subdued market pressures over the past year. More specifically,exchange rate and monetary policy flexibilityprincipal line of defense during episodes of market volatility. Securingand targeted liquidity provision could be helpful as well. deepening the local investor baseAll countries, especially those with weaker macroeconomic fundamentals, can increase their resilience to shocks by rebuilding fiscal spaceaddressing the legacies and problems hamstringing credit. that boost growth potential will also attract more stable