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  1. 1. http://www.imf.org/external/pubs/ft/reo/2007/EUR/ENG/ereo1107.htm<br />
  2. 2. Overview<br />Outlook for the European economy<br />moderate slowing with risks ahead<br />financial market turbulence needs to dissipate to validate the baseline<br />through turbulence to sustained growth<br />Analytical focus: strengthening financial systems<br />tuning the financial systems of advanced economies<br />managing rapid financial deepening in emerging Europe <br />sustaining financial development in emerging Europe <br />
  3. 3. Outlook for the European Economy:moderate slowing with risks ahead<br />
  4. 4. Some slowing ahead, but Europe’s economic outlook remains positive<br />
  5. 5. Rapidly growing economies set to cool <br />
  6. 6. Recent inflationary pressures<br />
  7. 7. Some of the downside risks have materialized<br />
  8. 8. Good fundamentals keep domestic demand in better shape than in the US <br />
  9. 9. Convergence is now underway<br />
  10. 10. Baltics have been catching up faster<br />
  11. 11. Convergence driven by fast economic integration<br />
  12. 12. But external imbalances in emerging Europe raise concerns <br />
  13. 13. Despite tightening, monetary conditions are loose<br />
  14. 14. Financial Market Turbulence: needs to dissipate to validate the baseline<br />
  15. 15. The shock in the U.S. spread into Europe’s money market<br />
  16. 16. Debt spreads have increased<br />
  17. 17. Emerging Europe not directly affected, but risk spreads have increased<br />
  18. 18. Stock markets recovered ground lost in turbulence<br />
  19. 19. Contagion possible<br />
  20. 20. Lower confidence in advanced economies may affect emerging Europe<br />
  21. 21. Through Financial Turbulence to Sustained Growth<br />
  22. 22. The immediate challenge for policymakers is to:<br />Restore confidence in key financial markets<br />Support economic activity<br />Contain inflationary pressures<br />Disclosure of losses in financial institutions is the key for reducing uncertainty<br />
  23. 23. Emerging Europe needs to buckle up to manage financial speeding <br />The best is yet to come from the financial sector<br />Debt and equity markets have room to grow<br />New member states will benefit from EU harmonization and integration<br />Improving institutions will reinforce the foundations of financial development for non-EU members <br />Financial supervisors need to stay on the ball<br />speed entails risk, supervision more important than ever<br />Raise prudential standards<br />Remove distortions in bank lending<br />Increase capital requirements where necessary<br />Establish risk-based and forward-looking supervision<br />Upgrade supervisory cooperation and coordination<br />Enhance disclosure of risk<br />
  24. 24. Risk management needs to keep up with innovation <br />Financial innovation comes with risks<br />the sub-prime mortgage crisis has exposed flaws in private and public prudential frameworks <br />What needs to be done?<br />better liquidity management (mostly a private sector matter but also task for supervisors to make sure it is adequate)<br />improved risk assessment models and due diligence<br />balanced review of prudential arrangements, financial safety nets, and crisis resolution mechanisms <br />more transparency<br />
  25. 25. But we should not lose the “patient” during the “operation”<br />All traditional forms of financial intermediation have gone through tests <br />Benefits from innovation: <br />lower cost of finance when banks are able to sell securities to institutional investors<br />a wider menu of investment options, and<br />increased access of households which boosts welfare <br />
  26. 26. Financial innovation is a positive force and has contributed to Europe’s recent good performance <br />
  27. 27. Fiscal policy in need of a healthy diet to prepare for tomorrow<br />
  28. 28. Recent labor market reforms have paid off, but unemployment still high<br />
  29. 29. Structural reforms, the protein for the muscles of an economy: makes it stronger and more flexible<br />
  30. 30. Reducing role of the state and cutting red tape essential in emerging Europe<br />
  31. 31. Emerging Asia’s flexibility allows faster growth<br />
  32. 32. Summarizing<br />Moderate slowing with risks ahead<br />Europe is set to weather financial turbulence relatively well<br />Emerging Europe has been resilient, but risks have risen<br />Europe needs stronger financial systems<br />Financial innovation needs to continue/risk management needs to keep up<br />Emerging Europe needs to manage financial speeding/the best is yet to come<br />Reforms key to sustained growth<br />Fiscal policy should prepare for tomorrow<br />Structural reforms are necessary to increase growth and deliver the promise of convergence <br />
  33. 33. Ireland has shown fast convergence is possible(GDP per capita in US$, difference with EU-6)<br />1988<br />1998<br />1988<br />
  34. 34. But Portugal needs a second chance to make inroads on convergence <br />
  35. 35. What does all this mean for Croatia?<br />Progress has been achieved in recent years…<br />…but the reform process must be stepped up to sustain fast growth and address external vulnerabilities <br />This means more ambitious fiscal consolidation by expenditure from very high levels<br />Steps to strengthen financial sector supervision should continue<br />Structural reforms is the way for a successful convergence<br />The current monetary policy framework is suitable for Croatia, but needs support from other policies<br />
  36. 36. Analytical focus: strengthening financial systems<br /><ul><li> Tuning the financial systems of advanced economies
  37. 37. Managing rapid financial deepening in emerging Europe
  38. 38. Sustaining financial development in emerging Europe </li></li></ul><li>Financial systems in advanced Europe have become increasingly sophisticated, but there is ample room for progress<br />
  39. 39. Rapid financial deepening in emerging Europe, but mainly fast expansion of bank credit<br />
  40. 40. Financial development in emerging Europe: the best is yet to come<br />
  41. 41. Equity markets: growing capitalization, but limited liquidity<br />
  42. 42. Emerging Europe needs to turn imbalances around over time<br />
  43. 43. Hard to tell who has been speeding, but only highly flexible economies can afford large imbalances<br />
  44. 44. Policy implications<br />Managing the risks of the expansion stage<br />err on the side of caution<br />Hitting the brake desirable, but not always possible <br />Supervisors need to stay on the ball<br />Meeting the challenges of the reorientation stage<br />Fostering flexibility and financial development<br />
  45. 45. Supervisors need to stay on the ball by building buffers and reducing vulnerabilities<br />Raising prudential standards<br />Bank distortions<br />Capital requirements<br />Risk-based supervision<br />Upgrading supervisory cooperation & coordination<br />Across borders, between home and host supervisors<br />Within borders, between bank and nonbank supervisors<br />Enhancing risk disclosure<br />Disclosure requirements <br />Public awareness campaigns<br />
  46. 46. Fostering flexibility and financial development will help turn around imbalances smoothly<br />Fostering flexible labor and capital markets<br />Flexibility in terms of not only hiring, firing and hours but also skills is required for labor markets<br />Diverse financial systems are needed for capital markets<br />Rigid exchange rates strengthen these needs<br />Improving financial infrastructure<br />Creditor protection, corporate governance, credit information help channel resources to tradable sector<br />Developing missing market segments will help mobilize domestic savings<br />Building the government securities market<br />
  47. 47. Reinforcing the foundations of financial development<br />
  48. 48. Next REO: Europe April 2008<br />

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