East-West Conference 2003

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Ladies and Gentlemen, 

It is a great pleasure for me to welcome you to the second day of the East-West Conference. The first two sessions today deal with topics of great importance against the background of EU enlargement: first, the role of the state with respect to financial markets and second, the role of macroeconomic policies in the stabilization of expectations. At the outset, let me make a few very general remarks. 

The Central and Eastern European countries have experienced an impressive transformation of their economic system over the past 15 years. This process has provided substantial opportunities for foreign investors, including Austrian firms. Today, Austrian companies belong to the largest investors in terms of the invested capital stock. In some countries, like Slovenia or Croatia, they even rank first. 

Over the past 15 years, the acceding countries have come a long way in reforming their financial systems and improving their stability. Bank restructuring, recapitalization and privatization have been advanced to a substantial degree or even completed. State ownership of banks has been significantly reduced, while the opening up of the sector to foreign ownership has led to a predominant share of majority foreign-owned banks in total bank assets. 

Austrian banks as well have invested heavily in the Central and Eastern European – the CEE – region. For example, in the Czech Republic, Slovakia and Croatia, Austrian banks’ market shares reach impressive levels of around 30% of total assets. Moreover, CEE subsidiaries account for around a quarter of consolidated pre-tax profits, which further stresses the importance of these markets for Austrian banks. 

Still, the structure of the financial sectors of the new Member States differs significantly from that observed in the EU. In particular, the degree of financial intermediation remains below EU levels. Additionally, bank lending tends to be overwhelmingly short term, while interest rate spreads between deposit and lending rates suggest inefficiencies and insufficient competition, especially in retail banking. Similarly, the capital markets of acceding countries are small, not only in absolute terms, but also in terms of their share in GDP. 

The state’s role in CEE financial markets has diminished over the past decade, and further integration will undoubtedly be based primarily on market mechanisms. However, the authorities will need to assist the process, especially as further financial market integration and the opening up of new business opportunities may entail more and new sorts of risk. This will in turn necessitate efficient financial market supervision structures. 

In this respect, I would like to stress that the acceding countries have already almost completely adopted EU legislation and have introduced provisions which are in line with international standards. Nevertheless, they continue to face the task of effective implementation and law enforcement. In addition, legal norms will have to be upgraded permanently to stay in line with further capital market developments and the liberalization of international capital movements. Moreover, intensified cross-border capital flows will require closer cross-border cooperation between supervisory authorities. 

Financial market supervision is closely related to the issue of corporate governance, which is understood as a network of relationships involving the corporate sector and the rules that frame these relationships. Corporate governance is particularly important: not only does the lack of a properly functioning corporate sector hinder economic growth and employment, but insufficient transparency and accountability also fuel corruption. As a result, weak corporate governance may spill over into weak public governance, potentially establishing a vicious circle. 

Corporate governance has also become an issue of systemic stability in the financial markets. Undoubtedly, developments at Enron, WorldCom and other companies have prompted increased action in enforcing corporate governance and restoring public confidence in the capital markets. Consider, for example, how the Sarbanes-Oxley Act of 2002 tightened the regulatory framework significantly in the U.S.A. 

The acceding countries have made significant efforts to improve corporate governance standards over the past several years. This process has been encouraged by the acceding countries’ need to adopt the acquis communautaire in the course of EU membership negotiations. Despite their progress, more efforts, albeit to a varying degree in different countries, are still required. Some countries may need to modify existing legislation, whereas most need to ensure the efficient enforcement of existing legislation. Improvements in all related areas are necessary to make longer-term lending more appealing for banks and to ensure that the expansion of business activities does not trigger an excessive rise in associated risks. 

Ladies and Gentlemen, 

Let me now turn to the second session, which deals with the topic "Stabilization of Expectations – Macroeconomic Policy in an Enlarged Euro Area." Permit me to start with a brief comment on the present situation of fiscal policy in the euro area, which – as I will aruge – is closely linked to the role of expectations: According to the latest available data, there is growing evidence that most accession countries will miss the budgetary targets for 2003, and the prospects for 2004 do not seem to be reassuring either. Moreover, we have even seen a violation of the 3% deficit ceiling in several euro area countries. While the deterioration of budgetary balances does partly reflect the low economic growth rates, it is worrisome that countries with severe budgetary imbalances have come up with insufficient consolidation measures to address the budgetary slippages. 

To put it very clearly, the Stability and Growth Pact is an appropriate framework for maintaining fiscal discipline, which also provides adequate bounds of flexibility. Contrary to the notion of several observers, who dubbed the Pact a "mechanical scheme to constrain fiscal policies," the Pact provides not only agreed-on rules, but also – what may be even more important – adequate time frames and procedures. This is particularly relevant for countries which try to prevent or have to correct severe budgetary imbalances. Furthermore, a country’s fiscal efforts and changes in the economic environment are assessed regularly, especially before further steps are taken. In this respect the Stability and Growth pact takes into account two economic findings. First, expectations play a major role in the behavior of economic agents, and second, negative output effects can be reduced or even avoided by stabilizing expectations. 

In addition, abolishing agreed-on rules would certainly result in a severe loss of credibility. Especially nowadays such a violation of the political framework would be counterproductive, above all for growth prospects. Although there is increasing evidence that the economy of the euro area passed the turning point of the cycle this summer, and that the speed of the recovery gains momentum, the upswing is still fragile. Therefore I believe that it is of utmost importance that the Pact is respected, since an erosion will ultimately lead to a deterioration of credibility and a destabilization of expectations – which must be avoided. 

Ladies and Gentlemen, 

Compliance with the fiscal policy rules of the European Union will also constitute an outstanding economic policy challenge for most of the Central and Eastern European countries in the years ahead. Upon EU accession, the ten new Member States will have to regard their policies as a matter of common concern and conduct their economic policies with a view to contributing to the objectives of the European Union, such as sound public finances. As EU members, these countries will be subject to multilateral surveillance within the EU policy framework. As long as they are Member States with a derogation, however, the penalty mechanism, which is part of the excessive deficit procedure, will not be applicable. 

Looking further ahead, EU membership also includes the commitment to the eventual adoption of the euro, which requires the fulfillment of the Maastricht criteria. Most CEE countries’ need for further efforts to meeting the budget deficit criterion is striking. The deficit in most acceding countries is currently significantly above the 3% benchmark. In many cases we have observed a deterioration in the fiscal balances this year, and in individual cases the deficit ratio is expected to increase next year. Some countries already had to pay a price for this, namely the loss of confidence among financial market participants and significant deteriorations of exchange rates. 

Admittedly, this assessment does not apply to all countries. Some acceding countries are distinguished by deficit ratios well below 3% or well on track towards that level. 

The next steps toward further integration of the new Member States into the monetary structures of the EU, I mean the participation in ERM II, are expected to contribute to the stabilization of expectations as well. Yesterday we heard a very interesting debate on this issue. I think that if the announced central parity is backed by sound economic policies, ERM II could help to reduce exchange rate fluctuations. As a result, import prices would become less volatile. This combination would smooth real exchange rate developments, contributing to the process of real convergence. 

Still, it has to be clear that the timing of entry of each acceeding country must be well considered, since – and this is the other side of the coin – ERM II participation amounts to a significant limitation on a country’s active exchange rate policy, which represents one of the most powerful economic policy instruments. 

Ladies and Gentlemen, 

Before I hand over the floor to Thomas Wieser, who will chair the first session, let me conclude by hoping that you are going to enjoy the following presentations and discussions and by wishing you a fruitful, stimulating and successful second day of the conference. 

Thank you very much for your attention.