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Ensuring Financial Stability in the EU: The Central & Eastern European Member States


The global financial crisis has caused particularly severe problems for some of the former Communist bloc countries that joined the EU in 2004 or later.  This paper, which is complementary to the recent SE group papers “The EU and the Financial Crisis” and “Ten Years of the Euro”, looks at the economic and financial difficulties faced by some Member States and at the prospects of further support that the EU could provide.

The Central & Eastern European Economies

The new Members of the EU after 1 May 2004 opened up their economies in accordance with Single Market rules and in most cases saw a sharp increase in their rates of economic growth.  Growth rates of six or seven per cent, year on year, were common amongst the accession states in the period 2004-2007.  In Poland, one of the most successful of the former centrally-planned economies, growth rates rose from under two per cent to over six per cent by 2007. [1]  But economic performance was uneven with several countries becoming particularly dependent on external credit.  Only Slovenia and Slovakia have so far qualified for, and then joined, the euro. 

The scale of the credit problems became clear when first Hungary and then Latvia had to seek International Monetary Fund (IMF) support in the autumn of 2008.  In both cases, consumers had borrowed heavily in other currencies than their own, as eurozone interest rates, for example, were lower than those at home.  This importing of foreign capital led to the build up of large current account deficits, in Hungary’s case of over six per cent of GDP by the end of 2007 but as high as 23 per cent in Bulgaria (economists often regard a current account deficit of 5 per cent as having the potential to cause a balance of payments crisis). [2] The falling value of their national currencies and the fall in foreign direct investment as the world economy turned down left these countries and their citizens exposed.  Many central and eastern European citizens have mortgages or other loans that are now more expensive as a result of the dramatic fall in value of their national currency against the currency in which their loan is denominated. 

A particular factor in the external deficits of Eastern European countries was that, although they had been financed successfully for some time by foreign direct investment, by 2008 they had become more dependent on short-term loans. [3] It was the withdrawal of this type of facility in the autumn of 2008 which caused the crisis for Hungary and Latvia.  Hungary had to borrow €20 million to stabilise its financial markets (60 per cent of loans to private companies in the country were in foreign currency). [4] Further support may be needed by other EU Member States in eastern and central Europe who have similarly exposed financial positions.  Romania was the third country to need such a package of support; it applied to the IMF for help in March 2009 because of the large scale of its private sector debt but it also has a public deficit of 5.4 per cent (it was granted €12.9 billion in May).

The shock that the credit crunch has caused some of the newer Member States, both economically and politically, has been considerable.  These countries embraced the free market – albeit with varying degrees of enthusiasm – and experienced considerable growth in the run up to their joining the EU and in the years since.  High rates of growth and booming property prices all seemed initially to be signs of the success of the eastern European economies, but had become the focus of concern for the governments of those countries by 2007/08.

The swift collapse in rates of growth in the third and fourth quarters of 2008 and the weakening of national currencies were a severe shock.  To many eastern Europeans the  free market approach they adopted after 1989, based around increased exports, openness to foreign investment and flexible models of employment, seemed to be failing.  The fact that the EU advocated this free market model and that some of the older Members of the EU seemed reluctant to support them at this difficult time damaged the credibility of the EU in central and eastern Europe.

The EU’s Capacity to Intervene

The EU does not (as opposed to its Member States) have the capacity to provide direct support to banks nor is it empowered to manage the kind of economic and financial restructuring programmes traditionally provided by the IMF.

The Maastricht Treaty of 1992 set out the rules for economic and monetary union (these are referred to in the SE group paper ‘Ten Years of the Euro’).  It is sometimes not understood that it also contained provisions concerning economic co-ordination amongst all Member States – building on previous Treaty provisions – which covered both cross-border capital movements and excessive national deficits. 

The capital movement provisions were designed to ensure that free movement of capital was realised within the Single Market.  But they also were intended to enable such movements to be halted in times of emergency.  Article 73f of the Maastricht Treaty permits the Council, acting by qualified majority on a proposal from the Commission, to take “safeguard measures” for up to six months if movements of capital to or from third countries “cause, or threaten to cause, serious difficulties for the operation of economic and monetary union”. 

The economic and monetary union provisions contain several elements intended to deal with unforeseen difficulties.  They include the right of the EU to provide Community financial assistance to a Member State when that state is “in difficulties or is seriously threatened with severe difficulties caused by exceptional occurrences beyond its control” but unanimous agreement is required except in the case of natural disasters (Article 103a). 

However the German Government and Bundesbank were concerned lest some of the weaker members of the Eurozone should exploit it to borrow excessively and have to be bailed out by the ECB, financed by the richer countries.  They therefore insisted that the Treaty should specifically prevent the ECB providing overdraft or other credit facilities to Member States or EU institutions.  This prohibition applies as much to regional and local government, public bodies and nationalised industries as to central government and also includes a ban on the ECB or central banks buying the debt instruments of public bodies (Article 104).

Furthermore, Article 104b states that the “Community shall not be liable for or assume the commitments of central governments, regional, local or other public authorities”, including nationalised industries, of any Member States.  Member States cannot be held liable for the commitments of other Member States either.  (There is an exclusion to enable the joint funding of specific projects).  

The Treaty’s provisions on excessive deficits limit a Member State to a government deficit of three per cent of GDP and specify a procedure by which a Member State which exceeds this limit can be the subject of enforcement proceedings (albeit limited to large fines which would be politically difficult).  So far, the Council of Ministers has been reluctant to enforce the three per cent limit, to the disquiet of several Member States. The European Council, meeting in March 2009, reaffirmed the commitment to “sound public finances and to the Stability and Growth framework”.  The reality is that during the critical phase of the financial crisis many Members will exceed the 3 per cent limit and so the Council called for Member States to return to “their medium-term budgetary objectives as soon as possible, keeping pace with economic recovery”. 

Article 109h of the Treaty enables the EU to act where a Member State is in difficulties as regards its balance of payments or “as a result of the type of currency at its disposal”, provided that such difficulties “jeopardize the functioning of the common market”.  The Commission is bound to investigate such situations and recommend measures to be taken by the Member State.  This provision does not apply to eurozone countries but only to those Member States who have not yet met the conditions for the adoption of the euro (or who have opted out, as in the case of the UK). 

Finally, the EIB has, since it was established under the Treaty of Rome, provided loans to Member States and to projects within Member States in accordance with EU policy objectives.  Some have seen this as a potential tool in the stabilising of the economies of the eastern European Member States.  Others have objected to this notion, not least because of the difficulty in raising funds through the sale of bonds by the EIB at a time when the markets are swamped by government bond sales.  The EIB will increase its lending in 2009 by 30 per cent to over €60 billion; the European Council agreed in December 2008 that the capital of the EIB should be increased by €67 billion this year as well.  The EU’s funding programme for “green” vehicle development in the car industry is being paid for through the EIB. 

The EU has provided support in two ways to Member States adversely affected by the financial crisis.  It has partnered the IMF in offering loans to Member States.  As part of the October 2008 package of support for Hungary, the EU lent €6.3 billion.  This was not taken out of the EU’s agreed budget but will be paid for through the issue of EU bonds by the European Investment Bank (EIB).  It is the EIB which provides a potential vehicle for supporting the eastern European states.

The March 2009 European Council agreed that the EU should make balance of payments assistance available to eligible Member States who need it and agreed to the amount set aside to do that being doubled to €50 billion.

The same meeting of EU leaders announced that individual Member States would provide, on a voluntary basis, loans to the IMF totalling €75 billion.  This additional capital is vital to enable the IMF to continue to provide support to countries in difficulty.

Future EU Action?

As the financial crisis has developed, governments and central banks have been forced to adopt innovative methods to tackle an unprecedented crisis.  As this paper has outlined, there are a number of ways that the EU could intervene, as it has done already. The relaxation of state aid rules has assisted the recapitalisation of banks for example.  But as has been said, the EU is not a substitute for the IMF, which has the skills and experience (and can impose the conditions) necessary to support countries that are experiencing serious financial problems. The EU may also not wish to take the political responsibility for the austerity measures that will be needed in a number of Member States, particularly but not exclusively in eastern Europe, to enable them to reduce their excessive deficits, to stabilise their currency and to return to economic growth. 

It is doubtful whether the EIB’s current role could be extended so that it became, in effect, a stablisation fund for Member States experiencing financial difficulty.  Such an approach would be seen as undermining the long-term credibility of the EIB as an investment institution as well as raising the costs of its bond sales because of market resistance.  The EIB has an important part to play in the current crisis but it is not a substitute for action by other international bodies.  Of course, Member States have the capacity to intervene on a national basis where the EU cannot act collectively.

If the financial crisis continues for some time, and/or worsens, problems may develop affecting some of the larger Member States.  This could mean countries like Greece, Italy and Spain needing substantial support.  If any EU Member State appeared to be in serious danger of defaulting on their sovereign debts, pressure will rise for EU action of some kind to support them.  It is too early to try to guess what form it might take.

May 2009



[1]   World Bank data.

[2]  ‘New Europe and the Economic Crisis’, Katinka Barysch, Centre for European Reform Briefing Note, February 2009

[3]  ‘New Europe and the Economic Crisis’, op cit.



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