68299 The World Bank EU10 Regular Economic Report Main Report Securing Recovery Amid Headwinds November 2011 Focus Note: Skills, Not Just Diplomas This report is prepared by a team including Simon Davies, Stella Ilieva, Ewa Korczyc, Matija Laco, Sanja Madzarevic-Sujster, Catalin Pauna, Kaspar Richter (task manager, krichter@worldbank.org) and Emilia Skrok. The team is very grateful to Lars Sondergaard for the focus note, and to Marcin Piatkowski, Lucio Vinhas de Souza and the World Bank Global Prospect Group, coordinated by Annette De Kleine, for excellent inputs. EU10 refers to Bulgaria, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, the Slovak Republic and Slovenia. EU10+1 includes Croatia. 1 EU10 November 2011 Summary of Main Report  At the beginning of the year, EU10 countries were the peaks during the crisis, and even there they are looking forward to an acceleration of growth and still more than three times the pre-crisis levels. progress on fiscal consolidation supported by a A challenging external environment, weakening rebound in private domestic demand, an increase in sentiments among businesses and consumers, and credit growth, a decline in unemployment and a persistent unemployment translate into weak growth stable external environment. As 2011 is drawing to a prospects. Growth in 2012 is set to drop almost one close, the year has not quite turned out as expected. percentage point, returning to the 2010 level. Even Progress has been difficult to achieve in some areas, such sluggish growth is at risk in case the situation although the region has shown remarkable resilience deteriorates further in the euro area or the global in others. economy. We start with the strong points. First, regional A weak and uncertain economic outlook means that growth in 2011 has been solid. The EU10 region has strong, three-pronged policy action is essential. taken advantage of its openness, and supported First, governments, central banks and financial growth through a strong expansion in exports. supervisory authority across the EU have to shore up Second, Estonia, Lithuania and Latvia, the growth confidence of financial markets. Building on recent laggards in 2009, have turned within two years into policy measures, priorities include prudent risk growth leaders, reaping the benefits of the flexibility assessments, following-up plans for recapitalization of their economies. Third, EU10 countries have and restructuring of banks as needed, and bolstering delivered on their promises to make good on fiscal the resilience and stability of the financial system consolidation. Fiscal deficits have declined in 2011 through macro-prudential regulations. Second, while across the region to the lowest level in three years. monetary policy can be supportive of the recovery in As governments are preparing the budgets for next light of low inflation pressures, most EU10 countries year, all EU10 countries are broadly on track with have to pursue reductions in fiscal deficits to rebuild meeting their fiscal targets in line with their fiscal buffers in line with their plans. This would commitments of the EU Stability and Growth Pact. ensure that weak fiscal balances do not become a These achievements are impressive, as they have source for financial market volatility. Many come in spite of a fair share of disappointments. countries still have to adopt specific additional The external environment has been more challenging measures to bring about the envisioned fiscal than hoped for, especially in the second half of the adjustments, especially in case the economic outlook year. Growth of the global economy is losing worsens further. Finally, structural policies in momentum, and the expansion in the EU15 is support of growth can help to overcome the grinding to a halt towards the end of the year, as the financial, labor and fiscal challenges. This means sovereign debt crisis originating from the periphery making workers and businesses more productive of the euro area continues to rattle financial through EU funds and FDI flows, improving markets. Since the EU10 is closely tied through technology and strengthening skills. Deepening production, trade and finance with the EU15, economic and financial ties between the EU10 and adverse developments can spread just as much as the EU15 is part of this agenda. The strong record of desirable ones from the west to the east of the EU. convergence over the last two decades demonstrates the benefits of closer integration in spite of today’s While EU10 financial markets weathered well euro economic problems. area volatility earlier in the year, they took a turn for the worse later in the year. As worries about EU10 Growth prospects sovereign debt in some euro area countries 2010 2011  2012 translated into concerns about European banking EU10 2.1 3.0  2.1 groups holding these sovereign bonds, currencies Bulgaria 0.2 2.0  2.0 depreciated, stock markets contracted and financial flows dwindled. Even though financial markets Czech Republic 2.2 2.1  1.0 recovered somewhat in recent weeks in response to Estonia 3.1 7.6  3.5 policy action, volatility remains elevated. In Latvia â€?0.3 4.0  2.8 addition, with global prospects worsening and Lithuania 1.3 5.8  3.5 financial markets stalling, private demand has not Hungary 1.2 1.7  0.5 been able to pick up the slack from public demand. Poland 3.8 4.0  2.9 As a result, with the exception of Estonia, Latvia, Romania â€?1.3 1.5  2.0 Lithuania and Poland, domestic demand remains weak. Furthermore, as domestic demand has failed Slovenia 1.4 1.3  1.4 to take off, unemployment persists at elevated Slovak Republic 4.0 3.0  1.5 levels. Only Estonia, Lithuania and Latvia have made Note: The 2012 GDP growth forecast for Romania is an some headway in reducing unemployment rates from interval from 1.8 to 2.1 percent. 2 Recent Developments and Future Prospects  Output  The economic recovery in the EU10 is slowing down as the global economy has been pounded by a series of shocks. An earthquake and tsunami in Japan, high oil prices, strains in financial and sovereign debt markets of the euro area, and the slowing recovery in the US have dampened global economic activity, which was already under pressure from the end of the inventory cycle and fiscal consolidation. As a result, the economic sentiment in key OECD countries deteriorated during the course of the year (Figure 1). Driven by weaker performance of high income countries, growth of the global economy is set to slow down in 2011 (Table 1). Figure 1. OECD Composite Leading Indicator Table 1. Global growth prospects, percent 2010 2011f 2012f Germany United States Major Five Asia OECD â€? Total 110 World 4.0 2.7 2.7 High income 2.9 1.6 1.7 105 Developing countries 7.3 6.1 5.6 Euro area 1.7 1.6 0.5 100 EU10 2.1 3.0 2.1 95 90 85 Aprâ€?07 Aprâ€?08 Aprâ€?09 Aprâ€?10 Aprâ€?11 Julâ€?07 Julâ€?08 Julâ€?09 Julâ€?10 Julâ€?11 Octâ€?07 Octâ€?08 Octâ€?09 Octâ€?10 Janâ€?07 Janâ€?08 Janâ€?09 Janâ€?10 Janâ€?11 Source: OECD, World Bank staff calculations. Source: World Bank DEC Prospects Group. Notes: Major Five Asia refers to China, India, Indonesia, Japan and South Korea. The recovery of the EU10 countries was well on track in the first half of 2011. EU10 output growth accelerated to 3.4 percent year-on-year in the first half of 2011 from 2.9 percent in the second half of 2010. Growth benefited from the base effect, as the region returned to growth only in early 2010. It also reflected the dynamism of the economies. The quarter-on-quarter growth rates of the EU10 exceeded those of the EU15 for the sixth quarter in a row. The recovery reflected both the global upturn and policy action, including sizeable fiscal consolidation, to shore up market confidence. 3 Figure 2. GDP growth in EU10 countries and EU15, percent year-on-year not seasonally adjusted quarter-on-quarter seasonally adjusted 3Q 10 4Q 10 1Q 11 2Q 11 3Q 10 4Q 10 1Q 11 2Q 11 3.5 12 10 3 8 2.5 6 2 4 1.5 2 1 0 0.5 â€?2 0 â€?4 â€?0.5 EU15 EU10 BG CZ EE LV LT HU PL RO SI SK EU15 EU10 BG CZ EE LV LT HU PL RO SI SK Source: Eurostat, World Bank staff calculations The expansion relied on both domestic and external demand. The breakdown of GDP components shows that the inventory cycle, the most important growth driver in 2010, was less important in the first half of 2011. Instead, net exports made the largest growth contribution, and consumption and investment further boosted growth (Figure 3). Figure 3. Contribution to GDP growth in the EU10 and the EU10 countries, year-on-year, not seasonally adjusted, percent EU10 EU10 countries Final consumption GFCF Changes in inventories Net exports Other GDP Final consumption GFCF Changes in inventories Net exports Other GDP 10 10 8 8 6 6 4 4 2 2 0 0 â€?2 â€?2 â€?4 â€?4 â€?6 â€?8 â€?6 â€?10 â€?8 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 â€?10 1Q 11 2Q 11 1Q 07 2Q 07 3Q 07 4Q 07 1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 4Q 10 BG CZ EE HU LV LT PL RO SK SI Source: Eurostat, Central Statistical Offices, World Bank staff calculations The recovery remained multi-speed. Growth was highest in Estonia, Lithuania and Latvia, which had seen the sharpest contraction in 2009, thanks to a strong export performance and a recovery in domestic demand. Growth in Poland relied mainly on solid domestic demand. By contrast, the Czech Republic, Hungary, Slovakia, and Slovenia took advantage of a strong rebound in global trade as their open economies are well integrated in European production networks. Estonia and Bulgaria also benefited from export-driven growth. Weak domestic demand lowered growth in Slovenia, Bulgaria, Hungary and Romania. Indeed, investment in the second quarter of 2011 remained below pre-crisis levels in all countries but Poland. Consumption exceeded pre-crisis levels only in Poland, Slovakia, Slovenia and the Czech Republic. 4 Figure 4. Recovery in gross fixed investment and final consumption from pre-crisis peak to 2Q 2011, index, peak = 100, seasonally adjusted Gross fixed capital formation Final consumption expenditure 120 120 107 101 101 99 101 101 100 100 100 87 89 92 91 88 86 84 83 85 84 80 80 76 72 66 65 63 60 52 60 47 40 40 20 20 0 0 EU15 EU10 PL CZ HU SK BG RO SI LT EE LV EU15 EU10 PL SK SI CZ BG HU RO EE LT LV Source: Eurostat, World Bank staff calculations Notes: Pre-crisis peak refers to the best quarter within the period 2006-2008 EU10 economic activity is moderating in the second half of 2011 in response to the worsening of the external environment. Growth is slowing across Europe, dampened by the crisis in parts of the euro area and worries about the global economy. High frequency indicators, such as retail sales, industrial production, exports and imports, show declining growth in the third quarter for both the EU15 and EU10 (Figure 5). While businesses in the EU10 and EU15 were optimistic about their prospects in April 2011, their sentiment reversed in the summer, although more in the EU15 than in the EU10 (Figure 6). Consumer confidence also worsened in the EU15, and remained depressed in the EU10. However, the timing of the slowdown differs across the EU10 countries. In particular, flash estimates for year-on-year growth in the third quarter of 2011 suggest that economic performance remained strong in Latvia, Lithuania, Estonia, and Slovakia, and improved in Romania. Figure 5. High frequency indicators for EU10 and EU15 countries Industrial production and retail sales Exports and imports EU15 IPI EU10 IPI EU15 Exports EU10 Exports EU15 Retail EU10 Retail EU15 Imports EU10 Imports 14 35 12 10 30 8 25 6 20 4 15 2 10 0 5 â€?2 â€?4 0 Aprâ€?10 Aprâ€?11 Febâ€?10 Sepâ€?10 Febâ€?11 Junâ€?10 Julâ€?10 Junâ€?11 Julâ€?11 Marâ€?10 Decâ€?10 Marâ€?11 Augâ€?10 Octâ€?10 Augâ€?11 Janâ€?10 Mayâ€?10 Novâ€?10 Janâ€?11 Mayâ€?11 Decâ€?10 Augâ€?10 Octâ€?10 Augâ€?11 Aprâ€?10 Aprâ€?11 Janâ€?10 Novâ€?10 Janâ€?11 Febâ€?10 Mayâ€?10 Sepâ€?10 Febâ€?11 Mayâ€?11 Sepâ€?11 Marâ€?10 Junâ€?10 Julâ€?10 Marâ€?11 Junâ€?11 Julâ€?11 Source: Eurostat, World Bank staff calculations Notes: 3M moving average growth rates 5 Figure 6. Industry and consumer confidence indicators for EU10 and EU15 Industry Consumer Aprâ€?11 Octâ€?11 Aprâ€?11 Octâ€?11 10 10 0 0 â€?10 â€?10 â€?20 â€?20 â€?30 â€?30 â€?40 â€?40 â€?50 â€?50 EU15 EU10 BG CZ EE LV LT HU PL RO SI SK EU15 EU10 BG CZ EE LV LT HU PL RO SI SK Source: Eurostat, World Bank staff calculations Notes: Consumer confidence indicator represents the arithmetic average of the answers (balances) to the four questions on the financial situation of households and general economic situation (past and future) together with that on the advisability of making major purchases. Industry confidence indicator is the arithmetic average of the answers to the questions on production expectations, order books and stocks of finished products. Although the momentum is weakening, growth in 2011 remains robust. The slowdown towards the end of the year is balanced by the strong expansion early in the year. EU10 growth is expected to reach 3.0 percent in 2011, just slightly below government projections of 3.2 percent from spring 2011. For the first time since the crisis, all EU10 countries are projected to grow this year. EU15 growth is projected to be only 1.5 percent, half the rate of EU10 countries (Figure 7). Two EU15 countries are expected to remain in recession in 2011. Among the EU10 countries, Estonia, Latvia, Lithuania and Poland are projected to grow by 4 percent or more, thanks to a higher contribution from domestic demand and improving labor markets. Hungary, Romania and Slovenia are set to expand by less than 2 percent, as growth is held back by weak investment (Hungary and Slovenia) or consumption (Romania). Slovakia, Bulgaria and the Czech Republic grow at between 2 and 3 percent, aided by exports. Figure 7. Comparison of 2011 growth forecast and Convergence or Stability programs projections 8 8 CP/SP WB CP/SP WB 7 7 6 6 5 5 4 4 3 3 2 2 1 1 0 0 EU15* EU10 EE LT LV PL SK BG CZ HU RO SI Source: World Bank staff calculations, Convergence/ Stability Program Summer 2011 Notes: *For EU15 data is from EC November 2011 forecast 6 Trade and External Developments  While global trade eased after last year’s cyclical rebound, it remained crucial for growth in Europe. Global trade lost momentum in the second quarter of 2011, as output growth weakened in advanced economies and the oil price peaked. Nevertheless, it stayed more vibrant than expected in Europe. For example, the IMF upgraded in September its April projections for 2011 export volumes from 7.8 percent to 8.8 percent for the EU15, and from 7.9 to 11.0 percent for the EU10 (Figure 8). Figure 8. Exports and imports performance in 2011 relative to April 2011 expectations Exp Imp Exp Imp 35 35 30 30 25 25 20 20 15 15 10 10 5 5 0 0 Apr 2011 Apr 2011 Apr 2011 Apr 2011 Apr 2011 Apr 2011 Apr 2011 Apr 2011 Apr 2011 Apr 2011 Apr 2011 Apr 2011 Sep 2011 Sep 2011 Sep 2011 Sep 2011 Sep 2011 Sep 2011 Sep 2011 Sep 2011 Sep 2011 Sep 2011 Sep 2011 Sep 2011 EU15 EU10 LV SK PL RO LT BG SI HU CZ EE Source: World Bank staff calculations, WEO April 2011 and Sept 2011 Trade contributed to EU10 growth through strong exports and weak imports. Export volumes in 2011 are set to expand more than 10 percent in Estonia, Romania, the Czech Republic, Slovakia and Latvia. Compared to the same period in 2008, during the first eight months of the year, EU10 exports exceeded their pre-crisis level by 16 percent. Estonia, Latvia and Romania, which underwent large recessions during the crisis, boosted their exports more than 25 percent compared to the pre-crisis period (Figure 9). They took advantage of higher demand for intermediate goods, and, in the case of Estonia and Romania, also for capital goods. In addition, Estonia and Latvia did well on diversifying their trade from EU countries to other regions, including Asia, and improving competitiveness. However, export growth in July and August dropped in most countries noticeably compared to the beginning of the year in response to the global slowdown. The reduction in export growth was large in Bulgaria and Romania whose intermediate goods trade is especially dependent on the global demand cycle, although it remained high in both countries (Figure 10). Going forward, with growth in Europe and other major economies rapidly slowing down, demand for EU10 goods is set to slow down further. In contrast to exports, imports remained in most countries below pre-crisis levels in light of weak domestic demand. 7 Figure 9. January to August import and export for Figure 10. Composition of export, EU10, January EU10 countries, Jan-Aug 2008=100 2008-July 2011 (billion Euro) Exp Imp 50 Intermediate goods Capital goods Consumption goods Cars and fuel 150 45 140 40 130 35 120 30 110 100 25 90 20 80 15 70 10 60 5 50 0 2010 2011 2010 2011 2010 2011 2010 2011 2010 2011 2010 2011 2010 2011 2010 2011 2010 2011 2010 2011 2010 2011 2010 2011 Janâ€?08 Mayâ€?08 Sepâ€?08 Novâ€?08 Janâ€?09 Mayâ€?09 Sepâ€?09 Novâ€?09 Janâ€?10 Mayâ€?10 Sepâ€?10 Novâ€?10 Janâ€?11 Mayâ€?11 Marâ€?08 Julâ€?08 Marâ€?09 Julâ€?09 Marâ€?10 Julâ€?10 Marâ€?11 Julâ€?11 EU15 EU10 BG CZ EE LV LT HU PL RO SI SK Source: Eurostat, World Bank staff calculations The EU10’s current account deficit increased relative to 2010, but remained at a moderate level and adequately funded through portfolio and FDI investments. The EU10 current account deficit increased from 2 percent of GDP in 2010 to 4 percent in the first half of 2011. This reflected solid demand for foreign goods in a number of countries, including Poland and the Czech Republic, as well as large income transfers. Current account deficits were funded mainly through FDI in the Czech Republic and Romania, through portfolio investments in Poland, and portfolio investments and other flows in Slovakia. Figure 11. Current account developments in EU10 Figure 12. Current account financing in EU10 countries (% of GDP) countries (% of GDP) Goods Services Income Transfers CAB  FDI Portfolio Other investment and changes in reserves CAB inverted 15 15 10 10 5 5 0 0 â€?5 â€?5 â€?10 â€?10 â€?15 â€?15 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 1Q 11 2Q 11 EU10 BG CZ EE LV LT HU PL RO SI SK EU10 BG CZ EE LV LT HU PL RO SI SK Source: Eurostat, Central Banks, World Bank staff calculations Notes: On cumulative basis Trade and current account balances have improved substantially since 2008. The EU10 trade balance, which improved for all ten countries, moved from a deficit of 5 percent of GDP in 2008 to a balanced position in the first half of 2011. The current account improved in line, driven by contracting domestic demand and a sharp slowdown in capital flows. Only in the Czech Republic, which had a moderate current account deficit going into the crisis, the current account deficit worsened somewhat due to large income transfers to foreigners. The EU10 countries with the highest pre-crisis current account deficits saw the largest improvements, including Bulgaria, Estonia, Latvia, Lithuania, Hungary and Romania, in response to dwindling capital inflows. For example, the current account balance in Bulgaria moved from a deficit of 23 percent of GDP in 2008 to a surplus of close to 2 percent of GDP in the first half of 2011 (Figure 13). 8 Figure 13. CAB and trade balance in EU10 countries (% of GDP) Trade balance CAB 10 5 0 â€?5 â€?10 â€?15 â€?20 â€?25 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008 2008 1H 11 1H 11 1H 11 1H 11 1H 11 1H 11 1H 11 1H 11 1H 11 1H 11 1H 11 EU10 BG CZ EE LV LT HU PL RO SI SK Source: Eurostat, Central Banks, World Bank staff calculations Notes: On cumulative basis Gross external debt-to-GDP ratios contracted over the last year and a half, helped by lower external borrowing due to improved current account balances. For the EU10, external debt declined slightly from 83 percent of GDP at end-2009 to 81 percent of GDP at mid-2011 (Figure 14). The current account improvements helped Estonia, Bulgaria and Lithuania to lower external borrowing. Hungary’s external debt dropped almost 30 percent of GDP. The government utilized one-off receipts from dissolving the private pension pillar to lower outstanding debt. Government external debt exceeded bank external debt in some EU10 countries as banks continue to deleverage while governments tapped international markets to finance fiscal deficits (Figure 15). External government debt, however, remained at less than 7 percent of GDP in Bulgaria and Estonia and declined substantially in Slovakia. Figure 14. Gross external debt developments 2009 Figure 15. Structure of the gross external debt in - 2Q 2011, percent of GDP June 2011 (% of GDP) 2009 Jun 2011 Public debt Banks Other sectors Foreign direct investment 200 160 180 140 160 120 140 120 100 100 80 80 60 60 40 40 20 20 0 0 EU10 CZ PL RO LT BG EE SK SI HU LV EU10 CZ PL RO LT SK BG EE SI HU LV Source: Central Banks, World Bank staff calculation Source: Central Banks, World Bank staff calculation Notes: Calculations refer to data in EUR. 9 Inflation and Exchange Rates  With an easing of international commodity prices, a slowdown in growth and monetary policy tightening in some countries, inflation has moderated in the second half of the year. EU10 headline inflation dropped from 4.4 percent in May 2011, the highest level since April 2009, to 3.4 percent in September 2011. EU10 core inflation, which excludes energy and unprocessed food, was 3.0 percent September 2011, down by 0.3 percentage points since its peak in June 2011 (Figure 16). Headline inflation eased more than core inflation, as the international commodity price index declined 13 percent for energy and 6 percent for food from April 2011 to October 2011. Core inflation declined in light of persistent unemployment, weak growth prospects and increases in policy rates in a few countries. The picture varies across the region reflecting country specific factors. The largest declines in inflation took place in Bulgaria, where inflation dropped from 3.5 percent in June to 2.9 percent in September, and Romania, where it slowed down from 8.5 percent in May to 3.5 percent in September, the lowest level in the last two decades (Figure 17). In both countries, a good agricultural year helped to lower prices of food items, which account for a high share in the consumption basket. In addition, the impact of the VAT increase in July 2010 on year-on- year inflation tapered off in Romania. As a result of strong domestic demand and/or tax increases, inflation runs highest in Estonia, Lithuania and Latvia. Figure 16. HICP overall index and core index for Figure 17. HICP overall index for EU10, annual rate EU10 and EU15, annual rate of change, percent of change EU10 overall EU10 core Sepâ€?11 Janâ€?11 Aprâ€?11 EU15 overall EU15 core 10 5 4 8 3 6 2 1 4 0 2 â€?1 Sepâ€?09 Sepâ€?10 Sepâ€?11 Marâ€?09 Julâ€?09 Marâ€?10 Julâ€?10 Marâ€?11 Julâ€?11 Janâ€?09 Novâ€?09 Janâ€?10 Novâ€?10 Janâ€?11 Mayâ€?09 Mayâ€?10 Mayâ€?11 0 BG CZ EE LV LT HU PL RO SI SK Source: Eurostat, World Bank staff calculations Note: HICP is a harmonized index of consumer prices. The renewed volatility in euro area financial markets led to depreciation of several currencies in the region. Similar to the responses to the Lehmann crisis in fall 2008, the exchange rate impact was smallest on the Czech koruna, in line with the country’s strong economic fundamentals, and largest on the Polish zloty, reflecting the large size and liquidity of Polish financial markets. However, more recently, the Hungarian forint depreciated noticeably in response to weak economic data. Overall, real effective exchange rates for Poland, Romania, and Hungary remain visibly below pre-crisis levels, in contrast to the Czech Republic, and Estonia and Slovakia, both euro area member countries (Figure 18, Figure 19). The third EU10 euro area country, Slovenia, has seen less appreciation of its real exchange rate than Estonia and Slovakia. 10 Figure 18. Nominal exchange rates to EUR, August Figure 19. Real effective exchange rates, August 2008=100 2008=100 CZ HU RO PL 110 CZ 110 105 100 EE 100 90 95 HU 80 90 PL 70 85 RO 60 80 SI 50 75 40 70 SK Decâ€?08 Decâ€?09 Decâ€?10 Decâ€?08 Decâ€?09 Decâ€?10 Octâ€?08 Octâ€?09 Octâ€?10 Augâ€?08 Octâ€?08 Augâ€?09 Octâ€?09 Augâ€?10 Octâ€?10 Augâ€?11 Octâ€?11 Augâ€?08 Augâ€?09 Augâ€?10 Augâ€?11 Aprâ€?09 Aprâ€?10 Aprâ€?11 Aprâ€?09 Aprâ€?10 Aprâ€?11 Febâ€?09 Febâ€?10 Febâ€?11 Febâ€?09 Febâ€?10 Febâ€?11 Junâ€?09 Junâ€?10 Junâ€?11 Junâ€?09 Junâ€?10 Junâ€?11 Source: Eurostat, World Bank staff calculations Source: BIS, World Bank staff calculations Notes: Downward movement denotes depreciation.   11 Finance  Financial markets have taken a turn to the worse since the summer. Renewed market turbulence originating from the euro area, along with weaker global growth prospects, have increased market risk aversion across asset classes (Figure 20). Sovereign and banking group risk spreads have increased and stock markets have declined since April 2011. Interbank spreads have remained more stable thanks to the ECB’s liquidity provision. Investors remain concerned about progress in shoring up fiscal sustainability in countries of the euro area periphery, the links between sovereign and banking risks in parts of the euro area, large funding needs of European banking groups for refinancing and recapitalization, and the implementation of the policy actions needed to restore market confidence. Gross capital inflows to EU10 countries slowed down noticeably in the third quarter of 2011. As risk appetite declined, gross capital inflows to the EU10 contracted from USD25 billion to less than USD10 billion in the third quarter of 2011 (Figure 21). Bank and bond flows declined, while equity flows remained robust. After a boost to bank-related flows in the second quarter due to lumpy transactions, bank-related flows returned to a low level in view of the ongoing deleveraging of European banking groups (Box 1). This reflects a number of factors, including weak growth prospects, funding constraints, sluggish credit demand, and regulatory changes to increase capital adequacy ratios. Public bond flows declined as governments postponed bond placements in view of elevated market risks. Figure 20. Asset class performance in the EU10 Figure 21. Gross capital inflows to EU10 markets, region, in basis points USD billions Nov 2011 Mar 2009 Apr 2011 Sep/Oct 2011  Preâ€?crisis peak Bond flows Equity flows Bank related flows 700 700 175 30 600 600 150 25 500 500 125 20 400 400 100 15 300 300 75 10 200 200 50 100 100 25 5 0 00 0 1Q 07 2Q 07 3Q 07 4Q 07 1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 3Q 11 5Y CDS CDS banks Interbank rates  Stocks spreads Source: Reuters, Bloomberg, World Bank staff calculations Source: World Bank DEC PG, staff calculations Notes: For stocks right axis applies, pre-crisis peak =100 Box 1. Bank’s cross-border claims in the EU10 Strong parent and subsidiary links have been a source of resilience in the recovery from the 2008/09 crisis in the region. At the same time, financial conditions remain more difficult than before the crisis and the increase in sovereign debt burdens poses risks to financial stability. Many countries are exposed to the same external lenders via cross-border loans to banks from their international parent banks. From a creditor perspective, bank claims are concentrated in few countries—Austria, Belgium, France, Germany, Italy, the Netherlands, Greece and Sweden—which account for three-quarters of total claims on the region. In light of ongoing uncertainty and the quality of bank assets, markets are exerting pressure on banks to improve their risk profile and build up capital buffers. With about three-quarters of the EU10 banking assets in foreign ownership, cross-border capital flows in the banking sector remain central to the stability of the financial system and credit provision. 12 As reported by the Bank for International Settlement Figure 22. Banks’ claims on EU10 region, USD bln (BIS), banks’ claims on the EU10 countries in June 2011 totaled USD452bn (Figure 22). This was 4 Nonâ€?bank Bank 700 percent less than in March 2011 but 16 percent more than in the same period last year. In the second 600 quarter in particular, claims decreased in banking 500 sector, while they remained almost stagnant in the 400 non-banking sector. Claims decreased 7 percent on 300 the banking sector, but increased 1 percent on the 200 non-banking sector. Banking sector claims declined 100 in Hungary, Poland, Czech Republic, Romania and Slovakia, although they improved in Bulgaria, 0 1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 Estonia, Latvia, Lithuania and Slovenia. Source: BIS, World Bank staff calculations Note: Adjusted for exchange rates Source: World Bank staff. Spreads on sovereign debt have risen, as markets have become increasingly worried about fiscal positions in countries of the euro area periphery. The volatility of sovereign credit default swap spreads remains high in line with fragile market sentiment. The risk perception of the EU10 countries was remarkably robust in the face of sovereign debt concerns in the euro area early in the year. However, the latest phase of euro area turbulence has triggered repercussions throughout the region (Figure 23). Nevertheless, markets continued to differentiate across countries. The impact was largest on Hungary, marked by the highest public debt ratio among the EU10 countries and sluggish economic data. It was lowest on Estonia and the Czech Republic in line with their strong fiscal and economic indicators. Mirroring the pattern of sovereign spreads, government bond yields of the Czech Republic remained far lower than those of Hungary, and they remained below the peaks of March 2009 in all EU10 countries (Figure 24). Figure 23. 5Y CDS spreads for EU10 countries Figure 24. 10Y bond yields in the Czech Republic, (basis points) Hungary, Poland, Romania and Bulgaria, percent Nov 2011 Preâ€?crisis Mar 2009 Sept/Oct 2011 Nov 2011 Preâ€?crisis Mar 2009 Sep/Oct 2011 14 1200 12 1000 10 800 8 600 6 400 4 200 2 0 0 BG CZ EE LV LT HU PL RO SI SK CZ HU PL RO BG Source: Bloomberg, World Bank staff calculations Source: Reuters, World Bank staff calculations Notes: RO– pre-crisis not available, BG – data prior to 2011 not available 13 Figure 25. Median government bond yields EU10 and GIPS countries (basis points) EU10 Feb 2011 GIPS Feb 2011 EU10 Sep 2011 GIPS Sep 2011 120 115 110 105 100 95 D D+2 D+4 D+6 D+8 D+10 D+12 D+14 D+16 D+18 D+20 D+22 D+24 D+26 D+28 D+30 Source: Bloomberg, World Bank staff calculations Notes: GIPS stands Greece, Ireland, Portugal and Spain. Banks’ funding pressures have remained elevated. Spreads of major European banking groups operating in the EU10 increased over the last six months (Figure 26). Banking risks are high in peripheral euro area countries where financial stress interacts with fiscal pressures and low growth. The sovereign debt crisis in some euro area countries makes the roll-over of wholesale funding more difficult for credit institutions, especially as governments compete with banks for financing. Furthermore, the rise in the sovereign credit risk of banks is amplified through the high interconnectivity and leverage of the banking sector. Figure 26. Parent banks’ CDS spreads 600 500 Raiffeisen 400 Deutsche Bank 300 Soc Generale Unicredit 200 Intesa 100 ERSTE SEB Bank 0 Octâ€?09 Octâ€?10 Octâ€?11 Aprâ€?09 Aprâ€?10 Aprâ€?11 Janâ€?09 Janâ€?10 Janâ€?11 Julâ€?09 Julâ€?10 Julâ€?11 Source: Bloomberg, Reuters, World Bank staff calculations Market volatility spread to the stock markets in the late summer. By early November 2011, EU10 stock markets remained 50 percent below the pre-crisis 2008 peak, and 16 percent above the March 2009 trough. The downward adjustments were largest in countries that had seen the biggest increases early in the year, including Poland, Estonia and Hungary (Figure 27). 14 Figure 27. Stock exchange indices in EU10 countries Figure 28. Interbank rates spreads, basis points and selected countries from the EU15, pre-crisis peak = 100 Nov 2011 Preâ€?crisis Mar 2009 Sep/Oct 2011 Nov 2011 Preâ€?crisis Mar 2009 Sep/Oct 2011 2000 100 90 1500 80 70 60 1000 50 40 500 30 20 0 10 0 â€?500 BG CZ EE LV LT HU PL RO SI SK BG CZ EE LV LT HU PL RO SI SK Source: Bloomberg, World Bank staff calculations Credit growth to the private sector remained sluggish. While credit provision improved in early in 2011, credit growth has slowed down again in recent months (Figure 29). About three years after the crisis, taking into account inflation, the amount of outstanding private sector credit was around 15 to 20 percent below October 2008 level in Lithuania, Latvia, Estonia, Romania and Hungary (Figure 30). In addition, with the exception of Bulgaria, credit to enterprises was below the October 2008 level in all EU10 countries. Only Slovakia, the Czech Republic and Poland have seen increases in real private sector credit thanks to a solid expansion of credits to households. The recovery in credit growth is delayed in part due to the reduction in bank-related inflows and the rise in non-performing loans (Figure 31). However, banks’ capital positioned improved early in the year in most countries and the banks’ regulatory capital, relative to risk-weighted assets, is especially high in Estonia and Bulgaria (Figure 32). Banks' credit standards for new lending also remain tighter than before the crisis (Figure 33). Nevertheless, demand side factors also play a role, as credit and GDP growth are closely linked (Figure 34). Credit growth could accelerate again once downside risks to growth in Europe fade. However, sustaining healthy credit growth will require measures to strengthen the resilience of EU10 banking sectors against contagion from selected euro area markets. Figure 29. Real credit growth, percent, year-on- Figure 30. Contribution to real credit growth from year Oct 2008 to August 2011 50 Credit to HHS Credit to enterprises Credit growth 15 40 10 30 5 20 0 10 EU15 â€?5 0 EU10 â€?10 â€?10 â€?15 â€?20 â€?20 Janâ€?08 Sepâ€?08 Novâ€?08 Janâ€?09 Sepâ€?09 Novâ€?09 Janâ€?10 Sepâ€?10 Novâ€?10 Janâ€?11 Mayâ€?08 Mayâ€?09 Mayâ€?10 Mayâ€?11 Marâ€?08 Julâ€?08 Marâ€?09 Julâ€?09 Marâ€?10 Julâ€?10 Marâ€?11 Julâ€?11 â€?25 EU15 EU10 SK CZ PL SI BG HU RO EE LV LT Source: European Central Bank, World Bank staff Source: European Central Bank, World Bank staff calculations calculations 15 Figure 31. Non-performing loans of banks in EU10 Figure 32. Bank regulatory capital to risk-weighted countries (% of loans) assets (%) 2009 2010 2011 2009 2010 2011 25 25 20 20 15 15 10 10 5 5 0 0 EU15 EU10 BG CZ EE LV LT HU PL RO SI SK EU15 EU10 BG CZ EE LV LT HU PL RO SI SK Source: IMF Global Financial Stability Report September 2011, World Bank staff calculations Notes: EU10 and EU15 aggregates show median, 2011 refers to March 2011 Figure 33. Credit growth Oct 2008 - Aug 2011 Figure 34. Real credit growth Oct 2008 – Aug vs. increase in non-performing loans (2008- 2011 vs. output level in 2Q 11 relative to 3Q 2011), percent 08, percent 15 20 Real credit stock in Aug 2011 relative to  SK 15 10 SK CZ 10 PL CZ 5 5 PL Real credit growth SI SI 0 BG 0 BG Oct 2008 â€?5 â€?5 â€?10 HU â€?10 â€?15 EE â€?20 LV RO â€?15 HU RO LV â€?25 LT EE â€?20 LT â€?30 â€?25 â€?30 â€?20 â€?10 0 10 20 0 5 10 15 20 Output level in 2Q 2011 relative to 3Q 2008 Increase in NPLs Source: IMF Global Financial Stability Report September 2011, Eurostat, ECB, World Bank staff calculations   16 Jobs The economy remains too sluggish to create jobs in most countries. Employment increased in the second quarter of 2011 in the EU10. The number of workers with a job rose from 42.8 million in the first quarter to 43.6 million in the second quarter (Figure 35). Employment increased in all EU10 countries apart from Bulgaria, Romania and Slovenia where weak economic activity and structural adjustments continued to lead to job losses. Employment growth was particularly strong in Estonia, Latvia and Lithuania, backed by improvements in export-led manufacturing. While this looks at first sight to be a noticeable improvement, three numbers suggest that employment in the EU10 continues to be weak. First, the increase from the first quarter was in line with standard seasonal patterns. EU10 employment was roughly unchanged from the level one year ago, and some 2 million less than the pre-crisis employment peak. Second, relative to the working age population, defined as the 20 to 64 year old population, the employment share was 65 percent, some 2 percentage points below the level in the second quarter of 2008 (Figure 36). Third, while employment was still below pre-crisis levels in the second quarter of 2011, the output was above pre-crisis level for the EU10, although the picture differs across countries. In Bulgaria, employment losses reflect mainly the contraction of construction. In Slovakia, the manufacturing sector remained cautious in expanding hiring but instead sought to boost output through productivity gains (Figure 37). Figure 35.Employed population in EU10 and EU15 Figure 36. Share of unemployed and inactive in countries, million working age population in EU10 and EU15 EU10 (LHS) EU15 (RHS) 36 46 184 34 45.5 183 32 45 182 30 181 44.5 28 180 44 26 Unemployed 179 43.5 24 Inactive 178 43 177 22 42.5 176 20 42 175 2Q 08 2Q 11 2Q 08 2Q 11 1Q 07 2Q 07 3Q 07 4Q 07 1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 EU10 EU15 Source: Eurostat, World Bank staff calculations Figure 37. Employment and output in 2Q 11 as percent of 2Q 08, seasonally adjusted Employment as a share of 2Q 2008 GDP as a share of 2Q 2008 10 5 0 â€?5 â€?10 â€?15 â€?20 EU15 EU10 LV BG LT EE RO SI HU SK CZ PL Source: Eurostat, World Bank staff calculation 17 The employment performance would have been even weaker without increases in fixed- term contracts and part time work in most EU10 countries. Such types of employment can be important to boost the flexibility of labor markets and allow parents to combine work with family. However, they need to be balanced with concerns of segmenting labor markets into regular and irregular employment. The share of fixed-time employment contracts increased by about one percentage point to almost 11 percent, close to the EU15 level (Figure 38). It increased in all countries over the last three years with the exception of Bulgaria where job losses were concentrated on workers on fixed-term contracts. More than one in five jobs in Poland is on a fixed-term basis. Legislation remains favorable for such employment which enables enterprises to reduce labor costs. The part-time work increased also in the last three years in all EU10 countries except Poland, although it remains to be seen whether this reflects a cyclical or structural change (Figure 39). In Poland, at around seven percent, it remained at only one third of the level in the EU15, where legislative efforts to encourage part-time work are more advanced. Figure 38.Fixed-term employed as percent of total Figure 39. Part-time employed as percent of total employed, percent employed, percent 2Q 08 2Q 11 2Q 08 2Q 11 25 25 20 20 15 15 10 10 5 5 0 0 EU15 EU10 PL SI HU LV CZ SK EE BG LT RO EU15 EU10 BG SK CZ HU PL LT SI LV RO EE Source: Eurostat, World Bank staff calculations Unemployment also stayed high. Two and a half years after growth resumed, unemployment remains stubbornly elevated. It reached 9.6 percent in September 2011, only 0.6 percentage points below the crisis peak (Figure 40). In fact, while unemployment fell somewhat during 2010, it remained more or less flat in 2011, roughly at the same level as in the EU15. In September 2011, some 4.3 million people were out of a job and actively looking for work in the EU10 (Figure 41). Figure 40. Harmonized unemployment rates, Figure 41. Harmonized unemployment rates, percent weighted average, percent Preâ€?crisis Crisis peak Current 11 20 10 15 9 8 EU15 10 7 EU10 6 5 5 Janâ€?08 Sepâ€?08 Novâ€?08 Janâ€?09 Sepâ€?09 Novâ€?09 Janâ€?10 Sepâ€?10 Novâ€?10 Janâ€?11 Sepâ€?11 Mayâ€?08 Mayâ€?09 Mayâ€?10 Mayâ€?11 Marâ€?08 Julâ€?08 Marâ€?09 Julâ€?09 Marâ€?10 Julâ€?10 Marâ€?11 Julâ€?11 0 EU15 EU10 LV LT SK EE BG HU PL SI RO CZ Source: Eurostat, World Bank staff calculations Source: Eurostat, World Bank staff calculations 18 The regional unemployment average masks a fair amount of country variation. Helped by a strong rebound and flexible labor markets, unemployment rates fell noticeably in Estonia, Latvia and Lithuania although it remained in excess of 15 percent in Latvia and Lithuania. By contrast, unemployment stayed high relative to pre-crisis levels in Romania, Bulgaria and Slovenia, as domestic demand remained weak, structural adjustment continued and public sectors employment was under pressure. Despite the strong recovery of manufacturing, Slovakia’s unemployment rate remained high at over 13 percent reflecting weaknesses in skills and labor market policies. Job market conditions remain especially difficult for workers with low education and little work experience as well as long-term unemployed. For example, unemployment rates among 20-24 year-olds was on average 13 percentage points higher than for the 20-64 year-olds in the second quarter of 2011. With headline unemployment having remained high for two years, more unemployed have been looking for work for more than a year. Long-term unemployment as a share of total unemployment reached almost 45 percent in the second half of 2011, up from 43 percent in the first quarter of 2011. It remained in excess of 7 percent of the labor force in Slovakia, Latvia, Estonia and Lithuania, the countries with the highest overall unemployment rate. While this reflected longer-standing structural issues in Slovakia, it was driven by large output reductions during the crisis in Latvia, Estonia and Lithuania. Figure 42.Unemployment rates for 20-24 and Figure 43. Increase in long-term unemployed 20-64 year-olds in 2Q 11, percent vs. change in output 2Q 08 – 2Q 11, percent 40 10 2Q 11 output as percent of 2Q 08 output Unemployment rate 20â€?64 years old PL 35 5 30 SK 0 CZ 25 BG 20 â€?5 HU LV LT SI 15 RO EE EE BG â€?10 LT SK HU 10 PL SI â€?15 LV 5 CZ RO 0 â€?20 0 5 10 15 20 25 30 35 40 â€?15 â€?10 â€?5 0 5 10 15 20 25 30 35 40 Unemployment rate 20â€?24 years old Increase in LTU unemployment Source: Eurostat, World Bank staff calculations Persistent unemployment reflects also a difficult job search process. The number of unemployed per job vacancy in the EU10 declined from 30 in the first quarter of 2010 to 26 in the first quarter of 2011, and 24 in the second quarter of 2011 (Figure 44). However, this compares to a pre-crisis level of only 6. In addition, more businesses complained about labor shortages even though unemployment remained unchanged (Figure 45). This could imply that the job matching process has deteriorated. Indeed, the experience from EU15 countries in the 1980s documents that low job finding rates might boost the duration of unemployment, which in turn can lead to rising mismatches between vacancies and job seekers as the skills of the unemployed are eroded. This in turn would make unemployment more persistent. 19 Figure 44.Unemployed per vacancy ratio Figure 45. Labor shortages and unemployment in EU10, 3Q 08 – 2Q 11 160 9 EU10 8 3Q 08 140 EU15 3Q 08 labor shortage indicator (%) BG 7 2Q 11 120 CZ 6 100 4Q 08 5 EE 80 4 LV 4Q 10 3 1Q 09 60 LT 2 40 RO 1 1Q 10 1Q 10 20 SI 3Q 09 3Q 09 0 0 SK â€?1 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 4 6 8 10 12 unemployment rate (%) Source: Eurostat, World Bank staff calculations Notes: Labor shortage = % of manufacturing firms indicating labor as a factor limiting the production Businesses continue to cater for higher demand through increases in labor productivity, which is delaying job creation. While quarter-on-quarter growth in labor productivity stalled in the EU15 in the second quarter of 2011, it remained positive for the ninth quarter in a row in the EU10. Over the last year, labor productivity increased faster in the EU10 than in the EU15, helping to boost output growth at existing employment levels (Figure 46). Figure 46. Change in real labor productivity per person employed in EU10 and EU15, quarter-to- quarter, seasonally adjusted EU15 EU10 2.0 1.5 1.0 0.5 0.0 â€?0.5 â€?1.0 â€?1.5 â€?2.0 â€?2.5 â€?3.0 1Q 08 2Q 08 3Q 08 4Q 08 1Q 09 2Q 09 3Q 09 4Q 09 1Q 10 2Q 10 3Q 10 4Q 10 1Q 11 2Q 11 Source: Eurostat, World Bank staff calculations Wage pressures remain subdued across the region, strengthening competitiveness. As the increase in compensation per worker lagged behind improvements in labor productivity in the first half of 2011, real unit labor costs trended downwards (Figure 47). This suggests that job markets could improve once domestic and external demand strengthens. However, consumers have become more concerned about unemployment in recent months. As the region enters the winter season, job markets continue to face an uphill battle (Figure 48). 20 Figure 47. Real unit labor cost in EU10 countries in Figure 48. EU10 Consumer unemployment 1H 2011, total economy, annual rate of change, expectations not seasonally adjusted, percent 2 Aprâ€?11 Octâ€?11 70 1 0 60 â€?1 50 â€?2 40 â€?3 30 â€?4 20 â€?5 â€?6 10 â€?7 0 EU15 EU10 LT BG EE RO LV PL SI SK CZ EU15 EU10 BG CZ EE LV LT HU PL RO SI SK â€?10 Source: Eurostat, World Bank staff calculation Source: EC, World Bank staff calculation Notes: Increase in the indicator means increased unemployment expectations. 21 Prospects  Europe’s growth is slowing down in 2012. Against the backdrop of a weaker global outlook, the rebound in the European Union is tapering off. As concerns spread from the periphery to core countries of the euro area, and the growth in global trade and industrial production is slowing, confidence of consumers, entrepreneurs and investors in many EU countries has taken a hit. As a result, private demand is not picking up the slack from public demand, which is tightening with fiscal consolidation, and the pace of the recovery is slowing. Assuming that there is no escalation of the euro area crisis, growth in the EU15 is set to moderate from 1.5 percent in 2011 to 0.5 percent in 2012. Growth in the EU10 will also weaken but remain higher than in the EU15. The deep economic integration of the EU10 with the EU15 means that the slowdown in the EU15 will spread to the EU10. Growth in the EU10 is set to decline from 3.0 percent in 2011 to 2.1 percent in 2012. This compares to government growth projections of 3.1 percent for 2011 and 3.7 percent for 2012 from summer 2011. While growth is slowing and falling short of expectations earlier in the year, it will be higher in the EU10 than in the EU15 (Figure 49). The EU10 will continue to catch up with the EU15, even though growth is slowing in both regions. The difference between EU10 and EU15 growth is set to rise from 0.4 percent in 2010 to 1.5 percent in 2011 and 1.6 percent in 2012. This compares to an average difference of 2.5 percent of GDP from 1993 to 2008 (Figure 50). Figure 49. EU10 growth forecasts Figure 50. Growth in EU10 and EU15, 2005 to 2012 2011 2012 EU15 EU10 8 8 7 6 6 4 5 2 4 0 3 2 â€?2 1 â€?4 0 â€?6 EU15 EU10 BG CZ EE LV LT HU PL RO SI SK 2005 2006 2007 2008 2009 2010 2011 2012 Source: World Bank staff Source: EC Autumn Forecast November 2011, World Bank Note: EU15 countries forecasts are from Autumn Forecasts staff of the EC, November 2011. Growth differences among the EU10 countries are set to diminish. With the 2008/09 crisis, economic performance diverged across the region, as countries with larger macroeconomic imbalances underwent sharper contractions. During 2010 and 2011, countries with strong export linkages and rapidly adjusting macroeconomic imbalances saw a stronger economic rebound than other countries. In 2012, the difference in the growth performance across the EU10 is set to diminish (Figure 51). Growth in Estonia, Lithuania and Latvia, the leader in growth in 2011, is expected to decline in line with weakening export markets. Growth will moderate in the Czech Republic, Poland and Slovakia on the back of slowdown in the EU15. By contrast, growth in Bulgaria is set to remain unchanged. In Slovenia, the laggard in growth in 2011, growth will pick up moderately as the drag from construction is fading. In Romania, a gradual rebound in private demand is projected to boost growth in 2012 in spite of fiscal consolidation and lower export growth. Growth in Hungary is set to be more moderate than elsewhere, held back in addition to external factors by weak credit and continued balance sheet adjustment in the private sector. The slowdown in growth means that it is taking longer than expected for countries to reach pre-crisis output levels. Only in Poland, Slovakia and the Czech Republic, 2012 output is 22 projected to exceed pre-crisis levels (Figure 52). These countries had the lowest macroeconomic imbalances going into the crisis and were well placed to take advantage of the global recovery through trade and production ties with EU15 countries. By contrast, Latvia, which faced the largest contraction in the EU in 2009, could still be more than 15 percentage points below pre-crisis level at end 2012. The gap is estimated to be between 1 and 6 percentage points for the other EU10 countries. Figure 51. Growth rate difference between worst Figure 52. Projected output levels in 2011 and 2012 as and best performer in 2009-2012 percent of the pre-crisis peak output 10 120 113 EE 104 104 SK 99 101 EE, LT 99 96 96 95 5 PL 100 94 94 84 0 80 SI HU RO â€?5 60 110 98 102 102 100 97 96 94 94 91 91 â€?10 40 82 â€?15 20 LV â€?20 0 2009 2010 2011 2012 EU15 EU10 PL SK CZ BG HU RO SI LT EE LV Source: Eurostat, World Bank forecasts from November Source: World Bank staff calculations 2011. The 2008/09 crisis might have lowered growth for years to come. Comparing growth projections from the eve of the crisis to actual developments and current forecasts suggests that the crisis led to both a downward shift and a flattening of the growth trajectory. (Figure 53) Two points are noteworthy. First, the growth moderation is starker for the EU10 than the EU15. The EU10 has been hit harder by the slowdown in inflows of capital and credit, and high growth rate in some EU10 countries in the run-up to the crisis reflected an overheating of the economies. Nevertheless, the growth trajectory in the EU10 remains steeper than in the EU15, as the EU10 has still vast potential to close the productivity gap with the EU15 through capital accumulation, skill development and technology absorption. Second, there are differences within the EU10. The impact is smallest in Poland, the only EU country with continuous growth over the last four years. But even in Poland, growth is unlikely to return to pre-crisis levels. Estonia, Latvia and Lithuania underwent the largest contractions during the crisis, but are rebounding with growth rates similar to those seen prior to the crisis (Annex Figure 1). Bulgaria, the Czech Republic, Hungary, Romania, Slovakia and Slovenia experienced both recession during the crisis and are now facing lower growth trajectories for the coming years. Lower growth translates into slower improvements in living standards and slower convergence, even though EU15 growth prospects have also weakened. 23 Figure 53. Comparison of growth projections from April 2008 and November 2011 – EU10 and EU15 to 2012 April 2008 forecasts November 2011 forecasts 140 140 EU15 EU10 130 130 120 120 110 110 100 100 90 90 80 80 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 Source: IMF WEO April 2008 and EC Autumn Forecasts November 2011, EU10 World Bank staff forecasts for 2011 and 2012. EU10 growth is not only weaker, but also more uncertain. Downside risks to the outlook have increased significantly. With around two-thirds of EU10’s exports going to the EU, and around four-fifths of EU10’s banking assets in foreign ownership, recent European and global tensions make adverse shocks more likely. In particular, a loss of confidence in sovereign debt and in the banking sectors’ asset sheets in the euro area could make investors more risk averse and spread to the EU10 (Box 2). In a severe tail-risk event affecting both the core and periphery of the euro area, the EU10 could face financial distress despite improved capital and liquidity positions of parent banks, subsidiaries, and domestic banks. However, liquidity support from the ECB and national central banks, support schemes from governments, and measures from host supervisors could limit spillovers to EU10 countries, as was the case during the crisis of 2008/09. Nevertheless, in such a scenario, European banking groups could still scale back their exposure to subsidiaries in the region over time, slowing down credit growth. The EU10’s policy challenges entail preparing for such short-term risks and boosting sustainable long-term growth. As discussed in the next sections, this will include supportive monetary policy, bolstering financial sector resilience, strengthening the fiscal framework, and advancing structural reforms. 24 Box 2. EU10 and euro area – contagion channels The principal channels of contagion between the Figure 54. EU10 trade by destination Jan-Sept euro area and the EU10, which includes the euro 2011 area member countries Estonia, Slovakia and 80 Slovenia, are trade and financial flows. Share of imports 70 Share of exports 60 Share of total trade While the EU10 countries make up only around 7.5 50 percent of the EU’s 2010 GDP, the wider euro area constitutes their largest market. For instance, over 40 half of the total trade of the EU10 during the first 30 three quarters of 2011 was with the euro area (EA) 20 (Figure 54). Germany is the most important EU10 10 trading partner. The euro area was also the source 0 of around four-fifths of the FDI flows into the region EA EU15 EU27 in 2009. Source: World Bank staff. The banking sector is another channel of Figure 55. Share of consolidated foreign claims transmission, with almost four-fifths of the assets in 120 the EU10 banking system being foreign-owned, and EU EA overwhelmingly so by euro area banks (Figure 55). 100 The potential financial contagion would likely be 80 transmitted mainly via this foreign-owned component of the EU10 banking system, as direct 60 exposure to stressed euro area sovereign assets by the domestic EU10 banks is negligible. 40 20 0 BG EE CZ HU LV LT PL RO SK SI EU10 Source: World Bank staff. Source: Based on internal World Bank note. Note: Chapter 4 of the October 2011 IMF Regional Economic Outlook for Europe discusses east-west linkages in Europe.   25 Policies  Monetary and Financial Policy  Monetary policy is likely to remain supportive for growth. The ongoing tensions in Europe’s financial markets have tightened financing conditions and undermined confidence, which are likely to dampen the pace of economic growth in the EU10 in late 2011 and beyond. The slowdown of the global economy is likely to moderate international commodity prices. With weak domestic and international demand, inflation rates are expected to go down, in spite of selective increases in indirect taxes and administered prices and exchange rate depreciation for some countries. At the same time, most countries have little room to slow the pace of fiscal consolidation in light of market pressures and large fiscal imbalances. Instead, monetary policy might be better suited to respond to the weaker economic outlook. Central banks might keep on hold further increases in policy rates, or even reduce them, as the economic recovery is losing strength and inflation pressures are receding. The pace and timing of the adjustment depends, among other factors, on the size of the output gap, the pass-through from international commodity prices and exchange rate volatility, and increases in taxes and administrative prices. Since the worsened economic outlook is likely to moderate price, cost and wage pressures going forward, the European Central Bank decreased in early November 2011 the key policy rate by 25 basis points to 1.25 percent (Figure 56). This reversed the increase in the policy rate of 25 basis points in April 2011. In response to the improvement in the short-term inflation outlook, the National Bank of Romania also cut its policy rate in early November 2011 by 25 basis points to 6.00 percent. Bolstering the resilience of Figure 56. Policy rates in selected EU countries and financial markets is also crucial for euro area the recovery. The renewed market 9 CZ HU PL RO EURO turbulence from the euro area 8 periphery, along with concerns 7 about the strength of the recovery 6 in major economies, has also 5 increased tension in EU10 markets. 4 In view of the large foreign 3 ownership of the EU10 banking 2 system, reforms of EU financial 1 markets are central for the EU10 0 region. Important recent steps Sepâ€?10 Sepâ€?11 Marâ€?10 Julâ€?10 Marâ€?11 Julâ€?11 Janâ€?10 Novâ€?10 Janâ€?11 Novâ€?11 Mayâ€?10 Mayâ€?11 included the acceleration of fiscal consolidation in some countries, the agreement of burden-sharing Source: Central Banks, World Bank staff calculation between the private and public sectors on Greek debt in the euro area, the decision to leverage the capacity of the temporary European Financial Stability Facility, the agreement on a coordinated mechanism to recapitalize euro area banks and boost their funding, and the strengthening of the economic and fiscal coordination within the euro area. Building on these measures, priorities going forward include a steadfast implementation of the agreed steps, with follow-up plans for recapitalization and restructuring, strengthening the euro area wide resolution mechanism, and bolstering the resilience and stability of the financial system through macro-prudential regulations, including at the global level. While the EU10 banking system is overall well-positioned to withstand further volatility, it is essential that supervisory authorities and banks assess risks prudently, make appropriate loan loss provisions, and increase capital as required.   26 Fiscal Policy  Shoring up fiscal sustainability remains central for economic stability. With the recovery losing steam four years after the Lehman crisis broke, EU10 governments would like to focus on creating jobs and generating growth. Instead, putting the fiscal house in order remains a key preoccupation of policy makers. Markets pay close attention to fiscal balances as public debt levels increased during the crisis, economic prospects remain uncertain in the coming years and population aging is accelerating in the coming decades. While government bond spreads in the EU bore little relation to public debt prior to the crisis, bond spreads are now rising with higher public debt (Figure 57). Figure 57. 5Y CDS spreads and public debt in the EU countries Pre-crisis, 2008 Latest, Nov. 2011 1000 1000 5Y CDS spreads, average 2008 5Y CDS spreads, Nov 2011 800 800 600 600 400 400 200 200 0 0 0 20 40 60 80 100 0 20 40 60 80 100 Public debt as % of GDP, 2008 Public debt as % of GDP, 2011 Source: Eurostat, EDP notification October 2011, Bloomberg, World Bank staff calculation As markets watch public finances closely, EU10 governments have proceeded with fiscal consolidation in 2011 in spite of weakening growth. Based on the October fiscal notifications, fiscal deficits are expected to go down across the region, reaching 4.0 percent of GDP in 2011, the lowest level in three years. The fiscal deficit reduction of 2.5 percent of GDP is slightly more than envisioned in spring, and somewhat more than what is expected for the EU15 (Figure 58). Fiscal balances improved in all EU10 countries. Only Slovakia is set to exceed the targeted fiscal deficit on the back of the Eurostat requirement to assign outstanding debt of state-owned railway companies and hospitals over 2008-2010 to 2011 (0.9 percent of GDP). Building on the substantial fiscal effort in 2010, Bulgaria is on track to meet its commitment to reduce the fiscal deficit below 3 percent of GDP under the EU’s excessive deficit procedure in 2011. While Hungary is well on track to meet its fiscal deficit target, the expected fiscal surplus relies to a large extent on one-off adjustments. 27 Figure 58. Planned and projected general government fiscal deficits in EU10 and EU15 countries, 2010- 2011 2010 2011 Projected 2011 Planned 2010 2011 Projected 2011 Planned 0 6 â€?1 4 â€?2 â€?4.0 2 â€?4.5 0 â€?3 â€?6.6 â€?6.5 â€?2 â€?4 â€?4.2 â€?4 â€?5 â€?5.0 â€?6 â€?6 â€?8 â€?10 â€?7 SK PL SI LT RO LV CZ BG EE HU EU15 EU10 Source: Eurostat, October 2011 EDP notifications, June 2011 Updates of Stability/Convergence Programs, World Bank staff calculations. Fiscal consolidation along with the rebound in growth has helped to moderate the rise in public debt-to-GDP ratios in 2011. They are set to increase for the fifth year in a row, and somewhat more than was planned in spring. However, the increase in the EU10 is less than in the EU15, and public indebtedness relative to the size of the economies remains far lower in the EU10 than in the EU15. Public debt is set to be some 2 percentage points higher than projected in the June 2011 Convergence Program in Poland, as the depreciation of the zloty over recent months has boosted the local currency value of public debt denominated in foreign currency. Figure 59. Planned and projected general government public debt in EU10 and EU15 countries, 2010-11 2010 2011 Projected 2011 Planned 2010 2011 Projected 2011 Planned 100 100 90 84.5 90 80 80 70 70 60 60 50 47.4 50 40 82.9 85.9 40 30 30 46.7 48.0 20 20 10 10 0 0 HU PL LV SI SK CZ LT RO BG EE EU15 EU10 Source: Eurostat, October 2011 EDP notifications, June 2011 Updates of Stability/Convergence Programs, World Bank staff calculations. Elevated fiscal deficits have not spilled over into public debt service burdens thanks to low interest rates. Across the EU10, payments to holders of government debt remain largely unchanged from the last year, in line with plans. Thanks to strong fiscal credentials, the Czech Republic is set to keep its interest rate burden 0.3 percent of GDP below the projected amount. However, the recurrent volatility in euro area markets is a reminder how quickly doubts over fiscal solvency can trigger a loss of confidence in financial markets and a rise in interest rates. 28 Figure 60. Planned and projected interest payments in EU10 and EU15 countries, 2010-11 2010 2011 Projected 2011 Planned 2010 2011 Projected 2011 Planned 4.5 4.5 4.0 4.0 3.5 3.5 3.0 3.0 2.8 2.5 2.5 2.3 2.0 2.0 1.5 2.9 1.5 2.7 1.0 2.2 2.3 1.0 0.5 0.5 0.0 0.0 HU PL SI LT RO LV SK CZ BG EE EU15 EU10 Source: Eurostat, October 2011 EDP notifications, June 2011 Updates of Stability/Convergence Programs, World Bank staff calculations. Many EU10 countries have executed strong public investment programs in spite of the difficult fiscal situation. This helps to strengthen growth prospects without undermining fiscal balances to the extent that this spending is financed through EU structural funds which are over time budget neutral. Public investment is likely to have increased in 2011 in the EU10 but decrease in the EU15. Along with Latvia and Lithuania, Poland continues to step up public investment ahead of the Euro 2012 championships. In contrast, Estonia, Hungary and the Czech Republic have cut back on investment plans due to tight co-financing and implementation delays. Figure 61. Planned and projected public investment in EU10 and EU15 countries, 2010-11 2010 2011 Projected 2011 Planned 2010 2011 Projected 2011 Planned 7 7 6 6 5.3 5 5 4 4 3 3 2.4 4.9 5.0 2 2 2.6 2.4 1 1 0 0 PL RO LT LV CZ BG SI HU EE SK EU15 EU10 Source: Eurostat, October 2011 EDP notifications, June 2011 Updates of Stability/Convergence Programs, World Bank staff calculations. EU10 governments have tabled draft budgets that envisage further fiscal consolidation in 2012. In light of elevated fiscal deficits and continued market pressures, EU10 countries are moving ahead with fiscal adjustment. Most countries are still finalizing the draft 2012 budget for submission to parliament and aim to ensure that fiscal targets are met in spite of the weaker growth outlook. In many countries, key expenditure measures for bringing about the reduction in fiscal deficits are freezes or reductions in public sector wages and pensions, consolidation of discretionary spending and increases in the flexibility of government expenditures. All EU10 members have proposed freezing, or cutting, public wages, and Bulgaria, Latvia, Lithuania, Romania and Slovenia have taken steps to limit increases in public pension. Efforts on the expenditure side are in some countries complemented with measures to broaden the tax base and strengthen tax administration. Since the crisis has undermined the tax base and weakened tax compliance, such policies are crucial to bolster revenue collection. 29 Table 2. Fiscal measures in 2012 draft budgets   Public  Pensions  New revenue measures  wages    Freeze   Direct  Freeze  VAT  Others  (or cut)  Tax  BG        CZ        EE      HU          LV        LT      PL      RO  *  *    SK      SI      Source: World Bank staff. Note: *In case of Romania, the public sector wage and pensions might be increased in the second half of 2012 if the economic situation improves sufficiently. Fiscal deficits are set to decline noticeably between 2010 and 2012 through a combination of expenditure and revenue adjustments. The pace and the structure of the projected fiscal adjustment vary among the countries. This reflects mainly differences in initial fiscal positions, economy prospects, and market pressures. Countries with larger fiscal deficits are envisioning larger adjustments up to 2012, with Latvia, Slovakia, Romania, Poland and Lithuania envisioning adjustments of 3 percent of GDP or more (Figure 62). The planned fiscal consolidations aim to meet commitments to reduce fiscal deficits to below 3 percent of GDP in 2012 (Latvia Lithuania, Poland and Romania) and 2013 (Czech Republic, Slovakia, Slovenia). However, some countries still have to underpin the envisioned adjustments in fiscal balances through specific measures and prepare additional measures in case the economic outlook worsens further. Until 2012, most EU10 governments target mainly expenditure reductions, often of structural nature (Figure 63). This is justified for two reasons. Coming into the crisis, many countries had poor structural primary fiscal balances. This reflected the lack of progress in public expenditure reforms, generous spending and weak public expenditure controls. In addition, governments are unwinding increases in social expenditures intended to protect vulnerable populations during the crisis. However, such measures have to be balanced with the objective of maintaining effective provision of public services to poor and vulnerable families, also because such reforms are more sustainable. In addition, measures to improve revenue collection are needed, since the crisis led to permanent revenue losses as output declined and weakened tax compliance. Revenue measures can also help to make the fiscal adjustment fairer. 30 Figure 62. Decomposition of fiscal deficit adjustment into revenue and expenditures 2010 vs. 2012, percent of GDP Increase in rev Decrease in exp Deficit reduction 6 5 4 3 2 1 0 â€?1 â€?2 â€?3 â€?4 EC EC EC EC EC EC EC EC EC EC EC EC CP/SP CP/SP CP/SP CP/SP CP/SP CP/SP CP/SP CP/SP CP/SP CP/SP CP/SP CP/SP EU15 EU10 LV SK PL RO LT BG SI HU CZ EE Source: June 2011 Updates of Stability/Convergence Programs, EC Autumn Forecast, November 2011, World Bank staff calculations. Figure 63. Decomposition of fiscal deficit adjustment into cyclical and structural component 2010 vs. 2012, percent of GDP Structural Cyclical Overall 6 4 2 0 â€?2 â€?4 â€?6 EU15 EU10 LV LT PL RO SK HU BG CZ SI EE Source: EC Autumn Forecast, November 2011, World Bank staff calculations. EU10 countries have made further efforts in strengthening fiscal institutions. These measures can enhance the credibility of commitments to reduce debt-to-GDP ratios, and thereby strengthen market confidence in the sustainability of public finances. Medium-term budgetary frameworks, an effective budget process, and independent fiscal agencies that monitor policy design and implementation all make fiscal policy more effective (Table 3). For example, fiscal rules that limit public expenditure increases during an economic upturn could, together with multi-year and performance-based budgeting, contribute to sustainable fiscal finances over the long-term. Many EU10 countries have moved in this direction. For example, Latvia is preparing a new Fiscal Responsibility Law and constitutional amendments to strengthen the medium-term budgetary framework; and Poland is planning to introduce a permanent expenditure rule. Through amending its organic budget law, Bulgaria introduced an expenditure limit of 40 percent of GDP and a deficit limit of 2 percent of GDP effective from 2012 onwards. 31 Table 3. European Council Recommendations on Fiscal Issues, Summer 2011    Fiscal Institutions  Social Security  Other  Bulgaria  *Design FR and MTBF  *Implement PR    Czech Republic    *Implement PR  *Improve efficiency of PI  *Shift from labor to indirect  taxation  Estonia      *Improve efficiency of PE  Hungary  *Implement fiscal    *Adopt permanent fiscal measures  framework    *Broaden remit of FC  Latvia  *Introduce fiscal  *Introduce    responsibility law  comprehensive PR  *Introduce targeted SSN  Lithuania  *Introduce expenditure    *Strengthen tax compliance  ceilings in MTBF  Poland  *Introduce ER in 2013  *Raise retirement age      for uniformed services  *Strengthen coordination  *Increase the effective  across levels of  retirement age  government  *Initiate reform of  farmers’ social security  contributions  Romania      *Reform tax administration  *Improve PFM  Slovenia  *Implement more binding  *Strengthen longâ€?term    MTBF  sustainability of pension  system  Slovakia  *Implement multiâ€?annual  *Strengthen longâ€?term  *Increase environmental and  expenditure ceilings in  sustainability of public  property taxes and increase VAT  2012  pillar of pension system  collection efficiency  *Introduce FC  Notes: CD correction deadline; ER expenditure rule; FC fiscal council; FR fiscal rules; MTBF medium-term budgetary framework; PE public expenditures; PFM public financial management; PI public investment; PR pension reform; SSN social safety net Source: WB staff, Official Journal of the European Union. 32 Structural Policy Boosting competitiveness to bolster growth in a sustainable way makes a real difference in strengthening financial market confidence and fiscal sustainability. It can trigger a virtuous cycle between improving financial and fiscal balances sheets and a flourishing economy. Growth helps private and public sectors to bring debt levels in line with incomes, and to mobilize resources for investments and innovation. In expanding economies, governments have an easier time in lowering fiscal deficits and markets see less risk (Figure 64, Figure 65). Figure 64. CDS spreads vs. GDP growth 2011 Figure 65. Fiscal deficit in 2011 vs. average GDP growth in 2011/12 8 6 Average GDP growth in 2011/12 6 5 4 4 GDP growth in 2011 3 2 2 0 1 â€?2 0 â€?1 â€?4 â€?2 â€?6 â€?3 â€?8 â€?4 0 500 1000 1500 2000 2500 â€?10 â€?5 0 5 5Y CDS spreads in Nov 2011 Fiscal balance in 2011 Source: Bloomberg, EU10 World Bank staff forecasts for 2011 and 2012. Structural reforms are also important to keep convergence to EU living standards on track. GDP is not as good a measure of well being as we would like it to be. However, GDP per capita, adjusted for difference in price levels, is still the most commonly used measure to proxy a country’s living standards. The EU10’s convergence to EU15’s income levels has proceeded during the crisis (Figure 66), although Estonia and Latvia have fallen behind due to the stark recession during the peak of the crisis. The EU10 reduced the gap to the EU15 from 47.6 percent in 2007 to 43.0 percent in 2010. Figure 66. Comparison of GDP per capita 2007 and 2011 adjusted for purchasing power parities – EU10 Countries, EU15 = 100 2007 2011 90 75 78 80 68 70 62 58 57 58 58 60 49 50 40 41 40 30 20 10 0 EU10 BG RO LV LT HU PL EE SK CZ SI Source: Eurostat, World Bank calculations. Revitalizing growth without bringing back the unsustainable pre-crisis domestic demand booms requires removing structural barriers. In response to the Europe 2020 strategy, EU member states submitted this April their National Reform Programs, in which they specified their reform priorities for the next years. In June, the European Council endorsed the country- 33 specific recommendations to boost growth and employment (Table 3). However, all countries face an agenda of enabling workers and entrepreneurs to contribute to and benefits from economic prosperity. Easing the cost of doing business remains central to these efforts (Box 2). 34 Table 4. European Council Recommendations on Structural Reform Agenda, Summer 2011   Human capital development  Governance and public  Energy and transport  Business Environment  Labor market and wage policy  Education and early child  procurement  care  BG  *Ensure longer stay in  *Promote social inclusion of  *Improve governance and  *Liberalize gas and    employment for older workers  vulnerable groups  quality of public  electricity markets  *Increase effectiveness of PES in  *Advance the reform in preâ€? administration  *Introduce incentives for EE  ALMPs  school / school  and higher  *Introduce better control  investment in buildings  *Link skills with labor market  education  of public procurement  needs  *Strengthen link between wage  policies and productivity growth  CZ  *Increase effectiveness of PES in  *Increase availability of  *Implement antiâ€?     ALMPs  early childcare facilities  corruption strategy  *Promote flexible forms of  *Introduce quality  *Adopt Public Servants  employment  evaluation in tertiary  Act  *Increase LM participation  education and link it to  funding  EE  *Increase effectiveness of  *Increase availability of preâ€?   *Increase EE in buildings    ALMPs   school education  and transport  *Reduce tax wedge in budgetary  *Enhance availability of  neutral way  vocational education and LL  programs  HU  *Increase effectiveness of PES in  *Expand preâ€?school and      *Implement regulatory  ALMPs   early child care facilities  reform  *Alleviate the impact of tax  *Lower the administrative  reform on lowâ€?earners  burden for businesses  *Increase LM participation of  *Improve SME access to  women  nonâ€?bank financing  LV  *Increase effectiveness of  *Reform preâ€?school and  *Improve governance and  *Increase EE  *Improve business  ALMPs  higherâ€?education  public admin through    environment    HRM institution  *Privatize stateâ€?owned banks  *Improve public  procurement system  *Remove bottlenecks to  EU funds use  LT  *Promote flexible forms of      *Improve EE in buildings  *Improve business startâ€?up  employment  *Strengthen competition in  conditions and construction  *Reduce disincentives to work  energy sector  permits  embedded in social assistance  *Reform SOEs  programs  PL  *Link education with labor  *Implement LL strategy    *Introduce incentives for EE  *Simplify legal procedures  market needs  *Enhance vocational  investment  involved in enforcing  *Increase LM participation of  education  *Develop crossâ€?border  contracts  women  *Strengthen links between  electricity grid connections  *Revise construction and    science and industry  *Develop plan for railway  zoning legislation  *Expand preâ€?school and  investment  early child care facilities  *Implement rail master  plan  RO  *Streamline wage setting    *Remove bottlenecks to      institutions  EU funds use  *Increase labor supply  incentives  *Reduce undeclared work  SI  *Increase effectiveness of  *Promote LL programs      *Improve business  ALMPs  environment  *Reduce asymmetries between  *Increase access to credit,  permanent and fixed term  improve banks’ balance  contracts  sheets  *Evaluate PES  *Link skills with labor market  needs  SK  *Increase effectiveness of PES in  *Reform general and  *Improve public      ALMPs  vocational education   procurement system  *Reduce tax wedge for lowâ€?paid  *Promote LL programs for  *Increase transparency of  workers  lowâ€?skilled  the judicial system  *Link higher education with  labor market needs  Notes: LL – lifelong learning, PES – public employment service, EE – energy efficiency, HRM – human resources management. Source: WB staff based on European Council Recommendations on National Reform Programs and Convergence/Stability Program Updates, Summer 2011. 35 Box 3. Doing Business 2012 for the EU10 region The World Bank’s Doing Business 2012 report indicates that the EU10 has fallen behind in the ranking over the last year as the pace of reforms slowed compared to other regions. The report assesses regulations affecting domestic firms in 183 economies, and ranks the economies in 10 areas of business regulation, such as starting a business, resolving insolvency, and trading across borders. The study’s methodology expanded this year to include indicators on getting electricity connections. In Doing Business 2012, the EU10 is ranked in 47nd place worldwide, a slippage of two places relative to last year's recalculated ranking, and of four places relative to the old methodology. The EU10 ranks thirteen places behind the EU15. While the EU10 performs better than the EU15 in the areas of registering property, getting credit and starting a business, it has room for improvement in the areas of enforcing contracts, dealing with construction permits, paying taxes and closing a business (Figure 54). Figure 67. Average EU10 and EU15 Rankings in Doing Business 2012 EU10 EU15 120 98 100 92 72 76 80 65 69 71 54 55 54 59 60 47 47 44 50 33 33 38 40 28 23 20 0 Trading Across  Paying Taxes Registering Property Starting a Business Ease of Doing  Getting Credit Resolving Insolvency Construction Permits Protecting investors Enforcing contracts Business  Borders Dealing with  Source: World Bank staff calculations. Estonia, Latvia and Lithuania are the most business friendly countries in the region. They perform better than the EU15 average (Figure 68). Among the EU10 countries, Estonia is the best-performer on trading across borders, and paying taxes, Latvia on getting credit and resolving insolvency, and Lithuania on registering property, enforcing contracts and dealing with construction permits (Figure 69). Figure 68. Ease of Doing Business rank in 2012 Figure 69. Best performers in EU 10 by reform and the change since 2011 area 80 60 EE â€?7 LT 50 70 6 51 â€?3 40 LV 47 â€?2 SI 60 30 LV SI â€?5 LT 32 â€?1 â€?5 20 LT 28 50 EE LV 24 21 10 15 0 3 4 7 40 â€?2 0 72 Registering Property Getting Credit Resolving Insolvency Protecting investors Construction Permits Trading Across Borders Enforcing contracts Paying Taxes Ease of Doing Business  Starting a Business 30 â€?2 62 64 â€?6 59 10 51 Dealing with  47 48 20 37 33 24 27 10 21 0 EU10 EU15 LV EE LT SI SK HU BG PL CZ RO Source: World Bank staff calculations. Source: World Bank staff calculations. The 2012 Doing Business Report shows that the EU10 made 18 reforms which made doing business in the region easier (Table 5). Six countries made resolving insolvency easier for firms; three took steps to facilitate registering property; three smoothed trading across borders; one made accessing credit easier; and two made improvements in credit access. Of these 18 reforms, seven involved increased use of 36 information technology, for example, by allowing for the payment of taxes or the submission of documents online, notably to register property or submit customs forms. Across the region, particularly good progress was made in indicators related to access to credit with most countries increasing the percentage of adults covered by private credit bureaus. Significant progress was also made by some countries in reducing the amount of time required to trade across borders. For example, Bulgaria introduced online submission of customs declaration forms. Table 5. “Easing Doing Businessâ€? and “Burdening Doing Businessâ€? reforms in Doing Business 2012 BG CZ EE HU LV LT PL RO SK SI ï?? ï?? Starting a business ï?? ï?? 1 1 Dealing with construction permits 0 0 Getting electricity ï?? ï?? 1 1 Registering property ï?? (E) ï?? (E) ï?? (E) 3 0 Getting credit ï?? ï?? 1 1 Protecting investors ï?? 1 0 Paying taxes ï?? ï?? ï?? ï?? (E) 2 2 Trading across borders ï?? (E) ï??(E) ï?? (E) 3 0 Enforcing contracts 0 0 Resolving insolvency ï?? ï?? ï?? ï?? ï?? ï?? 6 0 Easing Doing Business reforms 2 2 0 0 4 2 2 2 1 3 19 Burdening Doing Business reforms 0 0 1 2 0 1 0 1 0 0 5 (E) indicates an Electronic (Information Technology) related reform Source: World Bank staff calculations. The rankings of Estonia, Hungary and Romania declined five places or more over the last year.* They introduced measures that made doing business more difficult. Estonia introduced a municipal sales tax in Tallinn and Hungary a sector-specific surtax. However, these are both short-term taxes designed to raise necessary funds in the difficult economic climate and both will be eliminated by 2013. Aside from such temporary fiscal measures, Hungary made accessing credit more difficult by making reducing the amount of information available from private credit bureaus; Romania made starting a business more difficult by requiring a tax clearance certificate for a new company’s headquarters before company registration; and Lithuania made getting electricity more difficult by abolishing the one-stop shop for obtaining technical conditions for utility services. While fiscal consolidation is important for market confidence, EU10 countries need to be cautious about introducing reforms that make doing business more burdensome. It is important to continue structural reforms to progress towards the EU15 standard. In addition, many countries outside the region, including South Korea, Malaysia, and Macedonia, continue making fast progress in easing doing business. Past year’s experience suggests that greater use of information technology can facilitate procedures for firms. Source: World Bank staff, http://www.doingbusiness.org/ *For Dealing with Construction Permits, Estonia’s data point on cost was corrected. Rankings will be adjusted in the next published report. 37 Annex Figure 1. Comparison of growth projections from April 2008 and November 2011 – EU10 countries April 2008 forecasts November 2011 forecasts 140 140 140 Bulgaria Czech Republic Estonia 130 130 130 120 120 120 110 110 110 100 100 100 90 90 90 80 80 80 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 140 140 140 Latvia Hungary Lithuania 130 130 130 120 120 120 110 110 110 100 100 100 90 80 90 90 70 80 80 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 140 140 140 Poland Slovenia Romania 130 130 130 120 120 120 110 110 110 100 100 100 90 90 90 80 80 80 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 2005 2006 2007 2008 2009 2010 2011 2012 140 Slovakia 130 120 110 100 90 80 2005 2006 2007 2008 2009 2010 2011 2012 38 EU10 November 2011 In Focus:  Skills, Not Just Diplomas Introduction1  As EU10 governments are struggling to respond to high unemployment and low labor productivity, there is a renewed urgency in addressing the skills gap. Along with measures to strengthen labor market and structural policies, education policies are central in tackling skills mismatch. This note discusses that better information is vital for government to reform the education system in order to bridge the skills gap. Paradoxically, for a region with relatively high and expanding educational attainment (as measured by the number of years of completed schooling) and relatively high-quality education in the early years of schooling, a shortage of worker skills has emerged as one of the most important constraints to firm expansion in the countries in EU10. A recent regional World Bank publication entitled “Skills, Not Just Diplomasâ€? looks at the 29 countries located in Eastern Europe and Central Asia (ECA) and seeks to answer the questions: Why do ECA firms increasingly complain that they cannot find graduates with the right skills? What can ECA countries do to close the skills gap? A main message of the book is that policy makers cannot design policies to close skills gaps unless they first close an important information gap: across the region, data exist on the number of students who graduate (i.e., how many diplomas are issued), but internationally comparable data on whether graduates of upper secondary and tertiary institutions (from which the bulk of ECA graduates now enter the labor market) have the right skills and competencies for the job market do not exist. To close this gap, more tests to measure students, graduates and adults’ skills and competencies are needed. Moreover, to better understand graduates’ transition (or lack thereof) from their education institution to a job, tracer studies – surveys that survey graduates 1, and 5 years after graduation) are needed. Similarly, better and more detailed firm surveys on what skills firms cannot find are needed: is it technical, cognitive or non-cognitive (or socio-emotional) skills that they cannot find? Only by understanding better what firms demand and what education institutions supply, can policy makers design effective policies to improve the matching. Better information is not only needed by policy makers; firms and students need better information to help them make informed decision and become a stronger force in pushing education and training facilities to improve course and program’s alignment with labor market needs. One of the first large big decisions in the life of a young adult is the decision of what and where to study. Currently, this decision is being made in ECA’s countries without very limited information about likely employment and earnings prospects. This “focus noteâ€? summarizes the messages from Skills, Not Just Diplomas that relate to the darkness that cloud the skills debate, and presents the report recommendations on how to “turn the lights onâ€? in this debate. The skills challenge is real: firms struggle to find skilled workers  The European Bank for Reconstruction and Development (EBRD)–World Bank Business Environment and Enterprise Performance Surveys (BEEPS) show that ECA firms’ perception of skills constraints changed dramatically around 2005. By 2008, skilled labor shortages had become the second most commonly reported constraint to growth in the BEEPS survey across all countries in the region, second only to tax rates (Figure 70). On average, 30 percent of firms considered education and skills to be a major or 1  This Focus Note prepared by Lars Sondergaard is based on the World Bank report “Skills, Not Just Diplomas: Managing Education for Results in Eastern Europe and Central Asiaâ€?. The report can be downloaded in its entirety from http://www.worldbank.org/eca/skills. 39 severe constraint in 2008. The highest proportion of firms reporting constraints were found among the middle-income CIS countries, where upwards of 40 percent of firms were dissatisfied with the availability of skilled workers. A smaller proportion of firms in the Western Balkans reported similar levels of dissatisfaction, with significant variability in the dissatisfaction levels of firms in the EU10 and Turkey (BEEPS dataset 2008). While the recession may have provided something of a respite from these labor shortages, as the economies in the region recover, labor demand will tighten once again and skilled labor shortages will likely be worse than before. Figure 70. Distribution of Firms in ECA Region that Consider Worker Skills a “Majorâ€? or “Very Severeâ€? Constraint, 2008 Source: Authors’ calculations based on BEEPS 2008. Note: LI = Low Income, MI = Middle Income, x = % of firms (in respective countries) that consider education as an obstacle, Figure shows data obtained from the fourth round of the BEEPS carried out in 2008–09, which covered approximately 11,800 enterprises in 29 countries. To understand what skills firms are struggling to find, additional surveys were carried out in a number of countries in the region to probe further. In principle, the fact that firms are increasingly complaining about shortages of skilled works could imply a number of things: first, graduates may not have the necessary technical skills to do the jobs that employers have on offer. This is not solely a matter of educational attainment, that is, of completing a certain level of education. It is also a matter of whether students have the skills needed on the job—the relevant knowledge, the ability to apply that knowledge, and the know-how to complete tasks and solve problems—when they graduate. Second, graduates of education and training systems in the region may lack the necessary behavioral (or “softâ€?) skills needed by employers, such as job attitudes and teamwork skills (see Box 4 for the different types of skills that firms may be seeking). There is widespread evidence from across the ECA region that firms seek graduates who not only have knowledge as well as technical and general skills, but who also have behavioral skills. For instance, recent surveys of employers in Poland (Figure 71) show that firms – both innovative and traditional firms -- value such behavioral skills as highly (in some instances, more highly) as knowledge and routine cognitive skills (e.g., mathematics, computer skills)— important as the latter may be 21. 40 Figure 71. Employers’ Valuation of How important the following type of skills are in prospective workers, Poland, 2008 80 70 % of firms responding 60 50 40 30 20 10 0 Initiative and ability to work  Numeracy Communication Responsibility and reliability Advanced technical/vocational Basic technical/vocational Motivation & commitment Literacy communication technology Planning and organizing Problem solving Teamâ€?work ability Foreign language Customer care Use of information and  independently General and technical skills "Soft skills" Innovative firms Traditional firms Sources: World Bank 2010b. Box 4. Higher-Order Skills for the World of Work in the 21st Century In common-day language, the term “skillsâ€? tends to be associated with skills that involve manual dexterity -- that is skill and grace in physical movements -- and the use of methods, materials, tools and instruments. These are the skills commonly associated with vocational schools and with specific occupations. In Skills, Not Just Diplomas, these skills are referred to as “technical skillsâ€?. However, it is now widely recognized that individuals need a broad set of skills to succeed in life and in the work place. Therefore, in Skills, Not Just Diplomas use the term “skillsâ€? more broadly to talk about three distinct type of skills: (1) “cognitiveâ€?; (2) “non-cognitiveâ€? (or socio-emotional skills); and (3) technical skills. Cognitive skills are skills that involve the use of logical, intuitive and creative thinking. And the skills commonly associated with cognitive skills are skills such as verbal ability, numeracy and problem solving skills. However, evidence is emerging that non-cognitive skills are as important to succeed in life (e.g. see World Bank 2011 for recent evidence from Peru). In common-day language, non-cognitive skills are often called interpersonal, soft, or life-skills and they are closely related to what common-day language might also call “personality traitsâ€?: “self-regulationâ€?, perseverance, decision making skills, team skills, and the ability to set life goals and preserve in their pursuit. At present, standardized tests of secondary school students measure cognitive skills – both basic cognitive skills such as the ability to read as well as some higher-order cognitive skills such as critical thinking and analytical reasoning, but not behavioral skills. Recent research in Peru provides an example of how to incorporate the testing of behavioral skills into regular household surveys (see World Bank 2011b). Source: Authors, based on OECD (1999a) and materials available on the following Web sites: State Secretariat for Economic Affairs of Switzerland (www.seco.admin.ch), Australian National Centre for Vocational Education Research (www.ncver.edu.au), American Society for Training and Development (www.astd.org); all URLs accessed September 2010. 41 What skills is it that education and training institutions are failing to deliver?  From the surveys of firms, it is clear that – from the demand side – there is a perception that skills are not being provided. Turning to the supply side, it is a lot more difficult to pinpoint where, exactly, education and training institutions are failing to deliver them. The main problem – and this is a worldwide problem – is that that educational data tends to focus on quantity—for example, the number of enrolled and graduating students—and not the skills that students acquire (or fail to acquire). Moreover, data exists on the education attainment of the adult population but not on their mastery (or lack thereof) of technical, cognitive and non-cognitive skills. Where international comparative data are available, they focus on the quality of primary or lower secondary education. This focus on inputs and on youngster’s level of skills is particularly problematic because very few young people in the region enter the labor market with only a lower secondary education. As Figure 72 shows, most ECA students complete at least an upper secondary degree. But with no international assessment of the skills and competencies of upper secondary or tertiary graduates, it is impossible to quantify the gap in competencies between recent labor market entrants in, say, Poland and Germany. The data that is available today documents how many students graduate in a particular year, not what they offer employers in terms of competencies. Figure 72. Educational Background of 25–34-year-olds in the ECA Region, 2006 100 6 90 17 25 26 80 40 31 70 60 56 50 61 61 40 30 57 63 20 27 10 14 12 0 3 EU+1 Midâ€?CIS W. Balkans Lowâ€?CIS Turkey Compulsory or less Upper secondary Beyond upper secondary Source: Author’s calculations, based on EBRD-World Bank 2006 Lack of relevant data on students and their individual performance is particularly acute in the vocational sector because of the large variety of vocational schools in the ECA region and the (likely) heterogeneity of their student populations. The tendency of educational data to focus on quantity, rather than quality and relevance, is also acute in adult education and training. At best, current surveys in that sector measure the number of training hours and courses in which individuals participate, or whether a firm offers training. But no international comparative data yet exists to compare the quality or relevance of such training. Similarly, with enrollment in universities booming across the region, the lack of tests to measure the skills that students acquire during their studies is particularly constraining in terms of pinpoint problem areas. At the current juncture, neither students, employers nor policy makers know whether students acquiring skills and knowledge during their years of study. And, no one knows where in the system – e.g. by fields of study, by type of university –students are on a particular steep learning curve compared to other places. In part, such information exists for certain professions where the profession itself has developed “professional examsâ€? to certify that graduates are qualified. In many countries, such professional exam exists for lawyers, for teachers, for medical doctors and for architects. However, in many countries, in many countries the largest growth in enrollment has been in areas for which there are no professional certification exams, e.g. in economics, and business. Moreover, even these “professional examsâ€? have their limitations in terms of the evidence of they generate on skills: they only generate for graduates who decide to take the exam; and they only 42 provide a pass-fail score, not an assessment of the mastery each graduate has vis-à-vis particular desired competencies (e.g. in the form of a score on a scale from 1-100). And, alongside the exam, no socio-economic and other background information about the students are collected, making it impossible for a researcher to parse out whether a graduate’s performance on the exam is due to the value-added of the university, or due to he student’s background characteristics (e.g. parental education background, high school graduation marks etc). Take the following concrete example of how this gap in data on skills limit the ability of key actors in taking informed decisions and improving the quality of the sector: In Romania, there are 41 HE institutions teaching finance: 22 private and 19 state: ï‚· Student’s perspective: which institution does a better job at teaching me the skills I need to succeed? Without such information, the powerful force of students “voting with the feetâ€? is significantly limited. ï‚· Employer’s perspective: which graduates outside of the prestigious institutions (which may already have found jobs) have acquired mastery of skills and competencies that my firm needs? ï‚· Higher education institution’s (teaching finance) perspective: how does my program compare to other programs? Are my students acquiring as solid mastery in the core competencies in this field as other institutions? If so, how do I demonstrate that to prospective students, and potential employers of my graduates? ï‚· Policy maker’s perspective: how does the performance (in terms of quality and relevance of the education provided) compare with other fields? Which institutions are doing a good teaching imparting skills, and which are not? Which institutions need more support/guidance? Turning the lights on  To provide policy makers with the information needed to design better policies, and for students to become a stronger force to vote with their feet, the report recommends the following ways of “turning the lights onâ€?: • Continue participation in international assessments (e.g. TIMSS2 and PISA3) • Expand the use of national assessments of student, placing more emphasis on identifying strengths of weaknesses of the education and training systems as opposed to only testing students (e.g. are there groups of students that systematically fail to acquire the desired level of competencies?). • Introduce graduate tracer studies to track whether graduates find job (see Box 5) • Introduce tests of skills of tertiary students More data, alone, will not result in better policies; information has to be analyzed, dissemination and used for policy making. Countries that have succeeded in getting data on student performance used for policy making – e.g. Singapore, Poland, or Chile provide lessons for others to replicate. Some of these lessons include: • Building (domestic) technical capacity to design and analyze tests. In Singapore, this capacity was gradually build by working closely with Cambridge University researchers who, initially, designed and ran the tests. In Chile, the initial analysis was done on a pilot basis by a local university. Only gradually, was the assessment function moved to an autonomous agency. • Expanding access to data sets to encourage researchers to identify strengths and weaknesses. For instance, the OECD makes the entire PISA dataset publicly available for researchers to download online (http://pisa2009.acer.edu.au/; accessed December 2010). • Changing policies to make data matter, such as making improved student learning outcomes a component of teacher and school evaluations. (If the results of assessments have no impact, whether directly or indirectly, on policies or people’s careers, it is very difficult to mobilize and sustain resources to maintain assessment centers and train people to analyze results.) 2 Trends in International Mathematics and Science Study 3 Program for International Student Assessment (www.pisa.oecd.org) 43 • Actively disseminating results to all levels of the education system to ensure that curriculum design, and teacher training can be influenced by the strengths and weaknesses identified by the test results. Box 5. Are graduates getting a job? Introducing graduate tracer studies in Romania and Hungary With respect to tracer studies, two countries in the region—Hungary and Romania—are making rapid progress. In fact, these studies are becoming a core element of tertiary management in these countries. In Hungary, 2010 marked the first year that results from the new “Graduate Career Tracking Systemâ€? were produced (spanning graduates from 25–30 institutions). This project is the culmination of work that began in 2008 and involved 30 ongoing EU-financed projects. In Romania, data from a graduate survey will be available in 2011. By that time, policy makers will have results from surveys of students who graduated in 2008–09 (i.e., 12 months after they graduated), as well of students who graduated in 2004– 05 (i.e., five years after they graduated). As is the case with Hungary, the development of the tracer study in Romania is being financed by EU Social Funds. Hungary is moving ahead rapidly on tracer surveys for several reasons. In the first place, central policy makers in the country are pressuring tertiary institutions to start collecting such data. The 2005 Higher Education Act of Hungary, for example, makes it mandatory for every university and college to carry out surveys of graduates. The central government has also made tracer studies a part of quality assurance discussions, with the availability of such surveys now (or soon to be) tied to institutions’ accreditation agreements. In addition, the government is using the power of the purse, tying tracer survey data (or their availability) to three-year financing agreements. In the second place, institutions of higher education in Hungary themselves consider tracer data useful for a number of reasons: (1) they want labor market feedback to help them design better programs; (2) the data can be used in marketing; (3) the data is valuable for internal quality assurance; and (4) tracer surveys are one of many engagement tools for strengthening an alumni network. Similarly, several OECD countries provide examples of how data on graduation can be collected and disseminated. Norway has tracked such data since 1972; Italy, since 1998; and the Netherlands, since 1989. In the Netherlands, almost all graduates of higher education institutions are surveyed a year and a half after they graduate. The survey collects comprehensive information on a range of different topics, including information on the school-to-work transition (asking such questions as: How long did it take to find a job? Did it involve unemployment spells?); the type and quality of employment, if any (e.g., sector and educational and skills requirements); and students’ satisfaction with the education that they have completed (Did it provide a solid basis for entering the labor market? Did it develop the relevant skills? Did it achieve the right mix between practical and theoretical knowledge?). Table 1 below shows the types of information that the survey collects. Table 6. Information Collected from Tracer Study of Dutch University Graduates, 2007 Duration  Managerial  of job  Unlimited  or  High  search  Full time  term  professional  utilization  (in  employment  contract  Monthly gross  (% ISCO 1 or  of skills  High job  months) (%) (%) income (euros) 2) (%) satisfaction (%) Mean Mean Mean Mean Median Mean Mean Mean Science and math 0.7 88.4 45.6 2499 2429 83.6 71.0 77.5 Medicine and health 0.7 79.0 41.0 2904 2783 82.6 78.9 81.7 Engineering 1.0 94.4 66.2 2772 2631 87.4 75.2 72.8 Economics 1.0 96.1 71.3 2954 2783 70.3 65.6 70.1 Law 1.2 92.7 57.5 2864 2732 87.8 66.0 70.2 Humanities and arts 1.2 59.1 43.0 2188 2226 66.0 50.4 61.3 Social sciences 1.3 60.6 45.4 2317 2350 72.0 63.9 65.4 Agriculture 1.5 86.7 45.6 2137 2328 84.2 73.2 71.2 Source: Table provided by the Research Centre for Education and the Labor Market (ROA), The Netherlands, 2008, at request of the author. 44 World Bank initiatives to help close the information gaps  Across the globe, policy makers in the field of education are increasingly focusing on whether their systems provide the skills demanded by firms. And, across the world, the message from the World Bank’s analytical work has been the same: to close the skills gap, the information gap has to be narrowed. As a result, the World Bank has developed and launched skills and employer surveys that will be launched in 2012 in more than 17 countries around the world. The firm surveys will be probing what, exactly, firms are looking for in terms of skills needs. And skills surveys measuring both cognitive and non-cognitive skills will be administered to representative samples of the entire populations – not just youngsters. The surveys will be administered during the early part of 2012 with results available later that year. Similarly, to better understand the policies and institutions that support high performing education and training systems, the World Bank has launched an ambitious global initiative called “SABERâ€?: System Assessment Benchmarking for Education Results4. SABER is one of the most ambitious undertaking the World Bank’s education sector have embarked on: across the globe, teams are in the process of developing and piloting “SABERsâ€? in key thematic areas ranging from “assessment systemsâ€?, “teacher policiesâ€?, early child development – and, most closely related to the skills agenda, “workforce developmentâ€?. The aim of SABER is to have frameworks to organize how policies are discussed within each of these thematic areas; to provide tools for diagnosis; to facilitate self-evaluation and comparisons; highlight areas for improvement; identify areas for further research, and inform the policy dialogue. Notes  The countries included in the Europe and Central Asia (ECA) Region include Albania, Armenia, Azerbaijan, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Estonia, Georgia, Hungary, Kazakhstan, Kosovo, Kyrgyz Republic, Latvia, Lithuania, the former Yugoslav Republic of Macedonia, Moldova, Montenegro, Poland, Romania, the Russian Federation, Serbia, the Slovak Republic, Slovenia, Tajikistan, Turkey, Turkmenistan, Ukraine, and Uzbekistan. 4  For more information about SABER, please visit http://www.worldbank.org/education/saber  45