Macroeconomic and financial stability challenges for ascending and candidate countries

SUMMARY

Over the last years, acceding countries (Bulgaria and Romania) and candidate countries (Croatia and Turkey)1 have seen strong economic growth, coupled with disinflation or low inflation2. Domestic demand, fostered partly by rapid credit growth and strong capital inflows, has been the main engine of growth. In addition, given the increasing integration with the euro area and the EU, export performance has been buoyant, but outpaced by even stronger import growth. Recently, however, inflation has picked up or disinflation has slowed down, as the expansion of domestic demand has been accompanied by several negative supply shocks, including a significant rise in energy prices, adjustments in regulated prices, exogenous shocks, such as floods, and increasing wage pressures. Current account deficits have remained high or increased from already high levels. External private debt has grown rapidly, as banks and enterprises have substantially increased their borrowing abroad. Against this background, monetary authorities have tightened monetary conditions. Monetary and exchange rate regimes vary between the countries under review, eliciting different policy responses. Countries with a peg or tightly managed float have mainly relied on tightening prudential measures, raising minimum reserve requirements and introducing limits on credit growth. By contrast, countries with a floating exchange rate regime and inflation targeting have also allowed for nominal exchange rate appreciation and have either raised or curbed the decline in interest rates. Moreover, in all countries, fiscal policy has lent some support to monetary policy in safeguarding macroeconomic stability, as fiscal deficits have either declined or turned into surpluses.download