Ov e rv i ew Stress-Testing Households in Europe and Central Asia The Crisis Hits Home Ov e rv ie w The Crisis Hits Home Stress-Testing Households in Europe and Central Asia Erwin R. Tiongson, Naotaka Sugawara, Victor Sulla, Ashley Taylor, Anna I. Gueorguieva, Victoria Levin, and Kalanidhi Subbarao Washington, D.C. ©2010 The International Bank for Reconstruction and Development / The World Bank 1818 H Street NW Washington DC 20433 Telephone: 202-473-1000 Internet: www.worldbank.org E-mail: feedback@worldbank.org All rights reserved. 1 2 3 4 12 11 10 09 This volume is a product of the staff of the International Bank for Reconstruction and Development / The World Bank. The findings, interpretations, and conclusions expressed in this volume do not necessar- ily reflect the views of the Executive Directors of The World Bank or the governments they represent. The World Bank does not guarantee the accuracy of the data included in this work. 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All other queries on rights and licenses, including subsidiary rights, should be addressed to the Office of the Publisher, The World Bank, 1818 H Street NW, Washington, DC 20433, USA; fax: 202-522-2422; e-mail: pubrights@worldbank.org. ISBN: 978-0-8213-8222-6 e-ISBN: 978-0-8213-8223-3 DOI: 10.1596/978-0-8213-8222-6 Overview 1 Background across public, corporate and financial sectors. Finally, as commodity prices have fallen, com- Over the recovery period following the 1998 modity-exporting countries have suffered. As Russian crisis, some 50 million people moved a result of these shocks, unemployment levels out of poverty in the Europe and Central Asia have been rising across countries in the region (ECA) region. Poverty fell throughout all the while economic activities have collapsed. sub-regions of ECA led by the populous mid- All in all, the crisis threatens the well-being dle-income countries of the Commonwealth of close to 40 million people who are still poor. of Independent States (CIS). They experi- It also threatens the welfare of an additional enced the largest fall in poverty, particularly in 120 million people who are living just above Russia where the share of the poor and vulner- the poverty line and at risk of easily falling into able has fallen rapidly in recent years. Such a poverty as economies contract. massive reduction in poverty was driven by ris- ing incomes everywhere, particularly through rising real wages among the working poor. The global financial crisis, which has led The global crisis threatens the well- to a sharp slowdown in economic activity everywhere, including the emerging markets being of over 160 million people in the in ECA, now risks reversing the substantial region who are poor or are just above gains and improvements in living standards the poverty line. achieved by the region over the last few years. Countries in the region are facing a number of major and interrelated economic shocks. The first is the global slowdown in economic activ- A World Bank team recently sought to ity leading to diminishing export revenues. In understand the consequences of the crisis for addition, remittance inflows to low-income households in the region. The diagram below countries such as Moldova and Tajikistan have is a simplified representation of the analysis of been falling as economic activity has declined the impact of macroeconomic shocks to date in the major host countries. Meanwhile, as on household welfare. Three main transmis- major banks and financial institutions in sion channels are investigated: access to finan- developed economies have been left reeling, cial markets (including the cost of borrowing the crisis has drastically reduced the availabil- and the burden of debt service payments), ity, and increased the cost, of external finance the relative prices of goods and services, and, The Impact of the Crisis on Households: Main Transmission Channels Labor Market Income/Employment Shock Product Market Relative Price Shock Financial Market Credit Market Shock 2 The Crisis Hits Home— Stress-Testing Households in Europe and Central Asia the income and employment of members of a source of income). Government policy can, the household. in fact, either dampen the impact of shocks or worsen them, depending on how such policies are formulated and implemented. Pension pro- vision is also not accounted for. The nature and The crisis is hitting households on magnitude of the effects of the crisis via this multiple fronts. channel depend very much on the structure of a country’s pension system. Credit Market Shocks The focus on these three mechanisms reflects the lessons from analyzing the social The rapid rise in household access to credit—in effects of macroeconomic crises experienced in the new EU member states as well as in some various parts of the world over the last three Western Balkan countries, such as Albania and decades as well as data availability constraints. Serbia, and CIS countries such as Ukraine—has However, the diagram is highly simplified and both brought benefits to households and exposed ignores several important elements. For exam- them to a potential credit market shocks. ple, it overlooks second-round effects of the cri- There is no doubt that the lives of many have sis, the consequences of multiple shocks, and the improved because it has become much easier for distribution of social effects among households. households to borrow. Borrowing allows them Neither does the diagram take into account the to meet their needs, purchase durable goods, role of wealth effects as a transmission channel and invest in housing. It means being able to of the crisis to households, for example, through sustain a stable living standard, in good times changes in the prices of property or the value of and bad times. However, because of the specific equity holdings (directly or in pension funds). characteristics of household loans in the region, The above diagram also does not address the this rise in household indebtedness means that role of government policy and social assistance payment obligations may increase very sharply, (though social assistance may be thought of as as a result of the crisis. First, many households Household Debt in ECA, 2008 In percent of GDP 50 40 30 Percent 20 10 0 Bulgaria Croatia Czech Rep. Estonia Hungary Latvia Lithuania Poland Romania Slovak Rep. Slovenia Belarus Kazakhstan Russian Fed. Ukraine Armenia Turkey New EU member states (incl. Croatia) Middle-income CIS Other Overview 3 The Share of Vulnerable Households Before and After an Unemployment Shock In percent of indebted households 30 25 20 Percent 15 10 5 0 Estonia Hungary Lithuania Before the shock After the shock Latvia Household Loan Delinquency Rates and Unemployment Rate 20 15 Percent 10 5 0 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 2005 2006 2007 2008 2009  hare of household loans overdue by 31–90 days S Share of household loans overdue more than 180 days   Share of household loans overdue by 91–180 days  nemployment rate (seasonally adjusted) U borrowed in foreign currency and are now to interest rates, exchange rates and household exposed to exchange rate depreciations. As the income, may expand the pool of households value of the local currency falls, the payment that are unable to service their debt. The share obligations in local currency terms will rise. of vulnerable households or borrowers at risk Second, many households have loans that have variable interest rates, which means that their interest payment obligations may rise as aver- age interest rates rise. Those who have recently The debt service burden of house- lost their jobs will have an even more difficult holds will rise. Many households time meeting their payment obligations. will risk defaulting on their debt The results of stress tests on household loans recently conducted by the World Bank service obligations. suggest that ongoing macroeconomic shocks, 4 The Crisis Hits Home— Stress-Testing Households in Europe and Central Asia (in percent of all indebted households) will number of countries will have to adjust their grow, depending on the severity of the shock. energy tariffs to cost-recovery levels in the Although the share of indebted households and coming years. households at risk in the ECA region still lag behind those of richer countries, the aggre- gate effects of rising debt service burdens are already being seen in rising household loan The food and fuel crisis may not be delinquency rates. over. In some countries, food and fuel Price Shocks prices will rise as the value of curren- Global food and fuel prices have fallen because cies fall. The poorest consumers will of the slowdown in economic activity world- again be vulnerable. wide, and, as a result, falling global demand for commodities. In addition, increased agri- culture production activity led to a bountiful 2008 harvest and eased global food shortages. The impact on households of a food or However, international commodity price levels fuel price crisis is not straightforward. The have not returned to pre-2007 levels. Specialists experience with the recent food price crisis, have also pointed to longer-term challenges for example, tells us that the net effect of a in global food production that are yet to be rapid food price increase depends on whether addressed. In addition, falling currencies in households are net producers or net consum- some countries are resulting in a new round ers of food, it depends on how much food of price increases, depending on the share of they consume and whether there are cheap imported food and fuel in local consumption substitutes, and it depends on their sources of and the degree of pass-through of exchange rate livelihood and their ability to take advantage changes in domestic prices. Finally, in a num- of profitable opportunities in agriculture. ber of countries such as Belarus, Moldova, and These considerations suggest that, at least Ukraine, the utility reform program remains in principle, the poor are not necessarily the largely incomplete. As a result, for reasons of hardest hit. However, food represents a very economic efficiency or fiscal consolidation, a large share of the poor’s total consumption. Kyrgyz Republic: Poverty and the Food Price Crisis 20 15 Poverty headcount 10 5 0 Net food consumers Net food producers Before the crisis After the crisis Overview 5 In low-income countries of the region, the population who recently moved out of pov- food share of consumption among the poor is erty. This is not surprising given that regional 80 percent. Moreover, in reality, the poor are poverty is shallow, with many individuals sus- the worst hit, as many of the poor in Albania, ceptible to falling into poverty even with mod- Kyrgyz Republic, and Tajikistan, for exam- est falls in average income. Alternatively, one ple, are also observed to be net consumers, could think of them as the recent-poor, with with limited access to agricultural assets fragile links to the labor market, little savings, and inputs. but benefited from recent credit and construc- tion booms. The magnitude of the poverty impact var- ies by sub-regions. The middle-income CIS Poverty will rise. About 11 million more countries, on average, have seen the largest people will be in poverty and over and most significant downward revisions to 23 million more people will find their GDP growth projections. As a result, they are also seeing the largest percentage- themselves just above the poverty point increases in the projected poverty line because of the crisis. headcount. They are followed closely by the low-income CIS. The overall results mask the variety of possible effects within coun- tries, including the concentration of the Employment and Income Shocks poverty impact in selected economic sectors. The poverty impact of the regional recession Country studies recently completed suggest will be enormous. The results of simulations that for economic shocks transmitted mainly suggest that by 2010, there will be 11 mil- through the labor market, poverty will rise lion more people in poverty and over 23 mil- especially among households that have been lion more people just above the international dependent on remittance inflows and those poverty line, relative to pre-crisis projections previously employed in booming construc- for growth and poverty. The growth in pov- tion sectors where economic activity is now erty would represent a fifth of the region’s projected to decline sharply. The Poor and Vulnerable Population, 2007–10 Using the $5-a-day measure of poverty 175 160.0 158.7 153.6 Population (in millions) 148.8 150 145.5 125 130.7 119.3 100 2007 2008 2009 2010 Pre-crisis growth projection Latest growth projection 6 The Crisis Hits Home— Stress-Testing Households in Europe and Central Asia Percent Change in Poverty and Vulnerability, 2010 In percent of the population, most recent versus pre-crisis growth projection Estonia Latvia 3 or lower Hungary Moldova Poland 3 to 6 Croatia Belarus 6 to 9 Bosnia and Herzegovina Russian Federation Romania 9 to 12 Serbia Ukraine 12 to 15 Albania 15 or more Macedonia Bulgaria Turkey Georgia Kazakhstan Armenia Uzbekistan Kyrgyz Republic Azerbaijan Tajikistan Coping with the Crisis jobs are available. Some households draw down their savings or borrow money, in places where The results of the preceding analysis are credit is available. And besides turning to the indicative of how risks and vulnerabilities government for assistance, households suffer- are distributed across countries and, within ing from the impact of an economic shock turn countries, across broad types of households. for help to friends and family. In some cases, In some ways, the simulated effects may be households that have access to private land understated, as they capture only some of the plots use it to supplement their income by sell- first-round effects. The second-round effects ing home-produced goods or to augment their on access to education, health and social ser- own consumption with such home production. vices, in particular, will be significant. Lessons from the region’s own experiences with pre- vious crises suggest that temporary economic shocks have a lasting impact on human devel- The scope for households to engage in opment, as families cut back their education their traditional coping strategies will and health investments in response to a bank- ing or exchange rate crisis. Crises may also be limited. lead to increased social unrest, criminal activ- ity and human trafficking, disrupt communal and ethnic relations, or bring down fragile In the current global crisis, the scope for governments and fledgling democracies. households to engage in their traditional How will households protect themselves? coping strategies may be limited. Because of Households in the region have employed a vari- the global nature of the crisis, and because ety of coping strategies to protect their well- economic shocks are hitting households on being during previous crises. These strategies multiple fronts, these coping strategies may include household members holding secondary no longer be feasible. For the poorest house- jobs to augment income or family members holds, subsistence farming may be a viable migrating to foreign countries where well-paid alternative, though evidence from the recent Overview 7 food price crisis suggests that many of the poorest households do not have agricultural Fiscal policy responses are constrained assets and inputs. For some, transitions into informal sector employment may be possible, by falling revenues throughout the though for many households, earnings from region. Protecting social safety nets— informal sector, which has also been hit hard and expanding some of them, where by the crisis, will likely be insufficient to offset the poverty impact of the crisis. This sufficient resources are available—will means that the policy response to the crisis be an important element in the response will be critical. to the crisis. Appropriate Policy Response housing allowances, and targeted anti-poverty The immediate fiscal policy response is con- programs. Some countries in the region are yet strained by rapidly falling revenues. Substantial to reform a range of categorical benefits left- government deficits are currently projected for over the pre-transition period. the region. Where there are no new sources The region’s social protection systems cur- of financing and where there is little scope to rent vary in size and targeting performance mobilize revenues, many countries will have across countries. However, most countries in to resort to across-the-board cuts in spending. the region have at least one targeted safety Such blunt adjustments will likely substitute net program that can possibly be scaled-up for efforts to improve the efficiency of public in response to the crisis. Expanding such spending. The prioritization of labor-using programs can take place either by increas- investment expenditures—either from coun- ing the value of benefits they provide or by tries’ own budgets or from resources provided expanding their coverage to reach those by donors—could be one option for address- households still currently outside the sys- ing the labor market consequences of the cri- tem. However, in some countries, includ- sis, while accounting for constrained fiscal ing Belarus, Bosnia, Hungary, Kazakhstan, resources. Such investments could include Moldova and Russia, the targeting perfor- rural roads projects or irrigation systems reha- mance of existing programs remains weak. bilitation projects that can create short-term Depending on a country’s initial conditions, employment opportunities while creating the the response to the crisis in terms of social conditions for longer-term growth. Improving assistance may involve expanding some well- the efficiency of public spending may also cre- performing programs, reforming relatively ate some additional fiscal space. less effective interventions or, alternatively, Although social safety nets will be among introducing new programs as appropriate. those items likely to be cut as revenues fall, The experiences of other countries suggest protecting these programs—and possibly that programs such as conditional cash trans- expanding some of them, where some real- fers (CCTs), workfare schemes, and public location of resources are possible—will be an works programs can be effective instruments important element in the response to the crisis. for protecting the vulnerable from immediate Countries in the region operate a combination as well as longer-term (second-round) conse- of safety net programs, typically in the form quences of transitory shocks on nonincome of cash transfers with an emphasis on fam- dimensions of welfare, including human capi- ily allowances, social pensions, heating and tal accumulation. The global financial crisis, which has led to a sharp slowdown in economic activity everywhere, including the emerging markets in Europe and Central Asia, now risks reversing the substan- tial gains and improvements in living standards achieved by the region over the past few years. It threatens the well-being of millions of people in the region who are poor or who are living just above the poverty line and at risk of easily falling into pov- erty as economies contract. This book seeks to understand the key macroeconomic shocks confronted by the region and the impact of such shocks on household welfare, including the effect on household income flows, consumption levels, and liabilities. It draws on a large, cross-country database of recent house- hold surveys and presents regional overviews as well as relevant country examples to illustrate the incidence and distribution of specific vulnerabilities.