POVERTY THE WORLD BANK REDUCTION AND ECONOMIC MANAGEMENT NETWORK (PREM) Economic Premise MAY 2010 · Number 12 54506 The Crisis Hits Home: Stress-Testing Households in Europe and Central Asia Naotaka Sugawara, Victor Sulla, Ashley Taylor, and Erwin R. Tiongson The financial crisis and economic downturn threatens the welfare of more than 160 million people who are poor or are just above the poverty line in the economies of Eastern and Central Europe, the former Soviet Union, and Turkey. This note concerns the findings of recent World Bank analysis (Tiongson et al. 2010)1 that uses precrisis household data and aggregate macroeconomic outcomes in these countries to simulate the impact of the crisis on households--transmitted via credit market shocks, price shocks, and income shocks. The adverse effects are widespread, with both poor and nonpoor households being vulnerable. By 2010, for the region as a whole, it is estimated that some 11 million more people will be in poverty and more than 23 million additional people will find themselves just above the poverty line because of the crisis. Poverty Gains Made over the Last Decade Furthermore, to low-income countries such as Moldova and Are at Risk of Reversal Tajikistan, remittance inflows have fallen. Meanwhile, the crisis drastically reduced the availability, and increased the During the recovery period following the 1998 Russian crisis, cost, of external finance across public, corporate, and finan- some 50 million people moved out of poverty in the economies cial sectors. Finally, as commodity prices fell, commodity- of Eastern and Central Europe, the former Soviet Union, and exporting countries suffered. Turkey (the economies that make up the World Bank's Europe All in all, the crisis threatens the well-being of close to 40 and Central Asia Region).2 Poverty fell throughout all the sub- million people who are still poor. It also threatens the wel- regions of Europe and Central Asia, led by the populous, mid- fare of an additional 120 million people who are living just dle-income countries of the Commonwealth of Independent above the poverty line and are at risk of easily falling into States (CIS). Such a massive reduction in poverty was driven poverty as economies contract. by rising incomes everywhere, particularly through rising real wages among the working poor. The Crisis Is Hitting Households on Multiple The global financial crisis, which has led to a sharp slow- Fronts down in regional economic activity, now risks reversing the substantial gains and improvements achieved in living stan- Three main transmission channels through which macroeco- dards over the last few years. Countries are facing a number nomic shocks reach households are analyzed here: (1) access of major and interrelated economic shocks. The first shock to financial markets (including the cost of borrowing and is the global slowdown leading to lower export revenues. the burden of debt service payments), (2) the relative prices 1 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise of goods and services, and (3) income and employment. The durable goods, and invest in housing. However, because of focus on these mechanisms reflects lessons gleaned from an- the specific characteristics of household loans in the region, alyzing the social effects of crises over the last three decades this rise in indebtedness (figure 1) means that payment ob- as well as data availability constraints. However, this focus ligations can increase very sharply when shocks are realized. does ignore several important elements, such as wealth ef- First, many households borrowed in foreign currency, expos- fects associated with changing values of property and equity ing the local currency value of their payment obligations to holdings (including pensions), the second-round effects of exchange rate depreciations (figure 2). Second, many house- the crisis, and the combined consequences of multiple shocks. The role of government policy and social assistance is also not addressed explicitly in the quantitative analysis. Figure 1. Household Debt, Selected ECA Countries, 2008 Depending on how governments formulate and implement such policies, they may either dampen the impact of shocks 50 or worsen them. end-period percent of GDP 40 The Analytical Approach 30 During the financial crisis, stress tests of the health of finan- cial institutions have become subjects of intense interest to 20 policy makers, politicians, and the public. At the same time, parallel analysis at the household level has received in- 10 creased attention. Using precrisis household data, along with aggregate macroeconomic outcomes (because actual house- 0 hold survey data over the crisis period typically will not be ia ni a d Cz Cro ia h a Es ep un ia La ry Sl m d p an ia ak ia kh s Ar ne Tu nia ey an Fe za aru ec ati Ro olan Re ar H ton ov an tv ve ga rk R st ai e hu n lg available for some time), the household impact of key eco- lo kr m Ka Bel t sia Bu P Li S U us nomic shocks already being felt can be simulated. In turn, R this simulation analysis can feed back into financial sector country health through the effect on household debt distress. Much EU10 plus Croatia middle-income CIS other of the recent work in this area has been stimulated by rising levels of household indebtedness in both developed and de- Sources: European Central Bank, national central banks, International Monetary Fund, and UniCredit. veloping economies.3 Note: ECA = Europe and Central Asia. Building on this literature, Tiongson et al. (2010) analyze household vulnerabilities by examining credit markets, ex- ternal prices (food and fuel), and income shocks during the crisis and by assessing their impact on household welfare. Figure 2. Foreign Currency­Denominated Loans, 2008 The impact on household well-being is quantified as the percent of bank loans to households change in the household debt service burden, the fall in real 100 income, or movements into poverty, as appropriate. The mi- croeconomic simulation in the report draws on a large, cross- 75 country database of household surveys, bringing together for the first time comparable data on household indebtedness for a large group of European and Central Asian countries 50 using the European Union's Survey of Income and Living Conditions and Household Budget Surveys. 25 Many Households Will Risk Defaulting as Debt Service Obligations Rise 0 ac Uk Fed Po nia Ka Bel nia Cz Cro ia h a Es ep un ia ry Sl oma d ak ia Ru k s ia an ey th ia Tu YR Ar ep on ine za aru ec ati R lan ar H ton ov n Li Latv ga rk ss hst R R ,F ua e ed ra lg m n Bu ia The rapid rise in household access to credit--in the new Eu- ropean Union member-states, some Western Balkan coun- M tries (such as Albania and Serbia), and CIS countries (such country as Ukraine)--has both brought benefits to households and EU10 plus Croatia CIS other exposed them to potential credit market shocks. Borrowing enables households to smooth their consumption, purchase Sources: The National Bank of Hungary and other national central banks. 2 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 3. Vulnerable Households/Borrowers at Risk as a Result of price crisis, for example, tells us that the net effect of a rapid Unemployment Shock increase depends on whether households are net producers 30 before the shock or net consumers of food, on how much food they consume percent of indebted after the shock and whether there are cheap substitutes, and on their households 20 sources of livelihood and their ability to take advantage of profitable opportunities in agriculture. These considerations 10 suggest that, at least in principle, poor people are not neces- sarily the hardest hit. However, food represents a very large 0 share of the poor's total consumption. In low-income coun- Estonia Hungary Lithuania tries of the region, the food share of consumption among country the poor is 80 percent. Moreover, in reality, the poor are most greatly affected because many of them (for example, Sources: EU-SILC data and World Bank staff calculations. Note: EU-SILC = European Union's Survey of Income and Living the poor in Albania, the Kyrgyz Republic, and Tajikistan) are Conditions. The simulated shock is an increase of 10 percentage points in also observed to be net consumers, with limited access to unemployment rates. This refers to mortgage debt only. Vulnerable agricultural assets and inputs. households are identified using a 20 percent interest payment threshold. See Tiongson et al. (2010) for more details. Rising Poverty Resulting from Employment and Income Shocks holds have loans that have variable interest rates. In addition, The poverty impact of the regional recession will be enor- those people who recently have lost their jobs will have an mous.4 The results of simulations suggest that, in 2010, there even more difficult time meeting their payment obligations. will be 11 million more people in poverty and an additional The results of the stress tests on household loans suggest 23 million people just above the international poverty line that the adverse effects of the crisis on households are wide- (a total of 34 million more poor and vulnerable people), rel- spread. Both poor and nonpoor households may be affected, ative to precrisis projections for growth and poverty (figure depending on the shock, transmission channel, and house- 4).5 The growth in poverty would represent a fifth of the re- hold characteristics. The share of vulnerable households or gion's population who recently moved out of poverty. This borrowers at risk (among all indebted households) will grow is not surprising, given that regional poverty is shallow, with (see the unemployment shock example illustrated in figure many individuals susceptible to a fall into poverty even with 3). Although the shares of indebted households and house- modest decreases in average income. Alternatively, one could holds at risk in Europe and Central Asia still lag behind those think of these people as the recently poor, with fragile links of richer countries, the aggregate effects of rising debt service to the labor market and little savings, who have benefited burdens are already seen in rising household loan delin- from recent credit and construction booms. quency rates. The magnitude of the estimated poverty impact varies by subregion (figure 5). The middle-income CIS countries, on In Some Countries, Food and Fuel Prices Will Rise as the Value of Currencies Fall, with the Poorest Consumers Vulnerable Again Figure 4. Poor and Vulnerable Populations, 2007­10 175 Global food and fuel prices have fallen from their highs of 160.0 158.7 148.8 153.6 2008, but international commodity prices have not returned population (milllions) 150 to pre-2007 levels. In addition, falling currencies in some 145.5 countries have resulted in a new round of price increases, 125 130.7 depending on the share of imported food and fuel in local 119.3 consumption and on the degree of exchange rate pass- 100 through. Finally, in a number of countries (such as Belarus, 2007 2008 2009 2010 Moldova, and Ukraine), reforms in the utility sector remain year largely incomplete. As a result, for reasons of economic effi- precrisis growth projection crisis growth projection ciency or fiscal consolidation, a number of countries will (April 2008 WEO) (April 2009 WEO) have to adjust their energy tariffs to cost-recovery levels in the coming years. Sources: International Monetary Fund WEO databases and World Bank staff calculations. The impact on households of a food or fuel price crisis is Note: WEO = World Economic Outlook. This figure uses US$5 a day as the not straightforward. The experience with the recent food measure of poverty. 3 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Figure 5. Change in the Population's Poverty and Vulnerability in 2010, Based on Crisis and Precrisis Growth Projections percentage points 3.0 or lower 3.1­6.0 6.1­9.0 9.1­12.0 12.1­15.0 15.1 or more Source: International Monetary Fund WEO databases and World Bank staff calculations. Note: WEO = World Economic Outlook. Rise in the percent of the population in poverty, calculated using April 2009 WEO growth projections for 2010, relative to calculations using precrisis April 2008 projections. average, have seen the largest and most significant down- traditional coping strategies (such as secondary employment ward revisions to their GDP growth projections. As a result, or migration) may be limited. This means that the policy re- they are also seeing the largest percentage-point increases in sponses to the crisis are critical. the projected poverty head count. These countries are fol- In many countries, however, the immediate fiscal policy lowed closely by the low-income CIS countries. The overall response has been constrained by rapidly falling revenues. results mask the variety of possible effects within countries, Many countries have substantial government deficits; and, including the concentration of the poverty impact in se- in the absence of new financing sources or the presence of a lected economic sectors. Recent World Bank country studies limited scope in which to mobilize revenues, they may resort suggest that, for economic shocks transmitted mainly to across-the-board cuts in spending. Such blunt adjust- through the labor market, poverty will rise especially among ments likely will substitute for efforts to improve the effi- households that have been dependent on remittance inflows ciency of public spending. Although social safety nets will and those previously employed in booming construction sec- be among those items likely to be cut as revenues fall, pro- tors where economic activity is now projected to decline tecting these programs--and possibly expanding some of sharply (World Bank 2009a, 2009b, 2009c). them, where some reallocation of resources are possible--is an important element in the response to the crisis. The re- Coping with the Crisis and Policy Response gion's social protection systems currently vary in size and targeting performance, and so the response to the crisis may In some ways, the simulated effects described above may be involve expanding some well-performing programs, reform- understated because they capture only a subset of the first- ing relatively less-effective interventions, or introducing new round effects. Second-round effects on access to education, programs as appropriate. In the context of constrained fiscal health, and social services, in particular, can be significant. resources, prioritizing investment expenditures that use How can households protect themselves? In the current re- labor also could be one option for addressing the labor mar- gional downturn, the scope for households to engage in their ket consequences of the crisis. 4 POVERTY REDUCTION AND ECONOMIC MANAGEMENT (PREM) NETWORK www.worldbank.org/economicpremise Notes References 1. The full report on which this Economic Premise is based Alam, A., M. Murthi, R. Yemtsov, E. Murrugarra, N. Dudwick, E. Hamilton, and E. Tiongson. 2005. Growth, Poverty, and Inequality: Eastern Europe is available through the World Bank's Web site. See Tiongson and the Former Soviet Union. Washington, DC: World Bank. http://go. et al. (2010) in the References section. worldbank.org/12MK6K5P20. 2. Alam et al. (2005) provide analysis of the trends in Chen, S., and M. Ravallion. 2009. "The Impact of the Global Financial Crisis poverty in the region and details many of the household sur- on the World's Poorest." VoxEU.org, April 30. http://www.voxeu.org/in vey data sets used in the current report. dex.php?q=node/3520. Holló, D. 2007. "Household Indebtedness and Financial Stability: Reasons 3. For example, see the analyses of Sweden by Johansson to Be Afraid?" MNB Bulletin November: 23­30. http://english.mnb.hu/ and Persson (2006); of Hungary by Holló (2007); of the Re- Resource.aspx?ResourceID=mnbfile&resourcename=hollo_en. public of Korea by Karasulu (2008); and of Poland by IMF (International Monetary Fund). 2009. World Economic Outlook: Sus- · · Z ochowski and Z ajaczkowski (2007). taining the Recovery. Washington, DC: IMF. http://www.imf.org/exter- 4. See Chen and Ravallion (2009) for an analysis of the nal/pubs/ft/weo/2009/02/pdf/text.pdf. impact of the crisis on global trends in poverty. Johansson, M. W., and M. Persson. 2006. "Swedish Households' Indebted- ness and Ability to Pay: A Household Level Study." Sveriges Riksbank 5. These calculations are based on a comparison of the Economic Review 3: 24­40. poverty simulations for 2010 using the April 2009 Interna- Karasulu, M. 2008. "Stress Testing Household Debt in Korea." Working tional Monetary Fund's World Economic Outlook projections Paper 08/255. International Monetary Fund, Washington, DC. for growth with those using precrisis projections from the Tiongson, E. R., N. Sugawara, V Sulla, A. Taylor, A. I. Gueorguieva, V. Levin, April 2008 World Economic Outlook. and K. Subbarao. 2010. The Crisis Hits Home: Stress-Testing Households in Europe and Central Asia. Washington DC: World Bank. http://go.wo rldbank.org/Q7ZSI042V0. About the Authors World Bank. 2009a. "Armenia: Implications of the Global Economic Crisis for Poverty." Report No. 47770-AM. Human Development Sector Unit, Naotaka Sugawara is a consultant and Victor Sulla is an econ- Europe and Central Asia Region, Washington, DC. omist for the World Bank Europe and Central Asia Region; ------. 2009b. "Bulgaria: Implications of the Global Financial Crisis." Re- Ashley Taylor is an economist for the East Asia and the Pacific port No. 47792-BG. Washington, DC. Region of the World Bank; and Erwin R. Tiongson is a profes- ------. 2009c. "Republic of Tajikistan: Poverty Assessment." Report No. 51341-TJ. Washington, DC. http://imagebank.worldbank.org/servlet/ sor at the Center for Development Management, Asian Institute WDSContentServer/IW3P/IB/2010/01/18/000333038_20100118015 of Management, Manila, Philippines. 430/Rendered/PDF/513410ESW0P112101Official0Use0Only1.pdf. · · Z ochowski, D., and S. Z ajaczkowski. 2007. "The Distribution and Disper - The views expressed are those of the authors, and should not be sion of Debt Burden Ratios among Households in Poland and Its Impli- attributed to the World Bank or any affiliated organization. cations for Financial Stability." IFC Bulletin 26 (July): 62­74. http://www. bis.org/ifc/publ/ifcb26d.pdf. The Economic Premise note series is intended to summarize good practices and key policy findings on topics related to economic policy. It is produced by the Poverty Reduction and Economic Management (PREM) Network Vice-Presidency of the World Bank. The views expressed here are those of the authors and do not necessarily reflect those of the World Bank. The notes are available at www.worldbank.org/economicpremise.