world bank eu-8 quarterly economic report october 2004 thomas laursen lead economist world bank...

World Bank EU-8World Bank EU-8Quarterly Economic Quarterly Economic

ReportReportOctober 2004October 2004

Thomas LaursenThomas Laursen

Lead EconomistLead Economist

World BankWorld Bank

October 1October 188, 2004, 2004

The Political Economy The Political Economy BackgroundBackground

Changes in the political landscape continued: Changes in the political landscape continued: • New government in Poland and New government in Poland and the Czech the Czech

RepublicRepublic, new , new Prime Minister in Hungary;Prime Minister in Hungary;• Parliamentary elections in Slovenia Parliamentary elections in Slovenia -- shift from shift from

the incumbent center-left government toward the the incumbent center-left government toward the center-right;center-right;

• IIn Lithuania the ruling coalition lost to the Labor n Lithuania the ruling coalition lost to the Labor Party in the first round of elections; Party in the first round of elections;

Governments Governments busy busy preparing 2005 budgetspreparing 2005 budgets——little little further progress on broader reforms, further progress on broader reforms, with exception with exception ofof Poland, Slovakia and Poland, Slovakia and Czech Republic.Czech Republic.

The Political Economy The Political Economy BackgroundBackgroundLatviaLatvia

Minority government of Indulis Emsis survived Minority government of Indulis Emsis survived confidence vote in Septemberconfidence vote in September

Macroeconomic Policies and Macroeconomic Policies and

DevelopmentsDevelopments Output Output growth growth – – EU-8EU-8

• Output growth remainOutput growth remain robust through robust through the second quarter of 2004 on the the second quarter of 2004 on the back of the ongoing recovery in back of the ongoing recovery in Europe and improved Europe and improved competitiveness.competitiveness.

• ButBut dynamics this year affected by dynamics this year affected by stock-building in relation to EU stock-building in relation to EU accession, accession, some some signs that activity is signs that activity is becoming somewhat less buoyantbecoming somewhat less buoyant.


DevelopmentsDevelopments Output growth Output growth – – LatviaLatvia

• Strong output growth continued;Strong output growth continued;

• RReal GDP growth of 8.2% y/y in H1-eal GDP growth of 8.2% y/y in H1-2004; 2004;

• Growth driven by investment and Growth driven by investment and consumption while net exports consumption while net exports contribute negatively; contribute negatively;

• Construction, wholesale/retail trade, Construction, wholesale/retail trade, and transportation/communication and transportation/communication most dynamic sectors. most dynamic sectors.


DevelopmentsDevelopments InflationInflation – – EU EU 88

• SStabilizetabilizess following the jump in the level related to following the jump in the level related to EU accession. Should ease as the impact of one-off EU accession. Should ease as the impact of one-off factors fades, and tighter monetary conditions feed factors fades, and tighter monetary conditions feed through. through.

• Unemployment high in several countries in the Unemployment high in several countries in the region, wage pressures moderate - rapid closing of region, wage pressures moderate - rapid closing of output gaps, emerging bottlenecks in some labor output gaps, emerging bottlenecks in some labor markets, and risks of further increases in oil and markets, and risks of further increases in oil and other commodity prices suggests that monetary other commodity prices suggests that monetary authorities need to remain vigilant.authorities need to remain vigilant.


DevelopmentsDevelopments InflationInflation – – LatviaLatvia

• Further acceleration of inflation to nearly Further acceleration of inflation to nearly 8% (y/y) in August-September;8% (y/y) in August-September;

• Rapidly rising food prices main contributor Rapidly rising food prices main contributor to inflation;to inflation;

• Surge in inflation may jeopardize plans for Surge in inflation may jeopardize plans for early ERM-2 entry and Euro adoption.early ERM-2 entry and Euro adoption.


DevelopmentsDevelopments External External imbalancesimbalances – EU 8– EU 8

• RRemain worrisome in Hungary, but also emain worrisome in Hungary, but also sizeable in the Baltic countries and the sizeable in the Baltic countries and the Czech Republic although with a higher Czech Republic although with a higher coverage by FDI;coverage by FDI;

• Meanwhile, current account positions Meanwhile, current account positions remain strong in the other EU-8 remain strong in the other EU-8 countries as exports are booming.countries as exports are booming.


DevelopmentsDevelopments External External imbalances–imbalances–LatviaLatvia

• Current account deficit widened Current account deficit widened further to over 17% of GDP in Q2-further to over 17% of GDP in Q2-2004 (11.5% of GDP in H1);2004 (11.5% of GDP in H1);

• Reflects in large part booming Reflects in large part booming imports (some EU accession-imports (some EU accession-related);related);

• Only around one-half covered by Only around one-half covered by FDI.FDI.


DevelopmentsDevelopments Fiscal Fiscal performance performance – – EU 8EU 8

o BBetter than expectedetter than expected,, on the back of strong on the back of strong output and revenue growth; output and revenue growth;

o Hungary stands out negatively;Hungary stands out negatively;

o Budget plans for next year point to some further Budget plans for next year point to some further consolidation where most needed (Poland and to consolidation where most needed (Poland and to a lesser extent Hungary);a lesser extent Hungary);

o LLittle further progress in the Czech and Slovak ittle further progress in the Czech and Slovak RepublicsRepublics, , budgets eased in the Baltic countries; budgets eased in the Baltic countries;

o In view of the cyclical upturn in the region, In view of the cyclical upturn in the region, stronger fiscal consolidation would have been stronger fiscal consolidation would have been warranted.warranted.


DevelopmentsDevelopments Fiscal Fiscal performance performance – – LatviaLatvia

• Budget implementation in 2004 Budget implementation in 2004 better than planned reflecting strong better than planned reflecting strong revenue growth;revenue growth;

• But expenditure pressures growing;But expenditure pressures growing;• Budget 2005 targets deficit of 2% of Budget 2005 targets deficit of 2% of

GDPGDP• Fiscal expansion not conducive to Fiscal expansion not conducive to

reducing macroeconomic imbalances.reducing macroeconomic imbalances.

Special TopicSpecial TopicCorporate Taxation and FDI in Corporate Taxation and FDI in the EU-8the EU-8

• UUnfair “tax competition” nfair “tax competition” concerns concerns in the wake in the wake of sizeable of sizeable CITCIT cuts in the new member states; cuts in the new member states;

• TTax bases largely harmonized with many ax bases largely harmonized with many incentive schemes abandoned in the new incentive schemes abandoned in the new member countries, several old members also member countries, several old members also moved to cut rates, effective tax rates remain moved to cut rates, effective tax rates remain significantly lower in the EU-8 countries;significantly lower in the EU-8 countries;

• ButBut large differences large differences betweenbetween very low rates in very low rates in the Baltic countries and Slovenia and moderate the Baltic countries and Slovenia and moderate rates in the other countries in the region;rates in the other countries in the region;

Special TopicSpecial TopicCorporate Taxation and FDI in Corporate Taxation and FDI in the EU-8 (2)the EU-8 (2)

• LLower effective corporate tax rates attract FDI, ower effective corporate tax rates attract FDI, but but other factors more important—other factors more important—(i.e. (i.e. labor and other labor and other production costs, overall investment climateproduction costs, overall investment climate));;

• MMeanwhile, flow of capital from old to new member eanwhile, flow of capital from old to new member states is a natural part of the income convergence states is a natural part of the income convergence process, including because of low labor mobility process, including because of low labor mobility from new to old member states;from new to old member states;

• EU-8EU-8 countries—in particular those that have countries—in particular those that have already reduced statutory already reduced statutory CITCIT rates to relatively low rates to relatively low levels—may well be better off easing very high levels—may well be better off easing very high taxes on labor than lowering further CIT rates. This taxes on labor than lowering further CIT rates. This should go along with rationalizing social spendingshould go along with rationalizing social spending. .

Special TopicSpecial TopicCorporate Taxation in LatviaCorporate Taxation in Latvia

• Overall tax burden in Latvia among lowest in Overall tax burden in Latvia among lowest in the EU (only Lithuania and Ireland lower);the EU (only Lithuania and Ireland lower);

• Share of CIT revenues in GDP also relatively Share of CIT revenues in GDP also relatively low (about 2% of GDP before latest rate cuts);low (about 2% of GDP before latest rate cuts);

• Nominal CIT rate reduced to 15% in 2004 and Nominal CIT rate reduced to 15% in 2004 and plans for further cut to 12.5% in 2005 plans for further cut to 12.5% in 2005 (compared to average of 31% in EU-15); (compared to average of 31% in EU-15);

• Effective tax rate around 12% in 2003—among Effective tax rate around 12% in 2003—among the lowest in the EU. the lowest in the EU.

• Tax incentives in SEZs.Tax incentives in SEZs.

world bank eu-8 quarterly economic report october 2004 thomas laursen lead economist world bank...

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