Overall Developments

This year's assessment of progress made by candidate countries in meeting the Copenhagen economic criteria takes place at a time of rapidly deteriorating global economic conditions. However over 2000, and the first half of 2001, growth in the candidate countries was relatively strong.

The year 2000 showed the best growth performance since the introduction of the Regular Reports. Average real GDP growth for the candidate countries was around 5%, much above the 1999 outcome of zero growth. The average performance of the 10 CEEC countries was 3.6%, considerably higher than the 2.2% achieved in the previous year. Growth resumed the in the Czech Republic, Estonia, Lithuania and Romania, and 8 countries exhibited higher rates of growth. The exceptions were Poland and Slovenia, where growth weakened slightly, although it remained solid at 4% for Poland and 4.6% for Slovenia. On average, the Mediterranean candidate countries outperformed the transition economies with real GDP growth rates of 5% for Cyprus and Malta, and 7.2% for Turkey. By contrast, average real GDP growth for the EU was 3.3%, indicating that catching up, although small, was higher than in the previous years.

In the first half of 2001, with a deteriorating EU economic performance, there has been, on average, a deceleration of GDP growth in the candidate countries. So far, countries that have been on a higher and more stable average growth path are more affected. Countries just returning to more normal output growth after having been in recessions, such as the Czech Republic and Romania, appear to be holding better. Similarly the Baltic states that went through a cyclical diminution of growth in 2000, seem to be withstanding the current slowdown, partly supported by the external demand pull of higher growth in Russia and the NIS. Poland is going through a stronger slowdown, largely the result of a poorly co­ordinated policy­mix combined with the deteriorating external environment and domestic political uncertainty. Turkey's growth performance has turned sharply negative. Two deep financial crises occurred at the end of 2000 and the beginning of 2001, taking their toll on GDP growth, but at the same time leading the government to take much needed reform and corrective measures.

GDP per capita as a percentage of the EU average, and measured in purchasing power standards (PPS), went up to 39% in 2000, against 38% in 1999 for the CEEC­10. For all thirteen candidate countries it stood unchanged at the previous year's level of 35%. The closing of the existing large income gap is a medium to long­term project that requires relatively higher average rates of growth over time. Comparing the situation in 2000 with that prevailing in 1995, 9 candidate countries have made gains over this period, while 3 (Bulgaria, Czech Republic and Romania) have not and Turkey remains essentially at the same level. Estonia, Latvia, Hungary, Poland and Slovenia have made very good gains. The income distribution has tended to become more unequal, particularly in the CEEC­10. This outcome is to be expected, first because under the old regimes the income distribution was rather egalitarian; secondly, because of uneven growth pushing the demand for certain labour skills in some areas and sectors ahead of others. However the rising level of income should benefit many. Inequality is still lower than in the EU.

Despite the relatively healthy overall growth factors in all candidate countries, except Turkey, many imbalances have widened and macroeconomic conditions across countries remain mixed.

The 2001 Regular Reports present two figures for the government balance. One is based on the most commonly used national concept, and the other is calculated according to the European System of Accounts (ESA 95), which was reported by the candidate countries for the first time this year. On average, the ESA 95 general government deficit has deteriorated somewhat from about 3% of GDP to 3.5%. Large one­off increases were recorded in Czech Republic and Slovakia, due mainly to the fiscal cost of cleaning­up a number of banks, which, under ESA 95 rules, has to be taken into account in the general government net balance, the year it is incurred.

A number of countries are experiencing difficulties implementing reforms which are key to medium­term fiscal sustainability. Some non­transparent fiscal practices are returning in Hungary. Poland's municipal reform has not been accompanied by a realistic plan to pay for the costs of municipal services. In some countries the reform of social security is too timid or still at an early stage, such as the Czech Republic, Slovakia and Slovenia.

Overall, inflation rates are on the increase in many candidate countries and the CEEC­10 average, at over 15%, is considerably higher than last year's of around 10%. The main immediate cause of inflation has been the high increases in oil prices. Particularly worrying are cases where the monetary policy framework and the pass­through structural features are largely contributing to inflation inertia. In this sense, there are positive developments in Hungary and Poland, with their new exchange rate and monetary framework while Slovenia is lagging behind. Romania and Turkey have failed, for another year, to bring inflation under control, but have recently adopted stabilisation programmes with the IMF. Slovakia's high inflation is the result of much needed, and delayed, increases in administered prices. Bulgaria's rising inflation, in the context of the currency board arrangement, needs to be closely watched.

Despite the good growth performance, unemployment in the CEEC­10, at 12.5%, has continued to increase from just below 11%, pointing to the still negative impact of structural labour shedding reforms and high productivity growth. Exceptions are Hungary and Slovenia, with declining unemployment. Participation rates are generally stable, but remain low in some cases. Labour market rigidities and skill mismatches are putting a lower limit to unemployment even in high growth economies. Cyprus and Malta can be said to be close to full employment levels.

There has been, for the CEEC­10, an improvement of the current account deficit from 5.6% of GDP to just about 5%, in spite of a deterioration in the terms of trade. The correction has been substantial in Latvia and Lithuania, whose exposure had been too high. Malta had a marked deterioration of its current account deficit with a large one­off component. The recovery has brought about a deterioration of the external balance in the Czech Republic, which needs to stand ready to take corrective measures. In almost all cases, foreign direct investment (FDI) has contributed significantly to finance the external imbalance. The component of FDI, often stemming from privatisation, still seems to dominate total inflows in all candidates. Therefore, the level of external debt remains at past year's levels, except in Turkey. Turkey, due to the sharp depreciation of its currency caused by the financial crisis, is in a more precarious situation as the domestic value of its relatively large external debt has greatly increased. The level of FDI in Turkey remains significantly below its potential.

Candidate counties, with the exception of Cyprus and Malta, are still facing some difficulties in setting­up some elements of the legal and institutional framework needed for the functioning of a market economy, including enforcement of judicial decisions. The extent of the difficulties varies from the severe case of Romania and, to a lesser extent, Bulgaria, to countries where there are no significant barriers to market entry and exit and where the degree of legal certainty is high, like Estonia and Hungary. The main problem remaining is the implementation of bankruptcy laws. Progress in this area is crucial before accession.

Privatisation of manufacturing enterprises is almost completed in many CEEC­10, with the exception of Romania, where the privatisation agenda is still large, and to a lesser extent Bulgaria. Poland still needs to devise viable privatisation and restructuring strategies for some important traditional sectors. Privatisation strategies have moved into sectors such as the utilities, transport and energy and are accompanied by efforts to restructure these sectors. In the financial sector, the bank privatisation agenda is completed in a number of candidates such as Estonia, Hungary, Latvia and the Czech Republic. It has advanced in Lithuania, Romania, Poland and Slovakia and is lagging considerably behind in Slovenia. Concerning the state­owned banks not intended for privatisation, it is important that governments do not interfere with their operating practices and credit policies. For other parts of the financial sector, progress in privatisation is hesitant and uneven across candidates. The completion of land reform with the creation of a functioning land market lingers in many CEEC­10. This is hindering the development of land and housing markets and of construction, with unfavourable implications for the labour markets and financial intermediation.

Financial intermediation is still overall at a low level in the CEEC­10 economies. The sector contributes little to the financing of investment in what should be a growing private sector. Intermediation is particularly low and inefficient in Bulgaria, Romania and Lithuania. In general, further progress is needed before accession, as a proper working of the transmission mechanism for monetary policy would require higher levels of more efficient intermediation. The expansion of the financial sector has been accompanied by improved supervision in the banking sector, but supervision of the other parts needs to improve, not only on regulations but also on the administrative capacity and independence of supervisors.

Cumulative progress on economic integration of candidate countries in the EU has mainly taken place through the two channels of trade and capital flows, essentially foreign direct investment.

As to trade integration, in 2000, candidate countries on the average, sent about 62% of their exports to the EU and 58% of their imports came from the EU. Excluding Turkey, the shares are about 65% for exports and 62% for imports. Each of the CEEC­10 has over the period 1995 to 2000 increased its share of exports to the EU. Also as a group, they have increased their EU market share. Over the past decade, the CEEC­10 region shows the fastest growth in trade with the EU and accounted in 2000 for about 11 percent of total EU trade with third countries up from 6 percent in 1992. In the EU, the effects are greatest in the EU Member States closest to the region. The trade between candidate countries remains comparably low, although it slightly increased for several of the CEEC­10 in 2000 compared to the previous year.

As to financial integration, two thirds of net capital flows in the 1990s originated from the EU Member States. Most net capital inflows to the candidates have been FDI flows. Because of privatisation, nearly half of the FDI flows have been directed to non­tradable sectors such as financial institutions (banks) and public utilities (e.g. telecommunications). Greenfield investments are increasing in some countries, and for instance represent over half of FDI in Bulgaria and dominate in Hungary. In the tradable sector, one fifth of total FDI has occurred in relatively labour­intensive industries such as textiles, clothing, electrical machinery and motor vehicles. In the context of transition and real economic convergence, FDI has, and will continue, to contribute to replace the outdated capital stock and to introduce new technology and management skills.

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