External Balances

Following a stocktaking of the evolution of external balances between the Global Financial Crisis (GFC) and the war in Ukraine in the Central and Eastern European economies (CEEE), highlighting the large improvement in external flow and stock vulnerabilities, the chapter provides an overview of the impact of the external shocks stemming from the war in Ukraine on external balances in the region. First, the negative terms-of-trade shock stemming from surging energy prices led to a large deterioration in the current account balance in most CEE countries. Second, the tightening of external financial conditions was associated with capital outflows. The adjustment to the combined shock differed across CEE countries reflecting several factors, including differences in their monetary policy regime (members of the euro area and others) and policy preferences (degree of exchange rate flexibility in non-euro area countries), as well as their exposure to commodity prices. Going forward, the pre-war current account surpluses are unlikely to return in the medium term as the external position will be affected by population aging and investment needs related to economic convergence and digital and climate transition. Against this backdrop, fiscal and structural policies could help unlock investments, while the impact on the external position could be mitigated through the use of EU funds. Also, in order to maintain resilience to external shocks, it remains important to have adequate external buffers and conduct sound macroeconomic policies, especially for CEE countries that are not members of the euro area.