The interesting thing about the Central and Eastern European crisis is how quickly it turned. Even six months ago, economists and city analysts were saying more established markets like Poland and the Czech Republic would sail through the financial crisis largely unscathed.
The thinking being exposure was limited to toxic mortgage securities within the Eastern European banking system and downright recession could be avoided on account of decreasing dependence on exports markets — a type of Eastern European de-coupling. Growth in lending was still being detected, as well.
It’s true that with its twin deficits, Hungary always remained a concern. But the region’s stalwarts would be able to pull the area through the worst.
Now, note the most recent data from the European mortgage federation issued late February and looking at the third quarter of 2008 .
As can be seen, residential lending was still robust in Poland, and even growing back in the third quarter of 2008.
At FT Alphaville we were not entirely convinced everything was as rosy in the region as was being made out. The area did, after all, have a very big exposure to forex fluctuations on account of the practice of borrowing in foreign currencies. And this, indeed, became the outstanding concern when CEE currencies began to drop versus the euro and the Swiss franc in October 2008 — and rightly so.
The panic that time was quickly resolved through renewed government commitments to faster euro adoption. By mid January, this had done little to restore confidence in CEE currencies, which were continuing to weaken as it became increasingly obvious that faster euro-adoption wouldn’t quite be the breeze it was made out to be – Maastricht criteria to be met after all. All of which led us to caution over another potential CEE blow-up.
And then in February came Ambrose Evans Pritchard of the Telegraph with his exceptionally alarmist view on the region suggesting a) Eastern Europe was indeed on the verge of collapse and that b) any blow-up could transcend into a potential collapse of the entire European financial system. Some of his choice sentences included: “If one spark jumps across the eurozone line, we will have global systemic crisis within days. Are the firemen ready?”
That said, Ambrose Evans Pritchard was not wrong. The perils were and remain very real, especially as CEE’s massive exposure to Western banks becomes yet another one of its Achilles heel. The media and analysis snowstorm that followed, however, did compromise the issue by citing some very inconsistent figures regarding CEE exposure.
CEE now has its own issue with that.
Erik Berglof, the EBRD’s chief economist, who was originally quoted in the Ambrose Evans Pritchard piece saying the region would need €400bn to prop up its credit markets, highlights the case in a letter to the FT on Wednesday. He specifically refers to a certain BIS figure of $1,700bn, cited among others by Stephen Jen of Morgan Stanley in Pritchard’s story (our emphasis):
Sir, Your article “Eastern Europe wins €24bn to bolster fragile banking system” (February 28) is badly misleading. It gives false prominence to an analyst comparing the support package (“peanuts”) to a supposed total of $1,700bn “lent by banks to eastern Europe”.
Similar numbers were reported in “EU pledges aid for eastern states” (March 2). The comparison is simply nonsensical. The $1,700bn, which is taken from Bank for International Settlements statistics, represents the total claims of foreign banks and their affiliates on eastern Europe. Western banks own some 80 per cent of the region’s banking sector. The BIS figure therefore simply reports the region’s bank balance sheets. At $18,000bn the equivalent figure for western Europe is more than 10 times higher — should we be concerned?
A much better measure of refinancing need is short-term external debt owed by the region’s banking sectors to foreign creditors. According to central bank data, this is about $200bn for all of central and eastern europe. Excluding Russia and Kazakhstan, which can draw on their own resources, the number shrinks to about $130bn. Of this, more than half is debt owed by subsidiaries to parent banks. As the European leaders emphasised on Sunday, it is crucial that western parent banks continue lending to their affiliates. It is a key purpose of the European Bank for Reconstruction and Development, European Investment Bank and World Bank initiative to collaborate with bank groups in supporting their affiliates. In this light, the package of €24bn, around $31bn, is anything but peanuts.
Berglof was not the only one to dispute the interpretation of the numbers being reported. On February 24th, the Czech National bank issued the following statement (our emphasis):
On 19 February 2009, the Financial Times published an article called “Scare warns of potential quake ahead”, which included tables of data for selected countries. A table called “Foreign banks’ lending to Czech Rep” states that foreign banks’ loans to the Czech Republic totalled USD 192 billion (around CZK 4 trillion) as of 30 September 2008. The CNB regards this table and also the accompanying text as very misleading. According to CNB statistics, which are in line with international standards, the Czech Republic’s debt vis-à-vis foreign banks is USD 38 billion.
The difference between the real situation and the data in the article seems to have been caused by misinterpretation of the source statistics. The source was the Bank for International Settlements (BIS), which consolidates the balance sheets of international banking groups. These balance sheets consist of the balance sheets of local banks owned by such groups in individual countries.
The USD 192 billion in question thus corresponds roughly to the sum of the balance sheets of Czech banks owned by foreign banks as of the given date. As most domestic banks are foreign-owned, this figure in fact represents almost the whole balance sheet of the Czech banking sector. The aggregated balance sheet was CZK 4.1 trillion at the end of 2008 H1, which roughly corresponds to the amount mentioned by the Financial Times. Of course, the volume of loans provided is smaller than the banks’ balance sheet.
According to CNB data, total borrowing of households and corporations from banks was around CZK 1.6 trillion as of the same date, the overwhelming majority of which, however, was borrowed in Czech korunas. Although the borrowers are foreign-owned banks, they operate under the Czech Act on Banks and are supervised by the Czech banking supervisor. Contrary to what the FT article suggests, therefore, not even this substantially lower figure can be interpreted as an indicator of the Czech financial sector’s foreign liabilities. It represents the volume of loans provided by Czech banks to Czech economic agents, mostly denominated in the Czech koruna and financed by deposits in the same currency. Any conclusions regarding exchange rate or other cross-border risks drawn on the basis of this misinterpreted data are completely groundless and misleading.
If that wasn’t enough, Reuters on Wednesday reports Eastern European bank supervisors have now officially expressed concern about “misleading” comments on the risks in their financial sectors.
And it gets slightly more radical and John Le Carré-esque. Poland’s central bank governor, Slawomir Skrzypek while in Washington meeting World Bank chief Robert Zoellick called for governments to deny bailouts to financial institutions speculating in emerging markets, saying he would take the issue to the ECB and the European Commission. And there is a hint of “speculative attack” echoed in the joint statement also issued by Poland, the Czech Republick, Slovakia, Romania and Bulgaria. As Reuters reports:
In a joint statement, supervisory authorities from Poland, the Czech Republic, Slovakia, Romania and Bulgaria said “publicly announced initiatives” highlighting the exposure that banks in western EU members have to central and Eastern Europe were undermining their efforts to uphold stability.
“The published information… are often oversimplified and misleading, and it can have a negative impact on banks that are operating in these countries,” said the statement, published on the Slovak central bank’s website.
“Such self-fulfilling speculation totally disregards fundamental economic developments in the CEE countries and creates misperceptions that could inevitably be detrimental to both the CEE region and Europe as a whole.”
According to Reuters, analysts have been unimpressed by the central banks’ statements, saying they will do little to calm market nerves around the region. Also noted is the lack of Hungary in the list.
Of course, one of the CEE’s other complaints is the rest of world should be treating the countries in the region independently. Poland is not Hungary and Estonia is not the Czech Republic. That is a fair point. However, as Koon Chow, a strategist at Barclays Capital points out to Reuters, markets will not begin to differentiate between the fundamentals of different states until they all agree on a common plan to underpin confidence in the region as a whole.
Therefore it is even more urgent that some sort of plan be decided upon soon, as — irrespective of the $1,700bn BIS figure — and by Berglof’s own admission, there is still more than a $100bn shortfall in short-term external debt owed by the region’s banking sectors to foreign creditors (even after the €24.5bn aid package received last week). Note the chart below reflecting the BIS data in terms of short-term external debt as a percentage of national forex reserves:
What’s more, the EU’s Monetary Affairs Commissioner Joaquin Almunia said on Tuesday he thought the best course of action to restore credit channels in the region would be improve the balance sheets of the western banks that own CEE subsidiaries. While that’s all very, analysts are not convinced banks would necessarily pass on the benefits of capital injections as hoped to the region. A direct bailout package would be preferred.
And while all of the above is deliberated, we draw attention to another potential source of funding that appears to be failing in the region – CEE bonds. In Poland, 5-year bonds are now yielding around 200bp more than the central bank’s official rates writes Bartosz Pawlowski at TD Securities on Wednesday.
As he explains:
The magnitude of the recent move in yields has been similar to the one in October, when yields on the 5yr segment shot up by 150bp before coming off sharply when the MPC started cutting rates.
And specifically:
The finance ministry has recently had problems with selling longer-dated bonds. The last two 5yr bond auctions have not attracted sufficent demand (today the ministry sold merely PLN640m out of 1.0-1.5bn offered at the average yield of 6.05%). In previous years, there were occassional problems with selling debt but they were mostly affecting the 10yr segment of the curve).
Related links:
Eastern Europe gets €24.5bn – FT Alphaville
Another Eastern European meltdown? - FT Alphaville
The EE mortgage – FT Alphaville
The speculative attack that came in from the cold – FT Alphaville
SPECTRE - Wikipedia