Deleveraging of banks in the region far less than in the eurozone

Cross-border deleveraging of banks in most CEE countries has remained relatively mild and has been mitigated by a strong influx of portfolio investments and a doubling of inflows from the EU, reveals the second edition of Erste Group’s study ‘Living in a Time of Global Deleveraging’, published today.

However, Erste analysts warn that changes in the structure of foreign capital pose a risk in the event of a global sell-off of securities, and shifts in the distribution from the private to the public sector could jeopardize potential growth.
– During the period from the third quarter of 2011 to the second quarter of 2012, deleveraging of banks in CEE countries (Croatia, Czech Republic, Hungary, Poland, Romania, and Slovakia) amounted to $45 billion or 4 percent of GDP. When placed in the broader context of European banks facing significant regulatory pressure and the largest deleveraging since the Lehman collapse, these levels remain mild and are far from the deleveraging occurring in the eurozone periphery, which amounted to $600 billion or 14.9 percent of GDP – explained Juraj Kotian, head of the Macroeconomic Research Department for the CEE region at Erste Group, who is also the author of the report.
According to the latest data from the Bank for International Settlements, foreign banks reduced their exposure in CEE6 countries by about $8.6 billion in the second quarter of 2012 (or 0.8 percent of their GDP) and by $45 billion from the third quarter of 2011 to the second quarter of 2012 (or 4 percent of their GDP), with Hungary accounting for 40 percent of total outflows from the region. Hungary is an obvious exception in the region, both in terms of the size and reasons for strong deleveraging – which are mainly unusual measures, including early repayment of foreign currency loans that freed up some foreign currency financing.
A review of all capital flows between domestic and foreign entities shows that deleveraging in CEE, at an aggregate level, appears even less striking. In total, during the period 3Q11 – 2Q12, investors withdrew only $1.7 billion or 0.2 percent of GDP from CEE countries, compared to 39.6 percent from Portugal or 26.4 percent from Spain, when obligations to central banks and official government support are taken into account. Foreign investors withdrew only €3 billion from CEE6 countries in 2Q12 (or €1.5 billion when obligations to central banks are considered, or 0.2 percent of GDP). A strong influx of portfolio investments amounting to €4.6 billion (0.5 percent of GDP) offsets more than half of the capital outflows in other investments, which mainly represent flows in the banking sector, but also include changes in the obligations of local central banks and official government support.

– In an international context, the withdrawal of foreign capital from the CEE region (excluding Hungary) has been very mild and will not cause significant pressure on the balance of payments as in the eurozone periphery – emphasizes Kotian. Regarding the last quarter of this year, Erste analysts predict high demand for government bonds from CEE countries to further improve the influx of portfolio investments.

– Government bonds from CEE countries have recorded a strong decline in yields of an additional 50-100bp, as a result of reduced risk of adverse scenarios in the eurozone based on Draghi’s promise to do ‘whatever it takes’, and later facilitated by direct purchases of securities by the ECB and the third iteration of quantitative easing by the Federal Reserve of the United States – they explain at Erste.

They highlight that Polish and Hungarian government securities in local currencies reached their highest values to date in the third quarter of 2012 as non-residents increased their balance by a total of €4 billion in the third quarter. Additionally, the governments of CEE6 countries issued eurobonds worth €6.3 billion in international markets in September and October.
– High-frequency data on government bonds held by non-residents suggest that inflows of portfolio investments will continue to mitigate potential outflows of other capital investments in the third quarter – predicts Kotian.
Erste analysts conclude that deleveraging does not jeopardize the external stability of CEE countries, but shifts in the structure of foreign capital and reallocation from the private to the public sector could pose a risk for future growth.
– However, changes in the structure of foreign capital could represent a potential risk for the CEE region in the future. Increased inflows of portfolio investments could backfire in the event of a global sell-off and become a source of increased volatility, especially in countries with a high level of government bonds held by non-residents (Poland and Hungary). Another problem is that the distribution of foreign capital is changing – less foreign capital is directed to the private sector (through foreign direct investments, loans), but more inflows are directed through the public sector (through government bonds, inflows from the EU), which could undermine potential growth unless capital is effectively utilized in the manufacturing sector – summarizes Juraj Kotian.