These Factors Most Influenced Spread Changes During the Crisis

The results of the Croatian National Bank’s analysis ‘Cost of Borrowing for Selected EU Countries and Croatia – The Role of Spillover of External Shocks’ highlight the importance that spillover and contagion can have on the cost of external borrowing.

As stated, the analysis shows that in recent years, the dynamics of European spreads have predominantly been caused by the spillover component of external shocks. On average, more than 50 percent of the variance in spreads can be explained by the dynamics of the applied spillover measure.

It is also evident that during the public finance crisis, spreads for all countries rose significantly above the values implied by fundamentals. In other words, the effect of spillover and financial contagion is responsible for most of the changes in spreads during the recent crisis, and Croatia is not an exception in this regard. 

The majority of the variation in domestic spreads is related to the dynamics of external movements.
Although they do not have a dominant influence on the dynamics and levels of spreads, macroeconomic fundamentals affect the borrowing costs of all analyzed countries. The favorable impact of fundamentals has thus reflected on the spreads of a number of old and new EU members, with the most significant impact being for Austria and Germany. The list of countries that recorded the most significant adverse effect of fundamentals on spread changes is led by Ireland, Portugal, and Croatia. An important finding of the analysis is that the importance of fundamentals for the movement of spreads has been increasing in the recent period.

Particular attention was paid to the decomposition of spreads for those Central and Eastern European countries with which Croatia’s risk is often compared, such as Hungary, Romania, and Bulgaria. The spreads of these countries in the short term are determined by the spillover and contagion component, which dominates the decomposition of levels. The absolute contribution of fundamentals to the level of spreads in these countries is generally stagnating or declining. An exception is Croatia, where the absolute share of spreads related to fundamentals has significantly increased, from 80 basis points in mid-2010 to 200 basis points in mid-2012. This emphasizes the fact that implementing fiscal consolidation and reforms that will improve the business environment and enable higher growth is essential for reducing financing costs.

The results of the work, in addition to indicating the relative importance of individual indicators for the cost of borrowing, provide better insight into the differences in the perception of Croatia’s risk and that of EU countries by international investors. Additionally, the breakdown of spreads into domestic and foreign factors helps identify the part of the cost of external borrowing that domestic policies can influence and aids in defining policies that can make financing conditions more favorable.