1

Outlook for external financing of the public sector

in Southeast Europe

Dubravko MihaljekBank for International Settlements

Presentation at the Bank of Greece – University of Oxford (SEESOX) ConferenceAchieving sustainable growth in Southeast Europe: Macroeconomic policies, structural reforms, socio-political support and a sound financial system

Athens, 11 February 2011

The views expressed in this presentation are those of the author and not necessarily those of the BIS.

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Outline

1. Global portfolio capital flows

­ Advanced economies vs. emerging markets

­ Emerging market regions

­ Central and eastern / Southeast Europe

2. Cross-border financing (bank lending and international bonds)

­ Emerging markets

­ Central and eastern Europe

3. Conclusion

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Global portfolio capital flows

Advanced economies vs. emerging markets

Post-crisis portfolio inflows to EMEs peaked in Q3-Q4:2010

Jan-Feb 2011: shift to advanced economies, EM equity fund outflows strongest since 2008

Concerns: EM equity valuations, EM inflation, developments in Northern Africa

Why advanced economies?

• Mostly US equities – positive growth and earnings surprises in Q4:2010

• But also Australia, Japan, Italy and Spain

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Portfolio flows into advanced and emerging market funds1 In billions of US dollars

United States Other advanced economies2 Emerging market economies3

1 Quarterly sums of weekly data until February 2, 2011. Data cover net portfolio flows (adjusted for exchange rate changes) to dedicated funds for individual countries and to emerging market funds for which country or at least regional decomposition is available.

Source: EPFR.

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Portfolio capital flows (cont’d)

Emerging market regions (data through 2 Feb 2011)

Inflows peaked in October 2010

Sharp slowdown of portfolio inflows to emerging Asia and Latin America in Dec 2010–Jan 2011

Week from 26 Jan to 2 Feb 2011 – strongest outflows from equity funds to Asia in three years

Steady flows into CEE through January, but net outflows in the week from 26 Jan to 2 Feb 2011

Growth and interest rate differentials still likely to favour Asia and Latin America in 2011

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Fund flows into emerging market funds1

In billions of US dollars

Asia Latin America CEE2

1 Sums across economies listed, monthly sums of weekly data until February 2, 2011. Data cover net portfolio flows (adjusted for exchange rate changes) to dedicated funds for individual emerging market countries and to emerging market funds for which country or at least regional decomposition available. 2 Bulgaria, Croatia, Czech Republic, Estonia, Hungary, Kazakhstan, Latvia, Lithuania, Poland, Romania, Russia, Serbia, Slovakia, Slovenia, Turkey, Ukraine.

Source: EPFR.

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Inflation in emerging Asia Contribution to inflation1 Annual inflation rates2

1 Weighted average of China, Chinese Taipei, Hong Kong SAR, India, Indonesia, Korea, Malaysia, the Philippines, Singapore and Thailand based on 2005 GDP and PPP exchange rates; in per cent. For Korea and Malaysia, the latest observation for core prices is November 2010. 2 In per cent. 3 Wholesale prices.

Sources: Bloomberg; CEIC; Datastream; national data.

Rising inflation – one reason why portfolio inflows to Asia are reversing

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Equity prices declining, local currency bond yields rising as a result of higher inflation in emerging Asia

Asset prices in emerging Asia Equity prices1 Local currency bond yields2

1 MSCI total return indices in local currency; January 2009 = 100. 2 Ten-year government bonds; in per cent.

Sources: CEIC, Datastream; national data.

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Portfolio capital flows (cont’d)

Central and eastern Europe – larger economies

Portfolio inflows peaked in Oct 2010

In central Europe, mostly flows into bond funds (especially Poland)

In Russia and Turkey, mostly flows into equity funds

Turkey – similar pattern of capital flows as emerging Asia and Latin America (decoupling from CEE?)

Russia – benefitting from rising oil prices

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Portfolio flows into larger CEE countries1 In billions of US dollars

Czech Republic (lhs) Hungary (lhs) Poland (lhs) Russia (rhs) Turkey (rhs)

1 Monthly sums of weekly data until February 2, 2011. Data cover net portfolio flows (adjusted for exchange rate changes) to dedicated funds for individual emerging market countries and to emerging market funds for which country or at least regional decomposition is available.

Source: EPFR.

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Portfolio capital flows (cont’d)

Southeast Europe

Pattern of inflows differs from other emerging markets, CEE

Much smaller inflows than to other CEE countries

Mostly inflows into bond funds

Some evidence of spillovers from Greece in 2010

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Portfolio flows into emerging market funds1 In billions of US dollars

Bulgaria (lhs) Croatia (lhs) Greece (lhs) Romania (lhs) Serbia (lhs) Turkey (rhs)

1 Monthly sums of weekly data until February 2, 2011. Data cover net portfolio flows (adjusted for exchange rate changes) to dedicated funds for individual emerging market countries and to emerging market funds for which country or at least regional decomposition is available.

Source: EPFR.

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Cross-border banking flows

Resumption of cross-border bank lending to emerging Asia and Latin America in 2010: Q1–Q3 inflows exceeded pre-crisis (full-year) peak from 2007

Bank lending to CEE was the last to recover among EM regions (Q3:2010 vs. Q3:2009 in Asia)

Some slowdown in bank lending to Asia, increase to Latin America and CEE in Q3:2010

Bank lending to CEE unlikely to recover to pre-crisis peaks → Not surprising, inflows before the crisis were not sustainable (26% of gross inflows of private capital to EMEs in 2006, vs. only 11% of EMEs’ GDP)

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Table 1 Cross-border bank lending to emerging market economies1 In billions of US dollars

2009 2010 2007 2008 2009

Q4 Q1 Q2 Q3

Total EMEs 512 111 –153 68 116 93 107

Asia 111 –65 10 46 72 47 46

Hong Kong and Singapore 140 39 –49 32 40 40 19

Latin America 61 15 –21 6 17 15 30

CEE2 200 123 –93 –16 –13 –8 11 1 External loans of BIS reporting banks (on the residence basis) vis-à-vis individual emerging market economies; exchange rate adjusted changes in gross amounts outstanding. Does not include changes in reporting banks’ holdings of emerging market securities. 2 Total of 10 new EU member states from central and eastern Europe, south-eastern Europe (including Turkey), Russia, Ukraine and Kazakhstan.

Source: BIS, locational banking statistics.

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Cross-border financing of CEE economies

Very slow recovery in cross-border bank lending Still no cross-border bank lending to Southeast Europe in

Q3:2010

• Cross-border lending to banks resumed on a larger scale only in Albania, Croatia, FYR Macedonia and Turkey

• …and to the non-bank sector only in Bulgaria and Croatia

(Note: lending to the “non-bank” sector includes the public sector)

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Cross-border lending to CEE during the crisis

Cross border financing of CEE economies1 In billions of US dollars

2008 2009 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10

Central Europe and Baltics2

Cross border loans 56 –23 –16 –3 –3 –2 –6 –1 4

International debt securities3 22 38 4 9 13 12 13 4 5

Southeast Europe4

Cross border loans 51 –16 –9 –2 –5 –1 –3 0 0

International debt securities3 –0 8 2 2 1 3 2 1 3

Memo: Greece

Cross border loans 7 9 5 5 5 –6 8 –0 –11

International debt securities3 44 68 34 32 7 –5 23 33 5 1 External loans of BIS reporting banks vis-à-vis individual countries, exchange rate adjusted changes in gross amounts outstanding in US dollars. 2 Total of Czech Republic, Hungary, Poland, Slovakia, Slovenia, Estonia, Latvia and Lithuania. 3 Net issuance of all issuers (sovereign and corporate), by nationality of issuer. 4 Total of Albania, Bosnia and Herzegovina, Bulgaria, Croatia, FYR of Macedonia, Montenegro, Romania, Serbia and Turkey.

Source: BIS, banking and international financial statistics.

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Change in external loans vis-à-vis the banks in CEE1 Estimated exchange rate adjusted changes, in millions of USD

2007 2008 2009 1Q10 2Q10 3Q10

Central Europe2 39,951 25,554 –18,201 –1,417 3,867 4,844

Baltic Republics3 13,178 7,883 –6,728 –3,449 –747 –1,341

Southeast Europe: 17,088 20,033 –4,780 2,087 3,202 1,583

Bulgaria 2,118 5,208 –858 –622 –504 28

Croatia –890 569 2,391 –348 208 –1,882

Romania 12,671 8,828 –4,868 121 –957 272

Turkey 3,087 4,426 –2,743 2,906 5,376 3,383

Albania 150 –157 50 172 –254 37

Bosnia-Herzegovina 612 419 –265 –88 –232 –110

FYR of Macedonia 31 –53 90 –32 20 40

Serbia –1,165 493 1,509 –25 –420 –191

Montenegro 474 300 –86 3 –35 6

Memo:

Greece 18,939 1,233 7,839 9,139 –4,593 –11,958 1 External loans of BIS reporting banks.

Sources: BIS, locational banking statistics.

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Change in external loans vis-à-vis the non-bank sector in CEE1 Estimated exchange rate adjusted changes, in millions of USD

2007 2008 2009 1Q10 2Q10 3Q10

Central Europe2 16,521 20,786 3,859 –370 –2,969 1,218

Baltic Republics3 3,783 1,587 –2,141 –508 –792 –488

Southeast Europe: 34,780 31,070 –11,579 –4,858 –3,108 –1,484

Bulgaria 1,550 3,562 –350 –276 2 115

Croatia 5,168 4,318 –600 –462 –103 234

Romania 5,676 7,853 –865 –1,397 –756 –376

Turkey 19,457 13,503 –9,376 –2,434 –2,169 –1,198

Albania –23 529 107 19 22 20

Bosnia-Herzegovina 270 249 175 –32 –52 –2

FYR of Macedonia 85 155 8 8 6 6

Serbia 2,408 652 –902 –177 –93 –258

Montenegro 189 249 224 –107 35 –25

Memo:

Greece –4,159 5,538 681 –940 4,119 876 1 External loans of BIS reporting banks.

Sources: BIS, locational banking statistics.

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Cross-border financing of CEE economies (cont’d)

International bond financing more resilient – despite the crisis, many CEE countries placed sovereign bonds in 2009 and 2010

But this came at a price: bond and CDS spreads remain quite high and fairly volatile

FX reserves position of several countries weakened in 2010

But coverage of short-term debt by FX reserves mostly good in SEE

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Bond spreads for selected countries1

Euro EMBI Global I Euro EMBI Global II Government bond spreads2

1 Spreads over benchmark euro area bonds, in basis points. 2 For Greece, 5-year government bond spread. 3 For Albania, 5-year bond; for FYR of Macedonia, 10-year bond.

Sources: Datastream; JPMorgan Chase.

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CDS spreads1

1 Senior five-year CDS mid spread, in euros. Five-day moving averages; in basis points.

Source: Datastream.

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Foreign exchange reserves and measures of adequacy

Foreign exchange reserves

As a percentage of:

Outstanding year-end position, USD bn

GDP Imports Broad money

Ratio of FX reserves to short-term

debt1

2009 2010 Change

in 20102

2009 2010 2009 2010 2009 2010 2009 2010

Bulgaria 16.1 14.4 –1.7 34.2 32.2 72.8 61.6 45.2 42.2 1.4 1.7

Croatia 14.4 13.7 –0.8 21.3 22.8 68.0 68.2 31.8 31.3 0.7 0.8

Romania 39.3 42.3 3.0 24.4 26.7 72.2 69.1 60.6 68.8 1.3 1.5

Turkey 69.2 77.5 7.8 11.3 10.6 49.1 41.8 20.0 19.0 1.3 1.3

Albania 2.2 2.3 0.0 18.2 20.2 49.0 50.9 24.0 24.7 1.8 2.0

Bosnia-Herzegovina 3.2 2.3 –1.0 19.0 14.3 36.6 25.1 30.7 22.4 1.7 1.4

FYR of Macedonia 2.0 1.9 –0.1 20.9 20.0 38.9 36.0 39.1 37.1 3.1 3.6

Serbia 14.7 12.1 –1.9 34.3 31.0 91.9 72.2 80.5 69.5 5.0 7.0 1 Short-term external debt defined as short-term liabilities to BIS reporting banks: consolidated cross-border claims of all BIS reporting banks on countries outside the reporting area with a maturity up to and including one year plus international debt securities outstanding with a maturity of up to one year. 2 From end-2009.

Sources: IMF; national data; BIS.

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Conclusion

Uncertainty about prospects for external financing of public sector in SEE:

Global capital flows no longer favouring emerging markets as in 2010. But still to early to see the trend

Within emerging Europe, SEE not a focus of international investors (except Turkey)

Resumption of cross-border lending very slow International bond issuance more reliable – but costly –

source of public sector external financing FX reserves buffer generally seems adequate