Download Speech by Mr. Ivan Iskrov, Governor of the BNB, at the spring

Speech by Mr. Ivan Iskrov, Governor of the BNB, at the spring
meeting of the Bankers’ Association in Bulgaria, Sandanski, 16
May 2008
TURBULENCES ON THE AMERICAN CREDIT MARKET
AND ITS INFLUENCE ON ECONOMIES ACROSS EUROPE
Charachteristics of the Turbulances on the Global Markets (1)
 The tension on the international financial markets, unlike the turbulences and the crises in
1990s (Mexico 1994-95; Asia 1997-98, Russia 1998, Brazil 1999), started namely in a
developed economy (USA) and not in a developing one.
 The problems in the USA are a result from low credit standards, distorted incentives for
banks and borrowers due to the massive credit securitization, historically low interest rates
in the USA, due to the Central bank’s policy and the high level of savings in Asia
economies, and the rich-in-resources countries, which created a strong demand for such
instruments. Last but not least important – weaknesses of the supervisory policy in the USA
(above all weaknesses in the supervision of the so-called “originators ”)
 The disturbances in the USA were partially carried over to Europe and the rest of the
world via the exposures of some banks (mainly investment banks) to American securities
backed by sub-prime mortgages and revaluation of risk premiums for all countries and
instruments.
 Due to the lack of information about commercial banks exposures there is a growing
tendency in retaining liquidity and increasing the three-months interest rates. This lead to
widening of the spread between the overnight and the three-months interest rates as well as
an intensive short term liquidity lending by the main central banks (FED, ECB, Bank of
England, Bank of Canada), including the introduction of new instruments for liquidity
lending.
Interest Rates in the Euro Area
Short Term Interest in Great Britain
Short Term Interest in the USA
Sovereign Risk Premiums
J.P.Morgan Emerging Market Bond Index
Charachteristics of the Turbulances on the Global Markets (2)
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 The initial expectations and speculations were, that turbulences in the USA will affect
very quickly the developing markets, especially those with relatively high deficits on the
Balance of Payments current account. This view was based on the general assumption that
these economies need a strong inflow of capital, in order to cover the deficit on the current
account, and in times of crisis the access to capital would be difficult. The above does not
take into account the fact that these economies (Bulgaria included) have marked a strong
inflow of direct investment, which created the deficit on the current account themselves, i.e.
the relation is contrary to the general view.
 In addition, as by rule, these economies had a stable fiscal position, low public debt,
favourable tax and business environment, growing productivity and relatively inexpensive
labour. In effect the crisis did not stop the capital inflow to the fast-developing economies.
Charachteristics of the Turbulances on the Global Markets (3)
 • The developing economies with stable macroeconomic policy continued to have
access to global financial markets, as the crisis influence manifested itself mainly by
increasing the risk premiums and the price of financing based on the market assumption
that the risk for those economies have grown.
 • The risk premia for the new EU member states, measured by the spreads of their
global bonds (JPMorgan Emerging Market Bond Index), have increased, again under the
influence of the deeply rooted assumption, that countries with high deficit on the current
account are a bigger risk, irrespective of the fact that their public debt is smaller, i.e. the risk
of default is less probable for those economies. This is an irregularity caused by the
automatic application of standard models by the participants on the market, without taking
into consideration the driving factors of large deficits on the Balance of payments of those
economies.
Similar volatility showed the credit default swaps, driven by similar factors and line of
though and analysis. The premiums on them grew quicker, but those instruments are less
liquid and very often the data include only quotations, and not the actual transactions.
Global Growth
(IMF forecast for 2008 and 2009)
Charachteristics of the Turbulances on the Global Markets (4)
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 The second channel which could be considered a possible conduit for the USA pressure
influence onto the developing economies, including the New Member States, is the
international trade influence. The assumption, that the slowdown of the economic growth in
the USA (or the recession) due to the very tightened access to credit, could lead to a
slowdown in economic growth in the euro area and in Asia (mainly China). Historical data
show strong dependence between the growth rates in the USA and in Europe. These
correlations are also factual grounds of the IMF forecasts for a slowdown in the euro area
growth rates.
 It is believed that, since the new EU member states, Bulgaria included, trade mainly
within the euro area, then a potential slowdown in the growth could reduce the demand for
goods from these countries and to influence negatively their export.
In addition, there exist as well the assumption, that a great part of the foreign investment
(including the direct and portfolio investments) in the countries are coming from the euro area
economies, therefore the deterioration of access to credit in the euro area countries will
probably influence the capital inflows in the new member states.
Economic Growth of Bulgaria
Fiscal Position of Bulgaria
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Inflation Rate in Bulgaria
Bulgarian Balance of Payments
Is Bulgarian Economy Influenced by Turbulences? (1)
 2007 was the first year of Bulgaria’s membership in the EU. Citizens, companies and
international investors were very optimistic about the development of the economy.
 By mid-2007 the external environment was quite favourable, and this together with the
optimism of households and companies speeded up investing, employment, wages and the
economic growth, as well as the falling rates of inflation due to the subsiding effect of the
increased indirect taxes in early 2006.
 This beneficial environment considerably accelerated the private sector lending and the
continuing increase in the current account deficit as a result of the massive inflows of
capital.
 From July 2007 the inflation trend changed because of the higher prices of foodstuffs
(determined by global and local factors), energy resources and the fast rise in wages which
kept consumers’ demand at high levels despite the increased consumer prices.
 At the end of July 2007 the BNB Governing Council decided to raise, from the beginning
of September, the minimum required reserves which commercial banks hold with the BNB
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– from 8 to 12 percent. As a result, commercial banks’ reserves with the BNB went up by
BGN 1.8 billion. The purpose of this measure was to withdraw liquidity from the banking
system and thus influence the cost of credit and the growth rate of credit, as well as “store”
liquidity at the BNB.
Sovereign Risk Premiums
JPMorgan Emerging Market Bond Index
Premiums on Credit Default SWAPS
Short-term Interest Rates in Bulgaria and the Euro Area
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Quarterly Interest Rates in Bulgaria and the Euro Area
Short-term Interest Rates in Bulgaria
Is Bulgarian Economy Influenced by Turbulences? (2)
 Bulgaria’s fiscal position was stable, and the wage growth rate in the private sector was
outpacing that in the public sector.
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 In these conditions, at the beginning of August 2007 we saw the first disruptions in
international financial markets.
 The spread on the Bulgarian global bonds, as a measure of the country risk market
assessment, rose from 18 b.p. in mid-2007 to 150 b.p. at the beginning of 2008, and fell
under 90 b.p. in the last few weeks (by the JPMorgan Emerging market Bond Index). The
premiums on Bulgaria’s credit default swap also rose from about 20 b.p. in mid-2007 to
nearly 150 b.p. at the end of the year. This trend carried on into the first three months of
2008 as the CDS premium for Bulgaria reached 200 b.p., and thereafter it fell to 140 b.p. in
early May 2008.
 The turbulences in international markets directly affected short-term interest rates in the
country. The average spread between the overnight rate in Bulgaria and that in the euro area
from January to August 2007 was 1 b.p. (5 b.p. only for August). From September to
December 2007 the spread increased to 48 b.p., and from early 2008 until now to 84 b.p.
 This spread increase was determined by several factors:
Is Bulgarian Economy Influenced by Turbulences? (3)
 To a small extent (up to about 20 b.p.) as a result of the increased minimum reserve
requirements, although the MRR in Bulgaria were higher than those in the euro area even
before September 2007, but there was no premium in the Bulgarian short-term interest
rates.
 Risk premiums increased because of the international financial turbulences and the greater
uncertainty and speculations about its possible effect on the developing economies.
 Some commercial banks refrained from opening long positions in BGN and covered their
purchases in Euro for BGN with spot repurchases. This groundless fear caused, as we
already saw, by the speculative statements about the vulnerability of the countries having
high current account deficits, led to a decrease in the BGN supply and an increase in the
BGN interest rates.
The ECB was massively providing liquidity and this brought the European market interest
rates down even below the reference rate which contributed to widening the spread with the
BGN interest rates.
Interbank Market Volumes
Net Currency Purchases by the BNB
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Is Bulgarian Economy Influenced by Turbulences? (4)
 On the whole, Bulgarian banks kept their trust of each other and the volumes in the
interbank market even rose in early 2008, after a slight decline in the last quarter of 2007 –
due to some uncertainties as well as excess liquidity at the end of 2007 caused by end year
government spending.
 The BNB is still buying the reserve currency (the euro) from commercial banks, and in
2007 these purchases reached a record level of Euro 2.5 billion (8.6% of GDP). This trend
continued in the first four months of the year 2008.
The banks operating in the country still have access to international financial markets. From
August 2007 to March 2008 they increased their loans from abroad by Euro 2.2 billion. The
expectations were that the new financing would be at a much higher cost. The data on the
foreign loans (including the subordinated term debt) registered by commercial banks at the
BNB do not show a large increase in the cost of funding from international markets. The data
is very volatile but what we see as a trend is a very small rise in the cost of external financing.
Access of Commercial Banks to International Markets
Price of Foreign Financing of the Banking System
(Based on data of the Balance of payments)
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Is Bulgarian Economy Influenced by Turbulences? (5)
 The increased uncertainty concerning the access to and the price of foreign financing,
forced banks to enter into more severe competition regarding the local deposits, which have
been growing in a steady rate.
 This lead to an increase in the price of local deposits (denominated both in BGN and in
EUR) to a degree much higher that the price increase of foreign markets financing.
The higher price of the commercial banks resource naturally reflected in the price of
household and business loans – this trend is very explicit in the area of euro-denominated
consumer loans and in the lev-denominated mortgage loans.
Household Deposit Interest Rates
Is Bulgarian Economy Influenced by Turbulences? (6)
 The higher price of loans, combined with the relatively high level of loan to GDP reached
so far, creates conditions for the slow down of private sector credit growth rate. This
development, was recommended by the BNB, and results both from the developments in
the international financial markets and the BNB policy decision to increase the level of
minimum required reserves. There was a slight slow down in the credit growth rate in the
beginning of 2008 (the growth of household loans is also influenced to a small degree by
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portfolio sale, but adjusted for this effect there is a tendency of growth rate to slow down),
and by the end of the year it is expected to be around 40%.
The growth of loan interest rates does not lead to deteriorating of the quality of loan
portfolios. The wage increase has a steady growth rate (around 17.6% in 2007). The profit in
the corporate sector allows a higher interest expense to be made.
Annual Percentage of Expenses on the Newly Granted Household Loans
Credit Growth Rate
Status of the Banking System (1)
 Despite the tension on the international markets, the favourable internal economic
environment provided a good basis for the growth of the banking sector and preserving of
its stability.
 As a consequence of the euro area interest rates increase and the reassessment of the risk
premium over the second half of the year, as well as of the increase of minimum required
reserves from the beginning of September the price of the commercial banks resource has
gone up slightly (from the average of 2.6% in 2006 to 2.9% in 2007, and 3.4% in the first
quarter of 2008).
 The banking system profit continue growing as a result of the increased volume of loans,
the growth of yield on the rest of interest bearing assets, and to a very small extent due to
the slight increase of loan interest rates.
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 In 2007 the return on assets (ROA) grew to 2.37% (2.15% in 2006), and the return on
equity (ROE) remained at a level close to the one it had over the past year – 23.9% in
2007,( 23.7% in 2006).
 The quality of portfolios remain unchanged, and the percentage of the standard loans even
grew from 93.9% at the end of 2006 to 95.4% as at 2007.
Status of the Banking System (2)
 The fast loan portfolio growth over the year was compensated partially by the increase of
bank capital, which lead to maintaining a good capital adequacy of the system - 13.9% as at
2007, from 14.5% at the end of 2006.
 These trends continued into the first quarter of 2008.
 The Bulgarian banking system is dominated by European banks, which had no direct
exposures and suffered no losses from the turmoil in the USA mortgage market. Therefore
they continued providing liquidity to their Bulgarian subsidiaries and branches. Bulgarian
banks have no direct exposures of securities backed by sub-prime mortgage loans.
Furthermore, the lending practices in the country are substantially different than the ones
common for the USA over the past few years, and which are in the heart of current
American problems. Bulgarian banks follow the classical model of banking, maintaining
high credit standards, irrespective of the strong competition. Banks operating in Bulgaria,
with domestic and foreign shareholders, are healthy, and have an adequate level of liquidity,
capital adequacy and profits.
Status of the Banking System
2006
2007
Banking system assets, million
42201
59094
BGN
Banking system assets growth, %
28.3
40.0
Banking system profit, million
786
1151
BGN
Banking system profit growth, %
37.2
46.4
Classified loans, %
6.08
4.56
Non-serviced loans, %
2.19
2.14
Capital adequacy, %
14.5
13.9
Return on assets (ROA), %
2.15
2.37
Return on equity (ROE), %
23.7
23.9
Liquidity, %
33.5
28.0
Q1/2008
59491
33.6
359
50.2
4.81
2.13
14.5
2.47
24.3
24.0
Economic Growth
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Expectations about the Development of the Bulgarian Economy (1)
 Current developments do not justify any presumptions that the instability in the global
financial markets will have a tangible negative effect on the Bulgarian economy. Data for
the first four months of 2008 show no signs of any negative developments in the country’s
economy. As already mentioned, a process of risk reassessment is underway with a
consequent upward trend in interest rates. This is a process of very gradual adaptation as
part of the overall mechanism of operation of the currency board.
 This is the tenth month from the start of the turbulences in the international markets. This
has been a sufficiently long period during which the Bulgarian economy demonstrated it
was built on sound fundaments and there should be no doubts as to the adequacy of the
country’s macroeconomic framework and policy.
 Naturally, there will always be institutions voicing negative or more conservative
forecasts – the IMF among them. We believe some of these projections are unjustifiably
pessimistic – a view already expressed by Mr. Bernanke and Mr. Trichet.
Expectations about the Development of the Bulgarian Economy (2)
 The BNB has positive expectations for the economic developments in the current and the
next year. We can already see some developments that confirm our view:
 The country’s fiscal position is stable and the tax revenues in the first quarter of the year
are steady, as evidence that economic activity keeps growing at sustainable rates.
 Data to March show indications of stabilization and slight improvement of the BoP
current account. The country’s exports have been growing at high rates, with decelerating
growth rates of imports. Capital inflows, including FDIs remain strong.
Inflation rate monthly data already show signs of abating inflationary impulses, which
allows us to expect that inflation will decline to the range of six – seven percent by the year
end.
Conclusions (1)
 We evidence the first signs of remission of the financial market turmoil in the US, but it is
still early to make any definitive conclusions.
 The Bulgarian economy demonstrated its resilience to the externalities of financial market
developments and the commodity and food market dynamics. The macroeconomic
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framework – based on the fixed exchange rate of the lev to the euro within the currency
board arrangement, prudent fiscal policy and the structural reforms – proved its
sustainability and ability to ensure macroeconomic stability and growth.
 The currency board and the fixed exchange rate of the lev to the euro at the existing parity
(BGN 1.95583 to EUR 1) will underlie the macroeconomic policy to be pursued by the
time Bulgaria joins the euro area.
Conclusions (2)
 The regular convergence reports of EC and ECB of May 2008 assessing the compliance
with the convergence criteria and the consistency of national legal frameworks with regard
to the monetary and economic union contain, in their part on Bulgaria, positive assessments
of both our progress and of the degree of meeting convergence criteria. Inflation remains
our fundamental challenge. The reports rightly underscore that the persistent strict fiscal
discipline, the labour market reforms aimed at enhancing economic activity, the
restructuring of the health and education systems, and the increased efficiency of public
administration (including taking care salary growth not to outpace the rate of productivity
growth) underlie the increase in productivity and efficiency in the economy and will help us
meet the inflation criterion. In terms of convergence of the legal framework, although
noting some specific imperfections, both reports stress that the Bulgarian legislation is
compliant with the requirements for joining the EMU.
 The banking system is in a good condition, but we should not feel complacent. Instead,
we should keep up the high level of credit standards. Banks belonging to international
groups should not try to balance their weaker results in other parts of the world by pursuing
a very aggressive credit policy in Bulgaria and trying to slacken their credit standards as the
price for a bigger market share.
Fiscal Position of the Bulgaria
Inflation Rate in Bulgaria
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Direct Foreign Investment in Bulgaria
Balance of Payment of Bulgaria
WE SHOULD STAY PRUDENT AS WE HAVE BEEN SO FAR.
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THANK YOU FOR YOUR ATTENTION!
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