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Credit growth and housing in Central Europe
Fri, Apr 18 2008, 13:35 GMT
by KBC Market Research Desk
Credit growth in the new member states: blessing or threat?
In many of the new member states of the European Union (NMS) domestic credit to the private sector has been growing at high rates for several years now. Not astonishingly, the understanding of the underlying factors driving credit dynamics and, more important, the assessment of possible risks associated with it, have become a key issue. In particular the question arises whether or not the observed credit boom can be viewed as excessive, i.e. disconnected from what economic fundamentals can explain, or whether it is a simply a result of catching-up. The findings in this paper suggest that the rapid credit expansion in the region to a large degree reflects wealth effects related to economic convergence and EU membership, lower interest rates and deepening and liberalization of the financial sector.
An assessment of the drivers of credit growth however also indicates that in a number of countries, notably the Baltic States and Bulgaria, credit growth has recently exceeded levels that would be consistent with economic convergence. The currency board regimes in these countries and a prolonged period of negative real interest rates have been an important driver of the credit boom. An assessment of macroeconomic balances confirms these findings.
While strong credit growth has not led to a region-wide deterioration of macroeconomic balances, again the Baltic States, Bulgaria and Romania have become more vulnerable. Credit fuelled domestic demand booms have translated into upward price pressure in goods and labour markets, negative real interest rates, real exchange rate overvaluation and excessive external deficits. Credit in the Baltic States and the two South East European countries has expanded most notably in the housing sector and in foreign currency, causing some concerns over potential currency and liquidity risks in the banking sector and asset prices bubbles. Prudential risks have increased and there is scope for improving forward-looking and risk based supervision in these countries. However, findings in this paper suggest that the banking sector in the New Member States is strong and able to withstand sizable macroeconomic corrections.
Published on Fri, Apr 18 2008, 13:35 GMT
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