Outlook for external financing of the public sector in Southeast Europe Dubravko Mihaljek Bank for International Settlements Presentation at the Bank of Greece – University of Oxford (SEESOX) Conference Achieving 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.

Outline Global portfolio capital flows Advanced economies vs. emerging markets Emerging market regions Central and eastern / Southeast Europe Cross-border financing (bank lending and international bonds) Emerging markets Central and eastern Europe Conclusion

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

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

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

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

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

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

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)

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)

Cross-border lending to CEE during the crisis

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

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