Maja Kadievska-Vojnovik, MSc Vice-governor National Bank of the Republic of Macedonia Sarajevo, June 6, 2014

1.External funding structure in SEE countries 2.Crisis effects - capital flows volatility 3.Macroeconomic policy measures 4.Potential risks and vulnerabilities 5.Policy priorities

 Both Southeastern European EU members (SEE-EU) and SEE non-EU countries are almost equally dependant on FDI and cross-border lending, with each accounting for 50-60% of their respective GDP  Portfolio investment is less important, and consists mostly of sovereign bonds  European Union countries are the main foreign creditors (90%) SEE External Funding Patterns, by instrument and creditor Source: IMF, Central, Eastern, and Southeastern Europe, Regional Economic Issues, Apr 14

 High reliance on foreign funding makes the SEE region sensitive to changes in external financial conditions, as well as to rollover and FX risks (having in mind the high level of financial euroization in the region)  The SEE-EU and SEE non-EU countries are highly financially opened, with gross external debt between 40% up to 120.4% of GDP Total External Debt to GDP (%) Source: IMF, Central, Eastern, and Southeastern Europe, Regional Economic Issues, Apr 14 SEE-EUSEE- non EU

 Gross capital inflows to Emerging Europe* have declined strong in 2008, and again in  The key driver of the recent reverse trend in gross capital inflows were higher U.S. returns, that were pushed up by the “taper talk” * Turkey, Poland, Romania, Hungary, Bulgaria, Serbia, Croatia, Lithuania, Albania, Bosnia and Herzegovina, Kosovo, Macedonia, and Montenegro Capital inflows to Emerging Europe* ( % of GDP) Source: IMF, World Economic Outlook, Apr 14

 The SEE countries were hit hard by the global financial crisis in , as exports shrunk due to collapse in the global trade.  After a brief recovery, in 2012 there was a renewed slowdown as the region felt the effects of the euro area crisis but, the slowdown was far less dramatic than in GDP growth rates (y-o-y %)CAD (% of GDP) Source: IMF and national statistical officesSource: Central banks, national statistical offices, Eurostat, IMF and NBRM calculations

 Some of the SEE countries depend significantly on income transfers as external funding source.... ....but, this exposes countries to economic conditions in Diaspora’s host countries Remittances and economic growth Source: Central banks, national statistical offices, Eurostat, IMF and NBRM calculations Source: Eurostat

 Remarkable increase in financial inflows to developing countries implied investment and growth opportunities in “normal” times... ...but, it also amplified the transmission of global financial shocks, when financial inflows fell abruptly. Composition of financial account, % of GDP Source: Central banks, national statistical offices, Eurostat, IMF and NBRM calculations

 The sharp tightening of the financial conditions on the global markets after 2007 resulted in decreasing of FDI in the SEE.  In such circumstances, SEE countries mostly relied on official borrowing as a source for external funding. Eurobonds Source: Bloomberg

 Revisions occurred in credit ratings of the SEE countries during the financial crisis in 2009 and economic and sovereign crisis in 2011 Ratings

 The public debt went on a rising track, contributing to external vulnerabilities build-up.  As governments of SEE countries were undertaking discretionary fiscal stimulus to support economy, the fiscal balances deteriorated sharply.  Fiscal policies are under pressures as the countries struggle to reduce their budget deficits or to comply with loan requirements by the IMF.  In Macedonia, fiscal policy was actively used to give impulse to economic growth, through large-scale public investment projects. Fiscal balances, in % of GDPGross external debt, in % of GDP Source: IMF and central banks Source: Central banks, national statistical offices, Eurostat, IMF and NBRM calculations

 As capital flows fell in 2008, decline in available financing particularly from parent banks was registered and credit conditions tightened significantly. External position of BIS – reporting banks vis-à- vis CESEE (Billions of US dollars) Source: IMF, Central, Eastern, and Southeastern Europe, Regional Economic Issues, Apr. 2014

 Worsened economic outlook pushed credit markets into bust cycle and triggered a rise in NPL`s.  Sound initial conditions (high capitalization levels), traditional banking model and low exposure to riskier financial instruments contained direct spillovers during the early stage of the crisis. Credit growth, %NPL` s in % of total credit Source: IMF and central banks Vienna Initiative –helped countries to avoid a massive and sudden deleveraging by cross-border bank groups.

Decreased capital inflows Market absorption? Tighter macro prudential rules? Targeted prudential measures? Capital controls? Structural/f inancial market reforms? Scope for fiscal stabilization ? Scope for tighter monetary policy? FX reserve buffers? FX interventio ns Increase interest rates Counter cyclical fiscal policy Allow exchange rate depreciati ons Stricter capital requirements Limits on bank`s open FX position Easing capital inflow regulation Temporary restriction on capital outflow Prudential measures Macroeconomic policy measures Source: World Bank

 Different impacts on FX markets among SEE countries: ◦ In countries with floating exchange rate, currency depreciation was allowed in order to mitigate the impact on crisis. ◦ In countries with fixed rates, interventions on the FX market enabled stability of domestic currency. Nominal exchange rates (national currency per EUR) FX reserves, % of GDP Source: Central banksSource: Central banks, national statistical offices, Eurostat, IMF and NBRM calculations

 From the conventional measures almost all countries adopted easing cycle of interest rates of the monetary policy.  However, in some countries major consequence of the limitations faced by monetary policy, macro prudential measures (mostly in RR) were extensively employed by all SEE countries to address inflation and financial stability risks. Interest rates, in %Reserve requirements by country Source: Central banks

In recent years, NBRM undertook few changes in the RR structure in order to address some structural issues in the Macedonian economy and banking system: Lowering maturity mismatch in banks balance sheet– created from dominance of the short-term deposits - Sep – introducing 0% RR for banks’ liabilities to private persons with contractual maturity of over 2 years. Decreasing of the systemic risk in banking sector created by the high degree of FX deposits in the liabilities, which influence the monetary transmission - July 2013 – encouraging savings in domestic currency by lowering the RR ratio for liabilities in domestic currency (from 10% to 8%).

Increasing of credit supply quality for systemically important sectors that generate net-FX inflows and sectors that can contribute to lowering the energy dependence of the economy o - Nov – possibility to decrease RR for the amount of newly granted credits to net-exporters and domestic electricity producers. Broadening of the scope of banks funding sources and establishing new market segments in order to boost competition and increase efficiency of the allocation of free resources o - July 2013 – introducing 0% for banks’ liabilities to nonresidents with contractual maturity of over 1 year. Source: NBRM

 While a large share of FDI in total external financing for the region provides a degree of stability, high reliance on foreign funding exposes countries to external shocks  Sizable gross external debt and rollover needs  Foreign currency exposure compounded by a high degree of euroization of the domestic financial system  Countries tend to borrow from relatively few common creditors and some depend on income transfers  Vulnerabilities may stem from three sources-stock, flow, and external fundamentals Source: CESEE REI SPRING 2014

 “Lessons” in coping with sudden stops in capital inflows ◦ Monetary and exchange rate policies can and should be used during episodes of market volatility. ◦ Preventive measures (such as securing external credit lines) and targeted liquidity provision could be helpful.  Structural priorities for SEE economies: ◦ Most countries still need to address crisis legacies, including high levels of NPL`s. ◦ Strengthening fiscal positions without jeopardizing the ongoing economic recovery. ◦ Boost growth potential through structural reforms. ◦ Greater use of macroprudential tools to prevent external vulnerabilities building up again and to improve external funding structure.

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