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Economic Risk in the Post Financial Crisis CEE

Economies

Dr. Robert J. Sonora

EFZG & FLC

EFOS

March, 2013

Sonora (EFZG & FLC) Economic Risk in the Post Financial Crisis CEE Economies

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Other Crises

Outline

1 Other CrisesCommon CharacteristicsDeveloping Countries/Emerging Markets

2The Current CrisisSeeds of the Crisis

Eurozone

3 Risk in CEECEE ...in it

EU Economic RiskCEE & Croatia

Croatia


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Other Crises Common Characteristics

Characteristics

Liberalization of capital/financial markets: bank capital, risky behavior, moralhazard, forbearance

Systemic Risk: Political/Economic

Asset bubble

Inflation rising nominal interest rates

Recession


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Other Crises Developing Countries/Emerging Markets

Latin America: 1980s

Deregulation of LA financial markets

LA viewed with a lot of high expectations retLA > retUS: loans in 70s rose at20.5% per year

US banks lent to LA countries: primarily Brazil, Argentina, Mexico

External debt $75 billion in 1975 $315 billion in 1983

Recession (Oil Crunch) hit

US iUS LA debt service

1982 Mexico defaulted

Sharp depreciation of Latin American currencies & IMF austerity introduced

Closest antecedent for CEE?

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Other Crises Developing Countries/Emerging Markets

Mexico Peso (La) Crisis

Figure : Mexican Peso - $US Exchange Rate


Th C C i i
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The Current Crisis

Outline


2 The Current CrisisSeeds of the CrisisEurozone



Croatia


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The Current Crisis Seeds of the Crisis

Overview

Began in US, but rest of the world not blameless

Increased competition in financial markets and deregulation led to exoticderivative products: futures, options, SIVs, MBSs, CDSs everyone had to learn abunch of acronyms

Repeal of Glass-Steagall Act (Gramm-Leach-Bliley Act)

Basel II/III: Normalize banking regulations internationally minimize risk andreformed capital requirements

assets traded internationally

Investment banks outside lawsBubble in real estate & stock market


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US Asset Bubble


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US Asset Risk


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Yield Curve and Exchange Rates


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GOV Response and Interest Rates: ARRA


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FED Response and Interest Rates


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Summarizing

Looking at the past financial crises there is a pattern . . .

Deregulation

Profit seeking in increasingly competitive marketHubris and arrogance and stupidity

and . . . moral hazard

IMF responsible too (lender in the last resort)?


The Current Crisis Eurozone
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Euro-Crisis

(i.) Spain/Ireland: Capital inflows housing bubble (crane index Ireland), badloans, etc. Bankia (nationalized),

maybe e 350 billion(?!?!) in bank support

(ii.) Italy: corruption, debt restructuring (Goldman Sachs), debt confidence, banklending in CEE, risk

(iii.) Portugal: Kind of caught up in the excitement, nonetheless it did see capitalinflows and rising real estate and now higher interest rates debt

(iv.) Greece: Low interest rates imported German interest rates when joined EZ

(v.) Money is flowing out these countries: worry that an Argentinean-like outflow collapse of banking sector corralitorestrict withdrawals risk run/panic?

Overall, lack of political will and/or solidarity

To put that in perspective, HR GDP e 50B, CO GDP e 205B


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Core Risk Premia 10Y


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PIIGS Risk Premia (Germany) 10Y

& What to make of the Italian 5 Star Party? euro?


Risk in CEE
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Outline


2 The Current CrisisSeeds of the CrisisEurozone



Croatia


Risk in CEE CEE ...in it
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Overview

CEE are very small economies compared to Germany, France, BENELUX,Austria

Eurozone divided: un-making an omelette

(i.) Core: Germany, France, BENELUX, Austria

(ii.) PIIGS: Portugal, Italy, Ireland, Greece, Spain? PIGS$$

$$Ireland(iii.) Along for the Ride: Slovenia, Slovakia, Estonia, Malta, Cyprus,

All but Austria and Germany have seen their bond ratings fall in the past twoyears or so


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Scandanavia + UK Risk Premium 10 Year


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PIIGS Output Gap: ln(yt/yt)

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EZ/EU Monetary Policy Response


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Fiscal Policy

They have applied the standard austerity IMF response to crisis:

(i.) Fiscal tightening: assuage bond markets

(ii.) Reduce inflationary pressures(iii.) High short run costs: u, rgdp,

HEL & ESP UR > 25%HR & POR > 15%


Risk in CEE CEE & Croatia
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CEE Risk Premium 3 Month


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CEE Risk Premium 10 Year


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Baltic + 2 Risk Premium 10 Year


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Fear? CBOE VIX Index/Emerging Market VIX


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Croatia in Particular

Fixed exchange rate,

(i.) but imposed capital controls on e to maintain foreign reserves (e.g.Mexico)

(ii.) makes exports relatively expensive to non-EZ countries but mosttrade with EU (e.g. Argentina)

(iii.) increased use of e denominated long term loans, but kn/emaking these loans more costly (Latin America and Russia)

(iv.) Large external debt: see exchange rate rate

(. . . a depreciation of the knwould be problematic, to say the least)


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HR Yield Curve


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Long Run and Short Run Lending Rates


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Long Run and Short Run Lending Rates


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HRK-EUR/HRK-USD Ex-Rate


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HR Kuna and Foreign Reserves



HR C d E d S i H
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HR Current and Expected Sentiment: Hope



HR C t d E t d S ti t H
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HR Current and Expected Sentiment: Hope



US CPI & PPI I fl ti
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US CPI & PPI Inflation



HR CPI & PPI Inflation
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HR CPI & PPI Inflation



HR Nominal and Real Wage
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HR Nominal and Real Wage


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Questions and Thank You

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sonora 2013

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