Central & Eastern Europe Credit Monitor

2014 a better year for GDP, less so for credit | December 18, 2013
Key views
Kazakhstan tops growth league table
Real GDP growth, % yoy KZ LV LT PL RO EE RU HU CZ BG HR UA -2 0 2013 2 2014 4 6

Economic recovery underway in Central & Eastern Europe (CEE). We expect a pick-up in real GDP growth across the board in 2014 with Kazakhstan, Poland and the Baltic countries topping next years growth league tables. The growth impulse from credit is expected to be limited. Continued rebalancing of the funding model. The withdrawal of Western bank funding from CEE is still ongoing, but the pace has slowed down considerably. CEE banks increasingly rely on domestic funding. It remains to be seen whether the mostly short-term domestic funding will be sufficient if credit demand picks up. High and sticky NPLs constrain credit growth. NPLs remain high in most countries and are even rising in Hungary, Croatia and Romania. Given the slow improvement in the legal framework and little incentive for banks to write off those loans, slow NPL resolution is likely to remain a constraint on lending in 2014.

Sources: IMF, Deutsche Bank Research

Economic recovery underway

Credit growth strongest in CIS
Real credit to the private sector, % yoy Russia Ukraine Kazakhstan Poland Czech Rep. Bulgaria Estonia Lithuania Hungary Croatia Latvia Romania -8 -4 0

Economic recovery is underway in most CEE countries. Preliminary Q3 GDP data show that only a few countries like Ukraine and (likely) Croatia have not exited the double-dip recession (i.e. the second since 2008/09) yet or risk slipping back into recession like the Czech Republic (see table 3).
End of the recession?
Real GDP growth, qoq saar

Jul -Sep 2013, avg.

RUS Q1 12 Q2 12
4 8 12

CIS UKR -0.8 0.5 -1.5 -0.8 0.6 -0.5 -0.4

Central Europe KAZ 0.2 1.6 1.3 1.0 0.7 na na POL 0.4 0.0 0.2 0.2 0.3 0.5 0.6 CZE -0.4 -0.4 -0.3 -0.3 -1.4 0.5 -0.1 HUN -1.4 -0.4 -0.3 -0.5 0.9 0.4 0.9

South-Eastern Europe ROM -0.9 1.5 -0.8 1.1 0.6 0.8 1.6 BGR 0.2 0.2 0.1 0.1 0.2 -0.1 0.6 CRO -0.9 -0.5 -0.3 -0.4 0.0 -0.2 na LTU 0.4 0.6 1.7 0.7 0.8 0.6 0.2

Baltics LVA 0.7 2.2 1.6 0.9 1.8 0.1 1.3 EST 2.3 -0.1 1.3 0.5 -0.1 -0.2 0.4

-0.3 0.4 1.2 0.5 -0.2 -0.3 na

Q3 12 Q4 12 Q1 13 Q2 13 Q3 13

Sources: IMF, Deutsche Bank Research

Credit impulse only positive in Baltics and Ukraine

Net new credit over GDP*, Q2 2013 Latvia Ukraine Lithuania Estonia Hungary Kazakhstan Czech Republic Russia Romania Poland Croatia -5 -3 *rolling 4 quarter GDP -1 1 3

Sources: Eurostat, National authorities, CEE marketwatch

In Russia, Q3 growth (qoq) was probably positive, and is set to accelerate in Q4 driven by investment of large state companies and a good harvest. Overall, we expect a pick-up in growth across the board in 2014, with Kazakhstan, the Baltics and Poland topping the list (see chart 1). However, credit is only growing strongly in the CIS countries (see chart 2) in the case of Russia perhaps too strongly, according to the CBR. Overall, the credit impulse on growth is expected to remain limited: net new credit has recently been positive only in the Baltic countries and Ukraine (see chart 4).

Sources: IFS, Deutsche Bank Research

Contact Marion Muehlberger | marion.muehlberger@db.com | +49 69 910-31815

Internet http://www.dbresearch.com

2014 a better year for GDP, less so for credit

Gradual deleveraging still ongoing
Foreign claims of BIS reporting banks, Q3 2008=100 105 100 95 90 85 80 75 70 65 60 08 09 10 11 12 CEE

Moreover, significant downside risks to GDP growth remain. As basically all CEE countries, apart from the CIS countries, have strong links to the eurozone, any deterioration of growth in the latter would derail the fragile recovery in CEE. A slump in oil and gas prices would obviously negatively affect growth in resource-rich economies like Russia and Kazakhstan. Finally, an escalation of the current political turmoil in Ukraine could deepen its economic crisis even further.

Continued rebalancing of the funding model

The withdrawal of funding of BIS-reporting banks from CEE is still ongoing, but the pace has slowed down considerably in recent quarters (see chart 5). Looking more specifically at the role played by Western European parent banks compared to non-parent foreign lenders, it emerged that they actually acted as shock absorbers when the financial crisis hit in 2008. Obviously they did not prevent deleveraging in CEE, but with the help of the Vienna initiative 1 coordination mechanism a rush to the exit was avoided. Comparing bank deleveraging patterns as experienced by Latin America after the 1983 crisis or Asia after the 1998 crisis suggests that deleveraging might take 7 years and may stabilise at only 60-70% pre-crisis lending levels (see chart 6). As foreign lending to CEE has already stabilised, it seems unlikely that this pattern is being repeated in CEE. Obviously, regional aggregates mask country-specific differences (chart 7). Deleveraging over the last five years was strongest in the Baltic countries and Hungary and lowest in Croatia, Poland, the Czech Republic and Russia. CEE banks have increasingly relied on deposits for funding. This has led to a drop in the average loan-to-deposit ratio to 123% (as of September) from a precrisis peak of 175% (see chart 9). However, as deposit growth could not fully make up for the reduction in external funding in some countries (for example the Baltics and Hungary), credit had to be curtailed (see chart 8).
t-20 t-14 t-8 t-2 t+4 t+10 t+16 t+22 t+28 Asia (t=Jun 1997) Eastern Europe excl. CIS (t=Sep 2009) Latam (t= Dec. 1983)

CEE excl. CIS

Sources: BIS (Locational Statistics), Deutsche Bank Research

No Latam or Asia-style bank deleveraging expected

Foreign claims of BIS banks, as % of recipient countries' GDP, peak=100 120 100 80 60 40 20 0

Some rebalancing needs met by a falling credit stock

Nominal credit to the private sector, % change Sep 2008 to Sep 2013 140 120 100 80 60 40 20 0 -20 -40 LV LT EE HU
Loans

Sources: BIS (Locational statistics), GI, IMF, Deutsche Bank Research

Strongest deleveraging in the Baltics

Foreign claims of BIS reporting banks, % of recipient country GDP EE LV HU LT BG KZ UA RO RU CZ PL HR -40

HR*

BG

RO

CZ
Deposits

UA

KZ

PL

RU

* Latest data from Jun 2013

Sep 2008 to Jun 2013

Sources: IFS, Deutsche Bank Research

-30

-20

-10

10

Sources: BIS (Locational Statistics), IMF, Deutsche Bank Research

Currently, the lack of foreign funding is not perceived as a major supply constraint for credit. The Vienna Initiatives CESEE Bank Lending Survey from September revealed that the main supply constraints for credit in CEE are the weak credit quality and unpredictability of regulation.

See also De Haas et al.( 2013); Foreign Banks and the Vienna Initiative: Turning Sinners into Saints?, IMF WP 12/117 and Hameter et al. (2012); Intra-Group Cross-Border Credit and RollOver Risks in CESEE: Evidence from Austrian Banks, OENB CEE Credit Monitor

| December 18, 2013

2014 a better year for GDP, less so for credit

Loan to deposit ratios have fallen
% 300 250 200 150 100 50 0 PL RO UA CEE BG HU RU EE CZ KZ LV LT

It is still too early to tell whether the rebalancing of the funding model has been successful. Firstly, it remains to be seen whether domestic funding (mostly short-term) will be sufficient if credit demand increases. Secondly, a new wave of deleveraging from Western banks could be triggered by a tightening of global liquidity conditions and/or the results of the ECB bank stress tests. Overall, we expect even more country differentiation along profitability lines (Western European banking groups currently do not earn their cost of capital in all CEE markets).

High and sticky NPLs as a constraint to credit growth

While NPLs have fallen in the Baltic countries and Russia, they continue to rise in Hungary, Croatia and Romania (chart 10). In all other countries NPLs seem to have stabilised, albeit at much higher levels than before the crisis (see chart 11). High NPL ratios are not only a legacy of the boom-bust cycle in CEE; the current slow economic recovery and weak loan growth contribute to their stickiness. Moreover, banks seem to have little incentive to write off bad loans as this would negatively affect their profitability. This holds true especially for countries where provisioning levels are low (see chart 12). In addition, weakness in the legal and institutional framework (e.g. slow enforcement of collateral, lacking insolvency frameworks for natural persons, inadequate tax incentives and underdeveloped 2 markets for distressed assets) hinder NPL resolution . And in some countries underreporting of bad loans (e.g. EBRD estimates NPLs in Ukraine at 40% while the official figure is 14%) masks the true size of the NPL problem.
Sticky NPLs in most countries

Sep 2013

Sep 2008

Sources: IMF, Deutsche Bank Research

NPLs still rising in Croatia, Hungary and Romania

NPLs in % of total loans 25 20 15 10

10

11

5 NPLs as % of total loans (national definitions) 0 Q3 2009 Q3 2010 Q3 2011 Q3 2012 Q3 2013 Croatia Hungary Romania 35 30 25 20
Sources: National Central Banks, Deutsche Bank Research

15 10 5 0 KZ RO BG Sep 2013*
* HUN, SRB as of June.

HU

UA

HR Peak value

LT

LV

PL

RU

CZ

EE

2008 eop

Provisioning levels differ widely

Provisions in % of NPLs, as of Q2 2013 100 90 80 70 60 50 40 30 20 10 0 RO UA BG CZ PL KZ LV RU HU HR

12

Sources: National central banks and regulators, Deutsche Bank Research

Sources: IMF, Deutsche Bank Research

EE

LT

From a macroeconomic point of view, it is essential to address the NPL overhang as it is a constraint on lending. The Baltic countries serve as a good example of a fast clean-up of banks balance sheets. Coordination among the main foreign banks and out-of-court restructurings have contributed to NPL reduction. Some improvements in legal frameworks in the rest of CEE are visible, but it is a long process and the coordination problem among key players will be hard to overcome. Thus, some central banks and regulators (e.g. in Serbia) might at some point turn to mandatory write-offs to speed up the cleanup of loan books.

Working group on NPLs in Central, Eastern and Southeastern Europe, European Banking Coordination Vienna Initiative, March 2012 CEE Credit Monitor

| December 18, 2013

2014 a better year for GDP, less so for credit

Contact: Maria Arakelyan (+49 69 910-31874, maria.arakelyan@db.com) Jakov Milatovic Marion Muehlberger (+49 69 910-31815, marion.muehlberger@db.com)

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