Author: Vedran Obućina

Analyst, journalist specializing in the Western Balkans and Middle East domestic and foreign affairs

Despite the crisis central banks must remain independent

In October 2020, central bankers from the Western Balkans discussed monetary policies and financial stability in the COVID-19 era, as well as the financial sector's response to the corona crisis during their meeting in Croatia.
Despite the crisis central banks must remain independent

(Steve Parker, CC BY 2.0)

“The response to the crisis caused by the coronavirus was unprecedented in its scope and in the measures that were applied,” said the Governor of the Croatian National Bank (CNB) Boris Vujčić. “We found ourselves in a situation of pliers, or as it is often called a perfect storm — on the one hand, panic in the financial market, and on the other hand the pressure to convert from the HRK deposits to the EUR deposits by ‘ordinary’ citizens and speculators. The value of the funds in which investors invested has been steadily declining, investors have begun to exit funds and convert funds into the EUR. At the same time, the CNB had to provide the HRK liquidity to stabilize the bond market and maintain exchange rate stability — two goals that are largely directly opposed”, the Governor stressed.

The situation, which began in March 2020 culminated in early April. It turned out that high international reserves owned by Croatia were the salvation, as CNB intervened and sold only foreign currency to banks worth almost 6 per cent of GDP. CNB has also started buying bonds, government securities worth 5.6 per cent of GDP. In this way, on the one hand, the value of funds or government bonds was stabilized, and on the other hand, the situation on the foreign exchange market was closely monitored, first through interventions in the foreign exchange market, and then by concluding a swap line with the ECB.

Governor Vujčić also commented on the fact that Croatia was allowed to enter ERM II at the central parity, which is set at EUR1.HRK7.5 plus/minus 15 per cent deviation, and many European countries had less room for maneuver. He said that all countries had been treated de jure in the same way, and that the European Central Bank and the European Commission were aware the CNB would continue its exchange rate policy.

According to Mr. Vujčić the dynamics of loans were as expected: at the beginning, in April, companies, due to their need to create a stock of liquidity, applied for more loans, while loans to the household sector fell, especially cash loans. They also became a major source of non-performing loans, which increased marginally from March to June 2020. Mortgages growth is on the rise due to government incentives. The lag in recognizing credit risk was due to the CNB’s measures on the classification of bad loans, fiscal assistance to companies and the moratorium on repayment of loans, but this trend could change in the coming months. “We have moratoriums that are still ongoing, and banks — which is positive — have already started reclassifying placements in June. Some of the companies that have taken the moratorium have sustainable operations, and part will have to restructure. It seems that the ‚zombification’ of companies is happening due to expansive monetary policy, low-interest rates, state aid and moratorium. Some companies should already be in restructuring without the presence of these elements, some will be able to maintain a business model”, stressed Governor. For those companies that do not have a healthy economic future, it is better to start restructuring as soon as possible. Longer-term “zombification leads to a drop in productivity, and thus in the long run to lowering citizens’ living standards. These firms should start procedures for resolving insolvency — bankruptcy and pre-bankruptcy — which should be worked on in Croatia in the next 18 months.

The Governor of the Bank of Slovenia Boštjan Vasle explained that his country has better prepared and well-capitalized banks. At the same time Slovenia has reduced fiscal capacity due to a significantly higher public debt compared to the previous crisis. At that time, the debt amounted to about 20 per cent of GDP, and last year it reached about 65 per cent. However, before the current crisis government borrowing was much more expensive, which is not the case now because Slovenia can borrow on ten-year bonds with a negative yield.

Senad Softić, the Governor of the Central Bank of Bosnia and Herzegovina, explained that a country that has a currency board does not have too many tools at its disposal. BiH did what it could to maintain the stability of the system. “The Bank was asked to do much more than it can,” he said, “but maintaining the state’s credit rating confirmed the correctness of the decision to defend the credibility of the currency board and its moves.” He also added that the fiscal space is wide because public debt is only 32 per cent of BiH’s GDP.

Robert Holzmann, the Governor of the Central Bank of Austria, believes that monetary policy faces four key challenges in these unusual circumstances. The first is to hit the right moment to end the extremely unconventional policies pursued by the monetary side, so that the abrupt withdrawal of robust measures would not harm the recovery of the European economy. Secondly, central banks must preserve their independence from the fiscal level, which has reacted in a timely and comprehensive manner, relying heavily on monetary policy. However, the Austrian Governor noted that fiscal dominance must not be allowed in the long run, i.e. there must be a clear division between monetary and fiscal policies. Thirdly, the communication of unconventional and new monetary policies to the public and other stakeholders must be better and clearer in the future, as evidenced by the decision of the German Constitutional Court, which recently sought clarification of the European Central Bank’s emergency measures during the pandemic. Fourthly, monetary policy must be vigilant about all possible negative side effects of unconventional measures, such as capital market exaggeration, which largely separated from economic fundamentals during the pandemic, increasing inequality and hampering productivity by creating a so-called zombie economy.

Vitalis Vasiliauskas, Chairman of the Board of the Bank of Lithuania, said that a lot had been done since the last recession to strengthen Europe’s financial system through better bank capitalization and the establishment of several supervisory and resolution mechanisms. According to him, in the current crisis the monetary policy response was fully timely and sufficient, and what differs from the previous crisis is the good cooperation between monetary and fiscal authorities, although the monetary policy of the Eurozone is supranational, while the fiscal one is national. The most important instrument used by the ECB was the establishment of the PEPP, i.e. the urgent securities repurchase program. On the one hand it ensured liquidity and on the other hand the stability of the financial sector. The program was flexible and focused on where it was most needed. “The most important thing now,” Mr. Vasiliauskas warned, “is for the fiscal policy to continue to do its part and for the monetary policy not to be the only game in the city, as was the case in the last recession.” He said that in a crisis one should not be afraid to use unconventional and innovative, macroprudential policy measures and that EU members now have the opportunity to use money from the new recovery fund to digitalize and make their economies more green, as well as to achieve sustainability.

According to bankers commercial banks will play a key role in reviving economic activity and achieving financial stability during the COVID 19 pandemic. Banks will ensure sufficient liquidity and support quality investments aimed at creating new jobs. „It is encouraging that, despite the pandemic, banks have maintained lending activities with historically low-interest rates and quality lending conditions,” President of the Croatian Banking Association, Zdenko Adrović said. He added that by July, bank placements amounted to HRK234bn, which is 3.8 per cent more than in the same period last year, and that guarantee schemes are especially important in the recovery from the coronavirus pandemic.

According to the analysis, the use of guarantee schemes is between 3 and 4 per cent of Croatian GDP, which is more or less the level of Denmark and the Netherlands, but significantly less than in France, Germany or Belgium. “The banking sector in this part of Europe must look to the future, redefine guarantee schemes and hope that the situation will improve in some sectors, which may not be able to survive without these schemes,” he added.

(Steve Parker, CC BY 2.0)