Comparison of government debt in the countries of
Central and Eastern Europe

Date: 05.07.2010

The last crisis originated in the US subprime crisis and was exported via global trade in products that bundle risks and are traded throughout the networked financial system. The enormous dimension of this trading led to a global financial crisis which ended in a massive crisis of confidence, and ultimately, in a real economic crisis. The financial burden of the crisis ultimately cropped up in the most diverse cases of sovereign indebtedness shown by the dramatic widening of new and total debt. On the one hand, the financial and economic crisis seems to be over. The massive monetary and fiscal policy measures of the central banks and governments finally succeeded in containing the crisis. Overall, it was the equity and credit markets that discounted this improved development with price gains over the past few months. However, future burdens on financial and currency markets will arise due to the reduction of the extremely high government debt. A strong differentiation will be made between countries and asset classes in this case. Only an objective analysis of fundamental data and facts – rather than superficial generalizations – will show the right way out of the crisis. A comparison of the levels of indebtedness in Central and Eastern Europe is given below:

Summary on CEE:

• The indebtedness of the countries of the CEE region is far below the average of the euro area. This means that they do not need as much refinancing.
• The liquidity surplus on most CEE markets is expected to keep demand for government bonds high.
• The budget deficits in the CEE have widened. Now the countries have to do their homework to reverse the negative developments.
• The CEE6 countries are not facing consolidation measures as painful as the euro area, but a more stringent interpretation of the sustainability criteria could postpone the euro introduction to 2015 or 2016.
• Based on the budgetary development of the CEE countries, premiums on their government bonds will decrease during the current year.
  

The rising government debt and the problems this potentially entails for sovereign financing is creating nervousness in Europe. Last year, the problem of budget deficits was veiled by the generous liquidity made available to stabilize the financial sector. Now many EU states have to pay the bill for a policy of monetary easing and also take measures to that could slow down the economic recovery.

Government indebtedness of all CEE countries is lower than 60% of GDP; Hungary’s is around the level of the euro area. In the CEE6 countries ¹  government debt is far below that of the countries of the euro area in nominal terms as well as in relative terms (in relation to GDP) (see Chart 1). Together the government debt of Hungary, Czech Rep., Slovakia, Romania and Croatia is around EUR 200bn and therefore lower than the government debt of Greece (EUR 300bn).  Even if one were to consider Poland, the government debt of the entire region is still below EUR 400bn and therefore lower than in Spain (estimated at EUR 700bn). It is not even one-fourth of the government debt of Italy (estimated at EUR 1,800bn). All CEE countries (except for Hungary) have contained their government debt below 60% of GDP. The Hungarian government debt is estimated at around 80% of GDP in 2009, which is precisely the average of the euro area. 

 

An important indicator with respect to government debt is the share of government bonds held outside the country. If this ratio is high, the probability of a rapid sell-off is higher. This is the case in Greece, where some 2/3 of government debt (90% of GDP) is held outside the country. In comparison, the corresponding share in CEE6 is around ¼ (2% to 23% of GDP).

Considering the much lower government debt and the lower budget deficit in CEE economies in comparison to the countries of the euro area, the volume of funds that the CEE countries will have to raise is much lower than for the euro area. The Czech Republic, Slovakia and Romania (see also Chart 2) will profit from their lower levels of debt and have the smallest amount of maturing debts to refinance (around 4% to 5% of GDP). Poland, Croatia and Hungary will have to refinance higher volumes of maturing government bonds of around 8% to 10% of GDP. 

The liquidity surplus on most CEE markets is expected to keep demand for government bonds high. Even though refinancing demand is lower than in the euro area, the question still arises of who will buy the government bonds of CEE6. The liquidity surplus on the CEE markets is expected to support local demand. On the one hand, the banks will continue to invest the large share of deposits in government securities as credit volume growth will remain subdued. Net demand from local banks for government bonds, which results from the changes in customer deposits and loans is expected to be around 1% of GDP. Apart from banks, demand for government bonds by local pension funds, insurances and investment funds is estimated to reach around 0.5% to 2.0% of GDP in 2010. Poland might issue euro bonds this year. It is very likely that also the Czech Republic, Hungary, Slovakia and Croatia will tap international markets (or already have) and this is expected to ease the tension on local bond markets.

The budget deficits in the CEE have widened. Now the countries have to do their homework to reverse the negative developments. Budget deficits have widened in the past few years in the CEE6 countries. There were two reasons for this development. First, these countries did not make use of the good years to reduce their deficits. The high economic growth rates drove up tax revenues. But this led only to even higher spending and veiled the growing structural deficits during the period 2005 to 2007. The lack of deeper consolidation measures came to light when the economy collapsed. Second, some countries revised their budgets too late and adjusted their spending to the changed macroeconomic expectations too late. This exacerbated the structural deficits even more in all countries except for Hungary and Romania, which under the IMF program were forced to act quickly and monitor spending growth closely.

Hungary is the leader in budget consolidation. However, all countries of the CEE6 region took measures to reverse the negative development of their budget deficits. Many of them raised value added tax rates to raise tax revenues (Hungary, Croatia, Czech Republic). Romania managed to avoid having to hike VAT, but took other measures to meet the IMF criteria (cut in government personnel costs, cuts in discretionary spending and diverse structural changes such as the revision of pension law). Hungary plays a leading role in budget consolidation. The country was able to lower its budget deficit despite weak economic growth and the effects of the global economic crisis and push down its budget deficit within three years from 9.4% to less than 4% of GDP.

The CEE6 countries do not face consolidation measures as painful as the euro area, but a more stringent interpretation of the sustainability criteria could postpone the euro introduction to 2015 or 2016. Considering that the deficits of the CEE countries are lower than the average of the euro area and that some countries started consolidation efforts earlier (mid 2009 and end 2010 ²), consolidation will be easier to achieve there and less painful than in the euro area. Pursuant to the convergence program, Hungary must lower its deficit to below 3% by 2011. Poland and Romania are expected to correct their excessive deficits by 2012, the Czech Republic and Slovakia by 2013. Starting out from the level of the year 2009, Poland and Romania will have to lower their deficits every year by almost 2 percentage points in order to achieve the 2012 target.
The analysts of Erste Group expect the European Commission to devote attention to the “ credible and sustainable” fulfilment of the Maastricht criteria apart from the efforts to lower the overall government debt to below 3% of GDP. This means that in the future the candidate countries will probably have to leave more room for manoeuvring when meeting (or exceeding) the criteria and/or will have to keep their deficits below 3% of GDP for a longer period (and not only at a certain time) in order to achieve a positive assessment. The European Commission could demand structural deficits to be cut to below 3% of GDP ³ and the initiation of structural reforms (reform of healthcare, pensions) to reduce the effects of higher life expectancy on government finances. This would mean a positive assessment of the Maastricht criteria at the earliest one year after the reduction of the deficit below the level of 3% which could postpone the introduction of the euro for CEE countries (except Estonia ⁴) to 2015/16.

Based on the budgetary development of the CEE countries, the premiums on their government bonds will decrease during the current year. The development of the government budget should have a greater influence on interest premiums on government bonds than in previous years. In the light of the stability of the Hungarian and Romanian currency and the budget consolidation already achieved, the central banks will be able to continue their policy of monetary easing. This will entail a further decrease of yields. For example, Romania has the lowest level of government indebtedness in the EU which increases the probability of substantial reduction of the deficit. The analysts of Erste Group expect yields on Romanian government bonds to drop from currently 8% to around 6.5%. In Hungary, a country with one of the lowest budget deficits, yields are expected to shrink from currently 7% to 6%. The high net issuing volume of Czech and Slovak government bonds could lead to higher yields if sentiment worsens versus CEE. The liquidity surplus of the Czech banks is relatively high and this could make the placement of larger volumes easier. On the other hand, the Slovak banks already have high volumes of government bonds in their portfolios (20% of assets) because after joining the euro area they invested their free liquidity in government bonds ⁵. This means that the financing of new Slovak government debt is much more dependent on demand from foreign investors and the refinancing by the ECB.

^{1 This report covers the six CEE countries of Poland, Hungary, Czech Republic, Slovakia, Romania and Croatia. It does not cover Serbia and the Ukraine, because these countries  do not form a homogenous region with the CEE6. They are not EU members (not in the foreseeable future) and have not securitized their government debt to such an extent up to now.
2 Hungary started consolidating its budget already in 2007 after the budget deficit had climbed to 9.3% of GDP in 2006.
3 Slovakia would not have met the euro requirements had it eliminated the cyclical components from its deficit. 4 Estonia will probably introduce the euro by 2011 – thanks to the historic lowest budget deficit and the low level of government debt.
5 Currently, Slovak banks are net borrowers vis-à-vis the ECB because they apparently – just like other members of the euro area – take advantage of the low interest rate level for carry trades (they refinance via the ECB to buy government bonds with higher yields.}

Author:
Friedrich Mostböck, CEFA,
Head of Group Research, Erste Group Bank AG