Strengthening the role of local currencies in EU candidate and potential candidate countries Ulrich Windischbauer *, Senior Economist, Deutsche Bundesbank, International Monetary Affairs Jean Monnet Conference, Düsseldorf, 23- *The views expressed are those of the author and not necessarily those of the Bundesbank, the Eurosystem or the ECB.
Overview 1 2 3 4 Introduction Drivers and drawbacks of unofficial euroisation/dollarisation Selected country cases of successful de-dollarisation Unofficial euroisation in EU candidate and potential candidate countries 5 Conclusions Page 2
Introduction EU candidate and potential candidate countries Candidate countries (CCs): (Iceland*), Montenegro, Serbia, Turkey (accession negotiations opened) Albania, FYR Macedonia Potential Candidates (pccs): Bosnia and Herzegovina (has applied for membership) Kosovo** * Icelandic authorities declared in spring 215 that they would not want Iceland to be considered as an EU candidate country anymore. ** This designation is without prejudice to positions on status, and is in line with UNSCR 1244 and the ICJ Opinion on the Kosovo Declaration of Independence. Page 3
Introduction Some characteristics of EU candidate and potential candidate countries in the Western Balkan Successor states of former Yugoslavia plus Albania Political instabilities (e. g. Bosnia and Herzegovina, Kosovo status, tensions in FYROM) Institutional deficiencies, structural weaknesses Economies characterised by high external imbalances, high unemployment, volatile growth performance, fiscal deficits, high euroisation Different exchange rate regimes Financial sector dominated by foreign (mainly EU headquartered) banks, high NPL ratios, shallow markets Selected macroeconomic indicators, candidate and potential candidate countries in the Western Balkan Real GDP growth Current account Inflation (CPI, annual General government Unemployment (%) (%) balance (% of GDP) % change) balance (% of GDP) 214 215 214 215 214 215 214 215 214 215 Albania 1,8 2,6-12,9-11,2 1,6 1,9-5,2-4, 17,9 17,5 Bosnia and Herzeg. 1,4 3,2-7,5-5,6 -,9-1, -2, : 43,6 42,9 Kosovo,9 : -7,8-9,1,4 -,5-2,2-2, 35,3 32,9 FYROM 3,5 3,7 -,8-1,4 -,3 -,3-3,4-2,9 28, 26,1 Montenegro 1,8 3,2-15,2-13,4 -,5 1,4-3,1-8,4 18, 17,6 Serbia -1,8,7-6, -4,8 2,1 1,4-6,6-3,8 19,2 17,7 Page 4 Source: European Commission, DG ECFIN, EU Candidate and Potential Candidate Countries' Economic Quarterly, Technical Paper 1, July 216
Introduction Dollarisation/euroisation Widespread phenomenon in developing and emerging economies Distinct from official (unilateral) euroisation/dollarisation Choice to (partly) outsource the functions of money to a foreign currency typically as a result of low trust in the domestic currency Significant drawbacks for monetary policy and financial stability Optimal level probably >, but < high levels observed in many countries Experience shows that reducing euroisation/dollarisation rates is a long-term and difficult process as it needs to (re-)install confidence Nevertheless, some factors and measures that foster deeuroisation/de-dollarisation can be identified Page 5
Overview 1 2 3 4 Introduction Drivers and drawbacks of unofficial euroisation/dollarisation Selected country cases of successful de-dollarisation Unofficial euroisation in EU candidate and potential candidate countries 5 Conclusions Page 6
Drivers and drawbacks of unofficial euroisation/dollarisation Drivers Demand-side ( pull ) factors: High inflation / hyperinflation, inflationary memory High volatility of inflation and the exchange rate currency substitution Lack of monetary history General macroeconomic instability Risk and return on domestic vs. foreign assets asset substitution Lack of functioning local currency capital markets financial dollarisation original sin Supply-side ( push ) factors Fixed exchange rate regimes fear of floating Interest-rate differential used by banks to gain market shares Integration into world trade and financial markets For EU CCs/pCCs: Perspective of EU membership, foreign bank ownership Page 7
Drivers and drawbacks of unofficial euroisation/dollarisation Drawbacks Particularly relevant for central banks as the guardians of both price and financial stability Drawbacks for monetary policy Loss in effectiveness as money supply contains a component outside the control of the central bank More complex transmission mechanism In inflation targeting regimes the room for moving interest rates limited by the need to maintain an interest rate differential to anchor currency Exchange rate leverage limited due to fear of floating Less room to influence macroeconomic variables Less seignorage income Drawbacks for financial stability Effects on banks balance sheets in the event of adverse exchange rate developments (currency mismatch, net open fx positions, unhedged borrowers) Limited lender of last resort function Page 8
Overview 1 2 3 4 Introduction Drivers and drawbacks of unofficial euroisation/dollarisation Selected country cases of successful de-dollarisation Unofficial euroisation in EU candidate and potential candidate countries 5 Conclusions Page 9
Selected country cases of successful de-dollarisation Experiences vary but also display common features Attempts of forced de-dollarisation (legal restrictions on the use of foreign currency) usually failed Reforms of macroeconomic regimes and institutions, often accompanied by prudential and administrative measures and the development of local currency capital markets seem to be more promising, but take time. Cases of Israel, Poland and Peru represent examples of successful de-dollarisation of three different regions and time periods Page 1
Selected country cases of successful de-dollarisation Foreign exchange lending and deposits Israel, 1994-214 Peru, 1994-215 Poland, 1996-215 CPI inflation (annual % change, rhs) FX credit to total credit, private sector (%) Fx deposits to total deposits, private sector (%) CPI inflation (annual % change, rhs) Fx claims to total claims (non-financial sector, %) Fx deposits to total deposits (non-financial sector, %) CPI inflation (annual % change, rhs) Fx deposits to total deposits, private sector (%) Fx credit to total credit, private sector (%) 4 14 4 2 9 12 35 3 25 2 15 1 5 12 1 8 6 4 2-2 35 3 25 2 15 1 5 Dec-96 Oct-97 Aug-98 Jun-99 Apr- Feb-1 Dec-1 Oct-2 Aug-3 Jun-4 Apr-5 Feb-6 Dec-6 Oct-7 Aug-8 Jun-9 Apr-1 Feb-11 Dec-11 Oct-12 Aug-13 Jun-14 Apr-15 15 1 5-5 8 7 6 5 4 3 2 1 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan- Jan-1 Jan-2 Jan-3 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 1 8 6 4 2-2 Sources: Bank of Israel, Haver Analytics and ECB staff calculations. Sources: Narodowy Bank Polski, Haver Analytics and ECB staff calculations. Sources: Central Reserve Bank of Peru, Haver Analytics and ECB staff calculations. Page 11
Overview 1 2 3 4 Introduction Drivers and drawbacks of unofficial euroisation/dollarisation Selected country cases of successful de-dollarisation Unofficial euroisation in EU candidate and potential candidate countries 5 Conclusions Page 15
Unofficial euroisation in EU candidate and potential candidate countries Highly euroised Rates mostly falling on the asset side Diverging developments on the liability side Foreign exchange lending 28-215 (% of total loans to non-financial corporations and households) economies 28 29 21 211 212 213 214 Sep-15 Period average Albania 72.3 69.1 68.5 66. 62.1 6.6 59.1 56.9 64.3 Bosnia and Herzegovina 73.3 73.9 7. 66.9 63.1 62.9 62.4 62.1 66.8 FYR Macedonia 59.7 6.1 59.9 55. 51.6 48.1 46.5 54.4 Serbia 76.3 78.8 78.9 79. 72.1 74.5 76.6 Turkey 32.6 3.9 3.2 32.3 29.6 32.4 33.4 36.4 32.2 Foreign exchange deposits 28-215 (% of total deposits from non-financial corporations and households) Ulrich Windischbauer Page 16 28 29 21 211 212 213 214 Sep-15 Period average Albania 41.9 44.1 47.6 48.2 48.7 47.8 48.4 49.5 47. Bosnia and Herzegovina 5.7 49.4 48.4 46.5 46.4 45.5 43.4 44. 46.8 FYR Macedonia 49.1 6.8 55.2 52.4 48.2 45.3 42.5 43.1 49.6 Serbia 7.6 72.5 77.1 75.7 78.8 76.5 75. 74.5 75.1 Turkey 39.8 37.7 33.6 37.6 36.1 4.2 39.9 5.7 39.4 Sources: Haver Analytics, national central banks and ECB staff calculations.
Unofficial euroisation in EU candidiate and potential candidate countries Key drivers Inflation legacy and lack of monetary history 4 CPI inflation (year-on-year changes, period averages) Albania Bosnia and Herzegovina FYR Macedonia Serbia Turkey 35 3 25 2 15 1 5-5 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan- Jan-1 Jan-2 Jan-3 Jan-4 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Sources: IMF/WEO and ECB staff calculations. Page 17
Unofficial euroisation in EU candidiate and potential candidate countries Key drivers Low trust in domestic currencies Partly reflecting low levels of trust in domestic public institutions and political systems 1..5 Level of trust in local currencies (Normalised sample means per country; -2.5 fully disagree, neutral, 2.5 fully agree) Albania Bosnia and Herzegovina FYR Macedonia Serbia. -.5-1. -1.5-2. Page 18 Notes: Respondents were asked whether they agree or disagree on a scale from 1 (strongly agree) to 6 (strongly disagree) with the statement: "Over the next five years, the local currency will be very stable and trustworthy." Sources: OeNB Euro Survey
Unofficial euroisation in EU candidiate and potential candidate countries Key drivers Commercial banks lending rates for foreign exchange and domestic currency loans (%) Interest rate differentials Ulrich Windischbauer Page 19 8 75 7 65 6 55 5 28 29 21 211 212 213 214 215 9 85 8 75 7 65 6 55 Foreign exchange loans to total loans (lhs) Interest rate, foreign exchange loans (rhs) Interest rate, domestic currency loans (rhs) Foreign exchange loans to total loans (lhs) Interest rate, foreign exchange loans (rhs) Interest rate, domestic currency loans (rhs) Albania Serbia 5 211 212 213 214 215 Sources: National central banks and ECB staff calculations. 2 18 16 14 12 1 8 6 4 2 25 2 15 1 5 7 65 6 55 5 45 4 29 21 211 212 213 214 215 5 4 3 2 1 Foreign exchange loans to total loans (lhs) Interest rate, foreign exchange loans (rhs) Interest rate, domestic currency loans (rhs) Foreign exchange loans to total loans (lhs) Interest rate, foreign exchange loans (rhs) Interest rate, domestic currency loans (rhs) FYROM Turkey 28 29 21 211 212 213 214 215 2 18 16 14 12 1 8 6 4 2 3 25 2 15 1 5
Unofficial euroisation in EU candidiate and potential candidate countries Key drivers Trade integration with the euro area and remittances Stabilisation and Association Process with EU Trade with euro area constitutes between 45% of total merchandise trade in Serbia and 55% in Albania Remittances from the EU reach between 8½% of GDP in Albania and Serbia and 18% of GDP in FYROM Presence of foreign banks Share of euro-area headquartered banks in total banking sector assets ranges from 5% in FYROM to 7% in Bosnia and Herzegovina and Serbia EU and euro area accession perspective Page 2
Unofficial euroisation in EU candidiate and potential candidate countries Regulatory and other measures Official dinarisation strategy in Serbia MoU signed between the government and the national bank in 212 Monetary and fiscal policy measures geared at strengthening the macroeconomic environment by delivering low and stable inflation through a managed floating exchange rate regime, alongside durable economic growth Development of a market of dinar securities Flanking prudential measures Efforts undertaken also in other EU candidate and potential candidate countries Partly related to Basel II requirements or ESRB recommendations Page 21
Unofficial euroisation in EU candidiate and potential candidate countries Regulatory and other measures Prudential measures Category Measure Implemented in Ceilings on fx exposure Regulations regarding reserve requirements Limits to the net open fx position as a percentage of banks capital Debt-to-income limit more favourable on domestic currency debt Loan-to-value limit for foreign exchange mortgage loans Mandatory down payment for foreign exchange or indexed loans Reserve requirements more favourable on domestic currency liabilities Reserve requirement in local currency for fx deposits Prohibition of new fx loans in currencies other than the euro AL, BH, SR, TR SR SR SR MK, SR, TR SR SR Liquid asset requirements Provisioning requirements Fx currency assets liquidity requirement Tighter provisioning requirements for fx loans Page 22 AL, MK, TR Sources: Kokenyne et al (21), IMF AREAR reports, national central banks. AL
Unofficial euroisation in EU candidiate and potential candidate countries Regulatory and other measures Compliance with ESRB recommendations on fx lending Recommendation Risk awareness of borrowers Creditworthiness of borrowers Credit growth induced by fx lending Internal risk management Capital requirements Liquidity requirements Implemented in AL, SR AL, MK, SR, TR AL, MK, SR, TR (AL), MK, SR, TR MK, SR, TR AL, MK, SR, TR Reciprocity - Source: Survey conducted among national central banks and supervisory authorities by 213 ESCB expert group on financial stability challenges in EU candidate and potential candidate countries, updated in 215. Bosnia and Herzegovina not covered due to lack of data. Page 23
Unofficial euroisation in EU candidiate and potential candidate countries Regulatory and other measures Development of local capital markets Generally shallow (exception: Turkey) In recent years trend to increasingly issue government securities in domestic currency and to lengthen maturities Market capitalisation (in % of nominal GDP) Page 24 5 45 4 35 3 25 2 15 1 5 28 29 21 211 Bosnia and Herzegovina 212 213 214 FYR Macedonia Serbia Turkey Sources: Bloomberg, IMF/WEO, national stock markets and ECB staff calculations. 45 4 35 3 25 2 15 1 5 28 Total government securities issued in domestic currency per year (in % of nominal GDP) Bills Bonds 21 212 Albania 214 28 21 212 214 Bosnia and Herzegovina 28 Sources: IMF/WEO, national central banks and ECB staff calculations. 21 212 214 28 21 212 214 28 21 212 FYR Macedonia Serbia Turkey 214
Overview 1 2 3 4 Introduction Drivers and drawbacks of unofficial euroisation/dollarisation Selected country cases of successful de-dollarisation Unofficial euroisation in EU candidate and potential candidate countries 5 Conclusions Page 25
Conclusions Results mixed so far in EU CCs and pccs Levels of euroisation still too high In Bosnia and Herzegovina and FYROM declining euroisation rates both for lending and deposits In Albania fall on the lending side and slight increase on deposit side Highest rates observed in Serbia, only recent decline on lending side, stable on deposit side Stable development in Turkey, albeit at significantly lower level Page 26
Conclusions Three groups of success factors Macroeconomic stabilisation Necessary, but not sufficient condition Prudent fiscal policies, growth-friendly environment, low and stable inflation, central bank independence, sustainable external balances Results on exchange-rate regime not clear-cut Prudential regulations Should be well-calibrated, country-specific ESRB recommendations Development of capital markets in domestic currency Governments can play an active role Evolution of secondary markets Development of local corporate bond markets Page 27
Thank you very much for your attention! Ulrich Windischbauer Occasional Paper Series Strengthening the role of local currencies in EU candidate and potential candidate countries Looking forward to further discussions Ulrich.windischbauer@bundesbank.de Note: This Occasional Paper should not be reported as representing the views of the European Central Bank (ECB). The views expressed are those of the author and do not necessarily reflect those of the ECB. https://www.ecb.europa.eu/pub/pdf/scpops/ecbop17.en.pdf Page 28