THE FINANCIAL CRISIS OF 2008-2010 IN EMERGING
EUROPE. AN OVERVIEW OF THE EFFECTS ON EXTERNAL
FINANCING OF NON-FINANCIAL FIRMS.
Maria Prisacariu
“Alexandru Ioan Cuza” University of Iaşi
Iaşi, Romania
maria.prisacariu@uaic.ro
Silviu Ursu
“Alexandru Ioan Cuza” University of Iaşi
Iaşi, Romania
silviu.ursu@uaic.ro
Abstract
This paper will explore some consequences at firm level of the financial crisis that started in
2008 in advanced economies and then escalated dramatically worldwide, mainly in the socalled Emerging Europe. The main focus will be on the analysis of financing constraints of
the non-financial companies within this region caused by the deterioration of conditions in
financial markets, including a decline in equity prices, a reversal of capital flows and a
freezing up of credit markets. It will also provide a general overview of the evolution of
financing through market instruments, the role of bank credit and the potential “crowding
out” effect, by also highlighting some of the policy responses for the past couple of years.
Keywords
Corporate financing, financial crisis, Emerging Europe.
1. A GENERAL OVERVIEW OF THE FINANCIAL CRISIS
Since its inception in September 2008, the current financial crisis has been one of
the major challenges for the world economy.
Between this crisis and the recession that followed we can find many similarities
with previous episodes of boom-bust cycles, which were also characterized by a
sharp reduction in economic activity, following an extended period of rapid
expansion in financial markets and excessive risk taking by financial institutions.
At the same time, there are at least two reasons for differentiating the current crisis
and previous ones. First of all, from a global perspective, it is the most severe and
widespread downturn since 1945. As estimated by the World Bank, global GDP has
contracted in 2009 by 2.2 %, the first absolute decline in global GDP among the
postwar crises [14]. Second, this crisis had eventually a strong impact on virtually
every economy within the world, although in the year following the outbreak of the
U.S. subprime crisis in August 2007, when advanced economies were falling into
mild recessions, emerging and developing economies were still experiencing a
growth at robust rates. However, the rapid deterioration of the situation in financial
markets, following the default by Lehman Brothers and successive government
interventions in U.S. and advanced European economies to rescue American
International Group and other systemic financial institutions, meant a major shift in
the perceived risk, that finally infected other economies as well, albeit their previous
limited exposure to the U.S. subprime market. Therefore, the strong recession that
followed the bursting of the global financial bubble, has been felt in almost every
economy, either advanced or emerging, even though the risky behaviour that
contributed to this negative outcome was not specific to all the institutions and
countries affected.
So how was the financial crisis propagated worldwide? We can base our answer on
three explanatory channels: equity, credit and trade.
Galesi and Sgherri [7] suggest, by using a VAR analysis, that the equity price and
credit channels had the primary role in the transmission of the initial shock in the
U.S. subprime market to the real economy, mostly in the advanced countries of
Europe. The decrease in equity prices, often larger than 50 percent, raised the cost of
capital, with a strong negative effect on investment. However, in many emerging
economies, especially those from Central and Eastern Europe, different explanations
are needed given the traditional approach of local banking systems, with a low direct
exposure to toxic assets. The increased risk aversion that followed new crisis events
and the unleveraging path for parent banks from advanced economies with toxic
assets in their balance sheets led to a considerable contraction of inflows to
emerging economies, and, as consequences, a decline in the credit growth and, for
some of them, even a credit crunch.
The trade channel is equally important for explaining the transmission of the crisis
in countries that previously did not experience an asset boom or did not have
significant liabilities in the private sector. One example is Europe, whose major
economies were strongly affected by cutbacks in orders from United States and
Asia, for their specialized goods.
Besides the "three-channel" explanation above, when considering the links between
advanced and emerging economies, two types of factors are put forward to explain
how the financial stress gets transmitted [9].
 common factors;
 country-specific factors.
Common factors include global shocks that produce similar effects across all
emerging economies. The most important for the current crisis is the global shift in
the risk perception that had several negative effects, such as herd behaviour or
common-lender effects [4]. Another common factor that developed over the past 30
years, on the background of financial globalization and increased financial
integration, is the growth in total foreign liabilities of emerging economies, mostly
in portfolio equity and direct investment.
Country-specific factors serve the purpose of explaining why individual emerging
economies cope differently with the current crisis. They can be included into two
broad categories: (a) linkages between advanced and emerging economies; (b)
domestic vulnerabilities due to specific country characteristics.
Linkages that explain the transmission of financial stress can be further divided into
trade-based and financial-based. The first is related to the trade channel discussed
above and explains an increase in financial stress by the actual decline in exports of
emerging economies to advanced economies already in crisis. According to Forbes
and Chinn [6], trade linkages are the main country-specific factor in explaining the
transmission of financial shocks. A different view is supported by Kaminsky and
Reinhart [8]. Along with trade, they emphasize the role of the financial channel,
analysed either by the decrease in capital inflows to emerging economies by
investors in advanced economies or, more rarely, by actual losses on assets invested
in advanced economies by emerging investors. The relative importance of these two
linkages to stress transmission is usually measured by the ratio of several
macroeconomic indicators (export to advanced economies, foreign liabilities to
advanced economies or assets held in advanced economies) to domestic GDP.
Domestic vulnerabilities relate to weaknesses in current account and fiscal balances,
or in foreign exchange reserves (measured by months of import coverage). These
country-specific factors can signal sovereign default risks and therefore can cause a
stronger negative reaction from investors in emerging economies.
Considering the factors discussed above, the crisis has had a major impact also in
emerging economies, although not as immediate as in the advanced economies
where it originated, but sometimes to a much greater extent. Moreover, the countryspecific linkages and vulnerabilities can offer a good explanation for the
considerable variation in the extension of the negative effects and later
developments among regions and also between countries of the same regional group
(table 1).
Table 1 Emerging Economies: Regional and Country Differences in Real GDP
and Current Account Balance during the Financial Crisis of 2008-2010
Emerging Economies
2008
2.9
0.7
5.0
7.3
0.6
6.0
2.4
2.8
-4.6
-3.6
7.0
5.5
4.3
5.1
5.5
(in percent)
Real GDP1
2009
20103
-3.8
2.9
-4.7
5.2
1.7
2.7
-7.1
0.8
-6.3
-0.2
-5.0
0.2
-5.8
0.2
-15.0
-1.6
-18.0
-4.0
-14.1
0.8
5.6
8.2
-6.6
4.0
-1.8
4.0
2.4
4.5
2.1
4.7
Current Account Balance2
2008
2009
20103
-7,3
-2,0
-3,3
-5.7
-2.3
-4.0
-5.1
-1.6
-2.8
-12.2
-4.4
-5.5
-7.2
0.4
-0.4
-24.2
-9.5
-6.3
-9.2
-5.6
-6.3
-11.9
3.8
2.7
-13.0
9.4
7.0
-9.4
4.6
4.7
5.6
4.9
4.5
4.9
2.6
4.0
-0.6
-0.5
-1.0
15.5
1.8
5.2
0.9
-2.1
-1.7
Emerging Europe4
Turkey
Poland
Romania
Hungary
Bulgaria
Croatia
Lithuania
Latvia
Estonia
Emerging Asia5
Commonwealth of Independent States
Western Hemisphere
Middle East and North Africa
Sub-Saharan Africa
Source: International Monetary Fund [9]
1
Annual percent change;
2
Percent of GDP;
3
Projected values
4
Emerging Europe is a relatively new concept to differentiate between countries within Europe that are
not classified as advanced countries. It includes European Union Member Countries not part of Euro zone
or the Advanced European Countries Group and two prospective EU members – Croatia and Turkey.
Although increasingly used in research papers and institutional reports, it is not one the regional
breakdowns of the group of emerging and developing economies, according to the IMF World Economic
Outlook Classification. For Europe, this is represented by CEE (Central and Eastern Europe) that includes
also Albania, Bosnia and Herzegovina, Macedonia, Montenegro, Serbia (but surprisingly not Moldova,
Ukraine and Belarus which belong to CIS group). However, many reports (sometimes the same report)
are not employing the above definition and use the term to include all non-advanced European countries.
Another difficulty, mainly in comparisons over time, consists of continuous changes in its structure, the
more recent one (2010) being the reclassification of the Czech Republic and Slovakia as advanced
countries.
5
Emerging Asia comprises all economies in Developing Asia (among the most important being China
and India) and Newly Industrialized Asian Economies (Korea, Taiwan Province of China, Hong Kong
SAR, Singapore).
2. THE FINANCIAL CRISIS OF 2008-2010 IN EMERGING
EUROPE
Among emerging and developing regions, Europe has been the most negatively
affected by the global financial crisis, an evolution apparently contradictory given its
previous considerable economic growth.
Both categories of common and country-specific “financial stress-transmission”
factors have a distinctive role in describing such a development.
First of all, the process of financial integration within Europe highlights strong
financial and trade linkages between advanced and emerging countries. The
interdependencies between the two groups, through foreign ownership of financial
systems and intra-firm outsourcing from firms in advanced economies, has created
opportunities for profit, but had also a side effect - an increased speed in the
transmission of adverse shocks across borders.
Emerging Europe was one the fastest growing regional groups before 2008. This
was largely a benefit of the greater financial integration that started in 2004, with the
first main European Union enlargement wave. The region-specific process of
integration had also, a major contribution in the “downhill” capital flows from rich
to poor nations [1].
Capital inflows, by total volume and also by each component (total FDI, portfolio
debt and equity, other investments liabilities of banks and corporate such as loans,
currency and deposits), were larger in Emerging Europe than in other emerging
economies. At their peak in 2007, they accounted for 20% of GDP, a percentage
more than double that in Latin American emerging group and part of this evolution
is attributed to the rapid increase in foreign bank ownership [13]. In their quest for
higher returns, banking groups from advanced countries acquired banks in Emerging
Europe and, later, increases the cross-border loans and deposits to these affiliates.
Over the past 10 years, liabilities to advanced economy banks have grown rapidly in
Emerging Europe. However, as a downside effect, this trend has generated increased
vulnerability of the region to external bank crises. The main source of banking flows
has been banks from advanced European economies, so the common-lender effects
in Emerging Europe were most likely generated by Western Europe.
In Emerging Europe, country-specific vulnerabilities have mattered too. Overall, the
region was one of the few in the group of emerging and developing countries that in
the eve of the crisis showed twin deficits on both current account and fiscal balance.
However, an intra-group assessment shows some divergence between individual
economies. In some countries such as Bulgaria, Croatia, Latvia, Lithuania, Romania
and Turkey the private sector held large foreign currency obligations. At the same
time, large current account deficits, exceeding 10 percent of GDP, were specific
only to countries such as Bulgaria, Romania, Latvia and Lithuania.
Given the differences within the countries in this group, the idea of a single
Emerging Europe was soon rejected and the analysis of financial crisis’ effects
shifted to an individual country level. Anecdotally, one might say that a major
“achievement” of this crisis was the adjustment of investors’ perception of emerging
(European) economies when “thinking outside the box” of their advanced
economies. Instead of the traditional dichotomy „advanced economy – emerging
economies”, a new one emerged within Europe: „advanced economy – individual
emerging European economy”.
In the initial phases of the crisis, most of the emerging economies in Europe were
heavily reliant on foreign finance. The region experienced strong credit expansion,
high external debt levels, significant currency mismatches in balance sheets of both
corporations and households, and ran considerable larger current account deficits
than emerging economies in other regions (table 1). The overall outcome, besides
the obvious benefit of economic growth, was, on the downside, an increased
vulnerability to a reversal in capital flows. Together with the financing difficulties of
the parent banks when the crisis started in advanced economies, the former can
explain why the impact of the crisis is deeper in Emerging Europe. As table 2
shows, among all the emerging and developing countries, Emerging Europe has
suffered the largest drop in private financial flows, mostly on other private financial
flows, including other investment liabilities, loans, currency and deposits.
Table 2 Private Financial Flows in Emerging and Developing
Economies between 2005 and 2010
(in billions of US dollars)
Emerging Countries Group
All Emerging Economies
Developing Asia
Commonwealth of Independent
States (CIS)
Western Hemisphere
Middle East and North Africa
Sub-Saharan Africa
Emerging Europe2 (total), of
which:
- Private Direct Investment (net)
- Private Portfolio Flows (net)
- Other Private Financial Flows (net)
Source: International Monetary Fund [12]
1
Projected values
2
Emerging Europe refers to the full CEE
the IMF country classification
2005
289.3
88.1
Private financial flows (net)
2006
2007
2008
2009
254.2
689.3
179.2
180.2
54.2
195.9
33.8
145.5
20101
209.8
76.0
29.3
52.2
129.8
-95.6
-55.6
-56.5
46.1
2.0
21.3
33.7
-19.9
15.8
107.4
43.9
26.3
56.9
5.4
24.8
32.3
16.8
18.2
79.7
12.9
40.6
102.5
118.2
186.1
153.9
23.0
57.1
40.0
18.3
44.2
64.4
-0.6
54.5
77.7
-3.6
111.9
67.8
-10.0
96.1
31.3
8.7
-16.9
41.8
16.0
-0.7
(Central and Eastern Europe) regional group, in accordance to
On this background of sharp contraction of the capital inflows in the region, from
their previous level in 2007 to almost none in 2009 [13], real GDP in Emerging
Europe declined by 3.8% in 2009 and its’ projected increase in 2010 is lower than in
other emerging groups, as shown in table 1.
However, besides the initial flight to safety that encompassed most of emerging
economies, the internal country-specific vulnerabilities became later a major
concern of foreign investors. The crisis made financial markets participants to pay
less attention to the whole group and focus on individual country performance with
domestic inflation and the financing of the current account deficit. Therefore, not all
emerging countries from Europe were equally affected by the ongoing economic and
financial crisis. The most negative impact of the crisis occurred especially where
both global and specific factors were present.
Facing more extreme financing difficulties, three NMS (Hungary, Latvia, Romania)
and other CEE countries (Ukraine, Belarus, Serbia) implemented adjustment
programs supported by the IMF and from other sources, including the European
Union (EU) and the World Bank, whilst another – Poland, requested access to the
IMF’s new Financial Credit Line to sustain international confidence.
3. EFFECTS OF FINANCIAL CRISIS ON EXTERNAL
FINANCING OF EMERGING EUROPEAN FIRMS
The outburst of the financial crisis raised also the question of how vulnerable were
non-financial firms.
This became a major concern mostly for firms from Emerging Europe that benefited
from the rapid growth of domestic credit, denominated usually in foreign currency.
That was determined by the relative cheap funding of local subsidiaries from their
parent bank, and also from the large inflows of foreign direct investment, especially
intercompany debt, attributed to the strong regional trade and financial integration.
The liquidity boom during the first seven years of the 21st century created favorable
financial conditions by reducing the cost of capital in most of world countries and
had a positive effect on the balance sheets of non-financial firms. At the start of the
crisis, emerging European firms had large liquidity due to the easy access to credit
and strong profitability in line with firms from other economies. At the same time,
their aggregate level of leverage (computed by weighing country data by market
capitalization valued at market exchange rates) was the lowest among all the
emerging groups and also when compared to advanced Europe (figure 1).
However, the further deterioration of conditions in financial markets, including a
major decline in equity markets, a reversal of capital flows and even a freezing up of
credit markets, had a subsequent impact on firms’ access to finance and suggested
deterioration in the health of the nonfinancial corporate sector from both advanced
and emerging economies. Further on, the absence of a developed legal framework
for corporate restructuring creates a large likelihood for the distress caused by a lack
of access to external funding to transform into insolvency and liquidation. Dealing
with corporate bankruptcies can then become a major challenge for emerging
economies since they could further damage both domestic banks and foreign
creditors with large exposures to them.
%
350
300
250
200
150
100
50
0
1994
1995
1996
1997
1998
DEVELO PED EURO PE
1999
2000
2001
EMERGING EURO PE
2002
2003
2004
EMERGING ASIA
2005
2006
2007
EMERGING AMERICAS
Source: International Monetary Fund [9]
Figure 1 Debt-Equity Ratios for Non-financial Firms during 1994-2007
Therefore, the effects of current financial crisis on the external financing of nonfinancial firms from Emerging Europe have become an important issue. An analysis
should focus on several aspects, such as financing through bond and equity, the role
of bank credit or the “crowding out” effect.
After years of rapid growth, the initial phase of the crisis showed an increased risk
aversion followed by a strong decrease in equity prices and falling assets values,
with the overall result of higher leverage ratios. At the beginning of 2009, the
average debt-equity ratio for Emerging European firms was 72%, more than double
the level in January 2007 (figure 2).
%
90
80
70
60
50
40
30
20
10
Eme rging Europe and Russia
Latin Ame rica
09/02
09/01
08/12
08/11
08/10
08/09
08/08
08/07
08/06
08/05
08/04
08/03
08/02
08/01
07/12
07/11
07/10
07/09
07/08
07/07
07/06
07/05
07/04
07/03
07/02
07/01
0
South Asia
Source: International Monetary Fund [9]
Figure 2 Leverage Ratios for Non-financial Firms during the financial crisis7
The deteriorating market sentiment on the perceived risk created for foreign
investors also a strong tendency for home bias and flight to quality. Therefore, in
2008, emerging markets experienced a sharp drop of about 40% (table 3).
The improved perception of risks, efficient policy measures, expectations of
appreciating currencies, as well as low interest rates and high liquidity in the
advanced countries that recovered from the recession sooner-than-expected,
determined in 2009 a global recovery in emerging markets, the amount of external
financing through bonds, equities and syndicated loans increasing by almost 70
billions of US dollars.
However, the process of global recovery follows varying speeds. The resurgence of
capital flows was only specific to some emerging economies, those from Asia and
Latin America. Others, especially Emerging Europe, are lagging behind. On the
upside, internal vulnerabilities prior to the crisis and individual policy responses
have become important for investors that started to differentiate between countries
in the same group. As shown in table 3, by contrast with other NMS from Emerging
Europe, the external financing of Poland was not affected by the current financial
crisis, the increase in 2009 being five times larger than in the previous year.
Table 3 Emerging Markets External Financing:
Total Bonds, Equities and Loans
(in millions of US dollars)
Emerging Countries Group
All Emerging Economies
Developing Asia
Commonwealth of Independent
States (CIS)
Western Hemisphere
Middle East and North Africa
Sub-Saharan Africa
Emerging Europe
2005
2006
2007
2008
2009
337,728.6
87,449.8
414,781.4
111,889.1
572,611.1
168,004.5
343,794.4
96,215.7
410,007.6
156,104.8
49,018.5
81,983.3
112,324.8
78,347.9
52,227.2
85,463.4
50,850.3
11,364.2
53,582.4
16,391.7
9,341.7
2,611.0
1,103.7
72,560.0
81,592.0
15,800.1
50,954.9
8,332.1
7,328.7
747.2
1,727.1
132,803.0
77,839.6
28,306.1
53,333.1
7,342.9
5,330.8
1,129.1
1,360.0
59,966.8
60,108.8
6,843.8
42,311.5
8,168.4
9,103.9
1,890.0
1,415
99,363.8
52,949.9
12,847.1
36,514.6
13,379.5
5,615.2
185.2
540.5
- Poland
- Hungary
- Romania
- Bulgaria
Source: International Monetary Fund [11]
1
Projected values
2
Emerging Europe refers to the full CEE (Central and Eastern Europe) regional group, in accordance to
the IMF country classification
Finally, an additional risk-factor for the market financing in emerging economies is
the ongoing transformation of investment banks into traditional banks, mostly in
United States. Over the past 10 years before the crisis, American investment banks
participated in about 90 percent of the initial public offerings (by value) from
emerging and developing countries [1]. Therefore such a development will reduce
the supply of financial services with a negative effect on the intermediation of
capital issuances. The most probable result will be a lower access of firms from
emerging economies to equity capital.
Bank credit plays also an important role in the analysis of external financing of nonfinancial firms from Emerging Europe during the current financial crisis. As
discussed before, developments in these economies in the run-up and during the
global downturn were mostly associated with bank-related capital inflows. Prior to
the crisis, bank credit, usually funded by foreign parent banks, experienced a high
growth in order to support the convergence process within the region which also
increased the risks in the banking sector, due to imprudent lending practices.
Therefore, two questions related to bank financing show up as important in
Emerging Europe: (1) is the availability of credit during this financial crisis
important for non-financial firms or there are better choices? (2) How will the
dominating foreign ownership of local banking systems affect the supply of credit?
When considering the first question, the theory states that, assuming there is no
financial friction, a decrease in bank credit can, at no costs, be compensated by firms
with other forms of debt, such as bond issuance, with no changes on their investment
decisions. However, as discussed in Bernanke and Gertler [2], market imperfections
have an important role in credit markets. Their presence implies that different forms
of credit are not perfect substitutes, and as a result, firms that are more reliant on
bank credit experience a slower recovery. Therefore, disruptions to the availability
of credit have significant real effects.
An empirical investigation of the impact of credit on the strength of recovery carried
out on firms from manufacturing industries in 21 advanced economies during 19702004 [9] provides evidence that a typical firm in an industry with high dependence
on outside funding grows about 1.5 percentage more slowly after the end of a
financial crisis than the typical firm that relies more on internal funds.
However, according to the same study, there are at least two mitigating factors –
product tradability and asset tangibility – that can potentially offset the negative
effects of a decrease in the supply of credit. Firms in industries that produce goods
with low tradability show a large difference, of about 3.3 percentage points, in the
growth rates of the subgroup that has a low dependency on outside funds when
compared to that with a high dependency. Additionally, when considering only the
industries with highly tradable products, the degree of dependency on outside
funding has no significant effect on the growth in value added. Asset tangibility,
measured as the ratio of plant and production equipment to total assets in a given
industry [3], is another characteristic with an offsetting effect on tighter credit, given
the possibility to pledge the available assets as collateral, thus increasing the
probability of obtaining outside funding or reducing the credit costs. The study
shows that during recoveries, firms in industries with a high degree of asset
tangibility are not significantly affected by the extent of their dependency of outside
funding, whilst firms with a lower degree of tangible assets and also with a large
reliance on external funds, experience a much slower growth in the recovery from a
financial crisis.
As for the second question, during the first two stages of the financial crisis, one
major concern for the banking systems in Emerging Europe was related to their
large dependency on advanced economies (more than 70 percent of domestic banks
being foreign owned, mostly from Western European Banks). Previous crisis
episodes, such as Argentina, showed that foreign bank ownership was associated
with financial fragility, several parent banks choosing not to capitalize their
subsidiaries or allowing their nationalisation. However, during Asian crisis, foreign
banks from United States or Europe had a better performance in terms of
profitability or loan quality than local banks, as shown by Detragiache and Gupta
[5]. Therefore, one can consider also some positive effects of the foreign ownership
in the banking system during crises in emerging economies. These might come from
larger profitability, efficiency and capitalization, including a relative easiness in
raising capital on international financial markets, than those of domestic banks.
Moreover, in such periods with increasing risk aversion that can hamper their access
to external funding, foreign banks subsidiaries can still benefit from the financial
support from their parent bank, either on a benevolent basis, determined by the
latter’s strong position in his own market, or as the effect of a policy response.
In conclusion, the availability of credit plays an important role for firms seeking to
recover from recessions associated with financial crisis, especially for those from
industries with less tradable products and less tangible assets. Therefore, this
stresses also the importance of policy responses aimed mostly at the banking system
so that the credit flows can be resumed rapidly. Moreover, when confronted with a
large foreign ownership of local banks and similar difficulties for parent banks,
policies should aim specifically at preventing a drop in bank-related capital inflows.
Therefore, in Emerging Europe, since the beginning of the crisis, several special
liquidity or credit facilities of central banks and government-guaranteed funding
programs have been put in place and have helped improve the functioning of
banking sector. Additionally, greater international cooperation has played a
significant role in avoiding the exacerbation of cross-border strains. The European
Bank Coordination Initiative has played a vital role in helping avert a systemic crisis
by preventing foreign-owned banks from pulling out. By making use of stabilization
programs supported with funding from the IMF and European Union, 15 parent
banks have made specific rollover and recapitalization commitments in five
countries – Bosnia and Herzegovina, Hungary, Latvia, Romania, and Serbia.
However, the policy responses have only managed to alleviate the problems.
Subsidiaries of foreign banks operating in Emerging Europe have largely maintained
their exposures, but overall, as shown in table 2, the drop in capital inflows has been
particularly abrupt for bank and corporate overseas borrowing. At the same time,
despite an improvement of financial conditions in some markets, private credit
growth suffered a continuous contraction since 2008, although recent bank lending
survey [11] have indicated that the worst may be over (figure 3).
Nevertheless, the private sector credit recovery will likely be slow and uneven as
banks continue the deleveraging process. Their reluctance to lend is evident in tight
lending terms, including short maturities and strict covenants, and also in stillelevated borrowing costs.
Moreover, additional risks can impede a rapid increase in the credit supply to nonfinancial firms from Emerging Europe.
One significant risk comes from bonds previously issued by banks that mature in the
next few years [11]. The related funding processes will mostly affect banks in the
Euro Area and this can have a potential adverse impact on bank lending growth not
only in their countries of origin, but also in Emerging Europe.
%
Private Credit Growth in Emerging Europe
50
40
30
20
10
20
04
M
1
20
04
M
4
20
04
M
7
20
04
M
10
20
05
M
1
20
05
M
4
20
05
M
7
20
05
M
10
20
06
M
1
20
06
M
4
20
06
M
7
20
06
M
10
20
07
M
1
20
07
M
4
20
07
M
7
20
07
M
10
20
08
M
1
20
08
M
4
20
08
M
7
20
08
M
10
20
09
M
1
20
09
M
4
20
09
M
7
0
-10
-20
Source: International Monetary Fund [11]
Figure 3 Private Credit Growth in Emerging Europe (2004-2009)
The largest exposure of mature European banks is to Emerging Europe, so future
funding strains for these banks can determine a withdrawal of their cross-border
credit flows and a renewed credit squeeze for some emerging markets, after the
recent stabilization due to the strong policy responses between 2009 and April 2010.
A much more important risk is related to the fourth stage of the current crisis, the socalled “sovereign risk” phase, that started in November 2009 and included the
turbulences related to Euro area countries with fiscal concerns. Given their greater
linkages, the spillovers from mature Europe are being felt most in Emerging Europe.
Recent widening in credit spreads has also corresponded with a collapse in
nonfinancial corporate bond issuance. For all European firms, the issuance in May
2010 was smaller even than in the immediate period that followed the start of the
crisis [11]. A continuation in these tighter conditions can determine also a strong
reduction in the availability of bank credit to corporations since the ballooning
sovereign financing needs may cause additional stress to the already limited credit
supply. This would also contribute to an upward pressure on interest rates. However,
the increase is unlikely to be uniform, and some sectors, especially SME and lowestgrade borrowers may face higher costs. Increasing domestic government borrowing
requirements risks crowding out private lending and this can further determine
financial sector instability if multinational banks withdraw from cross-border
banking activities.
Therefore, in Emerging Europe, further policy measures to address the supply
constraints exacerbated by current sovereign credit concerns, may be needed in
order to prevent an undesired extension of the crisis and improve the financing
conditions for non-financial firms.
Besides decreases in bank credit and different market financial instruments, the
external financing of firms from Emerging Europe can also be negatively affected
by changes in foreign direct investment. Although the rise in risk aversion and more
stringent regulation has a lower constraining effect on FDI compared to debt flows,
the higher capital costs faced by parent firms are likely to reduce their ability to
finance individual projects.
On this background of external funding constraints, the retained earnings are likely
to be the dominant source of funding for non-financial firms in Emerging Europe.
However, the continuing deterioration in their income poses considerable risk for the
corporate sector and also for the financial markets, as large-scale bankruptcies can
have strong spillover effects. Therefore, successful policies that aim at the credit
flows restoration will be essential for the future of both non-financial firms and
financial systems in Emerging Europe.
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