Academic journal article The European Journal of Comparative Economics

Assessing the Sustainability of Credit Growth: The Case of Central and Eastern European Countries

Academic journal article The European Journal of Comparative Economics

Assessing the Sustainability of Credit Growth: The Case of Central and Eastern European Countries

Article excerpt

1. Introduction

Credit booms are generally identified as a key factor behind financial crises, in particular in the emerging countries, as they tend to fuel excessive demand, inflationary pressures and speculative asset price bubbles. In this view, the severe financial crisis that hit some of the central and eastern European countries (CEECs) in 2009 could be attributed to previous excesses. Although the crisis was clearly triggered from abroad by the global financial turmoil, its severity is likely to have overwhelmed the mere contagion effects, especially in the Baltic States. In those latter countries, credit was soaring by 40% to 70% a year in 2006-2007, and has subsequently dried up in 2009. Most other CEECs have followed the same pattern, although with less extreme variations.

An important question is therefore whether the credit growth had been in excess in the CEECs in the years preceding the 2008-2009 financial crisis. This question is justified since credit growth has been shown to often precede credit crunches and financial crises. (Kaminsky and Reinhart, 1999). The theoretical literature on bubbles gives rationales for that, as leverage amplifies speculative behaviour as shown for example by Allen and Gale (2000). However, assessing the excessiveness of credit is tricky, especially in the case of the CEECS, because of their particular economic situation. As they are meant to catch up rapidly with the previous EU members, their levels of capital, productivity and income are converging towards those of advanced countries. Against this backdrop, it is not surprising that credit growth had been particularly strong, exacerbating external deficits and debt (Duenwald et al., 2005, Coricelli et al., 2006, Diev and Pouvelle, 2008).

Hence, the strong credit growth that was observed in the CEECs can be interpreted in two ways. First, it may have been part of a normal catching-up process. At the start of transition, between 1991 and 1993, the existing credit stock was eliminated by hyperinflation in some countries (in particular Poland and the Baltic States). Then, during the stabilisation phase, the pace of financial liberalisation and financial deepening steadily picked up. For instance, in 1997, the level of credit stock of these economies was still very low in percentage of GDP: less than 20% in the Baltic States, Poland and Romania (compared with, for example, 82% in France and 106% in Germany in the same period). Second, credit growth may also have been excessive, resulting in an overheating of the economy and inflationary pressures. This could be a concern for some of these countries that are expected to adopt the euro in the future and must therefore comply with the Maastricht convergence criteria, in particular the price stability criterion.

Two types of approach are used in economic literature to identify credit booms. The first is a purely statistical approach, based on deviations of credit series from their long-term trend, such as in Gourinchas et al. (2001), Tornell and Westermann (2002), IMF (2004) and Sa (2006). The second is econometric and seeks to explain the level of credit or credit growth as a function of economic fundamentals (Cotarelli et al. (2005), Boissay et al. (2005), Egert et al. (2006), Kiss et al. (2006)).

This article applies both types of approach using a large sample of emerging and developed countries, with a view to identifying a behaviour pattern that may be specific to countries of eastern and central Europe. The goal we pursue by using alternative calculations is to determine which one seems to be the better indicator of excessive credit growth. In the statistical approach, we test possible thresholds and indicators to define credit boom periods. In the econometric approach, we use an error-correction model. We first determine the equilibrium level of the credit/GDP ratio corresponding to the fundamentals in the sample as a whole. If the credit/GDP ratio has not yet reached its estimated equilibrium level in CEECs, the rapid credit growth may stem from the catching-up process. …

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