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

Abstract

Credit growth rates as high as 30% or 50% a year were observed in some Central Eastern European countries (CEECs) in 2006-2007, such as the Baltic States, Bulgaria or Romania. This strong credit growth could have been due to the catching-up process but could also have been excessive, paving the way to the credit crunch that followed the crisis in 2008-2009. We try to assess the excessiveness of credit by applying a number of methods. First, we consider the gap between current credit and its long-term trend and we find some signs of credit booms, in several CEECs in 2005-2007. Second, we assess the "normal" growth of credit with regard to fundamentals through econometric estimations. Credit growth is also shown to have been excessive in several countries just before the 2008-2009 financial crisis.

JEL codes: E30, E51, G21

Key words: credit boom, transition, financial development

(ProQuest: ... denotes formulae omitted.)

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. …

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