Aurelio Maccario of Unicredit -
The CEE economies showed convincing signs of recovery in 2010. A more supportive macroeconomic environment translated into some improvement in household financial conditions. Moreover, signs of an easing in job market tensions gradually firmed during 2H10, weighing positively on consumer sentiment and household behaviour, although the situation was still fragile and uneven among countries.
The propensity to save continued to prevail over that to consume. Household financial assets recorded solid growth in 2010 boosted by a relatively positive performance by capital markets, with pension funds reporting the strongest gains, followed by mutual funds and bank deposits. At the same time, the weak dynamic in household spending continued to weigh on a full recovery of lending activity, leading to further improvement in net financial wealth accumulation.
The development in household financial conditions in early 2011 looks promising, but is confronted with a growing number of challenges. The recent price increase in food and energy prices is an issue to monitor as are the related downside risks on economic activity. Apart from the negative psychological effects of perceived inflation on the consumer climate, the surge in prices might have a disproportionately negative impact on households' propensity to buy, as they spend a high proportion of their income on these items. Moreover, higher energy and food prices could hit low income earners especially hard. Austerity programmes are another risk factor, although the bulk of the adjustment is probably behind us. Countries that front-loaded the adjustment are already relaxing their austerity measures but in others the tightening is not over and could weigh on household income prospects. Ongoing policy initiatives concerning pension systems also deserve careful monitoring. The re-nationalisation of the pension schemes to fill budget needs may do substantial damage to the pension funds industry and impact the household financial saving ratio, as in addition to the direct effect from reduction of assets, it might undermine confidence in the level of safety of their investments.
With economic recovery gaining momentum, we expect further normalisation in labour market conditions and consolidation in the growth of household disposable income to remain the key drivers for the accumulation of net financial assets over the next couple of years. On the asset side, we expect a gradual return of the trend in increasing sophistication of household financial assets, with bank deposits retaining their significance but mutual funds and equities likely to experience the strongest growth in the near term. Pension funds should also remain among the fastest growing assets, although with strong cross-country variation and uncertainty related to the impact of domestic policy initiatives.
The gradual improvement in job market conditions and more solid income growth should also support some resumption of household debt appetite. The overall pace of growth should, however, remain below the pre-crisis level. Mortgages should continue to outperform consumer lending, supported by the penetration gap and increasing household needs to improve housing conditions. However, limitations on FX lending in some countries and tighter regulatory requirements could constrain growth in this segment. Local currency mortgages may become an alternative, but their feasibility depends substantially on further strengthening of policy initiatives to improve availability of long-term local currency funding and to develop domestic capital markets.
CEE household financial conditions gradually returning to normal but encountering a growing number of challenges
After a challenging 2009, last year CEE economies showed convincing signs of recovery, benefiting from stronger external demand and in some cases from a recovery in domestic demand as well. Among the EU members, Poland was a top performer, posting a GDP gain of almost 4 % last year, the only EU country not to suffer a recession in 2009. A rebound in economic activity was also particularly strong among non-EU members. Turkey was the fifth-largest emerging market worldwide and the fastest growing European economy in 2010, recording a gain in real GDP of over 8 %. The pace of recovery, however, remained uneven, with SEE economies lagging in terms of momentum and both Romania and Croatia still experiencing a recession during last year.
The more supportive macroeconomic environment translated into some improvement in household financial conditions throughout the region, although the situation was still fragile as domestic labour market conditions and the disposable income dynamic remained challenging and even deteriorated in some countries. At the same time, the relatively positive performance of capital markets helped to boost the value of household financial assets and encouraged new inflows into more sophisticated financial instruments. This together with only marginal reacceleration in household debt and a weak dynamic in spending because of a lingering reluctance to consume, led to further improvement in the accumulation of net financial wealth. Overall therefore, the propensity to save continued to prevail over the one to consume, with the strength in the dynamic of the household financial saving ratio clearly a positive function of the overall strength of the economic recovery process.
Household financial assets expanded by a hefty 21 % yoy in 2010 to reach around EUR 1,200 bn in the region, marginally accelerating over 2009 (+19 % yoy). The positive dynamic has been supported by equity markets' good performance which contributed to the renewed interest in mutual funds investment, as well as by the still attractive deposit rates that encouraged further accumulation into bank deposits.
Household financial liabilities also resumed growth in 2010, posting a 17 % annual gain. The overall growth in household liabilities does, however, reveal important cross-country differentiation (growth still subdued in SEE and some CIS countries - e. g. Kazakhstan and Ukraine) and looks more contained when correcting for the effect of exchange rate movements (given the large relevance of mortgages denominated / indexed to Swiss franc in some countries). Overall, re-acceleration in household indebtedness became more evident starting from the second half of last year mainly on the back of a resumption in mortgage lending which benefited from ongoing restructuring activity and government-sponsored programmes, while consumer financing still stagnated.
In line with the ongoing improvement in macroeconomic conditions, growth in real wages has also been recovering, albeit with a mixed trend. Wages have continued to stagnate in the case of Hungary and Romania following the impact of government austerity measures and in the Baltics due to the internal devaluation process. Romania had a 25 % cut in public sector salaries, while wages in the private sector grew only moderately as a result of delayed economic recovery.
In the rest of the central european economies, real wage growth did not decline throughout the crisis although it lost momentum, while growth accelerated strongly last year in Russia and Ukraine led by a strong recovery in manufacturing.
Even in the context of still high unemployment in 2010 (averaging 9.8 % in the region), job market tensions gradually eased during last year. The performance remained mixed among countries but the dominant trend has been one of improvement, with employment dynamics bottoming out in mid-2010 in most of the countries, while remaining still weak particularly in SEE due to the delayed recovery process. Sectoral heterogeneity of the employment upswing is also one peculiarity of the current labour market recovery. Sectors such as construction and to a lesser extent real estate remain under water, although signs of bottoming out should soon start to emerge. The improved prospects on CEE labour markets have weighed positively on consumer sentiment and household behaviour. In line with trends observed in the Euro area, the perception about changes in the financial conditions of CEE households over the last twelve months has also recorded steady improvement, notably in the Baltics, although remaining below the pre-crisis level. Positive developments have also started to emerge in depressed SEE economies particularly since the end of last year.
The overall dynamic in household financial conditions in early 2011 looks promising, although it shows some weakness in Central Europe. The recent price increase in daily necessities (associated with the massive rise in food and energy prices around the globe) is an issue to monitor as are the related downside risks on economic activity - more evident for smaller countries in the region. The surge in prices might indeed have a psychological impact on the consumer climate and negatively affect households' propensity to buy, as they spend a high proportion of their income on these items.
Empirical evidence tends to suggest that consumers with lower household incomes exhibit the highest propensity to consume, while households with higher incomes tend to save a rising percentage of incremental income. If this information is combined with the share of expenditure related to food and energy in total disposable income, it is quite clear that higher energy and food prices could hit low income earners especially hard. Moreover, the weight of spending on energy and food tends to differ significantly not only by income quintile but also by country. Although expenditure ratios in CEE appear generally well above the level recorded in mature Western European economies (e. g. Germany and Austria), countries such as Romania, Lithuania and Bulgaria stand out with substantially higher expenditure ratios relative to the rest of the region, indicating that households in these countries might feel the pain much more strongly than elsewhere.
Rising inflation pressure may have been behind the recent deterioration in consumer confidence indicators. After bottoming out in early 2009, household confidence has been improving in 2010.
However, most recent trends in 1Q11 show a renewed weakness in consumer expectations. This is especially evident in Central Europe, with substantial drops in household expectations particularly in Hungary and the Czech Republic. Poland has also been trending lower since late 2010. In SEE, Bulgaria experienced a strong deterioration in 1Q11, yet Romania stood out with a substantial improvement (which reflects a later recovery than elsewhere).
Austerity programmes are another risk factor, although the bulk of adjustment is probably behind us. Countries that front-loaded the adjustment (e. g. Romania and the Baltics) are already relaxing their austerity measures. However, in others the tightening is not over, whereby austerity measures in Slovakia, Czech Republic and Hungary are still going to weigh on household income prospects over the 2011 - 2012 period. Moreover, the nationalisation of the pension schemes in order to fill budget gaps may do substantial damage to the pension funds industry, as in addition to the direct effect from reduction of assets, it might undermine households' confidence in the level of safety of their investments, thus damaging the industry's prospects over the long-term.
Looking ahead, with economic recovery gaining momentum, labour market conditions should further normalise, although the process will be rather lengthy and uneven. The improved outlook coupled with consolidation of the recovery in household disposable income is likely to remain the key driver for the accumulation of net financial assets over the next couple of years. Overall, net financial wealth as a percentage of GDP is projected to marginally decrease this year on the back of some recovery in private consumption and debt appetite to 26 % from roughly 27 % recorded in 2010, then maintain a stable upward trend to reach around 32 % by 2015.
Continued capital markets recovery and marginal return of risk appetite delivered sound growth in household financial assets
2010 saw solid growth in total household financial assets, which expanded by 21 % yoy. All asset classes recorded growth, with the exception of fixed income securities. The strongest gain was reported in the pension funds segment, followed by mutual funds and bank deposits.
Attractive deposit rates encouraged deposits growth, although this slowed in some countries during 2010 as abundant liquidity prompted banks to moderate their deposits collection efforts and gradually lower interest rates. A visible acceleration in growth was recorded in Russia on the back of high market risk and an uncertain economic outlook and to a lesser extent in Turkey, while it was more contained in Bulgaria, Croatia and Slovakia. After years of a declining trend, the growth dynamic of building societies deposits in Slovakia and the Czech Republic also picked up marginally last year, supported by various incentives offered by building societies (particularly in the Czech Republic) in an attempt to mitigate the effect of diminishing government support for this scheme. A notable difference from 2009 was much weaker growth in currency holdings, reflecting a general improvement in confidence (as a natural post-crisis reaction).
After an outstanding performance in 2009, investments in listed shares have seen more moderate growth as equity markets rose less rapidly than last year. The MSCI Emerging Markets Index grew 16.4 % compared to a 74.5 % increase recorded in 2009. Rises in equity prices have also moderated in CEE and even stagnated in several countries, i. e. Slovenia, Slovakia, Bulgaria and Kazakhstan. The Baltics proved an exception with a strong equity performance in 2010.
Pension funds enjoyed the strongest gains in 2010 compared to other asset classes. The expansion was primarily driven by rising equity valuations, but also by the inflow of new funds (mainly related to mandatory contributions). Nominal wage growth also has been a supportive factor behind growth in pension funds assets in Poland, Bulgaria and Russia. At the same time, the sector has been affected by a range of policy initiatives, often moving in the direction of partial / total re-nationalisation of a previously privatised pension system (see Box 1).
Apart from the immediate impact on workers' claims (it is estimated that in Hungary, pension funds assets lost 90 % of their value), such initiatives might have considerable consequences for household confidence in long-term vehicles, thereby contributing to a measurable slowdown in accumulation into these instruments in the future.
A recovery in risk appetite also supported growth in mutual funds, which were the second best growing asset class in 2010. Growth was generally driven both by market performance and new inflows.
But in countries such as Bulgaria (with the excepton of funds domiciled abroad) and Croatia, whose domestic capital markets performed poorly, mutual funds growth remained subdued. Accumulation into mutual funds in Hungary, Poland and Romania recorded the strongest gains supported by net sales into open-ended funds and good equity market performance particularly in the case of Poland.
Insurance technical reserves started recovering in 2010, with growth achieved predominantly in the life insurance segment.
In Hungary and Romania non-life insurance actually contracted, as faced with falling incomes, customers terminated their insurance contracts. Stagnating car sales were also one of the main culprits in the weak performance of the non-life insurance segment. By contrast, in Poland non-life insurance performed well.
After being interrupted by the crisis, we expect a gradual return of the trend in increasing sophistication of household financial assets. Mutual funds and equities should grow the most rapidly in the near term, with local authorities' effort to promote private individuals' participation in IPOs (as in the case of Kazakhstan) which should further stimulate household investment into listed shares. By contrast, rising inflation and interest rates will discourage currency holdings and fixed-income investments. Pension funds should also remain among the fastest growing assets, although in the context of strong cross-country variation.
A solid performance is expected in Romania and the Czech Republic (boosted by policy initiatives), Russia and Turkey, while Hungarian pension funds should contract sharply in the nearest future due to the re-nationalisation of the pension system. Bank deposits should retain their significance, especially in the near term, as households are likely to be more careful about their capital investments with memories of the crisis still fresh. In countries such as Turkey and Russia, some persistent financial markets volatility might support households' preference for liquidity, resulting in a further marginal increase in the relevance of safer assets in total financial wealth.
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