Guy Norton in Zagreb -

Croatia has followed in the footsteps of Hungary and Poland by introducing measures designed to help borrowers deal with their increasingly unserviceable Swiss franc loans.

Although borrowing in Swiss francs only accounts for around 10% of total lending in Croatia, more than 42% of mortgages and some 47% of car loans are tied to the Swiss currency, which has appreciated by around 50% against the Croatian kuna in the last three years and placed a growing number of borrowers in danger of slipping into default and foreclosure.

According to the Croatian National Bank (CNB), some 10.7% of Swiss franc lending has already turned non-performing. Although that figure is currently slightly lower than the 11.9% number for overall lending, in the absence of any amendments to Swiss franc loan agreements that figure was widely expected to rise. The CNB recently warned that non-performing loans as a whole could total HRK37bn (€4.9bn), or 14% of all lending by the end of this year, versus HRK25bn at the end of 2010. That figure would be more than three times the level in 2008, when Croatia was first hit by the global economic downturn. Some 70% of all borrowing in Croatia is denominated in foreign currency despite the fact that almost all workers receive their salaries in Croatian kunas.

The CNB headed by Zeljko Rohatinksi has consistently warned about the dangers of foreign currency borrowing, but has had little effect upon Croatians' borrowing habits. While the CNB has successfully managed to hold the kuna steady against the euro in a range of HRK7.2-7.5 against the euro, it has been powerless to stop the kuna losing ground against the Swiss franc, which has become the global safe haven currency of choice in the wake of the debt crises in the Eurozone and the US. As of August 22, the kuna was trading at HRK6.595 against the Swiss franc, having hit a record high of HRK7.045 two weeks earlier.

A long-term lack of public confidence in the kuna has meant that foreign currency borrowing is the norm rather than the exception in Croatia. Contrast this with the Czech Republic, where the rise of the Swiss franc does not pose such a problem. Pavel Kysilka, chief executive of Czech bank Ceska Sporitelna, says: "Almost 100% of lending is in Czech korunas, as people know that the koruna is underpinned by the strong fundamentals of the Czech Republic, based on the country's strong export performance and economic competitiveness."

Lack of kuna confidence

Neil Shearing, an economist at research consultancy Capital Economics, notes that higher Swiss franc loan repayments will eat away at disposable income levels in Croatia, which is struggling to emerge from a two-year recession that has seen GDP contract by almost 8%. And with an eye on the December 4 parliamentary elections, the rightwing coalition government headed by the Croatian Democratic Union (HDZ) party, has in recent weeks been pressurizing Croatian banks, 90% of which are now in foreign hands, into agreeing to ease the repayment pressures on Swiss franc borrowers.

Having failed in its initial attempt to appeal to the banks' social conscience, the government opted for a hardball approach, threatening to introduce a banking tax and launch judicial investigations into whether the banks misadvised borrowers about borrowing in Swiss francs. The end result has been that the banks have given some ground. Prime Minister Jadranka Kosor claiming that as of October repayments on Swiss franc mortgages (but not car loans) will be cut by 10-30% given that the Croatian government has reached an agreement with the country's lenders to reduce the headline interest rates on Swiss franc mortgages (with the actual level to be decided by individual banks, but not to exceed 3.95% per annum), fix the Swiss franc's exchange rate at HRK5.8/SFR1 and defer the difference between the real and fixed rate into a lump sum or so-called "balloon" loan to be repaid five years later. "This is the maximum that we could achieve in the negotiations," Kosor told Croatian news agency Hina, adding that unlike in Hungary the authorities in Zagreb will not be subsidising the deal with taxpayers' money.

This compares with Hungary, where the government in May announced a mortgage relief programme, providing private borrowers with a fixed exchange rate, allowing them to transfer ownership of their apartments to the state, or relocating those with payments more than 90 days overdue to social homes the government is building.

The tetchy negotiations between the Croatian government and the country's banks put central bank governor Rohatinski in the role of an unwilling go-between between a government fighting for its political life and a banking sector determined to defend its financial rights.

Michael Glazer, chairman of investment banking boutique Aucris in Zagreb, cautions that the changes to Swiss franc lending conditions could prove controversial, however. "Clearly something had to be done as a political matter given the difficulties individual borrowers were facing. Croatia is hardly alone in reaching this conclusion. However, legally, preferential treatment of Swiss franc borrowers might not be constitutional. Neither might preferential treatment of individuals versus businesses. Practically, the banks cannot be left taking all the risk of exchange rate fluctuations, because, among other things, they will simply pass on any increased cost of funding to new borrowers," he says.

There is also the matter of irritating the banks' owners, primarily Austrian, Italian and German lenders, which could have political consequences for new Croatian government borrowings, which will surely be necessary given the country's persistent budget deficit.

Glazer stresses that Croatia must at all costs avoid perpetuating its image as a country that protects the interests of locals against foreigners, no matter the equities of the issue. "Foreign direct investment is essential to Croatia's economic recovery, and foreign interest is weak enough without questions regarding treatment of foreigners exacerbating an already fraught situation," he says.

Ironically, some Croatians normally resident in Switzerland who have returned home to Croatia for the summer holidays have found it impossible to exchange their Swiss francs at Croatian foreign exchange bureaux after the Swiss National Bank announced that it was considering measures to dampen the appreciation of the Swiss franc, which is hitting Swiss exports and tourism.