E.Europe credit boom costs may exceed gains -IMF

By Boris Groendahl

VIENNA, June 2 (Reuters) - The credit boom in Baltic and Balkan countries in the east of the European Union from 2003 to 2006 has left them poorer than they would have been if it had never taken place, International Monetary Fund economists say.

Western banks' expansion flooded some new EU member states with cash and helped build up imbalances that far exceeded those recorded before the Asian financial crisis, the economists say in a working paper released by the Fund on Tuesday.

The bust that followed the boom in the Baltics and the Balkans means that in a multi-year view they grew less than the central European countries -- Poland and the Czech and Slovak Republics -- which did not go on the same debt binge, they say.

'Countries with the highest credit growth not only saw the largest output volatility, but also saw lower average growth,' the IMF's Bas Bakker and Anne-Marie Gulde say in the paper.

The Baltic countries' GDP contracted by double-digit percentages last year with Latvia's 18 percent at the bottom. In contrast, Poland was the only EU country that grew in 2009 and the Czech and Slovak Republics had a milder recession.

'While the credit booms generated strong growth during the boom-phase, the subsequent bust has been so deep that seen over the 2003-10 period countries with the strongest credit boom have seen slower average GDP growth than countries that did not experience this boom,' they say.

IMF working papers do not necessarily reflect the IMF's official policy stance.

The authors, however, are actively involved in shaping the IMF's policies with regard to countries to which the assessments apply: Bakker is the IMF's mission chief for Bulgaria and Gulde has been part of IMF missions to Latvia.







CREDIT-FUELED CONSUMPTION

Cumulative capital inflows to eastern Europe were largely uniform in the years to 2003 but started to diverge massively after that. Cumulatively between 2003 and 2007, the Czech Republic had an inflow of 33 percent of its 2003 GDP, while Bulgaria had an inflow that was almost twice its 2003 GDP.

On average for all countries, this capital inflow was almost three times as large as in the run-up to the Asian crisis. In the countries with the highest credit growth, most of that inflow was capital transfer from Western bank parents.

The economists' findings cast a slightly less favourable light on the role of Western banks during the boom of the region, where they own the dominant lenders almost everywhere.

'The conclusion that the rapid expansion of the financial sector was beneficial for growth may thus have been too sanguine,' Bakker and Gulde say.

In the Baltics, Swedish banks including Swedbank and SEB are the biggest players, while in the Balkan countries, Austria's Erste Group Bank, UniCredit and Raiffeisen International are key.

While the rise in domestic demand that the Western lenders bankrolled did help raise gross domestic product, a large part leaked out through trade deficits, boosted inflation and worsened competitiveness, the economists say.

Pointing to the counter-examples of the Czech and Slovak republics, Bakker and Gulde say that while the crisis was triggered by global factors, policy failures were to blame too.

They say risks were underestimated in the boom by both policymakers and bank supervisors. Fiscal and monetary policy should have been more countercyclical and fixed rate currency regimes in some countries led to a lack of policy options.

(Reporting by Boris Groendahl; editing by Jason Webb) Keywords: EASTEUROPE/IMF ([e-mail]; [phone]; Reuters Messaging: [e-mail]) COPYRIGHT Copyright Thomson Reuters 2010. All rights reserved. The copying, republication or redistribution of Reuters News Content, including by framing or similar means, is expressly prohibited without the prior written consent of Thomson Reuters.