Presentation on theme: "Charles Robertson, Chief EMEA economist +44 20 7767 5310 Elena Ganeva, Research Analyst +359 2 917."— Presentation transcript:
Charles Robertson, Chief EMEA economist Elena Ganeva, Research Analyst Best EMEA economics team 2004 Institutional Investor (March 2004) October 2005 BULGARIA in 2015
ING Bank N.V. – Sofia Branch 2 A presentation in two parts Part I EU entry, Euro adoption and an exit strategy Part II Investing in the future
ING Bank N.V. – Sofia Branch 3 New Europe 2005 Estonia 2004 Latvia 2004 Lithuania 2004 Poland 2004 Czech Republic 2004 Slovakia 2004 Hungary 2004 Slovenia 2004 Turkey Romania 2007 Bulgaria 2007 Croatia EU members 2004 EU members 2007 In EU negotiations since 2005 Possible EU candidates Not EU candidates
ING Bank N.V. – Sofia Branch 4 EU accession, the Euro and exit strategies EU entry 2007 and Euro adoption 2010 Exiting the currency board into the euro Bulgaria has an exit strategy: euro adoption by 2010 – around the same time as Hungary, Poland, Czech Republic and Slovakia.
ING Bank N.V. – Sofia Branch 5 Timing: The EU and the Euro Entry applicatio ns Negotiatio ns begun EU entry ERM membership Euro adoption Currenc y Regime Central parity rate EU MEMBERS (since 1960) and those in negotiations Denmark1961/67/ ?KronerERM peg to euro with 2.25% bands7.46 Ireland1961/67/ EuroN/A UK1961/67/711973(Oct 90-Sep 92) PoundFree-float Greece Mar EuroN/A Spain Jun EuroN/A Portugal Apr EuroN/A Austria Jan EuroN/A Sweden KronaFree-float Finland Oct EuroN/A Cyprus Apr PoundERM Peg to euro 15% bands0.585 Czech Republic KorunaFree-float with euro reference Estonia Jun KroonERM currency board to euro15.65 Hungary ForintPeg to euro with 15% bands282.0 Poland ZlotyFree-float Slovenia Jun TolarERM Peg to euro 15% bands239.6 Malta1990/ Apr LiraERM Peg to euro 15% bands0.429 Latvia Apr LatERM Peg to euro 15% bands0.703 Lithuania Jun LitasERM Peg to euro 15% bands3.45 Slovakia KorunaManaged float with euro reference Bulgaria Jan-071H LevCurrency board to euro1.96 Romania LeuManaged float to euro NOT IN NEGOTIATIONS Croatia KunaManaged float vs euro Turkey No (2014)No (2015)No (2018)LiraFree-float Albania LekManaged float vs euro Macedonia DenarTightly managed float vs euro Bosnia MarkaCurrency board to euro1.96 Serbia DinarFree-float with euro reference Montenegro Euro (Deutschemark adopted as only legal tender in Nov 2000) 1 Ukraine HryvnyaManaged float vs US dollar Italics = forecasts Source: EU Commission, ING
ING Bank N.V. – Sofia Branch 6 What is convergence? Convergence is an over-used term. Initially it referred simply to convergence to the Maastricht criteria, with implications for bond and equity investors resulting from converging interest rates to low German levels. But, convergence has also been associated with political, regulatory and macro-economic convergence towards west European levels. We are confident that Bulgaria and Romania are convergence countries; Turkey and Ukraine also offer potential convergence gains if they join both the EU and Euro.
ING Bank N.V. – Sofia Branch 7 External debt compression In 2002 Bulgaria paid up to 4pps more than Germany to borrow on the international capital markets, now it pays less than 50bp more Over a two- year time horizon Bulgaria should trade through current new EU members like Poland or Hungary as it is likely to adopt the euro earlier Today 10Y Eurobonds of the new EU member states trade at some 20bps over Bunds, 10-15bps tighter than a year ago
ING Bank N.V. – Sofia Branch 8 Maastricht criteria Criteria cannot be met before 2008 Timetable - How quickly after EU entry can a country join the Euro minus 2+ years Join ERM - possible only after EU entry (eg, Jan-Feb 2007) minus 12 months Budget/debt criteria (eg, 2008) minus 7-11 months CPI/interest rates criteria (eg, mid-2009) Enter (eg. 1 Jan 2010) Exchange rate mechanism (ERM) membership for two years. Note Estonia joined in June 2004, less than two months after joining EU in May The budget deficit must be no more than 3% of GDP. Long-term (ten-year) interest rates must be within 2% of the average of the three EU countries used in inflation criterion – this will be done by the markets whenever they see EU entry as credible. Inflation within 1.5% of the best three EU countries record on price stability (ie, around %). Government debt (internal and external) must be no more than 60% of GDP, or falling towards this level. Central bank must be independent.
ING Bank N.V. – Sofia Branch 9 Maastricht criteria - public debt Public debt – an easy one Government debt (internal and external) must be no more than 60% of GDP, or falling towards this level. Both first and subsequent EU enlargement countries tend to have low debt (public debt, external and internal), decreasing the risks of a financing crisis, with the exception of Turkey. In , all central/east European applicants had a public debt to GDP ratio below the 60% level, unlike the Eurozone, where the average ratio was 70% of GDP in 2004 (half the Eurozone was below 60%).
ING Bank N.V. – Sofia Branch 10 Maastricht criteria – long bonds 10Y local spreads over bunds – when the market believes it happens Long-term (ten-year) interest rates must be within 2% of the average of the three EU countries with the lowest inflation - the markets do this when they see euro entry as credible. Italy, Spain and Portugal all met this criterion in early 1997, one full year before it was necessary. However, we can see volatility in the meantime. In central Europe, spreads were around 200bp in , but have since risen to above 400 in Hungary. Bond yields in Bulgaria are already close to Eurozone levels because of currency board arrangement
ING Bank N.V. – Sofia Branch 11 Maastricht criteria – budget deficit Budget deficit – more difficult – will governments do it? The budget deficit must be no more than 3% of GDP. Unlike Italy or Greece, candidate countries do not have very high debt levels and apart from Hungary, they do not pay high interest rates either. So less easy to cut the deficit simply via fall in interest rates. But growth is faster than it was in EU in mid-1990s.
ING Bank N.V. – Sofia Branch 12 Maastricht criteria Inflation – only needs to be met once Inflation within 1.5% of the three EU countries showing best price stability (this excludes deflation countries) so on past precedent the range could be %
ING Bank N.V. – Sofia Branch Maastricht criteria CPI Part II Many countries joining the EU have lower inflation than existing Eurozone inflation countries, we urge the EU to only consider the Eurozone countries when setting the inflation and long-bond criteria.
ING Bank N.V. – Sofia Branch : EU entry and its effects While financial markets focus on euro adoption – and falling interest rates/currency stability – as the biggest consequences of EU enlargement, Bulgaria already has low interest rates and a stable currency. Euro adoption will secure these gains, but the boost to Bulgaria may be less than elsewhere. However, EU enlargement and euro adoption is not just an issue of interest rates. Other gains include: Free movement of labour – likely to improve from 2007 and be free of restrictions by Recognition of qualifications. For the economy, the benefits include: Huge EU transfers to the Bulgarian economy. Free trade and cheap wages encouraging investment. In addition, we can assume continuation of the lending boom.
ING Bank N.V. – Sofia Branch 15 New Europe 2015 Turkey Serbia FYROM EU members 2004 EU members 2007 In EU negotiations since 2005 Possible EU candidates Not EU candidates
ING Bank N.V. – Sofia Branch 16 Bulgaria may receive 2bn annually by 2015 One big benefit of joining the EU is the money that comes from EU membership - usually 3-4% of GDP each year for the poorest members. EU GDP was 9,324bn in 2003 and the EU budget was 100bn but EU spending on new countries was only 4bn (Bulgaria received roughly 0.4bn). But in 10 years time, perhaps 40bn of the 160bn EU budget (1% of 2015 EU GDP), will be spent on new countries. If Bulgarian GDP in 2010 is 33bn, then 3% of GDP would imply 1.0bn annually. If Bulgarian GDP in 2015 is 47bn, then 4% of GDP would imply 1.9bn in annual flows – just over 1% of the EU budget. This flow - via the current and capital account - will boost infrastructure and growth.
ING Bank N.V. – Sofia Branch 17 Fitting into the EU How big are these countries % of EU27 GDP/population in 2004 Receiving 1% of the budget would be much larger than Bulgarias economic weight would suggest - which in 2004 was just 0.2% of EU-27 GDP. However, with 2% of the EU population, 1% of the budget is arguably less than it should receive. The government can use its population weight in EU voting, to help win EU financial support.
ING Bank N.V. – Sofia Branch 18 Fitting into the EU - Politically Number of votes each country has/will have in the EU Council In 2007 when Bulgaria enters the EU, new EU members will account for 22% of the population, 32% of the votes (based on the Nice treaty - see left) … and 32% of the EU budget? Bulgaria will have 2.9% of the EU votes … 2.9% of the EU budget in 2007 could be 2.7bn Current EU constitution requires 55% of countries with 65% of population to approve. Proposed but not ratified changes suggested majority voting instead. (Bulgaria – 1 of 27 countries means 4% of EU votes, but this is influenced by the 2% weight of population)
ING Bank N.V. – Sofia Branch 19 Investment via the banking sector Increasing indebtedness, Greece from 34%/GDP to 74%/GDP Until the late 1990s it was not possible for households to be indebted, and lending to corporates was unsafe and sometimes politically motivated. Lending fell sharply after 1996, but is now growing strongly, up 10% of GDP in just 2004 alone. The credit boom will be the single biggest factor driving economic growth in the next 5 years, but also a factor widening the current account deficit. The government must aim to compensate for this by reducing its debt level.
ING Bank N.V. – Sofia Branch 20 It is a healthy banking sector Bulgaria has a healthy financial sector. Privatisation has brought in significant funds for Bulgaria, helping offset the current account deficit. Foreign ownership has also brought in expertise and advanced banking products. Foreign banks are less likely to suffer liquidity squeezes as they have easy and relatively cheap access to funds.
ING Bank N.V. – Sofia Branch 21 Wages data – 2004 and 2005 implied Wages in Bulgaria are roughly 10% of the level in the EU, and 35-40% of the levels in central Europe. In nominal terms, the difference in wages between the EU and Bulgaria is now 25 Euros per hour, compared to 22 Euros per hour in It has grown wider, making Bulgaria relatively more attractive than previously. Wages have risen to 2 Euros per hour in Bulgaria, up 45% over four years. While rapid, it is slower than rises in central Europe of up to 85% in Hungary. With central Europe now in the EU, foreign direct investors start looking farther afield for cheap manufacturing bases for Bulgaria. However, investors also go to countries with the best infrastructure and this is where EU cash is vital for Bulgaria.
ING Bank N.V. – Sofia Branch 22 Lastly it is worth noting that the currency does not appear to be overvalued. INGs own purchasing power parity basket of goods (23 imported and local products) shows how much lower prices are in Sofia, Warsaw, etc compared to Madrid in Spain, a relatively cheap EU member state. With prices in Sofia for these goods 27% cheaper than in Madrid, the currency does not look overvalued. PPP implies stable/stronger currencies Implied PPP currency over/undervaluation
ING Bank N.V. – Sofia Branch 23 Responsible fiscal policies have allowed Bulgaria to reduce debt levels, both external debt and public debt levels, contributing to falling interest servicing costs. The EU accession process has also been supportive and remains so. Prospective euro adoption in 2010 should ensure debt servicing costs will continue to fall, while also providing an exit strategy for Bulgaria. EU accession means big financial transfers to Bulgaria, helping the balance of payments while boosting investment and making Bulgaria more attractive for FDI. A healthy privatised and foreign owned banking sector should boost consumption and investment, fuelling growth. Cheap wages and free trade with the EU should see Bulgaria further integrate in the EU economy and attract more foreign direct investment. But future stability requires governments to stick to the responsible fiscal policies of recent years and try to restrain the current account deficit. Keeping fiscal policy tight is the best way to support growth Conclusions
ING Bank N.V. – Sofia Branch 25 EU – less forgiving political climate The risk of delay is some 20% for Bulgaria and 35% for Romania Romania and Bulgaria hope to enter EU in 2007 Safety clauses that could delay the entry till 2008 concentrate on Justice Environment Home affairs October EU report will shed some light on the likely entry dates but the final decision will likely be taken in 2006 From economic point of view the result of delayed EU accession is not necessarily a clear cut – less money from convergence funds but one more year to prepare better.
ING Bank N.V. – Sofia Branch 26 Population 2004 Population can give some idea of potential. The great untapped markets in EMEA appear to be outside the 1 st convergence group, like Ukraine and Egypt. Each square represents 1.5m people.
ING Bank N.V. – Sofia Branch 27 GDP 2004 This map shows EMEA countries in terms of GDP, with each square worth US$4bn. The disproportionate size (compared to population) of the new EU entrants highlights the positive impact of convergence on GDP. Note Frances nominal GDP in 2004 was around US$2,050bn, similar to the US$2,111bn total.