Croatian National Bank: "Solution for the Loans in Swiss Francs is a Threat to the Stability of Croatia"

By 12 September 2015

The governor of the Croatia National Bank wades into the Swiss Franc loan affair.

Jutarnji list has published a document in which the Croatian National Bank (HNB) presents its opinion to the finance minister Boris Lalovac about his solution for loans in Swiss francs. It believes that the actions of the government could do more harm than good. Since the Croatian National Bank has so far been impartial regarding the solution for loans in francs, it is shocking how critical governor Boris Vujčić is. The Croatian National Bank estimates that the government model of conversion of loans into euros could result in very serious financial and macroeconomic instability.

In particular, in the section titled "The Economic Effects", HNB concludes that "...such a sudden reduction of capital, if not anticipated and absorbed in the business expectations at the system level and at the level of individual banks, could cause adverse indirect effects and have an impact on the financial stability of Croatia".

HNB says that they still do not have sufficient data for precise calculations, but believe that the cost of conversion could "...amount to 7 or 8 billion kuna, and maybe more". A particularly interesting part is the one in which HNB explains to the finance minister Lalovac why the plan could do more harm than good: "The loss of foreign currency reserves would create additional risks for foreign exchange liquidity and, indirectly, for exchange rate stability and credit rating of Croatia", wrote the central bank and further explained that the IMF had already complained that the foreign exchange reserves were too low. "In this context, any loss of reserves would adversely affect their adequacy." If the IMF were to deem reserves to be inadequate, rating agencies could react negatively as well.

Furthermore, the central bank makes the point that the reduction in the annuity would increase the disposable income of households by just 0.1 to 0.2 percent, but even that small positive effect could quickly be canceled due to possible "...need to compensate for the adverse fiscal effects of conversion through stronger fiscal adjustment". In other words, minister Lalovac would possibly have to raise taxes.

"Also, it is questionable to what extent the households which are involved in the conversion would increase their personal consumption because the increased income could be redirected to deleveraging rather than spending." HNB believes that the decreasing trend in interest rates could be reversed, which would mean that the state would have a higher cost of borrowing funds. We should also expect lower revenues from income taxes and larger budget deficit due to an increase in interest expenses.

Perhaps the most dramatic message is contained in the following paragraph: "If the risks materialize simultaneously, we cannot exclude the possibility of a cascade process which would reduce reserves and distort the confidence in the monetary and financial system, leading to a very strong pressure on foreign exchange reserves and monetary measures that would be necessary to stabilize exchange rates, with an increase in interest rates in the inter-bank market which would effectively make loans inaccessible to all users."

In addition, the measures would help wealthier borrowers more than the socially vulnerable ones, says the assessment of the Croatian National Bank.

Original story in Croatian from Jutarnji List