Rising or Falling Tide in Economy

We are entering unfamiliar waters, warns the Deputy Manager of the Bulgarian National Bank - Kalin Hristov. Symptoms are present, and it is time to ask ourselves if a turn in the positive cycle is not ahead of us, adds Petar Andronov, Chairman of the Management Board of the Association of Banks in Bulgaria and Chief Executive Officer of UBB. Being careful with interpreting of data is the advice of the long-standing CEO of Unicredit Bulbank Levon Hampartsumyan: “We have one foot in a bucket of coals, and another - in a bucket of ice, and where the two feet come together is supposed to be statistically OK.” At The Banks and the Business annual conference, the situation was assessed and the potential cracks were identified.

Connected Vessels

Bulgarian economy is small in size and is heavily integrated into the European one; it does not have its own dynamics of the business cycle, but is influenced by the development of the Eurozone, Kalin Hristov reminds. He describes the situation as follows: We have zero and negative interest rates and a massive quantitative incentive when we buy government securities. This facilitates government funding and additionally creates an unnecessary incentive for the entire banking system in the Eurozone. We have never witnessed that until now, so we cannot know what to expect receiving such a signal. These incentives have led to improved economic activity in the entire Eurozone, even in peripheral countries, such as Italy and Portugal, which were also growing, with the argument that the tide raises all the boats, even the leaking ones. The question is whether the driving force behind this is purely the monetary incentive, or it is a result of structural improvements in the economy.

Déjà Vu

“We are entering a stage where growth in the Eurozone is getting slower, inflation is above the target. The cycle of the monetary policy is starting to change, the incentives are changing. It is expected that the interest will return to its normal rates and will affect growth. It’s hard to predict how quickly the ECB's interest rate policy would return to its normal state. An even more unpleasant phenomenon would be inflation above the target and a slowing growth. Due to our interconnection, this situation is also being transferred to Bulgaria. One of the channels is the monetary policy. Bulgarian lev has been fixed to the euro for 22 years now through the currency board, and the monetary policy of the ECB is mechanically transferred to our economy through the integrated banking system and through trade. Two years ago, when growth started in our country, it was driven by exports. This led to an increase in salaries and consumption. Household lending has risen again to the point where we have growth, dominated mainly by consumption. The effect through the interest channel is tangible. We also have a massive reassessment of interest rates on deposits, which saves costs that has been partly transferred to loan interest rates and has resulted in a massive revaluation of the entire existing credit. The net interest margin has also fallen. The reduction in the interest rates on loans leads to the borrowing of a new loan. And the reduced net interest margin has led banks to look for a return on payment services, but this potential seems to have been exhausted. From now on, it will be more difficult to raise interest rates on loans than what we have known in the cycle until 2009. This risk has to be managed,” the BNB Deputy Governor added.

What Comes Next

Now we are at a stage where growth is most likely to slow down. Record high employment, inflation, which has exceeded 3.5% in recent months, increased consumption and uncompromised credit growth, rising real estate prices, rising wages... These symptoms are a sign that we should ask ourselves if there is a reversal of the positive cycle coming, says Petar Andronov. And he reminds that the peak of the consumer portfolio net growth was in 2007. A similar increase in mortgage lending started in 2018. But in many ways the banking system is now much more robust, the environment is more balanced, but we should be cautious not to loosen the credit standards. Because if the trend of the last 18 months of increasing credit continues, we will find big price and other imbalances before we get the interest-rate medicine from the ECB.

The Road to the Eurozone

The joining of the Bulgarian lev to ERM II is an important topic for our country. Kalin Hristov explains: This is not a waiting room, but, in general, each country has to show that it can survive in an environment of fixed exchange rate because this requirement was introduced when the countries didn’t have a currency board. Italy and Greece have jumped over ERM II and have entered the Eurozone without proving that the fixed exchange rate is not a problem for them. But Bulgaria’s case is different, and for the 22 years of the currency board, no one has seen any tension on it. In fact, ERM II is a political construction, and the mystery is that there are no clear assessment criteria. Since its irrational period until 2008, the Eurozone has changed a lot, but this has not led to a tangible change in the rules.

Dynamics

In the last 2-3 years, banks have been robotised, but human attention is needed in order to avoid a crash in the actions of artificial intelligence – if you trust machines too much, you may lose control, Peter Andronov reminds. And Miroslav Vichev, Chief Executive Officer of Borika AD, notes that PSD II is a regulation that pushes forward technologies and digitalisation, and creates prerequisites for dynamic services on our market. According to him, cloud-based electronic signature will completely change the interaction between clients and banks.

The change is ongoing, but the warning signal is already on for the economy and the banks. What should be the response? Levon Hampartsumyan is laconic - When in 2010, the creator of Citibank – Sandy Weill was asked whether the crisis could have been avoided, he said: “As long as the music is playing, you've got to get up and dance, and when it stops, we will think what to do.”