Room for monetary policy stimulus decreasing

Published: 24/10/2019

Growing negative geopolitical and economic risks have a negative effect on economic growth expectations, despite continued favourable financing conditions, said Croatian National Bank Governor Boris Vujčić at Challenge of Change conference held by the Zagreb Stock Exchange and the Association of Pension Funds Management Companies in Rovinj from 23 to 25 October.

Surplus liquidity in the global environment pushes up the value of financial and real assets, which is reflected in an ever-rising share of assets with negative yields, noted the Governor, giving the example of bonds. If American bonds are excluded, the global share of investment-grade bonds with negative yields stands at a high 45%.

Turning to developments in the domestic economy, Governor Vujčić noted that GDP growth in Croatia was supported by favourable developments in the labour market and stable inflation. However, as in the rest of the EU, the growth of industrial production in Croatia is much slower than that of service activities; industrial production started weakening in 2018, influenced by negative developments in shipbuilding. In addition, external imbalances continue to decrease, albeit at a slower pace, while the struggle to prevent appreciation pressures increases international reserves and surplus liquidity, which contributes to a continued improvement in the conditions of financing of all the domestic sectors. Nevertheless, total lending remains moderate, except in the segment of consumer loans, and is accompanied by corporate deleveraging and public debt stagnation.

Current long-term projections of developments in interest rates and inflation indicate that they will remain very low over a prolonged period of time, stressed the Governor, adding that monetary policy cannot solve the key problems of companies.

Amid low and volatile yields on the domestic market, financial assets are growing very slowly, with the exception of pension funds, while households are increasingly oriented towards traditional investments in real estate, particularly appealing in Zagreb and on the coast, but associated with risks.

While the role of non-banking financial institutions is growing globally, the banks have continued to lose in importance at an accelerated speed since the global financial crisis. This may facilitate the funding of the economy but creates new risks to financial stability.

In conclusion, Governor Vujčić noted that macroeconomic outlook is influenced by global growth weakening, high uncertainty, structurally low inflation and interest rates and a low-for-long risk, particularly in Europe. The search for yield pushes up the value of financial assets and increases risks to financial stability, with the risks moving to the non-banking sector that has been growing in importance on the global level. At the same time, the room for additional measures of monetary policy stimulus is limited and the point at which additional lowering of the interest rates will have a contraction effect is probably not so far away.

By contrast, the expectations regarding economic growth and financing conditions are favourable in Croatia, with the risks arising from the global environment. From the perspective of financial risks, the favourable climate is also reflected in the absence of debt growth and in successful operation and deleveraging of companies. Government debt is also decreasing and only household debt is witnessing a small growth, although the structure of this debt suggests possible risks. Investments in real estate exhibit all the elements of search for yield, which is a potential risk, should these trends persist. In addition, very low interest rates are relatively new to Croatia and the challenges for financial intermediaries will probably increase with time, fuelled additionally by the introduction of the euro, concluded the Governor.