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Prospects Weekly: European commercial banking conditions have deteriorated since August 2011

Global Macroeconomics Team's picture
European commercial banking conditions have deteriorated since August 2011 on concerns about sovereign-debt exposures. Commercial bank bond-issuance has plunged, and in September (prorated) was only one-fourth the average of September 2008 through May 2011. And, European interbank spreads on overnight lending rates are at highest levels since the first weeks after Lehman Brothers collapsed. While many developing countries face significant policy challenges—for example, many have less fiscal space than they did ahead of the Lehman event—one positive factor is that most are in a better position to defend their currencies, given improved international reserve positions, were a serious global crisis to materialize. Terms-of-trade effects of elevated international commodity prices remain large for many developing countries, despite the marked decline across most commodity markets since early-2011. Oil exporters show strong gains, while some importers face large losses, particularly in the Middle East and North Africa, as food prices also remain high.
European interbank lending conditions have deteriorated since mid-2011 on mounting concern about counterparty-risk. At 77 basis points (on September 28), the spread between European interbank lending-rates charged to other commercial banks and the comparable return from deposits with the European Central Bank is at the highest level since the second half of September 2008. Concerns center on commercial bank holdings of sovereign debt and uncertainty about the extent of potential write-downs of the government paper. Similar spreads in the United States have also inched up, but by much less. Reflecting heightened risk aversion and increased borrowing costs, European commercial bank bond-issuance plunged to $34bn this month (prorated), 25% of average issuance between September 2008 and May 2011—suggesting that banks may be frozen out of their long-term markets, raising concerns about their ability to roll-over their maturing debt obligations and to meet the demand for new loans.
Most developing country foreign-exchange-reserve positions have strengthened compared with mid-2008, providing countries with an improved arsenal with which to defend their currencies in the event of a downturn. Over two-thirds of developing countries have seen some improvement in foreign reserves in terms of months of merchandise import cover, as of June 2011 (or most recent value) since June 2008. Forty-five percent have seen a gain equivalent to at least one-month of coverage. And, in aggregate, developing country short-term external debt represents just 14.6% of reserves as of Q1-2011 down from 18.6% in Q2-2008. All regions report improved reserve positions vis-a-vis short-term debt, except for South Asia, where short-term debt has increased to 37.8% of foreign reserves in Q1-2011 from 24.8% in Q2-2008.
Terms-of-trade losses remain significant in food and fuel-importing countries, as prices of these commodities remain markedly above their 2010 average levels despite recent sharp declines. While oil prices have retreated nearly 20% since late-April, the year-to-date (Jan-Sep) average price is 32% above the 2010 average. As a result, many countries have experienced large terms-of-trades effects in the first three quarters of 2011 relative to 2010, with oil-importing countries in the Middle East and North Africa suffering negative terms-of-trade impacts of 3.7% of GDP, while South Asia saw 1.9% deterioration—partly reflecting still elevated food prices. Sub-Saharan African oil-exporters posted strong gains of 8.8% of GDP, and those in the Middle East and North Africa and Europe and Central Asian saw gains of about 5%.


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