April 30, 2004
More about Money
If you don't find economics interesting, don't read this.
There are a couple of local wrinkles that complicate the credit situation here in Romania. The biggest one is that National Bank of Romania (Romania's Fed, more or less) has placed a lot of restrictions on the movement of credit. Some of these are stupid remnants of the bad old days of the command economy. Others, though, are entirely rational. The NBR is legitimately concerned about a currency crisis.
See, the banks would love to borrow on the international money markets. Romania is capital-starved, so interest rates here are really high. That means that the banks can go outside the country, borrow euros or dollars at low western interest rates, and then turn around and lend them to Romanians at much higher rates of interest. We're talking, like, borrowing at 5% and lending at 16%. Even given high risks and administrative costs, this is still an incredibly tempting and lucrative scenario.
But. When the banks loan money to borrowers in Romania, those loans are in Romanian lei.
So, picture this: a Romanian bank goes to, say, Frankfurt, and borrows 50 million euros at 5%. It converts the euros into lei -- 1 euro is about 40,000 lei, so it would be two trillion (!) lei. It lends the money out, collecting 12% interest. (It will be charging more than 12%, but some of that will be eaten by nonperforming loans and administrative costs.)
For the first year, the Romanian bank will owe 2.5 million euros of interest to Frankfurt. Since it will collect (2 trillion x 12%) 240 billion lei, that's not a problem -- 240 billion lei can be swapped for 6 million euros. The bank pays Frankfurt the 2.5 million and pockets the difference: 3.5 million euros. Nice.
But suppose the leu collapses?
This is not impossible -- it happened in Indonesia, where the rupiah crashed to about 1/4 of its original value in about 60 days. Some of that was hysterical overshoot, but when the rupiah stabilized it was trading at a bit less than half its original price.
Imagine that the leu suddenly crashes to 100,000 to the euro. The Romanian Bank is still collecting 240 billion lei per year. But those lei will only buy 2.4 million euros. Now the Romanian bank can't even cover the interest payments on its foreign loans. The bank is bankrupt.
Even a more modest drop -- say, from 40,000 to 60,000 -- would seriously trash the banks. They'd still be able to make interest payments, but their profits would disappear -- and they'd find it very, very hard to pay back the principal of loans that had (from their point of view) suddenly increased by 50%.
This is not an idle fear; it has happened several times in various places around the world. So the NBR places fairly sharp restrictions on the ability of Romanian banks to borrow foreign currency.
Of course, this in turn restricts the growth of lending -- the more Romanian banks have to rely on local deposits, the less they can lend. But that's a price the NBR is willing to pay.
Posted by douglas at April 30, 2004 10:44 PMThere could be a duration mismatch, as well. I imagine that the Frankfurt money is not looking to be locked into Romania for 20 years.
Posted by: Bernard Guerrero at May 1, 2004 12:11 AMYes, that's quite right. Foreign loans to Romanian banks are likely to be short- or medium-term. So the Romanian bank can get clobbered with repaying the hard-currency principal pretty quickly.
However, I have just (today) discovered that Romania is not that badly off. In a lot of developing countries, local borrowers refuse to take out foreign-currency denominated loans. They don't trust their own country's home currencies, so they're rationally afraid.
In Romania, although there are plenty of leu-denominated loans, the majority of loans are euro-denominated. (Plus a few dollar-denominated ones.) Paradoxically, this represents a vote of confidence by Romanians in their own currency. To be precise, it shows that Romanians don't think the leu is likely to crash against the euro.
It will continue to fall, sure, because of inflation. But it will be a slow, steady, predictable fall that can be taken into account.
Or anyhow, that's what Romanian borrowers are acting like they believe.
Does anyone else find this stuff remotely interesting, or should I not do these posts any more?
Doug M.
The demand for bank loans is quite high even though the conditions for getting a business credit (either working capital or investment in fixed assets) are tough . Usually banks ask for liquid mortgages at a minimum of 120% of the loan.
I would be actually curious to see statistics about the financial leverage of Romanian SMEs. I know there are some banks that are targeting the SMEs but both bureaucreacy and high conditions are somehow important barriers to be overcome. I even heard stories about people actually bribing for getting them.
Anyway, I think that the trend is upward with encouraging stories from the consumer credit side, even though it comes extremely expensive. it is true that SMEs are undercapitalized, but on the other hand truly signs of entrpreneurship need to be encouraged. There are some programs encouraging it, but my take is that the main engine should come from the educational environment. Then a microfinancing strategy perhaps would work both ways - for reducing banks' risk exposure and helping tons of valuable ideas that can be put up with $10-15k. It is just a marketing problem of the banks -- promote your microfinance programs, make it easy to get and focus on getting a scale. As far I saw, banks are more preocupied with the retail side, by looking for horizontal expanison all over the country.
Finally, actually this weekend I read a good business plan (which is not very often in Romania) from someboy with a compelling business proposition that was rather considering finding strategic investors than going to the bank. His reason: "I've had enough of their idiocy"
PS. I do find your observations about Romanian economy interesting, so I will be looking forward for new stuff. :)
Posted by: Dragos at May 3, 2004 04:59 PMI endorse the request for economics thoughts.
An anecdote to lead into a question: A colleague in Germany, re-modeling his century-old home, knocked out an exterior wall to discover millions in ReichMarks being used as insulation. Pressed during the hyper-inflation of the 1920's, it was of little value for any other purpose. My colleague brought in fistfuls of the stuff for souvenirs -- I have a sampling.
The oldest bills are multi-color on large-ish sheets of creamy linen/paper and are intricately printed on both sides from engraved plates -- say a 100 Mark bill. The newest looked like they'd been rubber stamped, in a single color, on one side, on post-it note sized paper too crude for a comic book -- a 20,000 Mark bus ticket.
A second anecdote also related to the question. Harpo Marx writes (not "tells") of a a train ride across 1930's Russia and a poker game in which the Soviet paper currency of the era changed hands so often it literally fell apart between Moscow and Lenningrad.
How does the Romanian currency now look and feel?
Will the paper wear out before the value erode to inflation -- or does the gov't appear to expect a bill to be in circulation a year or so hence?
Starting from next year there will be a change to the "heavy leu" meaning that we will cut 4 zeros from the current currency denomination. As such all the bills will be changed anyway. During the past years though it happened exactly what you asked -- the bills turnover was quite high due to the hyperinflation hence the need of new bills issuance.
Posted by: Dragos at May 4, 2004 08:43 AMDragos: the SME sector is painfully undercapitalized, right. Microfinance loans are very profitable right now, because the lenders can charge very high interest rates but still have a very high rate of repayment (like, 99.6%).
This is because the sector is so undercapitalized that there is a HUGE demand for loans. So lenders can "cherry-pick", selecting the best ones.
Most microfinance lenders are not banks, though. They are specialized microfinance institutions -- some nonprofit, some not. The banks are more interested in big commercial loans, although a few banks -- most notably Banca Transylvania -- are starting to market small loans, in the $20,000 - $100,000 range.
As to your friend looking for strategic investors: there are several equity investment funds wandering around Romania right now. Some of them are doing quite well.
Doug M.
Pouncer -- The state of the paper currency is pretty suggestive, sure. Soon after I arrived in Serbia, they replaced the old bills (which were printed on cheap paper and tended to decay very quickly) with crisper, tougher new ones... sending the message that they expected the Serbian dinar to stabilize, and these bills to remain in circulation for years to come.
An even better indicator, IME, is metal money -- coins. This is because coins cost more than paper money to produce, but stay in circulation much longer. (The oldest paper bill in your pocket is probably not more than 10 or 12 years old, but a pocketful of change will turn up coins that are 30 or 40 years old.)
Light, cheap coins made of something like aluminum are an indicator of an unstable currency. Contrariwise, massive, solid coins -- like the US quarter and dollar, the British pound coin, or the Euro and Two-Euro coins -- are designed to cost a lot but stay in circulation for decades. They implicitly state that the government has faith in the money.
Another good indicator is the level of the coin-bill transition. Very broadly speaking, the higher it is, the stronger the currency. So, for instance, the most valuable coin in Romania is the 5,000 lei coin, which is worth about 15 cents. In the US, the most valuable coin is the dollar. In Europe, it's the 2 euro coin. In Japan IMS it's the 100 yen coin, which is worth about 95 cents.
At the other extreme, there are a number of African countries that haven't had coins for many years -- the currencies are so unstable that they simply print huge wads of paper money, in denominations whose value goes down to a penny or less.
As a very rough rule of thumb: if the most valuable coin in general circulation is worth less than about 20 cents, you're probably looking at a developing economy.
Doug M.
Doug,
You think this is accidental or a signalling device saying "we're going to limit our seigniorage revenue"?
Posted by: Bernard Guerrero at May 4, 2004 02:53 PMIs it meaningful to talk about seignorage in the context of fiat money?
But anyhow, I think it's an artifact of rational decision-making on the government's part. Why make a massive, beautiful coin that will last for 40 or 50 years of circulation when inflation is likely to reduce it to a small fraction of its value within a decade or so? It's a waste of money from the government's POV.
In theory, a government might go ahead and make massive and beautiful coins anyhow, hoping to subtly encourage confidence in the currency. But that could backfire badly if the currency does sink. (Imagine how annoying it would be if quarters were reduced to the value of pennies.) So it's both cheaper and safer to make cheap coins, until and unless the currency really seems to have stabilized for the long term.
That's what seems to be happening, anyhow.
Doug M.
Doug, this is fascinating. I wish I knew more about it. Your examples are great.
How do routine "deposit" transactions work in areas with inflationary expectations? For example a tough plastic case holding two dozen heavy glass re-usable beer bottles tends to have a deposit -- a large coin for each bottle and a small bill for the case itself. Return the empties and get your full money back. What happens when there are no coins and the value of the bill won't hold as long as it takes to drink the beer? Do such regions go out of the beer biz?
Posted by: Pouncer at May 4, 2004 05:42 PM"a government might go ahead and make massive and beautiful coins anyhow, hoping to subtly encourage confidence in the currency. "
There are certainly gov'ts that print large and beautiful postage stamps for purposes other than moving mail around. The collector's market seems to offer a small way to hedge the bet.
Posted by: Pouncer at May 4, 2004 05:45 PMDeposits -- Serbia and Romania have bottle deposits. Inflation here isn't /that/ bad. 10% or 15% per year will cut the value of money in half every five years or so, but I think bottle deposits are usually shorter term than that.
How it works when there's really killer inflation -- like, 50% per month -- I don't know.
Most countries do produce a small trickle of special coins for collectors, like the "proof" coins from the US Mint. The stuff in circulation is what you want to look at, though.
Doug M.