Financing current account deficits

The article looks at the way current account deficits have been financed in different CEEC countries.

In 2003, the current account deficits in the CEEC exceeded 6% of GDP, except in Slovenia, which had a balanced current account, the Slovak Republic and Poland. Elsewhere, deficits have risen since 2002. The rise amounts to more than three GDP points in Estonia and Bulgaria, with deficits at nearly 16 and 10% of GDP respectively. How have these deficits been financed, between foreign direct investment, portfolio investment, bank indebtedness and non-bank private indebtedness?

• Foreign direct investment remains a major source of financing in half of the CEEC, but this is partly due to reinvested profits.

  Although slowing down, FDI still account for a large proportion of the capital flows into Bulgaria, the Czech Republic and Estonia: more than 4% of GDP. In Poland, FDI flows covered 90% of the current account deficit, which is particularly strong in the region (this ratio is similar in Bulgaria: 80%). This is due to a marked improvement in the current account deficit, to 2% of GDP, Polish exports having benefited from the depreciation of the zloty. Portfolio investment contributed more to external financing than in 2002 (21%, up from 13% in 2002) with an increase of € 4.1 bn in debt securities. FDI covers almost 50% of the current account deficit in the Czech Republic, Estonia and Romania. In the Czech Republic and Estonia, reinvested profits account for a significant part of FDI: 95% in the Czech Republic (up from 30% in 2002), and 45% in Estonia. In the Czech Republic, purchases of equity or debt securities by non-residents remained very limited, so that external financing has been completed by short-term capital inflows. In Estonia, net FDI flows reached 8% of GDP last year, from 3% in 2002. The banking sector provided the rest of the external financing, with more frequent short-term operations. In Romania, the proportion of profits reinvested in FDI (€ 1.3 bn) is not declared by the central bank. Long term bank indebtedness is growing by € 1 bn and accounts for a large proportion of the external financing.

• In other countries, the banking sector is taking over from FDI, and foreign exchange reserves have increased everywhere.

  In Hungary, the balance of FDI inflows and outflows has resulted in a net outflow of -2% of GDP: in Hungary, equity capital invested abroad almost offsets inflows of equity capital (€ 1.4 and 1.5 bn), whereas intercompany loans between Hungarian subsidiaries and their foreign parent companies resulted in a net outflow of € 1.6 bn. Debt securities contributed to the external financing, but to a lesser extent than short and long term flows of capital into the banking sector (€5.1 bn, from € 575M in 2002). This surge resulted in an increase in the foreign exchange reserves which had not been possible in 2002 (a negative variation of the reserves on the graph indicates an increase).

  Both in Latvia and in Lithuania, the decrease in FDI is largely offset by flows of capital into the banking sector. In Latvia, there has been no sovereign indebtedness, and there is a deficit in net portfolio investment. In Lithuania, the slight sovereign indebtedness is close to that recorded in 2002. The increase in external reserves is one of the largest in the region, i.e. 3% of GDP. In Slovenia, outward FDI flows exceeded inward flows; this deficit is largely offset by an increase in bank indebtedness as well as in the non-bank private sector indebtedness, and by a rise in the deposits made by non-residents in Slovenia. In Slovakia, the current account is balanced (-0.9% of GDP from -8.2% in 2002), since exports surged in 2003. The financial account recorded large inflows of short-term capital (attracted in particular by prospects of an increase in the value of the koruna), leading to a substantial rise in external reserves (+3% of GDP over the first 11 months).

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