Macro Research - Macro Focus

Macro Research
25 November, 2015

Macro Focus
ECB quantitative easing (QE) update for the
Baltics

The ECB signalled for more modifications of the QE programme

Baltic central banks purchases skewed to supranationals

Impact on real economies to remain rather limited in the Baltics

More modifications/extensions of the QE programme to come

Eight months have passed since the European Central Bank (ECB) has
started its Public Sector Purchase Programme (PSPP), under which those
euro-denominated debt securities with remaining maturities of 2-30 years,
complying with certain quality criteria and yielding more than the ECB
deposit rate (currently at -0.2%), are being bought by the national central
banks and the ECB. We analysed the programme and its impact on the
1
Baltics in March and concluded that, given the shortage of assets eligible
for purchase under the current setup of the PSPP, the ECB is likely to
loosen its eligibility criteria for the buyable securities and/or extend current
limitations. In September, the ECB made the first step in that direction and
raised the 25% limit of a single issuance to 33%. The ECB indicated that
more modifications/extensions are possible, and we expect more
adjustments to come in their December meeting. There are basically three
ways to act: to front-load purchases of existing instruments, to extend the
programme to other types of instruments (e.g., corporate bonds), and to
reduce rates (if not the policy rate, then the deposit facility rate can be cut
further).

Baltic central banks purchases skewed to supranationals

National central banks in the Baltics have been buying debt securities
largely in line with the assigned volumes. Since bond markets are very
shallow and illiquid in the Baltics and there are not enough national
government bonds eligible for the PSPP, the purchases have been
skewed towards supranationals and are expected to become even more
so in the future. Supranational bonds eligible under the PSPP are from the
following institutions: Council of Europe Development Bank, European
Atomic Energy Community, European Financial Stability Facility,
European Stability Mechanism, European Investment Bank, European
Union, and Nordic Investment Bank.
There are no government bonds outstanding in Estonia; thus a vast
majority of the central bank purchases were those of supranational
securities except for EUR 41 million in Elering bonds (the Estonian
national electricity grid operator). In Latvia and Lithuania, most likely over
60% of the national central banks purchases were of supranational
securities, and the central banks were not very aggressive in buying
national government bonds. Precise shares cannot be calculated due to a
lack of publicly available data ECB data on purchased national
1

Government debt securities of respective

countries bought under PSPP at market
value, EURm (corporate bonds for EE)
250
EE*

LT

LV

200
150
100
50
0

Source: ECB

Total debt securities bought under PSPP by

national central banks, EURm
Total,
30.09.2015

Average per
month

EE

855.0

122.1

LV

1239.0

177.0

LT

1773.9

253.4

Source: national central banks, Swedbank

calculations

Senior economist
Lija Strauna
Email: lija.strasuna@swedbank.lv
+371 6744 5875

http://www.swedbank-research.com/english/macro_focus/2015/mars/index.csp

November 25, 2015

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Macro Research - Macro Focus

government debt securities include both national banks and the ECB
2
itself, while data on total securities bought are available only from the
balance sheets of national central banks (not including ECB purchases).
There can also be differences due to bond market price fluctuations.
There have been quite a few new government bond emissions during the
past eight months, and government bonds outstanding now comprise EUR
3.6 billion in Latvia and EUR 6 billion in Lithuania (up from EUR 2.8 billion
and EUR 4.1 billion in March). Given that the limit for single issuance has
also been raised, there are now somewhat more eligible government
bonds to buy. Theoretically, roughly 13-14% of outstanding central
government debt in 2014 in Latvia and Lithuania can be bought under the
PSPP. However, the central banks of Latvia and Lithuania have already
bought about 45-55% of what is theoretically possible to be purchased. It
is important to note that it is virtually impossible to purchase all the eligible
bonds outstanding because of very low bond market liquidity.
Government bond yields have declined in Latvia and Lithuania; the
dynamics are largely following the development in the euro area. Yields in
Latvia and Lithuania hit negative numbers for some shorter maturities
before the introduction of the PSPP (due to deflationary expectations and
expectations of action by the ECB) and following it. Yields recovered
somewhat towards the summer, driven also by the expectations that the
Federal Reserve would start lifting its policy rate. Yet, uncertainty about
China and the delayed Fed policy action have caused yields to fall again.
Since the national central banks in the Baltics need to buy more
supranationals, this, technically, increases the external debt of the Baltic
economies an increase in a central banks assets is mirrored in its
Target 2 liability. This, however, is not a source of worry.
Holdings of government bonds by the national central banks, which are
80% of total PSPP purchases, are not risk shared. Yet, supranational
bonds, which make up 12% of all purchases under the PSPP (as well as
the national government debt securities bought by the ECB, which
constitute another 8%), are subject to risk sharing. This implies that total
profits or losses occurring from holding these bonds are then shared
among the national central banks of the euro area. Since the purchases of
the Baltic central banks are skewed to supranational bonds, risks for most
of the purchases on their balance sheets are actually shared. Also, as
securities with remaining maturities of 2-30 years are being purchased,
these possible profits/losses are unlikely to materialise any time soon,
especially if they are held to maturity and are not revalued daily at market
prices. Supranational yields have also slid down to negative numbers for
some shorter maturities; however, at least so far there is enough liquidity
in the supranational bond market to be able to avoid buying at negative
yields. The average maturity of all supranational bonds purchased under
the PSPP is about 7 years. There is a risk of default, for instance, if a loan
to Greece by the European Financial Stability Facility is being written off.
Yet, we believe that the potential losses, if any, are unlikely to undermine
the financial stability of the national central banks in the Baltics.

Outstanding government debt securities,

EURm
Eligible for
PSPP purchases
(at face value),
5.11.2015

33% limit

Bought (at
market
value),
31.10.2016

EE*

225.0

74.3

41.0

LV

3645.1

1170.9

630.0

LT

5966.7

1969.0

886.0

* Corporate bonds, no gov ernment bonds outstanding

Source: ECB, national State Treasuries, Swedbank

calculations

Yields for the government bonds with the

longest term to maturity, %
2.5
2.0

LT, 10/26
LV, 04/24

LT, 01/24

1.5
1.0
0.5

0.0

Source: Bloomberg

Impact on real economies to remain rather small

In line with our expectations, the PSPP is having a very limited direct
positive impact on the Baltic economies. The issue in the Baltics is not a
lack of cheap funding, but rather a lack of investment demand. We still
believe that the positive impact on public finances through cheaper
financing costs and, possibly, some redistributed profits from the central
banks from purchased asset holdings has been rather limited. At the same
time, there is pressure on commercial bank profitability, both via the lower
2

The ECB buys 8% of assigned volumes.

November 25, 2015

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Macro Research - Macro Focus

Euribor and the squeezing of interest margins, since still-fragile (albeit

growing) credit demand and the sizeable grey economy (especially in
Latvia and Lithuania) are holding back new lending growth. Competition
among banks has increased, but the decline in interest rates for new loans
has been quite minor the rising cost of capital due to tightened
regulations and capital adequacy requirements makes it harder to reduce
lending rates. To deal with negative interest rates, most commercial banks
have introduced a zero floor for the Euribor component of the lending rate.

Bilateral euro exchange rates, ECB

(Jan.2013=100)

How big an indirect positive impact will be via export growth and
confidence when/if QE supports a pickup in euro area growth largely
remains to be seen. There might have been a small direct support to Baltic
exports from the weaker euro exchange rate, since it improved
competitiveness of exporters trading with the UK, US, and those emerging
markets for which transactions are in dollars.
It remains to be seen what steps the ECB will take in December, but we
do expect only a limited effect on the Baltics from these (and, of course,
these are not the countries that the ECB is aiming to support). In case the
ECB decides to front-load purchases or extend the purchases to other
instruments, there will be hardly any effect on the Baltics, since there is
still very little to buy (no covered bonds, and a very small amount of
corporate bonds). We believe that the ECB will not alter its main policy
rate, but it is highly likely that the ECB decides to lower its deposit facility
rate. In that case, the pressure on commercial banks profitability would
gradually increase. The longer the rates stay low/negative, the stronger
the expected negative effect on banks profitability, and this is likely to
push them to search for higher risk in lending.

November 25, 2015

Source: Macrobond

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Macro Research - Macro Focus

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