| CEE - 10 challenges for the new decade |
| No. 9 Capital Markets |
Besides the Capital Markets Union initiative on an EU level, regional countries could foster their capital markets by improving market access and enhancing market efficiency. Improving financial literacy, incentivizing security issuance or strengthening the role of pension funds would also be helpful.
Capital markets are pretty small in CEE, and are also split along national borders. The low share of capital market financing leaves companies in the region without an important source of funding diversification. It also means that not as many investment options are available to savers as in Western Europe, or the US. The lack of investment options makes it more difficult to reach individual investment goals, i.e. saving for retirement. Deeper and more integrated capital markets could improve the shock-absorbing capacity of regional economies in case of a sudden economic downturn too.
The main reason why capital markets in CEE have not grown into much larger sizes is the strong risk aversion of savers, combined with a lack of financial literacy. Many households burnt their fingers during the post-communist transition either as minority shareholders in the aftermath of voucher privatization or as empty-handed investors in unregulated non-bank institutions that ended up as Ponzi schemes. The lack of diversification made this experience especially bitter. Given that bank deposits have been insured against bank failure, deposits have maintained their popularity and dominant share in the overall savings of households. Deficiencies in financial literacy and regulation are also clearly evident from the asset structure of pension funds, where conservative portfolios predominate over equities.
But how could the weight of capital markets be increased in CEE? Given the gap in per capita GDP compared to the EU average, it is natural to see some difference in the share of capital market financing even if no further burdens would exist. But besides economic convergence, several obstacles could be tackled, or methods exist that could be used, to foster the development of capital markets. We have identified the following areas for improvement:
- Encourage financial corporates to broaden their funding base into issuing more debt securities
- Protection of minority shareholders and unsecured creditors
- Regulation of second and third pillars in pension systems
- Increase of financial literacy of households
- QE of corporate bonds if more accommodative monetary policy is needed
- Fostering of standardization of capital market regulation across the region
What is the gap compared to the EU average?
CEE is behind the European average in the importance of securities markets in financing. As for non-financial corporates, CEE companies only have 0-6% of GDP in debt securities on their liability structure, as opposed to the nearly 12% on the EU level. The role of listed shares is between 2.4%-20.7% in CEE, whereas in the EU, this is nearly 47% of GDP. The gap is proportionately lower for loans, however, with CEE ranging between 37%-51% of GDP, while the EU standing at 65%.
Savings of households paint a similar picture. CEE countries are very heavy in cash and deposits (ranging between 27-63% of GDP), barely below the 69% of the EU average, while savings in listed shares is just 0.3%-3.9% in CEE compared to nearly 10% of GDP in the whole EU. CEE also remains well behind the EU in terms of insurance, pension and guarantees, and investment fund shares. As for debt securities, Hungary might look quite developed, but its high share is attributable to large holdings of 5-year retail government securities. These bonds offer a valuable put option after coupon payment and a yield to maturity nearing 5%, making this investment competitive to deposits.
With the low interest rate environment, households have started to seek higher returns. In recent years, investing in real estate has gained in popularity, as ownership of a tangible asset has been seen as a “safe long-term investment” and superior to investment in securities. It is only a matter of time before investors realize that real estate investments also have their cons – they are less liquid, require a high initial payment, lack diversification, and are more demanding in terms of property management and maintenance in the case of second-home ownership.
Pension savings could enhance the role of capital markets in CEE
Pension savings is another area where improvements could potentially enhance the role of capital markets in the region. Besides the pay-as-you-go (PAYG) systems as the first pillar, several regional countries introduced second and third pillars. Second pillar reforms (which means that some part of social contributions was needed to be channeled from the PAYG system) were reversed in Hungary and in Poland in recent years, however. The second pillar was also liquidated in 2016 in Czechia, downsized in Slovakia and temporary open for opting out. In Romania, the second pillar was only established in 2008, but Croatia established it in 1998 already. The latter has over 20% of GDP in pension assets. Due to the second pillar, Croatia scores relatively well in pension system sustainability, despite its ageing population and negative migration balance. Tax benefits for third pillars exist everywhere in CEE, but these pillars are mostly completely voluntary.
Financial literacy: a key to a more prosperous population
Financial literacy, financial inclusion and robust financial consumer protection framework are all crucial to empowerment of individuals and can contribute to the overall stability of the financial system. The COVID-19 crisis again revealed gaps in people’s financial knowledge and highlighted the need for better financial education and higher financial inclusion. According to OECD 2020 International Survey of Adult Financial Literacy1 conducted in 26 countries in Asia, Europe and Latin America on average around 70% of respondents reported that their savings would last them for up to 6 months with almost 30% having a financial cushion for one week or less. Therefore, as one of the elements of the COVID-19 recovery program, OECD announced that it will double efforts to promote financial literacy.
Furthermore, the OECD 2020 International Survey of Adult Financial Literacy2 found that the overall financial literacy score is low across sampled economies. Individuals scored just under 61% of the maximum financial literacy score, even in advanced economies with developed financial markets. Overall, the financial literacy score includes three sub-categories: financial knowledge, financial behavior and financial attitude. Financial knowledge score measures the ability of individuals to compare financial products and services and make appropriate, well-informed decisions. The financial behavior component looks at following behaviors of consumers: saving and long-term planning, making considered purchases and keeping track of cash flow. Finally, financial attitude looks at attitude to long-term financial planning. As far as the CEE region is concerned, Slovenia has the highest Financial Literacy Score followed by Poland, while Romania had the lowest score.
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CEE Challenges for the new decade:
No.1 Demography
No.2 Going Green
No.3 Rule of Law
No.4 Healthcare
No.5 Euro Adoption
No.6 Labor Market
No.7 Education
No.8 Regional Development