Bloomberg News

Czechs Shield Bonds From Euro Contagion With Debt Aversion

February 22, 2012

(Updates with new market prices in sixth paragraph, economic recession in 18th.)

Feb. 15 (Bloomberg) -- Sylvie Pekarova, a 33-year-old pharmaceutical researcher in Prague, has no debt. She doesn’t even own a credit card.

Consumers like Pekarova have helped the Czech Republic avoid the fate of the euro region, which is grappling with a debt crisis now into its third year. With private borrowing at half the euro region’s average, the country now boasts interest rates that are lower than 10 of the currency-bloc’s 17 members. That’s helping the government’s drive to sell benchmark Eurobonds, which started this week.

“It’s this feeling that if something goes wrong, you don’t want to be stuck with debts you don’t know how to pay back,” Pekarova, who lives in a rented apartment in central Prague, said in an interview. “Borrowing money for things like going on a holiday doesn’t make sense.”

Debt aversion in the central European nation has smoothed the acceptance of government austerity at a time when governments from Athens to Madrid are trying to persuade their voters to embrace more spending cuts. As German Chancellor Angela Merkel urges southern Europe to cut debt and spending, Czech borrowing costs are now the lowest among the European Union’s ex-communist states and close to those in Belgium, a higher-rated euro member.

The Czechs began meetings with bond investors Feb. 13, before a planned sale of a benchmark Eurobond worth as much as 2 billion euros ($2.6 billion), the first time the country would tap international markets since September 2010. With yields near record-lows, Deputy Finance Minister Jan Gregor said last month he expects the deficit cuts to secure better terms in the sale than others in the region.

‘Not Afraid’

The yield on the Czech Eurobond maturing in 2021 fell to a three-month low of 3.580 percent as of 4:27 p.m. in Prague today, 1.89 percentage points above the German bund with similar maturity and near its Sept. 30 all-time low of 3.479 percent. The yield on Eurobonds issued by Poland, the EU’s largest eastern economy, was 4.795 percent. Belgium, a euro-region member, returned 3.497 percent on similar debt.

Emboldened by an AA- credit rating at Standard and Poor’s, the fourth-highest investment grade and better than half of the euro region’s members, the Czech Republic was the only eastern member to reject the EU’s fiscal compact last month. Prime Minister Petr Necas said he’s “not afraid of isolation” over the move.

‘Right Response’

Stimulating the economy with a larger budget deficit during the 2009 global credit crunch was “absolutely the right response to the crisis,” Dmitri Barinov, who helps manage about $2.3 billion in emerging European debt at Union Investment Privatfonds in Frankfurt, said in e-mailed answers to questions on Feb. 13. “Then in 2011, they managed to decrease deficit to around 4 percent, which is reliable.”

Even with a credit boom after the country entered the EU eight years ago, Czech banks hold the most savings relative to debt among the bloc’s eastern members. Deposits are 37 percent higher than loans, compared with 15 percent in neighboring Slovakia, a euro member, central bank data show. Savings were 7 percent less than loans in Poland, 27 percent lower in Hungary and 48 percent short in Latvia.

This offers protection for Czech banks against a funding freeze from their western owners, according to UniCredit SpA. Lenders, including Erste Group Bank AG and Societe Generale SA, which control about three quarters of the region’s banking industry, are selling assets and raising capital to meet more stringent capital and liquidity requirements, curtailing credit to households and businesses in the east.

‘Safest Country’

“In a world where investors increasingly focus on bank deleveraging, we think the Czech Republic would actually come as the safest country in the region -- but also probably in the whole EU,” Gyula Toth, a Vienna-based strategist at UniCredit, said in a Jan. 20 report. “This is due to the fact that its banking sector is operating with the lowest level of leverage.”

Household debt in the Czech Republic was 54 percent of income in 2010, according to data compiled by Eurostat, the EU’s statistics institution. That compares with gross debt-to-income ratio, a gauge of indebtedness in relation to the ability to pay back debt, of 99 percent in the 17-nation euro region.

Historical Phenomenon

Czech caution with balancing savings and debt is similar to neighboring regions such as Austria, central bank Vice-Governor Mojmir Hampl said in a Feb. 7 interview. Much of the country was under the control of Hapsburg rulers from the 16th century, becoming part of the Austrian Empire in the 19th century.

“The tendency to save more than take loans is a historical phenomenon in the Czech Republic, which can be traced as far back as the data are available, to the 19th or the end of 18th century,” Hampl said.

The Czechs’ penchant for saving over taking debt has also been encouraged by inflation slowing more quickly than in other former communist countries during the transition from the centrally-planned economies after 1989, Hampl said.

Inflation slowed to less than 10 percent in 1994 and price growth has since stabilized below that mark, with the exception of 1998. Consumer price prices in Hungary rose faster than 10 percent every year until 2001.

Debt Aversion

Aversion to debt is also a central theme in Necas’ program. His 18-month-old government has cut state subsidies, reduced public wages, raised the value-added tax and increased the retirement age to overhaul public finances and slow an increase in government debt, which, at 38 percent of gross domestic product in 2010, was less than half of the EU average.

The coalition Cabinet plans to cut the public-finance shortfall to less than the EU’s limit of 3 percent of GDP by 2013, even as the economy slipped into recession in the second half of 2011 and a worsening economic outlook threatens to curb budget revenue. It wants balanced public finances by 2016. Pekarova, speaking at an old mill turned bar near the Prague Castle, approves of thrift.

“I don’t want to be accumulating debt,” she said. “I want everything I buy to be paid for by what I earn.”

--With assistance from Krystof Chamonikolas in Prague. Editors: Alan Crosby, Balazs Penz

To contact the reporter on this story: Peter Laca in Prague at placa@bloomberg.net

To contact the editor responsible for this story: Balazs Penz at bpenz@bloomberg.net


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