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In what follows I will concentrate more on some of the more general macro economic issues that the structural problems identified above by the IMF pose for Croatia, and in doing so I will also attempt to situate them in the more general context of major macroeconomic problems which currently confront Eastern Europe.

Well, taking the points one by one, Croatia has indeed experienced steady growth and comparatively low inflation in recent years. GDP growth has been “solid” but not “exaggerated” (think the Baltics or Bulgaria), so even though the rate has at this point accelerated to an annual 6.8% in the first half of 2007 (with a high point of 7% being attained in the first quarter) the average of around 4.75% for the 2001–2006 period does not seem out of proportion, and is indeed very close to the IMF staff economists estimate of capacity growth for Croatia as being in the 4 – 4.5% region. Thus it is hard at this point to speak of “overheating” in the Croatian context, although the 2007 surge in both GDP growth and construction-driven consumer indebtedness does need watching carefully.

The contribution of net exports to growth has been substantially negative, with domestic demand pressures and higher international energy prices leading both the trade deficit and the current acount one to widen as the century has advanced. This sustained drop in export competitiveness should be sending out alarm signals all over the place for those with the eyes to see what is happening. Basically to understand what may happen to countries like Croatia it is important to bear in mind that we do not live in the timeless world of neo-classical growth theory, but in the world of real economies in real time where populations come and go, and, in particular, age. I will return to this point later in the post, but the big danger I see in Croatia is that as the demographics shift inexorably upwards to ever higher median ages, and as the share of fixed capital investment (which has been basically accelerated by large government funded civil engineering projects and domestic housebuilding) drops back (due to the fiscal constraints impost by a higher elderly dependent population on the one hand and the liquidity constraints on a steadily older population in terms of housebuilding activity on the other) then domestic demand will undoubtedly weaken as we have seen in other high median age societies, and Croatia will come to need to depend more and more on exports to eke out growth. This is the process we have seen in Germany since the end of the property boom in the mid 1990s, and while, as I explain in this post, Germany has been able to shift the weight of maintaining employment growth on to the export driven back foot, it is hard to see how Croatia is going to be able to do this given the relative price structures that are emerging. And time here, along with population, is becoming an increasingly scarce commodity.

Meanwhile, while headline inflation has been normally contained within the 2–4% range in recent years (see chart above) – and with core inflation even lower – in recent months the inflation rate has started to tick upwards following a pattern which has recently become all too familiar across Eastern Europe. Obviously it is too early at this point to say where this is leading, but the situation does need careful monitoring, and the Croatian central bank we should remember cannot use monetary policy here (see more on policy instruments below) due to euroisation, and is left depending on the national government implementing a strong fiscal surplus to drain excess demand from the system.

Wages and salaries have been rising significantly above the rate of productivity increase over the last 18 months, but while the trend is not unimportant we are still a far cry from the 20% plus rates being seen in Ukraine, the Baltics, Romania and Bulgaria. So everything now depends on what the real available labour supply in Croatia actually is (for which see below), since this will determine the ability of Croatia to keep growing and keep a lid on the inflation issue. Retail sales, which give us another indicator of domestic demand, have been growing at a nifty but not exaggerated pace, rising 7% year on year in the January to September 2007 period.

Now one of the problems which comes into operation in a situation like Croatia’s where there is an effective euro peg, is that exchange rate and monetary policy become either effectively non-existent (the exchange rate policy case) or impotent (the monetary policy one ) to correct any growing competitiveness problems – since given the euroisation it is not practical to adjust downwards the exchange rate (since the debts would become unbearable for many people) and increasing the interest rate only puts upward pressure on the currency and attracts additional funds in search of yield which only serve to make the excess demand problem even worse. Thus the only real arm left in the government policy arsenal is the fiscal policy one, whereby the government attempts, by running a fiscal surplus, to “drain domestic demand” from the system, and thus work to effect some form of price deflation (for a fuller discussion of this complex topic in the Latvian context see this post). And this, of course, is exactly the policy that the IMF economists tirelessly advocate that the Croatian government practices.

But it is exactly here that we hit a problem, since far from running a fiscal surplus as required, the Croatian government has been running fiscal deficits, even if, up to the election year of 2007, they had been reducing.

Obviously the fact that this has been an election year hasn’t exactly helped put politicians in the frame of mind to pay the necessary heed to the IMF recommendations and spending pressures have been steadily mounting. Government approved increases in child and maternity benefits and free school textbooks (all of which are in principle a good thing in a society which is short of children) were introduced at the end of last year, adding in the process 0.3% of GDP to expenditure, without compensatory reductions in spending elsewhere (unfortunately here there are no free lunches). Demands to boost wages in the state sector have been frequent in the run up to the election, as have those to increase the pensions of post-1999 retirees — whether this be through a reversal of the existing pension reform parameters, or through “off-budget” accounting schemes. Now evidently increased economic growth can bring in increased revenue which can help pay for extra spending, but if the economy is already running up against its capacity limits then that growth can only have one result, increased inflation, and given the effective euro-peg this inflation means only one thing, a loss of export competitiveness. What has been happening elsewhere in Eastern Europe should give clear indication that this is no joking matter.

On the surface it would appear that spare capacity does exist in Croatia, since the unemployment rate remains high, despite recent declines that reflect both some small employment growth and a declining rate of labor-market participation. But this nominally high unemployment level may be deceptive since we do not know the quality of much of this (often elderly) reserve labour army, and indeed we do not even know how many of the people involved are even in the country (see below).

If we look at construction activity, we can see that after taking off in early 2005, and remaining strong throughout 2006, the rate has remained more or less stable in 2007, and we have not seen further dramatic increases in activity. Thus while pressure on manpower and salaries in the construction sector remains, it does not seem to be accelerating dramatically at this point. However we should note that within a constant level of activity, the relative shares have changed, and domestic homebuilding – fuelled by comparatively cheap euro or swiss franc loans, and financed by streams of income from remittances – has now become a much bigger partner, while government financed large-scale civil engineering projects have become steadily less important.

One of the things we should now be learning from looking at what is happening across Eastern Europe is that in an environment where a number of underlying problems exist – ranging from a lingering and heavy state presence in the economy, a high public sector debt and deficit level, an absence of strong goods exports competitiveness, labour supply shortages due to migration and long term low fertility, and extensive euroization of the banking sector – heavy capital inflows can come to seriously strain the entire macroeconomic framework. This risk becomes even greater if measures are not taken to drain excess liquidity from the system (by running a fiscal surplus for example), to loosen labour supply constraints by facilitating inward migration of unskilled workers, and to accelerate the pace structural reforms – and particularly those which facilitate the development of “greenfield” investment sites which help channel capital flows towards productivity-enhancing uses and in so doing raise exports.

Of all the transition countries that have joined or are soon to join the EU, Croatia has the highest share of euroised bank deposits, with approximately three quarters of all deposits being in euros. Virtually all loans in Croatia are indexed, and all loans depend on the exchange rate and are thus exposed to exchange rate risk. One way to remove this exchange rate risk would, of course, be to introduce the euro, but when you come to look at the economic stress issues which are emerging in one Eastern European economy after another, then it would seem that this potential solution lies a long way out in the future, at the very earliest. Meantime Croatia has to survive, and to export to live. Prices and wages as expressed in kuna need to become more competitive, and this is begining to represent a major problem.

Total foreign direct investment (FDI) into Croatia is close to the regional average—but a high share of this is associated either with privatizations or with the financial sector, while “greenfield” FDI remains well below what could be thought to be desirable. This is disturbing, since FDI which exclusively takes the form of privatisation participation is effectively a form of outsourcing state debt, and at some stage all of this has to be repaid in the form of income outflows and thus may well imply negative consequences for the current account, as Hungary is currently finding out to her cost.

Net FDI inflows averaged just below 5% of GDP annually during 2001–05, and 1.5% of GDP of this was accounted for by privatizations. The financial sector has received a very large share of FDI (both privatization and new capital), whether we are talking about the longer term (28 percent of total inflows over 1993–2005) or more recently (over 50 percent of FDI in 2005, partly reflecting capital injections to foreign-owned banks). Meanwhile non-privatization, non-financial sector related FDI inflows into Croatia have remained modest.

As the header to this post suggests, we are thinking here about Croatia’s economic situation in the context of general processes which we can observe in operation across the whole of central and Eastern Europe. The most important of Croatia’s problems is undoubtedly constituted by its deteriorating external competitiveness, as reflected both the goods and services trade deficit (see above) and, in particular, in the current account deficit.

Also it is worth noting that net transfers from abroad in the form of remittances have been a growing and fairly stable source of financing. Remittances were estimated by the World Bank to have been worth around 3% of GDP in 2006. Now one of the interesting things about this data on remittances is that it can help us take a first shot at solving another of Croatia’s enigmas, the “missing labour force” one, or if you prefer, why the employment participation rate of the Croatian population seems to be so incredibly low (only 42.8% of the over 15 population in the first quarter of 2007). Now one of the factors in play here must surely be the very low participation rates of males workers in the 50 to 64 age group (only 55.9% in Q1 2007) , but another feature of this apparently very low participation rate must surely be associated with the fact that significant numbers of Croatians are working abroad without recognition of this being reflected in the published figures. (This is quite a widespread problem with the East European data, as I explain in this post here). We can get some impression of the extent of the issue if we compare the 3% of GDP number for Croatian remittances with the 4.1% for Romania and the 1.3% for Poland (World Bank data) since in both cases substantial numbers of nationals are known to be working abroad. The size of the Croatian share makes it reasonable to assume that a reasonably large number of Croatians are economic migrants working abroad, but if we come to look at the statistics provide by the Croatian Statistics Office to Eurostat, you would never imagine this was the case, since you would get the impression that Croatia has been a small net receiver of migrants since the start of the century.

Now the very large movements of population which can be observed in the Croatian data for the 1990s are undoubtedly associated with the war and political convulsions of the time, but since the turn of the century virtually no movement is observed (apart from the flow of money), and how is this possible I ask myself? Undoubtedly one of the answers is likely to be found in the definition of ‘migrant’ which is used by the local authorities, who surely, as is standard practice across Eastern Europe, only classify as migrants those who emigrate permanently. The rest simply don’t show up in the data, and clearly many Croatian economic migrants currently working abroad still entertain the hope of returning home “one day”. But this is not the same thing as being “ready and available for work tomorrow”, and the labour market data we have to go on simply don’t reflect this underlying reality, and this is important, if Croatia doesn’t one day want to find itself with an inflation bonfire getting steadily out of hand such as the one which is currently to be found in the Baltics or Bulgaria.

So, and in conclusion, what we need to draw from all of this, is the idea that inflation in Eastern Europe is a complex issue, and that the sudden appearance of this phenomenon in one country after another should be sending us all warning signals. The combination of high catch up growth, constrained labour supply (associated with out migration and low fertility), strong capital inflows via the banking system and remittances, euro-pegging (or strong linking) and the absence of exchange rate and monetary policy as effective instruments all make for a potentially explosive mixture. When you add to this the steady ageing of the population, and a likely growing dependence on exports rather than domestic demand for growth, then you can begin to get a measure of the scale of the problem Croatia is facing, and it is no mean one.

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I agree completely with Montgomery’s opening paragraphs, about Serbia’s ruling coalition:

G17 Plus wants to improve the country’s international financial position and its overall economic underpinnings.

DS is trying to move Serbia towards full integration in the Euro-Atlantic institutions and more importantly, have Serbia perceived as a normal European country, sharing a common system of values.

DSS remains focused on Serbian national questions such as Kosovo and Bosnia. The rivalries and animosity among these three parties is far stronger and more evident than towards either the Socialist or Radical Parties, which would logically be their political and philosophical opposition.

The end result is a government with major internal contradictions; “fiefdoms” exclusively controlled by individual parties; a patronage system where party loyalty rates far higher than competence, honesty or effectiveness; stalled reforms; and lack of coordination in public statements which results in contradictory messages to the outside world.

Just so. After that, however, I think he heads off into mouth-breathing Serb Menace land. For instance:

The DSS has already taken steps to demonstrate that there will be serious regional repercussions in the event of Kosovo independence. A major initiative in this regard was to link the date of elections for the Serbian President to events in Kosovo.

In other words, the DSS has deliberately taken steps which make it far more possible that the next President of Serbia will be from the Radical Party. They are sending a message to the International Community that this is one of the potential downsides of unilateral recognition of Kosovo Independence.

Meh. What DSS is really doing here is signalling to its coalition partners that it would be willing to join a government with the Radicals. Since DSS has been sending these signals since the elections nearly a year ago, this is not exactly shocking. The only questions are whether anyone will ever find the nerve to call their bluff; and if so, whether they’re really bluffing.

A Radical President? Unlikely. Current President Boris Tadic is one of the most popular… no, that’s not right. One of the least unpopular politicians in Serbia. He had little difficulty defeating Radical Party leader Tomislav Nikolic three years ago. Nikolic will probably be the rival candidate again, and will probably be beaten again.

The second step which the Prime Minister and his party has taken is to support aggressively the Bosnian Serb leadership in its protests over measures taken by the High Representative to facilitate the work of the Bosnian Parliament and Council of Ministers.

This was accompanied by a coordinated media campaign reminiscent of the Milošević years. This was intentionally done to present a case of the International Community mistreating Serbs not only in Kosovo, but also in Bosnia.

True. And it’s kind of sad how willing most of Serbia’s media has been to swing into line on this. But not really relevant; protests from Belgrade are going to have little effect on events in either Bosnia or Kosovo.

The end result was to solidify, at least in the minds of the Serbs, a definite linkage between the two cases. It raises the possibility that any unilateral declaration by the Kosovo Albanians of independence could lead either to further Bosnian Serb challenges to the authority of the High Representative or even an effort to stage a referendum on independence for the Republika Srpska.

I think this is possible, though not likely. RS leaders have been muttering about a referendum for a while now.

Problem is, this would blow up Dayton, and give the international community an excuse for reorganizing Bosnia. Of course, that in turn would drastically escalate matters, so maybe not.

But on yet another hand, the status quo in Bosnia isn’t too bad for the RS leaders… they’re autonomous, and not for from de facto independent. The current High Commissioner can hassle them, but he isn’t changing the balance of power. I have trouble seeing them want to take a wild gamble like a referendum.

Thirdly, the DSS has taken the lead in visibly cozying up to Russia. This includes claims that the West’s purpose in supporting Kosovo Albanian independence is to create a “NATO State” in the Balkans and other NATO bashing. The obvious intent is to show that the end result of Kosovo independence would be a Serbia far, far closer to Russia and more distant from the EU.

Who cares?

Really. The whole “we’re going to jump into bed with Russia!” thing doesn’t resonate anywhere outside of Serbia. This is not a meaningful threat. You want to join Russia? Knock yourself out, guys. Welcome to Kaliningrad South.

Finally, even though the government has been careful to avoid any overt signs of support, the announced formation of a “St. Tsar Lazar Guard” composed of Serbian volunteers to fight to defend Kosovo in the event of an unilateral declaration of independence is obviously designed to raise the possibility of paramilitary units going into Kosovo as they did in Bosnia and Croatia in 1990-95.

I don’t think the current government is dumb enough to let these guys actually do anything; and if they are, I don’t think the international community would be dumb enough to let them get away with it. People do still remember the 1990s.

The hope of the DSS is that these threats and actions will be sufficient to scare key EU countries such as Germany so that they defer any action on Kosovo. At least as of today, however, it appears as if the majority of EU countries (including all of the “heavy hitters” with the support and encouragement of the United States has decided to proceed regardless of the potential consequences.

Since these threats and actions aren’t all that scary, this isn’t surprising. — Mind, it would be interesting to see an up-to-date nose count of who stands where on Kosovo. German seems to be tipping towards recognition, but does anyone have more on that?

In fact, it unfortunately seems that many in the West are beginning to view Serbia, as during the Milošević years, as a destabilizing factor in the region. The “honeymoon” following the downfall of Milošević is definitely over.

I’d say that’s true. It’s also a little unfair, since Serbia has a real grievance with Kosovo. But in terms of perception, yeah, the current Serb leadership is reminding a lot of people of the bad old dies. Croat President Stipe Mesic said this in a speech just the other day; since Mesic isn’t usually a big Serb-basher, it’s worth taking notice.

The question then becomes, exactly what will Serbia do in the event of unilateral independence. My best guess is as follows:

Duelling guesses! Woo hoo!

a) A contingency plan has already been worked out with Kosovo Serbs so that they will react immediately in rejecting any unilateral declaration of independence.

Probably.

Serbian-controlled areas will be established in Kosovo similar to those set up in Bosnia and Croatia sixteen years ago

Maybe. If so, this will only be in the northern, Serb-dominated part of Kosovo. The Serb enclaves in the south are too small to make this possible.

b) At least some “volunteers” from Serbia proper will go to help the Kosovo Serbs. The government will take a hands-off position and claim that it had nothing to do with it.

See above. I don’t think this will happen.

c) The Bosnian Serbs will be encouraged to further challenge the High Representative, possibly even with a referendum initiative.

They may be encouraged, but I’ll be surprised if they actually do it.

d) Large protest rallies will be staged in many cities in Serbia.

Whoop ti doo.

e) Efforts will be made in Parliament and in the media to significantly downgrade relations with countries which recognize Kosovo independence.

What, like Serbia’s major trading partners Italy and Germany?

I think “efforts will be made”, sure. There will probably be an outburst of anti-Americanism, in particular. And Germany has been a whipping boy of Serb nationalism since dirt was new. But I don’t think it will have much effect. What are they going to do, break off relations?

f) Serbia will renounce any responsibility for its debts in Kosovo with international financial institutions.

Umm. Any version of Kosovar independence is likely to include saddling Kosovo with some debt (though the Kosovars will vigorously resist, of course). But how is Serbia supposed to square “Kosovo is still part of Serbia!” with “but we renounce all debts”?

g) Serbia will close its boundaries with Kosovo for all traffic other than those with Serbian license plates and review its transit agreements with KFOR/NATO.

This might happen briefly. It’s very unlikely to stick. A blockade would cripple Kosovo’s economy (the overland connections to Macedonia and Albania are pretty bad), but it would inflict a lot of pain on Serbia too. The economies of southern Serbia and Kosovo are tightly interconnected — much to the irritation of both Serb and Albanian nationalists. Since Kosovo is on the euro, and runs a big trade deficit with Serbia, it’s an important source of hard currency. And the parts of Serbia that are exporting most to Kosovo are exactly the parts that are the strongest supporters of DSS.

h) Serbia will consider cutting off its supply of electrical energy to Kosovo.

“Will consider”? What kind of a prediction is that? Here’s my prediction: they won’t pull the plug.

i) Serbia even now will encourage Russia to use the renewal of the EUFOR Mission in Bosnia in the UN Security, which is scheduled for December, to extract unacceptable concessions in exchange for its support.

They may “encourage”, but it won’t work. Note that Russia has made noises about Bosnia — they’re very critical of the current High Rep — but has yet to even suggest concrete action there.

j) Serbia will do some “saber-rattling” by ostentatiously moving military units closer to the boundary with Kosovo and reinforcing the police units currently there.

Police, maybe. Military, no.

k) There may well be some highly-publicized departure of Kosovo Serbs, primarily from the more southern enclaves.

No “may well” about it; some Kosovar Serbs will leave.

But not many. Most everyone who was going to leave has already. The ones who are left are either fanatically devoted to the land, so poor they have nothing to lose, or both. (Talking about the enclaves here, not the north.)

What this adds up to is “not much”. There’s just not a lot Serbia can do here. Obviously they’ll refuse to recognize Kosovo, and obviously Russia will make as much diplomatic profit from the affair as possible. (Most notably by connecting Kosovo to Russia’s own “frozen conflicts” — if the Kosovars can do this, why not the Abkhaz?) But Serbia itself… well, what are they going to do? Elect a Radical government? Join Russia?

So, here’s my prediction: Kosovo will get some sort of independence, Belgrade and Moscow will cry foul, there will be a certain amount of huffing and puffing… and then, not much. The borders will stay open; the lights will stay on. The medium-term effect will be to create a sort of Balkan Taiwan, recognized by some states but not by others.

We’ll find out soon enough, won’t we.

Predictions! Anyone else want to try?

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Well, a number of reports which have been published during the last week, when placed alongside the associated comments from those responsible for overseeing of the eurozone banking sector do seem to underline just how serious the situation in the eurozone potentially is. First off we have the latest EU Commission economic forecast which draws explicit attention to the way in which the home loan credit squeeze is now beginning to work its way across the complete gambit of EU economies, pointing out in the process the likely implications of this for economic growth in the region:

An unexpectedly sharp correction in house prices resulting from the global credit squeeze poses a significant risk to growth in Europe, according to the European Commission.

Now even if I personally don’t regard the European Commission as last word in economic commentary and analysis (and in particular I tend to take each and every statement which emerges from the Economy and Finance Commission headed by Joaquim Almunia – a far cry this from the days when the department was run by the ever interesting Pedro Solbes – with the proverbial pinch of salt) I do think that this time round there are good reasons for sitting up and taking note of what is being said, and in particular of the fact that the Commission itself is now signalling the growing significance of the problem. In particular, and living in Spain, I cannot but agree with Almunia when he says that since housing and construction have contributed so enormously to Spanish growth in recent years, then the international problems in the housing sector will more than likely have a particular effect here. The Spanish consumer confidence index has now hit all time record lows for the second month in succession.

Secondly we have the business confidence reports (see for example the German ZEW and IFO indexes and the Italian ISAE) one) and in particular the latest results from the KPMG/NTC business outlook survey where they found that business confidence was dropping rapidly across the entire eurozone. The survey reported that the healthy confidence which could be found in the European business outlook only a few months ago has now given way to much weaker expectations for business activity. The contrast that exists here with what is happening in the BRIC economies – Brazil, Russia, China and India – where the underlying conditions are evidently very different from those in the more developed economies, couldn’t be clearer.

The confidence in the European business outlook of earlier this year has given way to much weaker expectations for business activity, revenues, profits, capital spending and employment. In contrast, corporate confidence in Brazil, Russia, India and China, the so-called Bric countries, is sky high….With Russia, India and China accounting for half the world’s economic growth for the first time in 2007, emerging markets arguably now have sufficient weight in the global economy to withstand an advanced world financial crisis.

Half the world’s economic growth! This isn’t “decoupling” as some people imagined it (of Europe and Japan from the United States), but it is a massive “recoupling” of the global economic train, and one which is of historic proportions, with some developing economies now assuming a role from which it seems there will be no turning back.

Clearly the ability of these developing economies to withstand a major financial crisis and economic slowdown in the developed economies is what precisely remains to be seen, and in particular it will be interesting to see who will withstand better than who. Will Russia and parts of Eastern Europe, for example, where rising inflation and rampant labour shortages following the evolution of very low male life expectancy, large scale labour out-migration and 20 years of rock bottom fertility be able to sustain the high rates of GDP growth which are currently taking place, or are some developing economies in serious danger of overheating and consequent correction. Well, we are all now going forward to a robustness test, and it will be interesting to see just who has been right and who has been wrong here.

Finally, and and returning to the main topic of this post, we have the question of the ongoing problems which beset the European banking system. Here some of the recent statements by José Manuel González-Páramo – the ECB board member responsible for open market operations – prove to be quite revealing. In a recent interview with the Financial Times González-Paramo indicated that there was “no deadline” for support for the banking sector and that the ECB Emergency help to try to calm markets would be provided for “as long as necessary…. and …to the extent that money markets remain subject to tension, we will stay there”. He also openly admitted being taken aback by the scale of recent write-downs in the banking sector adding that “frankly speaking I did not expect them to be of this size.”

Now as the FT also notes the ECB has in fact managed been reasonably successful in bringing overnight inter-bank interest rates back into line with its main policy rates, but the three-month inter-bank rates still remain stubbornly high (and this is a reflection of the nervousness which there is in the banking sector when it comes to one bank lending to another). These higher-than-desired rates thus threaten to act as a brake on real economic activity and to drag-down growth. As we can see from the chart below (please click on thumbnail for better viewing), the 3 month London Interbank Rate on euro denominated loans shot up in August on the back of the growing “financial turmoil”. The rate has now come down somewhat since a month or so ago, but it still resists a correction back to “normal” conditions. It is worth bearing in mind that the ECB refi rate has not been changed at all during this time. Now the 3 month euro Libor rate is useful as an indicator, since it gives us one of the best readings we can get on “sentiment” in the banking sector, and the outlook certainly has not improved dramatically at this point. (Data for the chart come from the British Banking Association).

Putting this question in a somewhat broader context, we could note that what is possibly the most widely quoted source for the state of the eurozone banking system is the quarterly bank lending survey published by the ECB. Normally a rather drab and tiring document, full of technical detail, last October’s edition was eagerly anticipated and widely read. In particular for this:

The results of the October 2007 bank lending survey which refer to the third quarter of 2007 indicate a net tightening of the credit standards for loans to enterprises (from a net easing of -3% in the second quarter of 2007 to 31% in the third quarter of 2007). This follows a long period of standards remaining basically unchanged or being slightly eased. The net tightening most likely reflects the worsening of global credit market conditions. In the third quarter of 2007, banks also reported a net tightening of credit standards for housing loans to households (from a net easing of -1% in the second quarter of 2007 to 12% in the third quarter of 2007), following a slight net easing in the previous quarter. Credit standards for consumer credit and other lending to households were eased slightly, compared with basically unchanged standards in the previous quarter.

The credit market events have had a different impact on credit standards depending on the loan segment. Loans and credit lines to enterprises were more affected than loans to households. More banks expect the recent developments in credit markets to have an effect on credit standards over the next three months than was seen over the past three months. Banks generally reported that the recent turmoil in the credit markets has hampered the conditions of access to wholesale funding over the past three months, and may hamper funding over the next three months. Banks’ willingness to lend over the next three months may be affected, to some extent, by the effect of the credit market events on the costs related to the banks’ capital position.

So basically the problem is an ongoing one, affects both households and companies, and possibly companies even more than households, and perhaps this offers us an insight into the background which lies behind some of the gloom to be found in the business and consumer sentiment surveys cited above.

So, if bank lending conditions actually have tightened, how does this affect you? Well it will obviously affect you if you either want to buy or sell a house, or if you work for a company which needs to borrow money, whether to invest or maintain liquidity levels. And if this isn’t your case, but you have a job or a business in the services sector, and your job or business relies on customers who either want to buy or sell a house, or who build them or sell them, or on customers who work in companies that need to borrow money, then you might just notice that you have less of them (etc, etc, etc). Surely this is not a situation for panic at this point, but it is one for concern. According to a statement issued by the ratings agency Standard and Poor’s earlier today, European banks are currently well positioned to face what is likely to be an “exceptionally demanding” market environment and in general are likely to retain their stable credit ratings outlook. S&P’s do note, though, that the banks face higher borrowing costs and scarcer liquidity in the months to come, giving them the expectation that interbank conditions will “remain relatively tight until at least early 2008″. So the scene is definitely set, now all that remains is the wait to see just how all of this will actually affect the pound – or the euro – you have in your pocket.

Update: 24 November:

The problems mentioned in this post are a long long way from disappearing. The Financial Times this morning reports that the ECB announced yesterday that it was taking fresh emergency action to pump funds into the money markets as renewed fears circulated that liquidity in European credit markets is once more starting to dry up.

On Friday night, the bank said it would inject an unspecified amount of extra liquidity next week, noting “re-emerging tensions” – and would do so until at least the end of the year. Earlier, Jean-Claude Trichet, ECB president, had pledged continuing action to keep short-term money market interest rates in line with its main policy rate.

The new promise of intervention came as three-month US interbank rates rose for the eighth day in a row to 5.04 per cent, more than half a point higher than the US Fed Funds target rate of 4.5 per cent.

Three-month money usually trades just above the Fed Funds rate which is 4.5 per cent. Europe and UK money markets are showing similar strains.

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For the curious, here’s a recent interview with EU proconsul-in-Bosnia Miroslav Lajčák. Lajčák points out — correctly enough — that his recent moves have been entirely legal; he just wants to end the obnoxious habit of entity representatives bringing legislation to a halt by not showing up. Of course, it could be argued that Lajčák is following the letter of Dayton but ignoring the spirit. On the other hand, twelve years have passed since Dayton; the country was supposed to be moving on by now.

(Is Lajcak good at his job? It’s early days — he’s only been there since July. But he’s certainly an improvement over his predecessor. And hey — at least he speaks good Serbo-Croat.)

Back in April, I did a league chart for the Western Balkans. Half a year on, this might be a good time to revisit it.

There are six countries in the Western Balkans. All want to join the EU. They break down neatly into three groups: two countries that are full candidates for membership, two that have Stability and Association pacts, and two that don’t even have that.

1) Croatia. Croatia is a full-fledged EU candidate, with membership expected in 2010 or 2011.

If it were up to me, I’d keep them hanging another year or two. Croatia is still a very troubled country. The fact that it’s relatively wealthy obscures some serious problems: deep social divisions, a thoroughly corrupt judiciary, security services that are still a state within the state. And there’s a lot of nastiness from the 1990s that has been swept under the rug.

But it’s not up to me, and it’s going to be very hard to keep Croatia out. They’ve already started negotiating their chapters. They have a per capita income higher than several current members, they’ve fulfilled their obligations to the Hague court (in the letter, if not in spirit) and they have strong support from several current members including Italy, Austria, Poland and Germany.

The Croats say they’ll be in by 2009. This won’t happen, but 2010 is plausible and by 2012 they should be in barring catastrophe. There are a few things that could derail their membership — the outstanding border dispute with Slovenia, for instance, or the continued inability of Croatian courts to deal with war criminals — but these are long shots.

One slight complication: the current set of EU treaties only allows 27 members. But this can be solved by an amendment, which can be ratified at the same time that everyone is ratifying Croatian membership.

Six months later: no change. Croatia’s judiciary is still biased and corrupt, no more Serbs have come back, and Croatia is still on track to join by 2010.

2) Macedonia. Macedonia is an EU candidate, but it’s several steps behind Croatia. Membership is not likely before 2012 at the earliest.

Macedonia has some problems. Here’s the dumbest one. A couple of years ago, France adopted an asinine constitutional amendment requiring a referendum on all new EU members. This was, of course, aimed at the Turks. (I know, I know… a thinly disguised appeal to xenophobia dressed up as a piece of populism. In the reign of Jacques Chirac! Who would have thought it?) But the Macedonians will probably be the first to be affected by it. Yah, that’s right — unless France amends its constitution back, France (population ~60 million) will have to hold a referendum on admitting Macedonia (population ~2 million). And then additional referendums for Albania, Montenegro, and every other country on this list.

Another problem: both the Greeks and the Bulgarians have muttered under their breath about blocking Macedonia’s membership. In the case of Bulgaria, this is probably just posturing. In the case of Greece, it’s hard to be sure — the Greeks have shown an impressive capacity for stupid behavior where Macedonia is concerned.

Not much change. Macedonia is doing OK economically. The Ohrid Agreement has kept the country from blowing up, but the two big ethnic groups still dislike and distrust each other. Membership is no closer than it was.

3) Albania. Albania is not a candidate, but does have a Stabilization and Association agreement.

Albania’s not close enough to membership to even think about a date. “Not before 2012″ is as close as I’ll venture. It’s still a poor and corrupt country with all the usual post-Communist problems plus some unique local ones as well. That said, Albania has seen several years of strong economic growth, and their last election was reasonably clean and not too violent. (It also marked the first peaceful transfer of democratic power in the country’s history.) PM Sali Berisha, while still an arrogant, pigheaded SOB with dismayingly authoritarian instincts, has been much less of a disaster than we all feared a couple of years ago. So, cautious optimism for Albania’s economic and political development.

One complicating factor for Albania: poll after poll shows that Albanian membership is not very popular with most EU members. This is partly the religion thing — Albania is a majority Muslim country — and partly because Albania has a very bad reputation; insofar as EU citizens are aware of Albania, they tend to associate it with crime and violence. That’s not entirely fair, but there it is.

Not much change, but Albania is doing OK. The economy continues to grow. Foreign investment is pouring in. The Berisha government continues to be, not good, but much less bad than anyone expected. If Albania weren’t, well, Albania, they’d probably be looking at real candidacy within a year or two.

4) Montenegro. They’re #4 right now, with the ink barely dry on their S&A, but I wouldn’t be surprised to see them zip past Albania within a year or two. They’re surfing a wave of good publicity from last year’s peaceful secession from Serbia. Djukanovic is a none-too-democratic Big Man, but he’s a smart Big Man, and the country’s small size means that some reforms will be easier to implement. If Djukanovic decides to pocket his gains and allow real no-kidding democracy, Montenegro’s prospects aren’t bad.

Not much change. Djukanovic has “retired”, though he is still the not-so-grey eminence behind the scenes. At this point, Montenegro’s separation from Serbia looks like a success.

Then there are the two slow students.

5) Bosnia. Bosnia still has a chance to get an S&A pact by the end of this year, but it’s probably not the way to bet. The EU has made it clear that it wants to see progress in everything from constitutional amendments to police reform, and no progress has been forthcoming. Basically, Bosnia’s various nationalists are holding its progress hostage.

Man, I hate being right about stuff like this.

6) Serbia. Well, what is there to say. Serbia’s EU aspirations have been frozen for a year now, as the Kostunica government has not been cooperating with the Hague Tribunal. Note that this lack of cooperation goes beyond not finding Karadzic and Mladic — Belgrade hasn’t even been making the required progress reports. I’m no fan of Carla del Ponte, but she’s right to be pissed here.

Kosovo complicates the picture considerably. It’s possible that the EU might award Serbia an S&A pact in return for accepting the cession of Kosovo. On the other hand, it’s hard to see any plausible Serbian government agreeing to such a deal. And even if they get a Stability and Association agreement — and improved cooperation with the Hague, too — there are internal dynamics that will make it quite hard for Serbia to work effectively towards candidate status.

I don’t want to be too pessimistic here. It’s possible that the Serbs might still pull it together and get candidate status by the end of the decade. But the sad fact is, at the moment they’re the very last in line.

Well, the big change here is that Serbia has moved up a step, while Bosnia has fallen to the bottom of the charts. Instead of an “SAA for Kosovo” deal, the EU has decided to grant the SAA more or less as a mulligan, presumably hoping this will strengthen Serbia’s “moderates”. Maybe.

Prediction: six months from now, Serbia will have an SAA and something will have happened with Kosovo. Otherwise, no change.

Thoughts?

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