The European Central Bank has rejected pleas from central and eastern European states for it to use its firepower to boost euro liquidity in the regions beleaguered banking system, Emerging Markets can reveal.
Non-eurozone central banks in eastern Europe had aggressively lobbied the ECB in recent months, to accept their local currency-denominated sovereign bonds as eligible securities in ECB refinancing operations with parent banks operating in the region.
But central banks in Poland, Hungary and the Czech Republic the most vocal of lobbyists on this issue yesterday received letters from ECB president Jean-Claude Trichet informing them he had rejected their calls, people familiar with the matter said.
The move was met with outrage yesterday by policy-makers across the region. I dont see the financial logic in the ECBs decision, Mykolas Majauskas, adviser to the Lithuanian prime minister, told Emerging Markets.
Majauskas said the ECB could mitigate exchange-rate risk a key sticking point behind its decision by applying an appropriate haircut to non-euro sovereign bonds to cover the risks.
He argued that countries such as Lithuania, which maintain a currency peg to the euro, have a stable exchange rate system.
And he added that proactive policy responses by the IMF and European Commission to address balance of payment difficulties in eastern European countries mitigated the risk of sovereign default, another ECB concern.
Sources privy to the discussions said hawks inside the ECB believe the central bank risked taking on currency risk with this measure, which would detract from its mandate of maintaining financial system stability.
Lars Christensen, senior analyst at Denmarks Danske Bank said: the ECB took the view that if they did it for Poland or Lithuania, they would have to do it for the whole region, which would be very ambitious.
But Katarzyna Zajdel-Kurowska, Polands representative to the IMF, said: Given the fact the ECB accepts mortgage loans as collateral, I dont buy the argument that the move would create significant credit risks.
She added: Western Europe has crowded out places like Poland in the international capital markets through fiscal stimulus measures.
Radovan Jelasic, governor of the Serbian central bank, told Emerging Markets: Many non-eurozone members would really love the ECB to accept their loans, but the ECB just really doesnt want to.
Trichet had assured regional central banks in March that the ECB would actively consider new monetary policy tools to boost liquidity in non-eurozone economies after aggressive lobbying from regional central banks, led by Hungary, said internal sources.
Hopes were raised that the ECB would take aggressive measures to boost euro liquidity in new member states, when the bank announced last week it would buy covered bonds, in a move widely viewed as quantitative easing. In August 2007 the ECB accepted high quality mortgage loans as eligible collateral for repurchase transactions with banks.
At a May 7 meeting between the ECB board members and representatives of the non-eurozone central banks, governors of the new member states were asked to leave while the board discussed the liquidity measure, according to a source close to the discussions.
The ECBs refusal to broaden its list of eligible criteria to include non-eurozone sovereign bonds in its repurchase transactions with banks has increased the cost of short-term capital.
Western banks operating in non-eurozone EU states have found their funding costs on the inter-bank market soar since the financial meltdown in mid-September. While the ECB has taken unprecedented steps to provide liquidity to banks operating in the eurozone, eastern Europes relative liquidity position has weakened.
As a result, parent banks have become more reluctant to commit their balance sheets to local subsidiaries, as financial institutions move to shore up their positions.
The ECB declined to comment. There are no ECB board members attending the EBRD annual meeting today.