In Bulgaria, these restrictions are now gradually being suspended. Rapid credit growth has contributed to a rise in imports and a deterioration of the current account in most CEE countries. This, combined with real appreciation, may increase the risk of speculation against these countries' currencies under the prevailing pegged or tightly managed exchange-rate regimes.
Currency-board arrangements provide a cushion for limited imbalances because contracting foreign-exchange reserves automatically reduce money supply and therefore dampen aggregate demand. This in turn reduces import propensity. If growth is hampered too much, however, holding to the fixed exchange rate might become increasingly costly.
Banks' potential exposure to indirect foreign-exchange risks may also have increased, since foreign currency-denominated lending represents a substantial proportion of total loans. Loans are increasingly being financed with liabilities other than deposits, as banks expand credit by changing the composition of their assets and by increasing external borrowing.
A sharper-than-expected decline in interest margins resulting from stronger competition may decrease profitability and thereby increase the vulnerability of the banking system. Loans are growing – faster than savings. The low savings rates in most of the SEE countries suggest they are highly dependent on the willingness of foreign investors to fund these deficits.
The pattern is similar to that of other countries, where misplaced optimism about future earnings led to a boost in asset valuations and a surge in capital inflows that allowed firms and households to borrow and spend.
A country may import more than it exports if foreigners are willing to exchange goods for ownership of domestic assets such as cash, treasury bills, securities or real estate. However, many SEE countries have been the target, not only of a rational appreciation of their strength by international investors, but also of a sudden financial infatuation.
There is a looming short- or medium-term problem: Unless capital inflows continue at the current rate every year, the currencies are becoming overvalued. If foreign direct investment levels off after privatization is largely completed, or if foreign lending becomes more restrictive due to deteriorating credit quality or a changing market sentiment, countries with large trade deficits might run into trouble.