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All-inclusive debt relief will store up trouble in central and eastern Europe

The author is chief economist at the European Bank for Reconstruction and Development

Myopia is a byproduct of democracy. Politicians dealing with short election cycles have every reason to focus on what they can deliver to satisfy voters before the next election. But applying a band-aid to a gunshot wound can make a problem worse in the long run.

Voters are hurt by high energy prices and rising interest rates. Unsurprisingly, many governments are responding with patching solutions to temporarily suspend fuel taxes and introduce mortgage moratoriums.

Helping insecure households should be a priority for any government, with means-tested transfers for the most deprived. Instead, governments in Canada, Germany, Italy and the UK are resorting to general temporary suspensions or reductions in fuel taxes and VAT on energy. Such measures are also popular in Central and Eastern Europe, where rising heating costs hit households harder. An average household in Romania spends a quarter of its budget on energy bills, compared to 7 percent in Germany and 12 percent in Italy.

General measures are popular with voters and can help incumbent governments in the next election, but they come with many drawbacks. They add to the existing pressure on public finances by the post-Covid tribe. They dampen price signals and give wealthier households with larger properties little incentive to save energy. Such price signals, leading to lower energy consumption, are urgently needed if Europe is to break away from Russia’s energy dependency and slow down climate change.

Once implemented, temporary measures often stick. Futures markets expect the price of Brent oil to reach $97 a barrel in December 2023. That is 18 percent higher than the spot price at the beginning of January. The pressure to extend the tax relief will therefore not disappear any time soon.

Likewise, it can be argued that poorer households need help paying down their debts in an environment of rapidly rising interest rates. But here too, governments are tempted to help everyone, not just those affected by job losses or temporarily unable to pay off their debts. This option is politically attractive if many beneficiaries tend to vote for opposition parties. Governments can use debt relief to lure these voters into the next election.

From August 1, a general moratorium on mortgage debt will be launched in Poland. It involves “debt vacations” of up to four months in the second half of 2022 and another four months in 2023. This essentially means extending mortgage loans for free.

The help is available to all borrowers, but only one mortgage contract per person is allowed and it must cover “own use” property. If all eligible borrowers participate in the scheme, the cost will exceed 20 billion zloty ($4.5 billion), according to the National Bank of Poland. The Polish Banking Association estimates it at 23 to 27 billion zlotys, based on slightly different assumptions. Whatever it costs, the banking sector will actually fund it.

Romania is working on a similar plan, which should also start this summer, but the legislative process is less advanced. Moreover, Romania’s moratorium appears to be at least theoretically limited to households hard hit by inflation. Nevertheless, all such measures are disturbances that use another disturbance as an excuse. The problem is that excess liquidity in the banking system has kept the deposit rate very low. This creates the impression that banks are now wrongly raising interest rates on mortgages and other loans.

Moratoria are expensive for banks and disproportionately benefit large property owners. They can weaken a central bank’s monetary policy transmission mechanism and require even higher rate hikes in the future. They create incentives for reckless borrowers by creating an expectation that the next shock will help the government quickly. Finally, they may encourage banks to increase borrowing costs as they too expect more debt relief measures in the future. Both the Bank of Poland and the Polish Banking Association have criticized the moratorium.

A cheaper, more sensible arrangement in Poland is a Support fund for borrowers for people who lose their jobs or whose mortgage payments exceed 50 percent of the monthly family income. This fund, financed by bank contributions, is expected to expand to Zloty 2 billion. Expanding to more households in need would limit the costs expected to arise from the general moratorium. But maybe the government would get less election boost.

The choices policymakers make today are important. Bad policy will make the already devastating impact of the pandemic and the war in Ukraine last much longer than it needs to be.

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