EASTERN EUROPE: Loans Make the Middle Class Poor

  • by Claudia Ciobanu (bucharest)
  • Thursday, October 29, 2009
  • Inter Press Service

Ioana Damian, a 47-year old social worker from Bucharest, has a monthly salary of 1,600 RON, the equivalent of 380 euros. As she ruffles through the pile of bills on the kitchen table in front of her, she lists the amounts she has to pay out every month: 90 euros for a bank loan she took out to install a new heating system in the house; 50 more euros in interest for current expenses loans she contracted in years she could not make ends meet; and another 80 euros for a loan from the union she is affiliated with.

Add to that heating, electricity and phone bills, and the total amount actually surpasses the 380 euros Damian makes every month. Earlier this year, she started cleaning houses to add to her income.

Damian's situation is common in Romania and neighbouring Bulgaria, where consumer loans have boomed since 2000. According to the World Bank (WB), household borrowings in Romania grew from virtually none to 20 percent of the GDP between 2000 and 2008. Similarly, in Bulgaria, household loans increased from 7 percent of GDP in 2003 to 24 percent in 2007 (the figures include mortgages).

The WB estimates that the ratio of household debt service burden relative to disposable income has now surpassed 20 percent in Romania and Bulgaria. But this figure represents an average, and in the case of people with low incomes, such as Damian, the ratio is much larger.

And the majority of people taking out consumer loans in Romania and Bulgaria are actually people with small incomes. According to a recent study conducted by economist Douhomir Minev from the Bulgarian Academy of Sciences, most Bulgarian debtors have monthly incomes of approximately 600 leva (300 euros). The total amounts they have borrowed range usually between 2,500 and 5,000 euros.

A part of the explanation for the boom in consumer loans lies with the emergence of a consumer culture in these post-communist countries combined with the rise of the banking industry. 'Once markets were liberalised, many Western goods appeared on Eastern European markets, and people's preferences shifted towards today's consumption and away from the future one,' explains Bulgarian economist Aleksandar Vasilev from the University of Glasgow. 'One may argue that people were not acting fully rationally.'

But Minev's research points out that, beyond the rabid consumerism, sometimes consumer credits constituted the only way out for people who had trouble surviving on their salaries.

'Our empirical research has showed that a large part of credits and loans (from friends and relatives) are received by people with low and very low incomes,' Douhomir Minev told IPS. 'Even more, a large part of the credits and loans are used for basic, primary needs (even food), and they do not improve the situation of the people taking them. In many cases, credits only worsen the situation and delay the moment of crash.'

According to the research conducted by the Bulgarian Academy of Science, 20 percent of Bulgarians have fallen below the poverty line, more than the 15 percent claimed by official statistics. In Romania, official statistics indicate that 25 percent of the population was below the poverty line in 2008.

Credits can make poor people poorer, warns Douhomir Minev's research.

People turning to banks in moments of desperation often do not fully understand the conditions in their loan contracts. And the banks make little effort to make the loan contracts transparent.

'It is true that the average consumer lacks the financial culture to grasp all the costs,' Aleskandar Vasilev told IPS. 'Many people do not distinguish simple from compound interest rates, and make their decision to take a loan based on the wrong calculations. Indeed, there are also many service fees that add to the cost of the loan. Everything is put on notice boards in small font in banks, so it is the borrower's responsibility to read through them and the contract before signing.'

In a report on financial services in Eastern Europe published this year (Diagnostic Review of Consumer Protection and Financial Capability), the World Bank notes that 'most of the risk exposures associated with the latest credit boom period were assumed primarily by households,' and calls on governments and banks in the region to take measures to remedy the 'power, information and resource imbalances which place consumers at a disadvantage vis-à-vis financial institutions.'

More transparency from the banks could be beneficial for people like Ioana Damian, who says she was affected by unexpected increases in interest rates on her loans over the past year (Romanian banks toughened credit conditions and marginally increased rates on existing loans to stabilise themselves in the current financial crisis).

'I need such crafted calculations to manage from month to month that any additional expense can bring me down,' Damian said. 'So, when the banks increased the interest rates over this past year, even if the increases were of just 10-20 euros, this really hit me.

'I am now considering taking an overdraft, just to be able to pay off accumulated debts,' she added.

Getting deeper and deeper into a spiral of debts is certainly not the solution for people like Damian. But, with governments slashing budget expenses and businesses cutting costs across the region in response to the financial crisis, there is hardly an alternative.

According to Minev, the recovery plans for the crisis can provide opportunities to address poverty and social exclusion. However, for this the recovery plans need to be much more radical than the ones currently being promoted by Bulgarian and Romanian politicians.

'Recovery plans which focus on the regulation and monitoring of the banking system -such as the Bulgarian Recovery Plan - do not analyse the real causes of the crisis,' the economist says.

'Financial reporting and the tax system require the same set of measures as the ones applied to the banking sector,' Minev argues. In turn, this would lead to shutting down of the channels through which illicit money is drained out of the economy, which can result in 'a huge and continuous flow of recovery funds without the need to increase 'budget restrictions', to further reduce the funds for social services or to 'tighten the belts' of those who can hardly breathe anyway.'

© Inter Press Service (2009) — All Rights ReservedOriginal source: Inter Press Service

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