Roubini Global Economics: Eastern European Tinderbox – How Explosive Could It Get?
By RGE Monitor
The Central and Eastern Europe (CEE) region is the sick man of emerging markets. While the global crisis means few, if any, bright spots worldwide, the situation in the CEE area is particularly bleak. After almost a decade of outpacing worldwide growth, the region looks set to contract in 2009, with almost every country either in or on the verge of recession.
The once high-flying Baltics (Estonia, Latvia, Lithuania) look headed for double-digit contractions, while countries relatively less affected by the crisis (i.e. Czech Republic, Slovakia and Slovenia) will have a hard time posting even positive growth. Meanwhile, Hungary and Latvia’s economies already deteriorated to the point where IMF help was needed late last year.
The CEE’s ill health is primarily driven by two factors – collapsing exports and the drying-up of capital inflows. Exports were key to the region’s economic success, accounting for a significant 80-90% of GDP in the Czech Republic, Hungary and Slovakia. By far the biggest market for CEE goods is the Eurozone, which is now in recession.
Meanwhile, the global credit crunch has dried up capital inflows to the region. An easy flow of credit fueled Eastern Europe’s boom in recent years, but the good times are gone. According to the Institute of International Finance, net private capital flows to Emerging Europe are projected to fall from an estimated $254 billion in 2008 to $30 billion in 2009. Whether or not this is formally considered a ‘sudden stop’ of capital, it will necessitate a very painful adjustment process.
Classic emerging markets crisis in the works?
Spillover effects to rest of world
So is this the making of a cross-border banking crisis? It could be. Given the sharp contraction in Eastern Europe’s economies, combined with high foreign currency-denominated lending (particularly in Croatia, Hungary and Romania), weakening currencies and heavy reliance on non-deposit external financing, Eastern Europe’s banks will likely see a large spike in non-performing loans. Banking systems in the region are likely only as strong as their weakest link – or in this case, weakest country. That’s because of the “common lender” phenomenon. As many CEE countries share foreign parent bank(s) in common, this paves the way for problems in just one of these countries to have ripple effects into other CEE countries. So even a relatively healthy economy/banking system like the Czech Republic’s – with a reasonable loan-to-deposit ratio and scant fx-denominated lending to households – is still vulnerable.
Austria is far and away the Western European country most heavily exposed to the CEE region (via Austrian-based banks like Raiffeisen and Erste Bank). These banks’ collective exposure to the region amounts to over 70% of Austria’s GDP. Notably, however, other Western European countries’ total exposure is far less.
Belgium and Sweden are the next in line after Austria; their lenders’ total exposure to the region amounts to a still significant 20-25% of GDP. Some fear that parent banks, if they get into trouble, could either fire-sell subsidiaries or simply walk away. Another concern is Europe’s fragmented regulatory system, which means that if a cross-border bank needs to be unwound, the process is likely to be extremely messy.
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Source: RGE Monitor, February 25, 2009.
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