Western Europe can’t abandon its neighbours: it owns most of the east’s banks
By IAN CAMPBELL 12 March 2009
‘We should not allow a new iron curtain to be set up and divide Europe in two parts.’ The iron curtain image revived by Ferenc Gyurcsany, the Hungarian prime minister, is powerful yet misleading. Western Europe can’t abandon its neighbours: it owns most of the east’s banks. The eurozone’s own troubles will be worse if the east is abandoned.
Mr. Gyurcsany’s words were part of an unsuccessful plea for a 240 billion euro (S$469 billion) regional bailout from the EU. His peers in the Czech Republic, Slovakia, Poland, Romania, and Bulgaria may have feared his curtain talk was too alarming and involved Hungary in a joint statement on March 4 that sought to distinguish between countries. The region is not ‘homogeneous’ and each country has its own ‘specific economic and financial situation’, the statement said.
The talk of specific crises is true. Each country, like unhappy families, is troubled in its own way. Some are much worse than others. But all face serious problems and there are common threads.
The crisis is, at heart, a private sector one. Though some governments have sizeable deficits and rising debts, sovereign defaults are not the big risk. At the core of the problem are banks, the companies and households to which they lent - often in euros or Swiss francs - and the economic growth that is now undermined by the retreat of credit, foreign capital and property prices.
Now that western banks are no longer merrily pouring vast amounts of money east, many loans will be tough to roll over. This year, the region faces amortisations of 222 billion euros in foreign debt, Goldman Sachs estimates - a sum equivalent to a staggering 22 per cent of the region’s GDP. Many of these loans are owed to parent banks in the west. Their willingness and ability to find fresh capital will be crucial.
Even on quite optimistic assumptions that some 180 billion euros in debt can be raised, Goldman Sachs judges that the region’s deficits on current account - the broadest measure of trade - will have to swing brutally towards surplus: an adjustment in the region as a whole equivalent to 10 per cent of GDP, and in Lithuania, Estonia and Bulgaria about a quarter of GDP. Thailand, the worst affected of Asia’s economies a decade ago, suffered an adjustment in its current account - from the happy foreign-capital-fuelled importing days to belt-tightened export surplus - of 21 per cent of GDP.
Eastern Europe’s crisis is on the same scale as Asia’s and has the same root cause: too much capital entered too fast.
That two of the Baltic Republics and Bulgaria face possibly the biggest adjustment in their external accounts reflects their rigid currency regimes. Together with Latvia - already in IMF intensive care - these countries run currency boards under which the exchange rate is fixed and the monetary base determined by the level of foreign reserves.
The imagined merit of the arrangement is that falling reserves provoke a slowdown in growth and therefore spending on imports, rebalancing the economy and protecting it from crisis. But capital flows that have poured in over the years can exit in weeks. In effect, the currency board mechanism provokes economic collapse. The Baltics are in profound crisis. Latvia and Estonia have lost a tenth of their GDP in the past year. Bulgaria has not yet succumbed. It is hard to believe that its bad time will not come.
The problem for the currency board countries is that they lack a feasible means of economic adjustment - or an exit route from their currency regimes, which unwisely encourage the local currency to be seen as a proxy for dollars or euros.
The Baltics’s pain is being felt in Sweden, whose banks have some US$86 billion exposure in the Republics - and are dangerously exposed to their crises.
In non-currency board countries, devaluation is more than possible: it has happened on a destabilising scale. The currency falls since August last year - by about one-third for the Polish zloty and Russian rouble, a quarter for the Hungarian forint, a fifth for the Romanian leu and Czech crown, and a half for the Ukrainian hryvnia - have begun the countries’ adjustment to relative poverty.
The devaluations have also precipitated crises for banks that were unwise enough to lend in foreign currencies - not to mention the clients unfortunate enough to have borrowed in them.
Poland and Hungary are particular victims of a high prevalence of foreign currency lending. Poland also faces a huge external financing requirement of about 140 billion euros this year while Hungary’s fortunes are made worse by large budget and trade deficits, and public debt that amounts already to about two-thirds of GDP.
Falling exchange rates can help bring external balance. Suddenly, more expensive imports shrink while cheap exports grow. But in countries where borrowing has been in foreign currency, devaluation risks are proving catastrophic.
Foreign currency borrowers are bankrupted, at the expense of the banks which lent to them. In Hungary, in particular, achieving external balance via devaluation without crushing the economy looks extraordinarily difficult, even with IMF support. No wonder Mr. Gyurcsany lead the attempt to bring relief from the EU.
Some help is on the way. Though the EU proved unwilling to respond to the call for a regional bailout, the European Bank for Reconstruction and Development, the World Bank and the European Investment Bank came up with 24.5 billion euros at the end of last month. Latvia, Serbia, Ukraine and Belarus have already also sought the help of the IMF. More countries will tread that path. The IMF could find itself committing some 100 billion euros to stabilisation plans in eastern Europe.
The European Union or western European governments also seem certain to become involved in the rescue effort. With the equivalent of some 70 per cent of Austria’s GDP tied up in loans to the east, the Austrian government may need either to assist Hungary or Romania, where its banks have heavy exposure, or, more probably, the Vienna-based banks themselves.
The loan losses that these banks suffer could easily amount to a third of their total exposure: enough to cripple Austria and severely harm Belgium and other western European countries. Taxpayers in countries such as Austria, Belgium, Greece and Italy could easily see some 100 billion euros added to their collective public debt burden.
The east is inflicting another blow on the eurozone’s growth prospects - and it will be worse for the west if it leaves the east to sink. Mr. Gyurcsany need not have worried. The west has no interest in letting the curtain come down.
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EU will come to the rescue in east Europe
Western Europe can’t abandon its neighbours: it owns most of the east’s banks
By IAN CAMPBELL
12 March 2009
‘We should not allow a new iron curtain to be set up and divide Europe in two parts.’ The iron curtain image revived by Ferenc Gyurcsany, the Hungarian prime minister, is powerful yet misleading. Western Europe can’t abandon its neighbours: it owns most of the east’s banks. The eurozone’s own troubles will be worse if the east is abandoned.
Mr. Gyurcsany’s words were part of an unsuccessful plea for a 240 billion euro (S$469 billion) regional bailout from the EU. His peers in the Czech Republic, Slovakia, Poland, Romania, and Bulgaria may have feared his curtain talk was too alarming and involved Hungary in a joint statement on March 4 that sought to distinguish between countries. The region is not ‘homogeneous’ and each country has its own ‘specific economic and financial situation’, the statement said.
The talk of specific crises is true. Each country, like unhappy families, is troubled in its own way. Some are much worse than others. But all face serious problems and there are common threads.
The crisis is, at heart, a private sector one. Though some governments have sizeable deficits and rising debts, sovereign defaults are not the big risk. At the core of the problem are banks, the companies and households to which they lent - often in euros or Swiss francs - and the economic growth that is now undermined by the retreat of credit, foreign capital and property prices.
Now that western banks are no longer merrily pouring vast amounts of money east, many loans will be tough to roll over. This year, the region faces amortisations of 222 billion euros in foreign debt, Goldman Sachs estimates - a sum equivalent to a staggering 22 per cent of the region’s GDP. Many of these loans are owed to parent banks in the west. Their willingness and ability to find fresh capital will be crucial.
Even on quite optimistic assumptions that some 180 billion euros in debt can be raised, Goldman Sachs judges that the region’s deficits on current account - the broadest measure of trade - will have to swing brutally towards surplus: an adjustment in the region as a whole equivalent to 10 per cent of GDP, and in Lithuania, Estonia and Bulgaria about a quarter of GDP. Thailand, the worst affected of Asia’s economies a decade ago, suffered an adjustment in its current account - from the happy foreign-capital-fuelled importing days to belt-tightened export surplus - of 21 per cent of GDP.
Eastern Europe’s crisis is on the same scale as Asia’s and has the same root cause: too much capital entered too fast.
That two of the Baltic Republics and Bulgaria face possibly the biggest adjustment in their external accounts reflects their rigid currency regimes. Together with Latvia - already in IMF intensive care - these countries run currency boards under which the exchange rate is fixed and the monetary base determined by the level of foreign reserves.
The imagined merit of the arrangement is that falling reserves provoke a slowdown in growth and therefore spending on imports, rebalancing the economy and protecting it from crisis. But capital flows that have poured in over the years can exit in weeks. In effect, the currency board mechanism provokes economic collapse. The Baltics are in profound crisis. Latvia and Estonia have lost a tenth of their GDP in the past year. Bulgaria has not yet succumbed. It is hard to believe that its bad time will not come.
The problem for the currency board countries is that they lack a feasible means of economic adjustment - or an exit route from their currency regimes, which unwisely encourage the local currency to be seen as a proxy for dollars or euros.
The Baltics’s pain is being felt in Sweden, whose banks have some US$86 billion exposure in the Republics - and are dangerously exposed to their crises.
In non-currency board countries, devaluation is more than possible: it has happened on a destabilising scale. The currency falls since August last year - by about one-third for the Polish zloty and Russian rouble, a quarter for the Hungarian forint, a fifth for the Romanian leu and Czech crown, and a half for the Ukrainian hryvnia - have begun the countries’ adjustment to relative poverty.
The devaluations have also precipitated crises for banks that were unwise enough to lend in foreign currencies - not to mention the clients unfortunate enough to have borrowed in them.
Poland and Hungary are particular victims of a high prevalence of foreign currency lending. Poland also faces a huge external financing requirement of about 140 billion euros this year while Hungary’s fortunes are made worse by large budget and trade deficits, and public debt that amounts already to about two-thirds of GDP.
Falling exchange rates can help bring external balance. Suddenly, more expensive imports shrink while cheap exports grow. But in countries where borrowing has been in foreign currency, devaluation risks are proving catastrophic.
Foreign currency borrowers are bankrupted, at the expense of the banks which lent to them. In Hungary, in particular, achieving external balance via devaluation without crushing the economy looks extraordinarily difficult, even with IMF support. No wonder Mr. Gyurcsany lead the attempt to bring relief from the EU.
Some help is on the way. Though the EU proved unwilling to respond to the call for a regional bailout, the European Bank for Reconstruction and Development, the World Bank and the European Investment Bank came up with 24.5 billion euros at the end of last month. Latvia, Serbia, Ukraine and Belarus have already also sought the help of the IMF. More countries will tread that path. The IMF could find itself committing some 100 billion euros to stabilisation plans in eastern Europe.
The European Union or western European governments also seem certain to become involved in the rescue effort. With the equivalent of some 70 per cent of Austria’s GDP tied up in loans to the east, the Austrian government may need either to assist Hungary or Romania, where its banks have heavy exposure, or, more probably, the Vienna-based banks themselves.
The loan losses that these banks suffer could easily amount to a third of their total exposure: enough to cripple Austria and severely harm Belgium and other western European countries. Taxpayers in countries such as Austria, Belgium, Greece and Italy could easily see some 100 billion euros added to their collective public debt burden.
The east is inflicting another blow on the eurozone’s growth prospects - and it will be worse for the west if it leaves the east to sink. Mr. Gyurcsany need not have worried. The west has no interest in letting the curtain come down.
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