Eastern Europe to feel credit squeeze

In the financial times today:

The turmoil in financial markets is turning into a nerve-racking test for the economies of central and eastern Europe and the former Soviet Union. Economists have said the fast-growing region faces a slowdown following the financial shockwaves reverberating around the globe.


But the precise impact is uncertain, especially on weaker economies. Even in the stronger countries there may be hidden dangers lurking within particular companies, notably banks, as the Société Générale debacle has highlighted.

“These countries will be hit,” said Pradeep Mitra, the World Bank’s chief economist for the region. “There is no way out of it.

“They are fundamentally strong enough to resist . . . but some are more vulnerable than others.”

The differences are registering in the financial markets. As investors reconsider their strategies, they are becoming more risk averse. Some have turned against emerging markets, including the ex-communist region. Others are discriminating more between countries. According to the European Bank for Reconstruction and Development, financing costs for less developed countries in the former Soviet Union and the Balkans have risen since last summer by far more than in the advanced states of central Europe.

The spread on five-year credit default swaps (a measure of risk) has widened by 26 basis points for the Czech Republic since last June and by 44 basis points for Poland. But for Serbia and Ukraine the increase is 151 basis points; for Kazakhstan it is 218 basis points.

Erik Berglof, the bank’s chief economist, said: “There has been a repricing of risk,” with credit costs rising most sharply in countries that are perceived to be the most vulnerable to external shocks.

The bank has trimmed its forecast for the region’s 2008 gross domestic product growth from 6.1 per cent to between 5 and 5.5 per cent.

Given the recent unprecedented credit-fuelled growth surge, this slowdown could be welcome in countries trying to cope with inflationary pressures, including Ukraine, Kazakhstan and Russia, and those facing labour shortages, such as Poland.

The benefits could be even greater in economies facing yawning current account deficits, notably the Baltic states, Romania, Serbia and Bulgaria. As Leszek Balcerowicz, the former Polish central bank governor, told a business conference this month: “We should welcome some amount of a slowdown, especially in the Baltic states, which have been growing the fastest . . . We don’t have the information that would make us predict a hard landing. Based on the current information a soft landing in the countries which have been growing fastest is more likely.”

EBRD economists argue that even though the Baltic states and some other countries have large imbalances by global standards, they are less vulnerable than other emerging economies because they benefit from the extra economic security offered by European Union membership. Investors assume greater risks than elsewhere because membership brings clear development perspectives and outside financial scrutiny.

However, things could still go wrong, either at the national or corporate level. Hungary offers a salutary warning of a country that ran into economic difficulties in spite of earlier establishing itself as a front­runner in economic reform. Successive governments allowed fiscal deficits to balloon to above 9 per cent of GDP in 2006 before Ferenc Gyurcsány, the prime minister, bit the bullet and ordered sharp cuts that have slowed GDP growth, with the loss of public sector jobs and more unemployment.

In the past year, attention has focused on the Baltics because of their particularly high inflation rates, headed by Latvia, with 14.1 per cent at the year end, the EU’s highest. But they may be less vulnerable to shocks than they appear because they began to see trouble well before the global credit crunch and have taken action. As Ilmars Rimsevics, the Latvian central bank governor, said: “We have been tested constantly for the past 12 months.”

The Balkans are also a concern. Bulgaria has the largest deficit, at over 20 per cent of GDP for 2007. Romania’s inflation rate is lower than its two neighbours but economists worry its fiscal policies are looser – and may be relaxed further with parliamentary elections due this year. International investors have voted with their wallets and driven the currency down 20 per cent against the euro from last year’s peak.

Farther east, the oil-rich governments of Russia and Kazakhstan run huge current account and budget surpluses and have public reserves to protect their financial institutions. But their international borrowing costs are rising and their stock markets suffering in the global battering.

Ukraine, an energy importer, may be more vulnerable. Even though it has kept its current account and budget deficits under control, it may struggle to cool the economy. A weak government may not be able to impose belt-tightening policies. Meanwhile, in spite of reforms, the large energy sector remains opaque and could provide cover for concealing bad debts. As elsewhere, the unknown threats to financial stability could be at least as dangerous as the threats that economists already have under watch.