Central and eastern Europe (CEE) is “in the eye of the global economic storm”, says Peter Garnham in the FT, as it is highly dependent on exports. What’s more, large current-account deficits and short-term foreign debt obligations mean it is dependent on external financing just as capital flows are dwindling rapidly. So the plunge in capital inflows expected this year “won’t just be a major blow to growth”, but could potentially trigger “a regional financial crisis”, says Nicholas Watson of Business New Europe.
The next challenge is refinancing a whopping $400bn this year, which is around a third of the region’s GDP. Ukraine, Hungary and Latvia have already turned to the IMF to bolster their banking systems. Meanwhile, Capital Economics sees “submerging Europe’s” economy shrinking by 3% in 2009.
The dismal outlook in CEE has also created a “ticking time bomb” for western Europe, says Parmy Olson on Forbes.com. European banks are five times more exposed to emerging markets than their US and Japanese counterparts, and they have bet big on CEE over the past few years. More than 80% of emerging European bank assets are owned by western European banks, says Peter Attard Montalto of Monura. Eurozone banks’ exposure to CEE is around €1.3trn; the countries with the largest exposure to the region by assets are Austria, Germany and Italy, with Austria’s lending to the region comprising around 70% of GDP. By this measure, Sweden is also highly exposed, with lending worth 30% of GDP.
Unfortunately, much of that lending was in foreign currencies; around 60% of mortgages in Hungary are held in Swiss francs. And with local currencies tanking against harder currencies, these loans have become extremely expensive for locals to service, raising the spectre of a wave of loan defaults. According to Austria’s Der Standard, a default rate of 10% could well mean the collapse of Austria’s financial sector. Yet non-performing loans in the region may reach above 25%, says Attard Montalto. The world is going to discover that “Europe’s financial system is sunk”, concludes Ambrose Evans-Pritchard in The Sunday Telegraph.
So it’s no surprise that Austria’s finance minister last week tried to drum up support for a stabilisation package for CEE. Meanwhile, some of the most exposed banks, including Italy’s Unicredit and Austria’s Erste Bank and Raiffeisen, are being sold off. And the prospect of further state bail-outs for wounded eurozone banks is compounding jitters over default risks in some European countries.
Now that Europe’s own subprime problem is in the spotlight, due to CEE weakness, the euro has become “tied to the risk of the European banking sector”, says Geoffrey Yu of UBS. Currently at a ten-week low against the greenback, it is set to come under further downward pressure.