As the eurozone crisis worsens, “countries far afield are being sucked into the maelstrom”, says Stefan Wagstyl in the FT. The MSCI Emerging Markets index has slid by 15% since early July. Trade flows are one reason. Exports to western Europe are a key driver of growth in eastern Europe. For example, EU members account for 80% of exports from Slovakia and the Czech Republic.
But while eastern Europe is most exposed in terms of trade, Asia is also vulnerable. As Bank of America Merrill Lynch points out, Europe is emerging Asia’s biggest trading partner, accounting for almost 17% of its exports – 5.2% of GDP. Export growth in South Korea and the Philippines was the weakest in two years last month. Year-on-year, the Philippines’ foreign sales were down by 27%.
Another channel of contagion is Europe’s banking turmoil. Owing to uncertainty over counterparties’ exposure to dodgy sovereign debt, many European banks are having trouble financing themselves in the interbank market. That hampers their ability to lend, while the credit squeeze is being exacerbated by tough new capital targets demanded by European regulators. Banks are meeting the targets by shedding assets since raising capital in the markets is currently a tall order. That means they are retrenching and cutting back on lending.
Commerzbank, for instance, plans to restrict new lending to Germany and Poland, cutting loose the rest of its eastern European operations. With Western banks – mostly western European ones – controlling almost 75% of eastern Europe’s banking system, “this is the region that has most to fear from a retreat of developed-market banks from emerging markets”, says the FT’s Patrick Jenkins.
Asia will also be affected. According to the Bank of International Settlements, continental European banks were responsible for 21% of the loans to emerging Asia at the end of the second quarter. European banks cut their lending to the region by a fifth during the last crisis, denting growth. With the risk of an Asian “growth pinch”, as HSBC puts it, on the rise, and parts of eastern Europe edging closer to recession, the outlook for emerging equities remains discouraging.