The global downturn and flight from risk threatens to turn some emerging economies from “shooting stars to shot ones”, as Ian Campbell put it on Breakingviews. Pakistan is already in danger of default, while Korea has been in the spotlight as its banks are more reliant on short-term wholesale funding from overseas than regional counterparts. Korea’s external debt exceeds the level reached at the time of the Asian crisis, while consumers and companies are overleveraged, noted Louise Lucas in the FT. The won has now slumped against the dollar. In a continent of current-account surpluses and modestly-leveraged balance sheets, Korea is a “fault line”.
The crucial danger zone
But the main financial danger zone exposed by global deleveraging is Eastern Europe. In the boom, many states racked up large current-account deficits as foreign capital arrived and consumption boomed. So they need foreign funding just as rattled global investors are cutting back. A key element of the region’s debt-fuelled expansion has been cross-border bank loans from Western banks, which totalled $1trn last year and fuelled asset bubbles across the region. Almost 50% of Hungarian mortgages were in foreign currency in 2007.
What next?
Now that Western banks are shrinking their balance sheets, these capital flows are under threat, and consumers’ debt-burden will mount as local currencies decline. Meanwhile, the recession in Western Europe is hardly helping matters, while in Hungary’s case tax hikes over the past two years to plug a towering budget deficit are exacerbating the downturn. The IMF has said it stands ready to help Hungary – and it may not be long before it’s engaged elsewhere too.