Eastern Europe
Developing europe, many used to part of the ex-USSR. Many are now members of the EU, or hopefuls...
Central Europe is defined as Bosnia, Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania and Serbia. We exclude Austria, Slovakia and Greece because those countries are in the eurozone.
Eastern Europe and Oil:
supply route from Russia, Mideast... to Western Europe:
Source EIA
Crisis 2009-2010?
Central Europe has borne the brunt of the global financial crisis, and countries that were once flying high on foreign direct investment are now receiving direct assistance from the International Monetary Fund. Burdened by $870 billion in external debt, a large portion of which is denominated in foreign currency, Central European countries are scrambling to keep their currencies strong to avoid a crisis caused by appreciating foreign debt. Ultimately, the only remedy is a mad dash to the eurozone.
Since October 2008, Hungary, Romania, Serbia, Bosnia and Latvia have all received direct assistance from the International Monetary Fund (IMF) while Poland has tapped the IMF’s Flexible Credit Program. Meanwhile, a slew of other countries in the region (Bulgaria, Croatia and Lithuania) are currently debating the merits of asking for international help
Before the crisis, the region was flying high on foreign direct investment, overtaking East Asia as the main destination for international capital in 2002. However, the massive influx of foreign capital that made the boom years possible is now the source of a very large problem for the region. Central Europe is indebted externally to the tune of approximately $870 billion dollars (77 percent of the region’s combined gross domestic product), of which around a third comes due for repayment in 2009.
Most of this debt is held privately, which means that governments themselves are not greatly indebted. However, massive defaults in the private sector are a problem for the government, which, at the end of the day, is the guarantor of last resort. Furthermore, a large proportion of the debt, taken out by both households and businesses, is denominated in foreign currency. Because of this, Central European governments have to make sure that their own domestic currency does not depreciate, since this would appreciate the real value of the debts and cause a cascade of defaults throughout the system.
Western countries at the edge of the region — particularly Italy, Sweden, Austria and Greece — looked to profit from geopolitical changes by reestablishing their former spheres of influence through financial means. The end of the Cold War meant that these former Central European powerhouses could once again carve out an economic niche without competition from more powerful banking centers like the United Kingdom, the United States, France and Switzerland. Banks from Milan, Vienna and Stockholm, in particular, hoped to use cultural and historical ties — in some cases to their pre-World War I territorial possessions — as an advantage. Therefore, Sweden rushed into the Baltic states, Greece into the Balkans and Italy and Austria pushed into the entire Central European region (save for the traditionally Scandinavian-dominated Baltics).
Italian, Austrian, Swedish and Greek banks therefore bought up local Central European banks, or simply established subsidiaries of their own banks, and began offering loans in euros and Swiss francs. A Hungarian, for example, could purchase an apartment in Budapest by applying for a euro-denominated, low interest-rate mortgage in a Milan-based bank branch in his home town. This financial tool allowed Central European countries with endemically unstable currencies and/or high interest rates to piggyback on the low interest rates of the euro and Swiss franc to spur consumption, which subsequently led to overall economic growth and a real estate bubble in the region.
risk:
The Hungarian enjoying his new apartment does not get paid in euros, since Hungary is not in the eurozone, but receives his salary in forint. As ...domestic currencies to depreciate, the loans that consumers and corporations took out in foreign currency started to balloon in real terms due to the foreign exchange discrepancies. The Hungarian getting paid in forint suddenly realized that his monthly paycheck no longer covered his euro-denominated monthly mortgage payment.
Even though most governments in the region have a very low debt exposure (except Hungary), the high private-sector exposure is threatening the creditworthiness of the countries themselves.
recovery:
Ironically, this means that the only way to stave off an economic Armageddon characterized by widespread defaults is to take out more foreign loans from the IMF and EU. Meanwhile, the very method by which growth could be spurred, lowering interest rates, would lead to currency devaluation, which could worsen such a default crisis. Lowering interest rates encourages domestic-currency borrowing. However, the looming foreign currency debt makes this strategy extremely risky because lowering interest rates also makes holding domestic currency unprofitable (since return on investment is lower) and could precipitate further capital flight. Central Europe has to depend on outside factors, in this case the return of global demand for their exports, to pull them out of the crisis.
But... Meanwhile, foreign currency loans are not being curbed — in fact, they are increasing across the region. By keeping interest rates high compared to the eurozone interest rate, Central Europe is simply continuing to encourage borrowing in euros at home.
For Central Europe, interest rate discrepancy with the eurozone is not a simple problem to overcome. The interest rates are essentially a price one has to pay for money. Larger, more stable economies have lower rates, while smaller, less stable economies have higher rates because investors demand a better return for the risk. Central Europe has to compensate for latent political risks and inflation concerns with high rates, while in the eurozone, the robust and inflation-averse German economy allows the euro to enjoy low rates.
Of course, it is always going to be tempting to borrow in euros at low interest rates instead of in forints, dinars, kunas, lei or leva at higher interest rates. Central European countries therefore have two choices: They can either legislate against foreign-currency lending, which would severely curtail credit in the region and thus stunt economic growth (and violate EU rules on the free flow of capital), or they can make a mad dash for the eurozone. The latter, of course, depends on the eurozone’s accepting Central European countries into the club, which would require the EU to significantly curb its eurozone accession requirements to lower the bar for a Central Europe rocked by recession.
Central Europe is essentially stuck with its $870 billion in external debt and eurozone membership as the only way to remove the risk of the loans ballooning in real value. Taking out IMF loans to protect against potential defaults shifts the burden to cover the debt from the private sector to the entire public. And IMF loans come with conditions that usually require governments to make extreme cuts in politically sensitive spending (pensions, unemployment benefits, public-sector jobs and the like).
The EU may provide a lending alternative to the IMF, but Brussels has its own conditions, including the requirement that EU banks operating in the region can be bailed out only with money that Brussels provides. This has been the case in Latvia, where Sweden (currently the president of the EU) ensured that half of the EU’s substantial 1.2 billion-euro injection into the country went to mostly Swedish-owned foreign banks at the risk of rising default rates due to the potential collapse of Latvia’s currency peg to the euro. These injections of capital with strings attached may have political consequences as well, particularly when populations across Central Europe realize they are essentially paying for foreign-bank bailouts through cuts in pensions and social welfare.
source: Stratfor.com
Another Look
By all accounts, the former Eastern Bloc countries that so successfully navigated their entry into world capitalism after the fall of communism have borrowed themselves into near oblivion and are about to inflict frightening losses on their own banks and Western European banks, their main aiders and abettors. Our good friend John Mauldin has been out front on this story, which has enormous implications for the global financial system. The ever prescient Christopher Wood has also been warning about an Asian-style banking crisis in the region, with serious ramifications for the Western European banks that loaned these institutions by some reports trillions of dollars. This is a story that needs to be followed in the coming weeks because it will have major negative consequences for world financial markets. To state the obvious, this is the last thing the world economy needs to deal with right now.
Michael E. Lewitt
CEE: central & eastern Europe:
Table of Contents:
Crisis 2009:
how to deal with the Central European financial crisis. Toxic U.S. assets did not create this problem, internal European practices did. Western European banks took dominant positions in Eastern Europe in the past decade. They began to offer mortgages and other loans at low interest rates denominated in euros, Swiss francs and yen. This was an outstanding deal unless the Polish zloty and the Hungarian forint were to plunge in value, which they have over the past six months. Loan payments soared, massive defaults happened, and Italian, Austrian and Swedish banks were left holding the bag.
IMF?
The United States viewed this as an internal EU matter, leaving it to European countries to save their own banks. Meanwhile, the Germans — who had somewhat less exposure than other countries — helped block a European bailout, arguing that the Central European countries should be dealt with through the International Monetary Fund (IMF), which was being configured to solve such problems in second-tier countries. From the German point of view, the IMF was simply going to be used for the purpose for which it was created. But Washington saw this as the Germans trying to secure U.S. (and Chinese and Japanese) money to deal with a European problem.
But what could be perceived as a massive U.S. donation to the IMF would resonate politically in the United States. The American political system has become increasingly sensitive to the size of the debt being incurred by the Obama administration. A loan at this time to bail out other countries would not sit well, especially when critics would point out that some of the money will be going to bail out European banks in Central Europe.
source: www.stratfor.com
see more in our discussion on: International Monetary Fund - IMF
Baltic States
read more: http://en.wikipedia.org/wiki/Baltics
The Baltic states in particular, under tight and direct control by Moscow for more than 80 years, were suddenly open for business from the West, with Scandinavian banks first to cash in, reestablishing what had been Stockholm’s sphere of influence in the 17th century.
Balkans
The Balkans is the historic and geographic name used to describe a region of southeastern Europe.
The region has a combined area of 550,000 km² (212,000 sq mi) and an approximate population of 55 million people. The region takes its name from the Balkan Mountains which run through the centre of Bulgaria into eastern Serbia.
Balkan peninsula with northwest border
Balkan peninsula (as defined by the Danube-Sava-Kupa line)
Line stretching from the northernmost point of the Adriatic to the northernmost point of the Black Sea. Read more: http://en.wikipedia.org/wiki/Balkans
U.S. venture capital in eastern Europe, Russia
cisco, the giant networking company, has expanded its venture capital investments to central and eastern Europe, taking a majority stake in a 30 million Euro ($40 million) fund there. It comes at a time of a flurry of investment activity in the eastern European and Russia region, an area that has so far been starved of venture capital. The region has a plentiful supply of well educated engineers, and so could be promising. Cisco started a venture investing in Russia earlier this year. The Russian government has just doubled its own commitment to support venture activities there, ... » Continue reading
Ex-communist states
The economic boom in the post-communist region has been extraordinary. In 15 former Soviet republics average growth for the last nine years (1999-2008) has been no less than 9 percent per year. But paradise always comes to an end. Today's original sin is inflation, there is wide variety in the amount of suffering, much of it depending on the macroeconomic choices that countries have made:
excessive public expenditures that led to big budget deficits...have hurt the country....leading to annual growth rate of 1 to 2 percent
Until last year, Kazakhstan was a star performer with a steady growth rate of 9 to 10 percent a year. But its commercial banks have borrowed too much abroad, boosting inflation to 18 percent. When international interest rates rose, their debts became untenable. Although none of them has gone under, these banks had to tighten their belts, and so has the country. Growth in gross domestic product has fallen by half to some 5 percent, but Kazakhstan's abundant oil revenues safeguards such a soft landing.
Estonia and Latvia have been the greatest economic successes, but even the sun has its spots. They have fixed their exchange rates to the euro. Therefore, their domestic prices have risen with increasing productivity in the export sector, and they have imported substantial inflation—currently 18 percent in Latvia and 12 percent in Estonia.With their fixed exchange rates, these countries cannot pursue any monetary policy, and their huge current account deficits have been financed by foreign direct investment and bank loans. Suddenly, the foreign banks that own the Baltic banks have minimized their loans. Demand, consumption, and real estate prices have fallen. The double-digit growth rates have plummeted to 2 to 3 percent. The question is how large bad debts will be revealed, but so far the Baltic states seem to take the hit well. As in Kazakhstan, their success story is likely to reemerge.
Romania looks worse. As in the Baltic countries, it has a big current account deficit, but it has predominantly been financed with foreign bank loans, which are now drying up, and its budget deficit of some 3 percent of GDP is excessive. So far, its salvation has been its floating exchange rate and an independent central bank that pursues a strict monetary policy, but Romania's growth will suffer.
Ukraine looks worst of all. Its inflation has just reached 31 percent a year, although its state finances are in excellent shape and its growth rate stays at 7 percent. Ukraine's outsized inflation is caused by its central bank, which, for some reason, insists on a dollar peg unlike all other countries in the region. Since the dollar has fallen 13 percent in relation to the euro in a year, Ukraine has imported about that much inflation. Furthermore, its central bank maintains a refinance rate of only 16 percent, which means a negative real interest rate of 15 percent, an extremely expansionary monetary policy. Consequently, Ukraine's money supply has ballooned by 56 percent in the last year, as foreign banks lend their subsidiaries in Ukraine excessive amounts, because they can finance their credits at about 5 percent a year abroad and lend in Ukrainian hryvna for 40 percent a year. This folly must end. The obvious solution is to let the exchange rate of the hryvna float freely to impede both the importation of inflation and speculative currency inflows.
Three countries have successfully withstood the current inflationary test—Slovakia, Poland, and the Czech Republic. Their present annual inflation is a moderate 4 to 7 percent, and their high growth rates continue. These countries all pursue inflation targeting, which means that their independent central banks focus on keeping inflation within a low target band, while maintaining tight monetary policy with positive real interest rates. Hence, their floating exchange rates have risen significantly in relation to the euro.
Russia's inflation is too high at 15 percent, and its macroeconomic policy is unbalanced. It relies too much on fiscal policy and too little on monetary and exchange rate policy. The country's inflation is driven by the large current account surplus, and the Finance Ministry has wisely balanced this surplus with a sound fiscal surplus to hold back inflation, but currently public expenditures are rising sharply.
For years, the Russian central bank has stated its intention to move to inflation targeting within three years, but it never does. It still pegs its currency to a basket of euros and dollars, although it should be floating the ruble, and the central bank maintains a negative real interest rate of 4 percent a year, which guarantees an excessive monetary expansion. The bank should follow the good Central European example and move to inflation targeting immediately to escape the dangers of rising inflation.
As in 1998, fixed exchange rates today are wrong, but then the problem was overvaluation. Now it is undervaluation leading to excessive inflation.
Floating exchange rates, balanced budgets, and inflation targeting are the current victors, while any fixed exchange rate is detrimental—worst of all any fixation to the sinking dollar. The lesson for Russia is to let the ruble float freely and to tighten its monetary expansion to control inflation.
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