The Sun Will Continue to Rise in the East


To be a Region or Not to be a Region – that is not the relevant question

Recently, a number of rating agency and media reports have pointed to high risks in Southern and Eastern Europe – and as a result, increased risk to both European parent banks engaged in the region and to their home countries. At the same time, both the European Commission and some of the countries involved, including the Czech Presidency of the EU, have vehemently denied the existence of such a “region”, claiming that all countries are different and affected differently by the crisis.

Certainly these media reports have contributed to a perception that the previous “Golden East” has turned into a basket case, increasing a perception of pervasive contagion from Mongolia to the Czech Republic (to name both the easternmost and westernmost countries of this “region”, leaving out Russia). All these countries, and others, happen to be the countries of operations of the European Bank for Reconstruction and Development. Thus, notwithstanding necessary differentiation, they represent a group of countries, bound together by their former communist regimes from whom they have escaped nearly 20 years ago (the only exception to this is Turkey which was recently added to the client countries of EBRD).

 

Until approximately last September, both EBRD and other multilaterals assumed that the incipient financial crisis would bypass this booming region which was growing faster than any in the world except emerging Asia. Since then the depressing truth has emerged that global financial markets do not bypass any region, that financial flows not only fed the exorbitant catching-up process of this region, but also affect it with the sudden onset of extreme risk aversion and drying up of financial flows. The latest forecast for the “region” in mid-March 2009 is for stagnation or a slight fall. This may very soon turn out to be over-optimistic.

 

While the most recent media-frenzy is overdrawn and adds to the problems of this region, recognition has set in in large parts of Europe that this region is extremely important for the “old” EU – not only because 70% to 80% of the banks in this region (again with strong variations) are owned by Western European banks, but also because significant supply chains have been built up linking these countries’ economies to “old” Europe, and because they have provided expanding markets for old Europe’s exports. To this one must add the energy resources and energy supply links of the region which make it a vital supplier of strategically important resources. And, of course, not to forget the geo-political and security importance of this region – which was recognized by the EU in its swift action during the Georgia crisis with Russia.

 

Central, Southern and Eastern Europe are Strategically Important for All of Europe

 

All the more reason to make sure that also in the future the sun will continue to rise in the East – and to take decisive action in old Europe to mitigate the effects of the crisis, severe in some countries, viz. Latvia and Ukraine, less severe in some other countries.

 

There is no doubt that the economic resources of the world’s largest exporter, its second-largest economic area, i.e. the EU are strong enough to help in this situation. The real question is more one of political will to act coherently and decisively and swiftly in a situation where all “old” European countries are themselves heavily engaged in combating the crisis in their own countries. So far EU countries have provided about 300 billion € for recapitalizations of their own banks, plus 2.500 billion € to guarantee loans – and we see daily new additions to these gigantic sums. In designing these packages EU member states did have in mind that many of their banks had significant interests in the CESE region, but national rules differ to what extent this aid can be deployed outside the country. Such limitations must be lifted as soon as possible, difficult as this may be politically with an ever more protectionist and nationalist-minded public. Here an important task for political leaders arises to counter these nationalist sentiments.

 

At a multilateral level a strong signal that “old” Europe will support its Eastern and Southern friends, be they members of the Eurogroup, new member states,  candidate countries or none-of-the-above is absolutely necessary to halt the rating agency and media-generated perception that the region is about to go under. Such a signal should emanate from the Spring European Council in two weeks’ time.

 

Symbolic and Real Help

 

But also “real” action is needed – and is already being organized. On February 27, the European Investment Bank, the European Bank for Reconstruction and Development and the International Finance Corporation published a Joint International Finance Institutions Action Plan for Central and Eastern Europe, dedicating around 25 bill € to support the banking sectors and the real economies in the region. This is an unprecedented and very welcome cooperative effort.

 

The European Commission did not join this initiative, because in its interpretation its legal framework requires it to distinguish countries according to the above institutional setting. But the EU is supporting Euro member states through the ECB, non-Euro members through balance-of-payments help (whose volume was increased to 25 billion € last November) and through significant front-loading of structural fund money; Candidates, pre-candidates and “neighboring” countries can obtain help through EU commitments to provide macro-financial assistance and other (smaller) instruments, most of them in the context of an IMF program.

 

In addition, parent banks have in a number of instances both stated their aim to keep up transfers to their subsidiaries or affiliates in the region, and also done that already. Still, since the recession of the real economy has only started to show its effects in the region, significant negative effects on the balance sheets of these and local banks are still to be expected when credit defaults set in on a lager scale.

 

Some of the countries in the region suffer from very large and unsustainable current account deficits, implying large indebtedness towards old Europe. Significantly, it is not so much sovereign loans, but private-sector loans in foreign currency which cause the most significant problems. Estimates by EBRD show that the whole region has about 150 bill € in debt coming due this year: more than half of that sum is owed by the new member states of the EU, of which a significant part is due to West European parent banks. These are strong enough to refinance these amounts, also with the help of the bank packages their governments have provided and with the help from International Financial Institutions.

 

Part of the remaining problem is that the region’s governments so far have – again very different from country to country – not been able or willing to establish stimulus packages of their own. Helping the banks in the region can only be successful, if demand in the region is stimulated.

This is where the IMF will have to come in, to help countries with their balance of payments problems in the face of significantly fallen exchange rates. Recent announcements that IMF resources be doubled to 500 billion $ would be a welcome sign that IMF has enough resources to help additional countries in the region (and elsewhere). In addition, the European Central Bank which so far has been rather quiet with respect to its role in crisis response – in spite of the fact that it has deployed swap lines e.g. to Denmark and has lowered the risk threshold of collateral it accepts – could play a much more active role, viz. the frenzied activities by the US FED and the Bank of England.

 

Strong Signals Necessary

 

The double crisis is deepening in the countries of the region. Both symbolic and “real” activities are necessary to mitigate it and its feedback into “old” Europe. We need to employ all possible actors and instruments in order to contain its effects. Since the whole region – notwithstanding the different legal/institutional status relative to the EU of the countries involved – plays a significant role for Europe’s longer-term well-being, both politically and economically, a strong commitment by Europe to help the whole region is urgently called for, under which joint country, EU and IFI measures must proceed on a country-by-country basis.

 

The present irrationality of “the markets” as witnessed by the extreme swings in ratings, credit default swap margins, currency and stock market fluctuations, must be countered by concerted strong commitments by Europe’s political leaders, both the Council, the Commission and the Parliament. 

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Filed under Crisis Response, Socio-Economic Development

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