Europe in Crisis
Neville, Laurence, Global Finance
Many of Europe's former star economies are still struggling to find their feet after falling prey to the credit crunch.
Emerging Europe is on the edge of a precipice. Already a number of countries, including Romania and Serbia by the end of March, have sought assistance from the International Monetary Fund, and others will follow. What was taken as economic convergence with Western Europe in recent years has in many instances been revealed to be an unsustainable spending binge fueled by cheap credit and encouraged by reckless governments.
The reversal of fortune that these formerly dynamic economies have ex- perienced is so dramatic that many fear emerging Europe could face serious so- cial and political upheaval - both in the region and, potentially, across the Euro- pean Union. Already, governments in the Czech Republic, Hungary and Latvia have fallen as a result of the eco- nomic crisis. At the same time there are hopes that Western Europe will act to save its Eastern neighbors - and poten- tially bind Europe closer together.
"This is the biggest crisis in CEE in the post-communist period," says Nigel Rendell, senior emerging markets strategist at RBC Capital Markets in London. "In many ways it follows the crises of Latin America in the early 1990s and Asia in the late 1990s. Now it's CEE's turn, and the causes of the current problems are surprisingly similar to those that caused earlier emerging markets crises."
In short, there was an assumption in Central and Eastern Europe that the good times would never end, and consumers, corporates and governments behaved accordingly - with dire results. "Some CEE countries were clearly overheated and overspent and had growing current account deficits before the credit crisis," notes Karine Him, partner and co-founder of East Capital in Stockholm. "When liquidity disappeared, they collapsed."
CEE's pain looks set to last longer and be deeper than that in many other regions. While, in GDP terms, private sector debt is not extreme, much of it is in foreign currencies, including as much as 80% of mortgage borrowing in some countries. In addition, many of CEE's economies are very open: The exportsto-GDP ratios of Hungary and the Czech Republic are around 80% compared with 25% for the United Kingdom. Consequently, they are dependent on external growth, which will be absent in the immediate future. Moreover, with large budget deficits and a lack of funding, they cannot stimulate domestic demand to fill the gap.
The problems the CEE countries are facing may seem local, but the crisis afflicting the region began in the Western financial system and has been significantly aggravated by foreign-owned banks operating in CEE. It is, of course, the responsibility of government to provide regulation, but many foreign banks that operated in CEE were, by general consent, greedy for market share because of the rapid economic growth there; they lent to almost anyone and are now suffering the consequences.
However, equally, consumers and companies need to take their share of the blame. "The ready supply of credit allowed them to convince themselves that they could accelerate their movement to Western standards of living without worrying about the consequences should their currencies ever come under pressure; everyone assumed that euro membership was inevitable," says Rendell. For many CEE countries, euro membership now looks further away than ever.
Western Europe Wakes Up To Crisis
Toward the end of 2008, a handful of voices were warning of the impending catastrophe in CEE. Then finally, earlier this year, Western Europe woke up to the scale of the problem and began to act. "The problems are being addressed adequately," says David Hauner, economist at Banc of America Securities-Merrill Lynch in London. "There were doubts whether Western Europe would rise to the challenge, but it now appears it will - largely because it recognizes that there are no other alternatives. …