The strong foreign banking presence in the region, long hailed as a strength, now increasingly looks like a potential weakness. Depending on the country, foreign banks hold about 60-90% market share. These foreign parent banks, under pressure from the global financial crisis and slowdowns in their home countries, are reducing lending to their Eastern European offspring. In an extreme (albeit unlikely) scenario, there is the risk that foreign parent banks, in the face of rising defaults and prohibitively expensive refinancing, would pull out of these markets.
In recent months, the IMF has agreed to dole out more than $18 billion in emergency loans to Hungary and Latvia. Since most economies in the region have similar vulnerabilities, the question is: Who could be next?
Estonia and Lithuania look to be headed down the same path as Latvia and may also be forced to turn to the IMF for help. All three boomed in recent years, at times posting double-digit growth rates, helped by cheap credit and strong capital inflows in conjunction with their EU membership in 2004. While Latvia is in the worst shape of the three due to a wider current-account deficit (the region’s largest in 2007 at almost 24% of GDP) and higher external debt, the other two Baltics are in similar straits. Like Latvia, they have double-digit current-account deficits, which make them especially vulnerable to the drop-off in capital inflows. Whereas these current account gaps were once funded primarily with FDI, this is changing, as evidenced by the buildup of external debt.
Bulgaria’s key vulnerability is its massive current-account deficit, which Moody’s expects to widen to around 23% of GDP in 2009, making it the region’s highest – and like others in the region is increasingly debt financed. Bulgaria’s external debt-to-GDP ratio is particularly high, above 100%. Like Estonia and Lithuania, Bulgaria runs a currency board, which the government staunchly supports. One strength - the government runs one of the biggest budget surpluses in Europe (projected at 7.5% of GDP in 2009) - a distinct contrast from fiscal deficits elsewhere in the region. And unlike the Baltics, Bulgaria is still expected to post positive growth in 2009 of around 2%, although its vulnerabilities pose substantial downside risk.
Once high-flying, Romania is poised to slow sharply to around 2% in 2009, but simmering vulnerabilities pose significant downside risks and an outright financial crisis cannot be ruled out. In recent months, S&P and Fitch cut its sovereign credit ratings to ‘junk’ status. On top of its double-digit current-account deficit (the 5th highest in the region), the country’s budget deficit is ballooning and is forecast to breach the 3% Maastricht Treaty limit in 2009. While external debt –about 60% of GDP in 2008 - is still moderate compared to Bulgaria and the Baltics, FDI coverage has been on a steady decline, meaning external debt will likely continue to rise rapidly. Unlike Bulgaria and the Baltics, Romania has a flexible exchange rate, but it’s unlikely to be a significant cushioning tool since it like most other CEE countries, has a high degree of foreign currency lending. Any significant depreciation of the leu would result in the insolvency of a great number of Romanian households and businesses, potentially posing a risk to financial stability.
Hungary secured a $25.5 billion loan package from the IMF, EU and World Bank in October 2008 to avert crisis. While the package may have alleviated external financing risks in the near-term, Hungary still has a long list of underlying vulnerabilities (examined in detail in an RGE post in October), which means the country could still be susceptible to crisis down the road. Hungary continues to suffer from twin deficits and high foreign currency lending, which could affect financial stability and constrain monetary policy. Unusual for the region, Hungary has a high government debt to GDP ratio of an estimated 73% - far and away the highest in the region. Long a regional growth laggard, GDP may contract 3% in 2009.
Despite a strong banking system and a prudent fiscal target for 2009, Serbia's vulnerabilities are growing. The current-account deficit, at an eye-catching 18% of GDP in 2008 is among the highest in the region while the currency has declined 20% since October 2008 despite repeated central bank interventions. As a precautionary measure, Serbia reached a $520 million standby agreement with the IMF in November 2008 which it is hoped will help stave off crisis in the face of the sharp re-adjustment.
Also worrying are the vulnerabilities in Serbia's western neighbor - Croatia. The large external debt (at around 90% of GDP), current account deficit (around 10% of GDP), and short-term financing needs of the government and corporate sector are key challenges given the tighter global financing conditions. To bolster investors’ confidence, Croatia’s government may also seek a precautionary program from the IMF.
While Turkey is headed towards an economic contraction, an outright financial crisis should be averted. Turkey is close to signing a deal with the IMF, which will reassure foreign investors and rein in government spending. The IMF package is expected to be in the range of $20-25 billion, although there is some concern at the fact that an agreement has not yet been announced. While Turkey’s banking sector is in much better shape following the 2001 crisis, its current account deficit (forecast at about 5% of GDP in 2008) and heavy external financing requirements make it vulnerable to tightening global credit conditions. According to S&P, Turkey’s external financing requirement stands at around 140% - one of the higher ratios among emerging markets.
Oil exporters like Russia, Kazakhstan and several GCC countries are now facing a reversal in their fiscal and current account balances which are shifting into deficit territory. Ample savings from the oil boom will now be drawn down to support growth and in many cases help the corporate and financial sectors pay off their large foreign debts accrued during the boom years. For GCC countries, the real vulnerability is their contingent liabilities, accrued through support of the financial system. Dubai corporates have been particularly hard hit by the credit crunch and their exposure to the domestic property markets.
Of the GCC countries, the UAE has the highest short-term debt relative to forex reserves which leaves it highly vulnerable. Its short-term external debt as a share of total external debt is expected to rise to 72.5% in 2009. Other vulnerability indicators put it among the worst in the Middle-East and well above the average of developed economies. It will likely call on its savings in 2009 to finance its spending as its current account also shifts into a deficit – Look for Abu Dhabi to support Dubai. Kuwait too is vulnerable, with its banks struggling to find new sources of finance in the face of defaults and Kuwaiti corporates facing investment losses. Kuwaiti financial institutions have already suffered some defaults, and further ratings downgrades are possible. Kuwaiti political divergence could also increase the difficulty of responding to the crisis. By contrast, Saudi Arabia may be least vulnerable given its ample reserves, conservative investment strategy and well-capitalized banking sector.
While Russia is unlikely to default on its sovereign debt, its corporate and financial sector debts now outstrip its stock of foreign exchange reserves ($386 bn in mid-January 2008). Although 2008 refinancing was accomplished, more than $110 bn in foreign debt will come due in 2009 and the depreciation of the rouble raises the risk of a cascade of non-payments. Russia’s economic indicators have quickly reversed along with oil prices and the country is likely to run its first 'twin deficit' in a decade in the midst of a sharp economic contraction in 2009. The fall in the value of the rouble, lack of finance, and the plunge in consumption (jobs are being shed at a faster pace than during the 1998 financial crisis) are also causing imports to contract which may limit the deterioration of the current account. Yet, the rapid depletion of reserves and use of the assets in its wealth and reserve funds to finance its fiscal deficit (a deficit of as much as 10% of GDP is possible in 2009) may trigger further ratings downgrades. All of this is likely to weigh on the rouble which has crashed through the new trading band.
Like Russia, Kazakhstan saved the bulk of its oil windfall, but Kazakh banks and companies borrowed heavily and have now turned to the government for funds. Kazakhstan will thus be left with little cushion if commodity prices continue to be weak through 2009-10. Further capital flight is possible if oil prices remain at current levels - uncertainty about the value of the tenge, which is likely to be devalued, could trigger a speculative attack putting pressure on the fragile banking system that is struggling to meet or roll over the foreign debts due for repayment in 2009. Kazakhstan was one of few oil exporters to run a current account deficit routinely during the boom years, and this deficit will widen in 2009.
Ukraine will see the sharpest slowdown in Eastern Europe in 2009 with a growth contraction of at least 6%. Its terms of trade is set to deteriorate further due to weak external demand and prices for key exports, especially metals. With steel exports falling along with the slowdown in FDI inflows, balancing the current account will be a major challenge in 2009. Yields on Ukraine’s $105.4 bn of government and corporate debt are amongst the highest for any country with dollar-denominated debt. If the hryvnia-dollar exchange rate widens further, mass loan defaults are expected. The latest gas accord with Russia increases Ukraine’s spending on gas by almost 7% at a time when Ukraine’s economy is surviving on the first installment of the IMFs $16.4 bn bailout. The IMF fiscal conditions are likely to rein in social expenditure including likely public sector wage arrears in 2009, deepening the Ukraine’s political divisions.
Similarly, Belarus received a $2.5 bn IMF credit line as adverse terms of trade, falling demand for its exports and lack of external financing led to a sharp decline in the country's forex reserves. To stop the reserves outflow and increase competitiveness, the Central bank devalued the Belarusian rouble by 20%, one of the IMF’s requirements.
Posts
No comments:
Post a Comment