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Wednesday, March 4, 2009

How Not To Manage Eastern Europe's Financial Crisis (Part 1)

"Saying that the situation is the same for all central and eastern European states, I don't see that......you cannot compare the dire situation in Hungary with that of other countries."
Angela Merkel, Brussels, Sunday

"Happy families are all alike; every unhappy family is unhappy in its own way"

In Europe, leaders rejected pleas for a comprehensive rescue plan for troubled East European economies, promising instead to provide “case-by-case” support. That means a slow dribble of funds, with no chance of reversing the downward spiral.
Paul Krugman

Bank regulators from Bulgaria, the Czech Republic, Poland, Romania and Slovakia met today and issued a joint statement, ostensibly to reduce the some of the impact of what they term "alarmist comments" from the Austrian government about how the regional banking system is now in such a precarious state that it requires urgent action at EU level to prevent meltdown. The Austrian government are, of course, concerned about the impact of any meltdown on their own banking system. The result of this "reassuring statement" can be seen in the chart below (10 years, HUF vs Euro).

Within minutes of the joint statement Hungary's currency plummeted to an all-time low against the euro and to a 6.5-yr low versus the US dollar. In fact the HUF rapidly depreciated to 312 per euro from 307.50 before climbing back in later trading to 310. And the reason for this swift reaction? Hungary was not invited to join the statement. As the forint plunged, Hungary 's banking regulator hurriedly signed up to the statement, blaming the original omission on a communications mess-up, but the damage was already done.

“Each of the CEE Member States has its own specific economic and financial situation and these countries do not constitute a homogenous region. It is thus important first to distinguish between the EU Member States and the non-EU countries and also to clarify issues specific to particular countries or particular banking groups."

Well this just takes us back to Tolstoy, each of them have their own specific problems, but the underlying reality is that they all face problems, and are vulnerable, each in their own way.

Hungary's economic fundamentals are clearly much weaker than those to be found in the Czech Republic and Poland as things stand, but what about Bulgaria and Romania? And the Czech Republic and Poland are about to have a pretty hard time of it as a result of their export dependence on the West, and Poland has the unwinding of the zloty options scandal still to hit the front pages. So there is plenty of food for thought here before throwing Hungary to the wolves. A default in Hungary could very easily lead to contagion elsewhere, and then the impact in the West is very hard to foresee. We should not be playing round with lighted matches right next to our fireworks stock. "Hey, it's dark in here" and then "boom".

Yesterday it was Latvia's turn, and the cost of protecting against a Latvian default (Latvia is the first European Union member priced at so- called distressed levels) rose to a record following the announcement that the unemployement level rose from 8.3% in December to 9.5% in January, the highest level in nearly nine years. In fact credit-default swaps linked to Latvia increased nine basis points to an all-time high of 1,109 basis points, according to CMA Datavision in London. The cost is above the 1,000 level, breached last week, that investors consider distressed, and is now about 270 basis points above contracts linked to Lithuania, the next-highest EU member.

So two countries are being systematically detached here - Latvia and Hungary - and statements by EU leaders are unwittingly aiding and abetting the process. But we should all remember, after they have eaten Latvia and Hungary for breakfast, the financial markets will undoubtedly chew on other luckless countries over lunch (Romania's Q4 GDP data was out today, and it was a shocker, and S&P have already said they are "closely monitoring" the situation), before perhaps moving on to bigger game for supper.

And we should remember here, no one is too big to fall, and I have already been warning about the gravity of Germany's situation, with a rapidly ageing population, a hefty bank bailout of its own to swallow, and total export dependence for GDP growth. Final data from Markit economics out today showed that Germany's composite PMI fell to 36.3 in February from 38.0 in January. That was the lowest level registered since the series began in January 1998. And it means that the German economy - which is highly interlocked with the whole of Eastern Europe (Austria holds the finance and Germany the industrial exposure) - is certainly contracting more rapidly in the first quarter of this year than it was in the last quarter of 2008, and may well contract in whole year 2009 by something in the order of 5%. So maybe someone over there in Germany should be reading the poem you will see below aloud to "our Angela" right now (Oh, and if you don't speak German, you can find a translation here).

Als die Nazis die Kommunisten holten,
habe ich geschwiegen;
ich war ja kein Kommunist.
Als sie die Sozialdemokraten einsperrten,
habe ich geschwiegen;
ich war ja kein Sozialdemokrat.

Als sie die Gewerkschafter holten,
habe ich nicht protestiert;
ich war ja kein Gewerkschafter.

Als sie die Juden holten,
habe ich geschwiegen;
ich war ja kein Jude.

Als sie mich holten,
gab es keinen mehr, der protestieren konnte.


Anonymous said...

Dear Edward,

I could not agree more that saying a flat "NO" to the East may not have been a very good idea from Western European governments at the weekend EU summit, and that all the upcoming problems are likely to badly backfire to the western side of the continent. But you could have equally sent the poem at the back of your piece to the signatories of that strange declaration, in which five (or indeed six) Eastern European countries are trying to explain, how different they are from (1) everyone else, and (2) from one another. This sounds to me strange, because in these days, these countries should probably try to find the ways how they are similar, rather than pointing to differences, in order to be able to formulate reasonable proposals for a common problem. They are not very different, in the first place. Take Poland, for example. Since end-2007, the euro appreciated 31% viv the zloty, against a 33% move in EURUAH. This does not look like a great difference, and we all know that Poland has a problem with FX loans and one with currency options. It is only parts of the western press (FT, New York Times) who believe that this is a special Hungarian problem, and is due to the fact that a stupid government there encouraged banks to lend in EUR and CHF. No, FX loans have been invented by western banks, and Eastern government would not have had the legal and economic means to stop them even if they wanted to (they did not). Consequently, FX loans are quite widespread everywhere in the region, where interest rate differentials are big enough to make FX lending meaningful. In Romania and the Baltics as well. Or take the issue of risk spreads. Are once again Latvia and Hungary singled out as the only bad guys? Well, not quite. Latvia is at the top, yes, but Lithuania, Romania and Bulgaria also carry a higher spread than Hungary, and Poland, Czech Republic are really not that far behind. Not surprisingly, as with the IMF behind, Hungary is in fact better funded on a one-year horizon than most of its Eastern partners. Or take GDP. At this moment, the Czech Republic, Slovakia, Poland and the New York Times may believe that the first three are quite stable compared to the Ukraine, Latvia, Hungary, etc. Well, this is just wishful thinking. Romania and Bulgaria have just been transferred from Group A to Group B on that, based on their Q4 2008 results, but industrial outputs in the other countries are also falling like a stone, and it cannot be any different at a time when their markets are falling like a stone, too. Will this cause problems in their banking systems? Yes, most probably. Will these problems be any different from the Latvian, Hungarian, Romanian ones? Not much, most probably. Watching this problem coming, calmly and quietly, and not making any effort to sort out the conflict of national monetary/currency systems and a single European market - an economic nonsense in itself - seems cynical. Treating the problem by asserting that I am different, only the others are bad ones, does not reflect mature thinking.

Best regards,

Edward Hugh said...

Hello Analyst.

I absolutely agree. This is pretty much the picture as I see it too. Thanks for the thoughtful comment.


Anonymous said...

I could not found the authors contact, so I am typing here. Erste bank today sent report that tries to put worries in western media about CEE region, indebtness and the stability of banking sector in different perspective.

Can you help me, where I can send it? Thanks for assistance

Edward Hugh said...


"I could not found the authors contact, so I am typing here. Erste bank today..."

Hello, I'm not sure what you are asking. Are you from Erste bank and you want to send me the report for consideration? If so, you can find my mail at the bottom of the sidebar. If not, you will have to contact Erste bank direct I'm afraid.