Thursday, November 06, 2008

Smouldering

Eastern Europe
Nov 6th 2008 | RIGA
From The Economist print edition


The ex-communist economies have been steadied. Deeper worries remain

How much will you give me to stop playing?

FLAMES out, but smoke still rising. That is how eastern Europe looks after huge outside intervention to douse worries in debt and currency markets. An IMF board meeting on November 5th approved a lightly conditioned $16.5 billion bail-out for Ukraine. Austria has offered a €100 billion ($129 billion) package for its banks, which are owed $290 billion by east European borrowers: Erste Bank took up a €2.7 billion equity injection on October 30th. In Hungary, which has also received an IMF bail-out, markets firmed as parliament passed a tough fiscal package, based on an expected 1% fall in GDP. Serbia, which is in talks with the IMF, said it would not need extra cash, though it might draw on its $695 billion deposit at the fund.

In London Latvia’s central-bank governor, Ilmars Rimsevics, sought to quell fears that his country faced a meltdown on Icelandic lines.

Flanked by representatives of Swedbank and Nordea, two Nordic banks which own a large chunk of the local banking system, he said Latvia’s currency peg to the euro was not in doubt. Unlike Iceland, Latvia has little external public debt and a thinly traded currency. But questions remain over some locally owned banks and the legacy of reckless fiscal policies (described by one minister as “hitting the gas pedal”). That brought double-digit growth, but did little for competitiveness. The coming months could bring a contraction of up to 5% in Latvia’s GDP.

The intricacies of Latvian economic policy may no longer hold foreigners’ attention. “We were getting a lot of calls about the Baltics and Scandinavian banks a couple of weeks ago. Now attention has shifted to Bulgaria,” says Neil Shearing of Capital Economics, a consultancy. Bulgaria has a large current-account deficit (expected to be 24% of GDP this year). So far, this has been filled by inflows of foreign direct investment. That looks good on paper (it is reliance on short-term borrowing that sets red lights flashing). But up to a third of that money went into property, inflating a bubble that has now popped.

Neighbouring Romania, the poorest country in the European Union, has problems too. Standard and Poor’s, a rating agency, downgraded its debt to junk last month. And the slowdown in “old Europe” will hit remittances from the many Romanians working abroad.

Foreign investment flows to eastern Europe may be shrinking too, now that businesses in the rich half of Europe have less cash to spare for foreign expansion. Having neglected competitiveness-stoking reforms in education, infrastructure, and public administration, ex-communist countries may find it harder to attract companies needing to cut costs. Governments in eastern Europe are now hurrying to adopt the macroeconomic policies necessary to speed the adoption of the euro. But their countries’ deeper problems remain.


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