East European economies
Fingered by fate
Mar 18th 2010 | BUDAPEST AND RIGA
From The Economist print edition
A region that a year ago looked as bad as Greece does now has averted catastrophe—but is not yet completely safe
see chart here
BELIEVE the headlines and Europe’s worst economic headache by far is Greece, financially feckless and socially volatile. Uncontained, its problems could infect other Mediterranean countries like Spain, Portugal and even Italy. The euro’s future and the European Union’s credibility are at risk. And so on.
This week EU finance ministers talked of the possibility of bilateral loans to rescue Greece, as a reward for the government’s new fiscal austerity—though details were conspicuously lacking. But history shows how fast the tide of worries can ebb. Twelve months ago, it was ex-communist countries—Hungary, Latvia, Ukraine and others—that were seen as the biggest problems. Banking and currency collapses loomed, stoking dreadful risks for the region and beyond. A year on, their problems seem humdrum, not horrific.
The fears were partly overblown. The idea of a single “ex-communist region” called eastern Europe does not bear scrutiny. What does prosperous Slovenia, which is richer than Portugal, have in common with Moldova, Europe’s poorest country? Countries like Hungary had big, over-leveraged financial systems, plagued by reckless lending and spendthrift consumers. But in the Czech Republic, the banks were solid and habits thrifty. Poland’s economy, the largest in the region, was so untroubled by the catastrophe that its GDP grew in 2009, helping all its trade partners.
A good example of outsiders’ wrong views was the market in credit-default swaps on Estonian debt. This was a chance to trade bets on, in effect, the death of a non-existent horse, as Estonia has no publicly traded government debt. Wrong numbers deepened the gloom. In particular, a misreading of some data from the Bank for International Settlements overstated the level of foreign banks’ exposure.
But ignorance only partly explains the jumpiness. Another element may have been self-interest. Officials mutter darkly that some bankers first shorted currencies and bank shares, and then published research notes forecasting default or devaluation. Others believe that west Europeans were eager to shift the blame for the recession, first to Wall Street and then to their wild and woolly east. Jacek Rostowski, Poland’s finance minister, says he was “surprised” by the “hysteria”. He blames “a deep psychological need to identify the source of crisis as ‘them’ not ‘us’.”
There is a striking contrast between riots in Greece and the grim patience of ex-communist voters, whose living standards have plunged amid soaring unemployment. The “institutional fragility” that some west European politicians worried about may be a genuine problem—but in the euro area, not in eastern Europe.
Over the past year politicians in the east facing the worst outlook mostly took commendably tough decisions (Ukraine, paralysed by political in-fighting, was the exception: it has stayed afloat thanks only to the generosity of outsiders). The spectre of populism proved a mirage. Seemingly weak coalition governments were actually rather good at pushing through reforms. In the worst-hit countries, Latvia and Hungary, the governments’ popularity even rose when the pain bit (though on March 17th Latvia’s coalition government lost its majority when a big party pulled out).
For their part, outsiders showed patience and ingenuity. A big but little-known effort was the “Vienna initiative”, brokered by the European Bank for Reconstruction and Development. In late 2008 its chief economist, Erik Berglof, spotted the danger of policy based solely on national interest. The Austrian government had just said it would support the troubled Erste Bank, but only if the money went to loans inside Austria. That approach risked a rampage out of eastern Europe by overexposed foreign banks that had lent unwisely (and often in foreign currency) during the bubble years.
This was a classic collective-action problem: each bank’s individual interest was to reduce exposure by calling in loans and dumping assets, but if all acted similarly, everybody would suffer. The international response has worked well. The European Central Bank’s provision of liquidity to foreign banks encouraged them to keep financing subsidiaries outside the euro area. The IMF and other lenders helped host countries to stay afloat—and to provide liquidity to banks, regardless of ownership. Regulators helped the banks by relaxing capital requirements.
No foreign-owned bank has pulled out of the region. In total 17 systemically important local banks went bust (mostly in Russia, Ukraine and the like). But inside the EU, just one, Parex in Latvia, had to be rescued by the government and the EBRD. That is a lot fewer than many were expecting—and it is a far better result than in the Asian financial crisis of 1997-98.
Other efforts by outsiders helped too. “Cash for clunkers” car-scrappage schemes boosted countries, such as Slovakia, with big car industries. The inflow of EU money for modernisation of infrastructure softened the effects of the fiscal squeeze in countries that had to sort out their public finances in a hurry. Those countries that could depreciate their currencies did so, keeping monetary policy loose. Those with currency pegs—the Baltic three and Bulgaria—have started on an “internal devaluation”, thanks to their flexible labour and product markets.
Sustainability remains a big problem. The overhang of private-sector debt in the region risks damping growth for years to come. Sharing out the burden of adjustment among lenders, borrowers and taxpayers in an orderly restructuring is a job that has barely started. As Capital Economics, a consultancy, notes, the banks remain fragile, a new fiscal squeeze looms and export growth is likely to stay sluggish. Through luck, judgment and friendly help, eastern Europe has staved off disaster. But to catch up on what the region missed when it was behind the Iron Curtain remains a mighty task.