Tuesday, February 10, 2009

A Glance At The Upcoming Eastern European Cataclysm

As most eyes are glued to CNBC and the exploration of the huge financial problem at home, few follow just how bad the situation is at fledgling developing economies. With news of potential defaults out of Russia, Kazakhstan devaluing its currency and begging for handouts, and Baltic states (Lithuania and Estonia) on the verge of downgrade, things in Eastern Europe are getting from bad to worse. This is most obvious when looking at the foreign currency exchange rates of countries in the region: since September 2008 the Ruble has lost 32%, the Polish Zloty 37%, the Hungarian Forint 29% and Ukraninian Hryvna 42%.

What are the immediate observable impacts of currency devaluation (this may also be relevant for the U.S. soon):

1. Speeds up asset quality deterioration and write-downs as unhedged corporate and retail customers that have borrowed in foreign currency face a relative increase in their debt burden.

2. Borrowers may chose to withdraw local currency savings to transfer them into a more stable foreign currency, which would shrink banks' funding base.

3. The capital ratio of banks with large foreign currency exposure will fall as a consequence of currency devaluation-related issues.

So as the vicious cycle of risk aversion accelerates in more countries, it results in domestic economies becoming worse off, thereby making traditional international commerce impossible, and impacting larger beneficiaries of globalization such as the G7.

But that is not all: in addition to sovereign risk, external investors also have creditor, liquidity and cash repatriation risk. The is because many West European banks acquired East European banks in the course of of privatization of state-owned banks during the transition from planned to market economies. According to the Bank for International Settlements, claims of West European banks on Eastern Europe amounted to €1.3 trillion in the first quarter of 2008, which depending on the degree of contraction and asset write-downs could be significantly impaired.

As the chart below shows, the countries that stand to be impacted worst by Eastern European bank deterioration (by being domiciles to investing banks) are Austria, France, Italy, Belgium, Germany and Sweden, as banks in these countries account for 84% of Eastern European bank claims. And of these, Austria is most on the hook, as E.E. banks account for half of Austria's global bank claims. Specific bank names that have the most exposure include Raiffeisen Bank, Erste Bank, Soc Gen, Unicredit and KBC.


This presents the case for the unwind of globalization, which is worthy of a much more indepth analysis. Over the past 10 years, as the globalization and credit bubble went hand in hand, we will inevitably see the ripple effects of a globalization in reverse, marked by constrained trade relations and minimized international commerce, in addition to the expected problems of how to deal with a widespread increase of domestic corporate and sovereign defaults, and spiking f/x rates and deflation. The true shape of the global economic problem is only now starting to take gradual shape.

Indicatively, the CDS levels of some Eastern European countries have been the biggest underperformers in recent days, and some are presented below.

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10 comments:

Anonymous said...

Tyler,

I just recently came across your blog/news-site. I am a Private Investor from the UK. I am glad I found Zero Hedge as it is very informative. Keep up the good work.

Thank you.

SIMON

Anonymous said...

Is globalization really going in reverse? Will VW decide that building cars in the Czech Republic and selling them in Germany is too risky?

It does seem that globalization will go into a lower gear and I, for one, will be glad for a change from the breathtaking pace of the last decade.

But the tide of economics moves on, relentlessly. The Germans may feel that can subsidize the auto-making jobs in their country forever, but they are just improvishing themselves by degrees.

Anonymous said...

Dont forget the Turks. They borrowed mucho dinero from the euro banks. I'm glad I brushed up on some history over the weekend. The '97 Asian crisis is happening all over again.

Anonymous said...

1) Kazakhstan is not in Eastern Europe. It is way on the other side of the Asian continent north of China.

2) Are Westerners completely incapable of talking about Eastern Europe without using the most hyperbolic language possible? Jesus! It's a real place, not a blank spot of the map with "here be dragons" written on it.

Anonymous said...

Christmas is early this year.

Central Europe's currencies arouse worries of contagion

By Edith Balazs and Christopher Emsden
430 words
11 February 2009
The Wall Street Journal Asia

Central Europe's various currency problems could be combining into a single regional crisis.

Some of the slides in the values of currencies in Hungary, Poland, the Czech Republic and Romania as well as Russia in the past few months have reversed the appreciation of recent years, when abundant credit made the emerging economies a favorite investment destination.

Their main export markets have since gone into recession, investors are pulling capital out of the region, the region's trade deficits are swelling and manufacturing activity has slowed.

The worry now is that investors will start indiscriminately selling currencies across the region, exacerbating the pain of these slowdowns and making it harder for governments to boost their economies.

"With poor or no growth prospects, shrinking foreign direct investment and fleeing portfolio investment, current-account deficits become a liability," said ING economist Agata Urbanska. One sign that psychology is driving currency prices: Currencies of some of the stronger countries are seeing currency drops as dramatic as the ones in weaker economies.

Analysts and bankers said Poland and Turkey have better fundamentals and stronger banking systems than some other countries in the region. But the Polish zloty is down 24% against the euro since September, and the Turkish lira is down 37% against the U.S. dollar.

U.K. Prime Minister Gordon Brown on Monday called for the IMF to do more to mitigate the risk of a regional currency meltdown by providing funds to recapitalize banks in the region. The IMF has so far organized emergency loans for Hungary, Latvia, Ukraine and Serbia. It is in talks with Turkey, and might soon negotiate aid packages with Poland, Romania and Bulgaria.

The IMF has already let it be known it would like to double its reserves to $500 billion. The European Central Bank, meanwhile, has offered Hungary and Poland currency swaps, intended at first to be a temporary fix to a liquidity squeeze.

"Local banks are surviving on the ECB's life support of overnight liquidity facilities," said Gyorgy Barcza, analyst at K&H Bank in Budapest, a unit of KBC. "Should this be terminated, the problem would be enormous."

The ECB could also help the region by offering more currency swaps to EU members outside the currency union, or even accepting government bonds from noneuro members as collateral, which would count as a strong vote of confidence for wary investors.

Edward Harrison said...

Tyler,

I just happened across this post and find it very informative. I am a blogger at the econ site Credit Writedowns. I have have written about this topic on several occasions, as has John Hempton at Bronte Capital. I will definitely link out to this post.

But, I also wanted to alert you to a few posts I have on this matter as well. Yon can find them under the tag 'Eastern Europe' (http://www.creditwritedowns.com/tag/eastern-europe) on my site.

Keep up the good work.

Cheers.

Edward

Chuck said...

The world through the 1990s and early 2000s, had been moving the way of the roaring 1920s, and now, the world has been moving in similar fashion from the stock market crash in 1929 into the great depression of the 30s.

This is not going to be fun and if you want to see some more comparisons you can go here and see what life during the great depression was like.

In Canada, layoffs are piling on like crazy, people are really feeling it.

Get out of debt, get liquid ASAP.

Minh said...

This all is bad karma. The Gods of Algebra is unhappy because these people attack their Babilonian childrens, n'est pas ?
Hell of a balance sheet nightmares.


http://en.wikipedia.org/wiki/Algebra
Algebra is a branch of mathematics concerning the study of structure, relation, and quantity.

While the word "algebra" comes from Arabic word (al-jabr , الجبر), its origins can be traced to the ancient Babylonians,[1] who developed an advanced arithmetical system with which they were able to do calculations in an algebraic fashion.

bb said...

1st learn how to read those BIS numbers, 2nd learn some geography, then blog in the spare time.

enjoy your recession!

Benjy said...

Interesting,

vs comments I say
1) subsidising workers to stay in work (Germany) is better than redundancies and them being on the dole (UK)

2) Polish currency had to take a hit, it was artificially booseted by so much £ being converted by immigrant workers and sent there.

vs article, nice high level stuff. What are the positive aspects of this, deglobalisation.... will companies/ investors pulling out of East Europe mean help back home?

Define East Europe? are we including everywhere east of Italy/ Austria/ hungary and south of Scandinavia and adding the old Bloc countries? if so we should invent a word for it.... "EEU Bloc" maybe