East European Debt Set To Explode

CAN DREAMTIME FINANCE SAVE EASTERN EUROPE ?

Andrew McKillop

18 Jan 2012

Speaking in interview with the Austrian newspaper ‘Wiener Zeitung’, World Bank official Andrew Burns said on 17 January that the western European banking crisis has moved east with a vengeance: “The problem is especially virulent in eastern Europe and central Asia because those countries strongly depend on loans from developed (west European) countries,” he added.

Former Strauss-Kahn IMF comfort girl Piroska Nagy, now a director of country strategy and policy at the European Bank for Reconstruction and Development (EBRD), said in interview “there is still a coordination failure” between eastern and western Europe on banking risks. And these risks are mightily growing because economic growth will tail down even faster in eastern Europe, as western Europe’s economies tilt into recession. The biggest lenders in the former communist countries, Italy’s UniCredit, Germany’s Erste Group Bank and Swiss Raiffeisen Bank International are all raising capital, shedding assets and tightening funding of subsidiaries to meet new rules imposed by the European Banking Authority and national authorities in western Europe. Next ranking lenders to the now tottering economies of eastern Europe are France’s troubled Societe Generale, Holland’s KBC Groep and Italy’s Intesa Sanpaolo.

The dreamtime solution is to quickly find, that is print as much as 150 billion euro additional and separate funding, for a bailout programme to save troubled banking entities in eastern Europe – including central banks. This will enable east European governments, money authorities and private banks to defend national moneys and service their loans, through handing over new, freshly printed, non-recycled cash to the private western banking groups which prop up the failing economies of east Europe – and which themselves are already deeply in trouble in most cases. In this categor we can note France’s three major banks, most of Italy’s major banks, Spanish, Dutch and Belgian banks, and certain highly exposed German, Austrian and Swiss banks.

The European Banking Authority has set an end of June deadline for European banks to build up their core capital reserves to 9 percent of their balance sheet lending, needing a considerable write down of their sovereign debt holdings in eastern Europe. As of January 2012, this funding gap stands at around 115 billion euros ($149 billion), but may climb to 150 billion or more, well before June.

DREAMTIME GROWTH

How can debt-wracked western European governments bail out eastern European economies, without a return of economic growth ? Alternatively, if west European commercial banks take new and additional losses in east Europe, on top of their “troubled loans” to the PIIGS of west Europe, how is their additional bail out need going to be financed, without a return to economic growth ?

The World Bank on January 18 announced its 2012 global forecasts: the world economy will grow 2.5 percent this year, down from its June 2011 estimate of 3.6 percent while the euro area will contract 0.3 percent, compared with its previous estimate of 1.8 percent growth. US economic growth was forecast at 2.2 percent, compared with the June 2.9 percent growth forecast. The World Bank was sufficiently honest to add that even achieving these much weaker outturns is highly uncertain and weaker growth in one region will reinforce the downturn in another, resulting in even stronger economic contraction as resistance thresholds are breached on the downside.

This shifts the focus back to the fundamental weakness of the dominant hands-off laisser-faire economic model, where de-industrialisation and outplacement automatically deepens national trade deficits, and this is plastered over by borrowing and in crisis conditions is cut by austerity measures. When the borrowing gets too large to service, the country goes into financial meltdown and crawls to the IMF for bailout, or in Europe goes to an emerging hybrid of European institutions and the IMF-World Bank duo.

What we know today is that when or if economic growth became feasible and self-reinforcing, the results will be 100% predictable: an explosion of commodity prices even bigger than the explosion of equity numbers printed on share certificates. Taking the leader-symbol for commodities, oil prices, these would be quickly levered up well beyond $125 or $130 a barrel, even by economic growth rates as low as 2.5% a year at the global level, as presently forecast by the IBRD. As we also know, both western and eastern European economies would ratchet up their trade deficits as commodity prices rose and their economies staggered forward at low or almost zero growth rates, just outside recession, this being “the best we can hope for” from hands-off political deciders committed to laisser-faire, except when it concerns saving their friends in investment banking, broking and dealing.

IMPOSSIBLE TO PLEAD “SURPRISE DEFICITS”

For the east European ex-Warsaw Pact countries, which apart from Ukraine and Byelorus (Belarus) and a few ex-Yugoslav republics and Moldavia are all now EU27 member states, their spiraling trade deficits and therefore “need to borrow” was totally predictable, even under the best-possible economic conditions. For the 12-year period 1992-2004, Central and Eastern Europe was the region with the most rapid growth of foreign debt among “developing and transition economies” (ex Communist), and the highest borrower region relative to GDP through the long period of 1989-2010.

The growth of foreign debt in the region is basically driven by persistent or ‘structural’ current account deficits. Several east European countries show debt growth figures worse than those of Latin American states in the pre-crisis years of the 1990s.

On entry to the EU, east European states abandoned their previous national foreign trade policies and adopted the EU’s “regional mercantilist” co-prosperity concept, becoming dependent not only on goods supply from western EU countries, but also on the free movement of services, enshrined as a basic principle in the EU treaties. This left central and eastern East European governments basically with the sole option to devalue their national currencies and borrow in euros as their trade deficits became “structural”. These deficits were then intensified by capital deficits, driven by western European-owned manufactured goods and service providers, operating inside east Europe, remitting profits and their interest payments on corporate loans back home.

The figures are drastic but for many reasons do not figure in Good News Media of west Europe or the USA – the net result is that extremely high profit remittances and interest payments have joined the commercial trade deficits, making the current accounts of central and eastern European countries worse than those in Latin America in the second half of the 1990s. We know what happened next in Latin America.

With the exception of Nicaragua and Panama during the crises of the 1990s, no Latin American country had current account deficits of more than 5% – 10% of GDP.

These are the rule, today, in eastern Europe.

Since 2000, and especially in 2004-2009, east European debt has grown faster, and higher than in the debt-prone Latin American economies of the 1990s. Increases range from around 175% for Poland to lurid increases in the case of the Baltic states (Lithuania: + 380%, Estonia: + 650%, Latvia: + 1500%). In all cases, the combination of overvalued national currencies, high current account deficits, industrial collapse, and ever rising borrowing (both by the state and enterprises) can only end in severe financial crisis.

With no suprise at all, and exactly as in all cases of sovereign debt crisis, short-term debt has grown much faster than long-term debt. The east European debt bomb is therefore now mature and ready to explode. This crisis will further deepen the funding and spending needed to prop up the euro prompting the question: Dreamtime Finance to the rescue ?

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