The financial crisis part two?

Vladimir Tsyglakov, MBA MIP
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Not long ago Eastern Europe was the Promised Land for Western banks and corporations, striving for new markets. Today, however, what was regarded as a source of profit threatens to prolong a financial crisis in Western Europe.
According to Morgan Stanley, Eastern Europe has borrowed $1.7 trillion abroad, much on short-term maturities. Only in 2009 it must repay – or roll over – $400bn, equal to a third of the region's GDP. The European Bank for Reconstruction and Development (EBRD) says bad debts are expected to be within the range of 10 to 20%. 

The illness of Eastern Europe is mainly determined by two factors: collapsing exports, which accounted for 80% to 90% of the GDP in the Eastern Countries, and the cutting of Western capital inflows, which are planned to fall from an estimated $254 billion in 2008 to $30 billion by the end of 2009 (Institute of International Finance).
“Survival is going to be very tough for the majority of privately-owned banks in Ukraine,” said James Watson, a Fitch director in Moscow: the Ukrainian currency has fallen more than two times to euro and dollar since the beginning of the crisis while steel prices collapsed. Latvian economy has shrunk 28,7 % for the first quarter. In Poland, 60% of mortgages are in Swiss francs, whereas the zloty has more than halved against the franc. Large losses are piling up in Hungary, the Balkans, and Turkey. Even for Russia necessity to pay back the $500bn debts combined with lower than expected oil prices presents a severe stroke. 

If this illness turn into a counterparts' default, a vaste negative impact on Western banking system is expected because almost all East Countries' debts are owed by Western Europe, especially by Austrian, Italian, Swedish, Greek, and Belgian banks. In particular, a heavy blow can strike on Austria, as its banks have lent to the East €230bn, which constitutes 70% of the country's GDP, and even the minimum expected failure rate can lead to collapse of Austrian banking sector.
According to Dejan Krusec, the expert of the European Central Bank, the Western banks are strong enough to withstand the current downturn if there is a rapid "V-shaped" recovery but not if it takes longer to refloat the economy. If this is 'U-shaped', the banks will have difficulties: "The problem is not 2009. Euro-area banks are well enough capitalized to cover losses. The problem is 2010. We are concerned about the length of recession." The ECB's forecasts have worsened, predicting a 4.6pc contraction this year and a further fall of 0.3pc next year, with no recovery until mid-2010, so that the V-shaped rebound seems to be precluded.

In conclusion, what seems to be a regional crisis in Eastern Europe can have a global impact. As Harvard professor Kenneth Rogoff noted in a recent article published by New York Times: "There would be a domino effect. International markets are linked, and so a snowballing credit crisis in Eastern Europe and in the Baltic countries could cause New York municipal bonds to fall." There is no need to say that if financial slump in the Eastern Europe can influence even US, which has a tiny share of bad debts in the region, what is the scale of domino effect we can expect in the Western Europe?