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The big borrowers

  • Stephanie Flanders
  • 27 Feb 09, 04:21 PM GMT

If you're wondering where the epicentre of the global financial crisis might be in 2009, I suggest you look somewhere east of the Danube.

Today's 24.5bn euro ($31bn; 拢21.8bn) shows that the dire figures coming out of the region are starting to focus minds. But this is just the beginning.

Why are these economies in a particularly painful bind? Well, you knew that big borrower nations like America and the UK were hit first by the credit crunch. As I discussed recently, countries that relied on exporting to the rest of the world are now also being thumped.

The very bad news for the Central and Eastern European economies is that over the past few years they've been big borrowers and big exporters. Now they're suffering the worst of both.

You might think horrendous is a rather emotive term for an economist. But it's the only word that comes to mind when you look at the figures. Until very recently, exports accounted for 80-90% of GDP in the Czech Republic, Hungary and Slovakia.

Meanwhile, US and British borrowing in the lead-up to this crisis was chickenfeed compared to what these countries were hoovering up, relative to the size of their economies.

I've brought together the most striking figures in a chart (see below).These are the IMF's figures for net capital inflows in 2007 as a share of GDP.

Capital flow bar graph

I must confess I was astonished to see that Bulgaria sucked in flows worth nearly 40% of GDP in 2007. America wasn't the only place where you had very risky imbalances hiding in plain sight. Trust me, there are plenty more where that came from, and I'm leaving out the likes of Tajikistan and Ukraine - they're a subject for another day.

As Graham Turner, of GFC Economics, points out, these inflows are far larger than anything seen in the lead-up to the Asian financial crisis of 1997-8. Thailand had net inflows of just under 11% of GDP in 1996, the year before its currency peg collapsed and investors in emerging markets started running for the door.

European governments last week called for a doubling of the IMF's lending resources to 拢500bn, in the hope that a lot of that money might find its way to the likes of Rumania and Bulgaria.

But there's no getting around the fact that many of the economies in trouble are in the European Union. This Sunday's special European summit in Brussels will be an opportunity for the likes of Germany and France to declare their solidarity with the East.

So far solidarity has been in fairly short supply. Czech officials were understandably outraged earlier this month by the French President Nicolas Sarkozy unveiling support for French carmakers which was dependent on keeping French plants open - and appearing to suggest they close their Czech plants down instead. Not a lot of fraternit茅 there.

Though all have been under pressure in the foreign exchange markets, not every country is in the same straits.

Poland and the Czech Republic, while poorly, are in better shape than most of their neighbours. Slovakia and Slovenia also face a hard slog but at least they are in the euro.

They don't have the problems of Rumania or Hungary - where a large chunk of the population, incredibly, now has mortgages denominated in Swiss Francs. (I guess it seemed like a good idea at the time, much as 125% mortgages seemed to make sense in Britain in early 2007.)

The situation for the Baltic economies is dire, too (sorry, it's a long list). A few weeks ago Latvia officially became the first country in this crisis to have seen a 10% drop in GDP.

The Baltics are all pegged to the Euro. Some say they should go ahead and join - which would at least give them the benefit of lower rates and stop the one-way bet to the speculators who think the pegs will break.

Riding out the storm inside the Eurozone is no quick fix. Ask Spain. But if you're on the edge of a full-blown current account crisis from the drying up of capital flows, being outside the Euro won't be comfortable either.

Whichever way they go, many of these countries are going to need support from EU and other multilateral institutions but also, probably, individual countries (several of whom, like Austria, have discovered their banks have a lot vested in the East.)

Eurozone economies may have to rely on that kind of bilateral help: the Maastricht Treaty explicitly forbids bailouts among euro members.

For EU members that are outside the Euro there are some funds available: the pool of available European Community assistance was doubled to 25bn euro ($31.6bn; 拢22.3bn) recently when the EU joined an IMF support package for Hungary and Latvia. But that's pretty small change compared to the scale of the problem. Knee-deep in bank bailouts, Western European governments will hardly relish the job of explaining to voters why they should bail out profligate East Europeans as well. But they didn't want to bail out the banks either.

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