Eastern Europe Threatened by West's Debt, Euro Crisis, EBRD's Berglof Says

The Greek debt crisis, which is threatening to bring down the decade-old euro, may spoil east Europe’s nascent recovery, the European Bank for Reconstruction and Development said.

The EBRD, a London-based development bank that helps former communist states in eastern Europe and central Asia transform their economies, said May 15 that the 30 countries it invests in may expand a combined 3.7 percent this year. The struggle to contain the debt crisis in western Europe may ruin that forecast, especially on the Balkan peninsula, the EBRD said.

“We have the Greek crisis, and it poses a risk in particular to southeastern Europe,” EBRD Chief Economist Erik Berglof said during the bank’s annual meeting in Zagreb, Croatia. “But there is a broader risk for the region. Clearly this is something we are very concerned about.”

The former communist countries in Europe and the former Soviet republics in central Asia are recovering from the deepest recession since switching to free-market policies two decades ago. Challenges include adjusting to a slower pace of growth as the European Union, the largest export market for most of the region, grapples with mounting fiscal problems, the EBRD said.

The euro has fallen 3.9 percent to $1.2358 in the past seven days. It traded for $1.2311 at 9:14 a.m. Central European Time.

German Chancellor Angela Merkel said May 14 that Europe is in a “very, very serious situation,” even after a rescue package for the region’s most indebted nations. The Spanish newspaper El Pais reported the same day that French President Nicolas Sarkozy threatened to withdraw his country from the euro. Finance Minister Christine Lagarde and other government officials denied the report.

Euro Defense

EU Monetary Affairs Commission Olli Rehn told participants at the Zagreb conference that “it is important that markets read our package and see that we are serious about our defense of the euro area.”

Yesterday, Greek Prime Minister George Papandreou said his country may take legal action against U.S. investment banks that might have contributed to the country’s debt crisis.

The euro region’s tensions may affect eastern Europe through “a disruption of capital markets” as well as “a decrease in import demand from countries like Germany or France,” EBRD President Thomas Mirow said at the close of the annual meeting. “There are potential risks that can be channeled through the subsidiaries of Greek banks. Up until now we haven’t seen this materializing. We have to watch and encourage policy makers to bear this risk in mind.”

‘Uncertain’ Outlook

The EBRD raised its forecast for Russian economic growth this year to 4.4 percent from 3.9 percent. It also boosted the outlooks for Turkey, Poland, Hungary, and Ukraine, while lowering expectations for Romania and Bulgaria.

“The outlook remains very uncertain because of a shift in risks from the domestic to the external,” Berglof said. “External risks have risen dramatically.”

While the EBRD now expects most countries where it operates to rebound, the recovery will be protracted, it said. Growth rates will remain below pre-crisis levels and former drivers of expansion, such as investment from abroad and consumer spending, will remain subdued. The region grew at an average pace of 5 percent annually before 2008.

The EBRD’s shareholders increased the bank’s resources for the next five years. They approved raising the bank’s capital by 50 percent to 30 billion euros ($37.2 billion), enabling it to invest about 52 billion euros until 2015. That’s more than the bank’s combined investments since its 1991 inception.

Capital Increase

The capital increase will open the way to investments of 9 billion euros in each of the next two years and 8.5 billion euros in the succeeding three years. The bank this year will spend 8 billion euros on loans and company stakes. Funding reached 1.76 billion euros in the first quarter, 60 percent more than in the same period last year, the bank has said.

The bank also announced a plan to limit foreign-currency loans by east Europe banks, after they brought some countries to verge of default during the global credit crisis.

Underdeveloped financial markets, low saving rates and high local interest rates contributed to a surge in foreign currency loans during the boom years, the EBRD said.

East European banks struggled to refinance foreign-currency mortgages, car and consumer loans because their parents in Austria, Italy, Germany and Sweden reduced funding during the credit crisis.

The EBRD helped limit the impact of the financial crisis, which hit Europe’s emerging markets hardest, by persuading western banks to remain in the region and providing them with funds to lend.

The bank’s 63 shareholders also pledged to support an EBRD program designed to help countries with excessive reliance on raw-material exports, such as Russia, or few manufactured goods, such as central Europe, to diversify their economies.

To contact the reporters on this story: Agnes Lovasz in London at alovasz@bloomberg.net; Boris Cerni in Ljubljana, Slovenia, at bcerni@bloomberg.net Daryna Krasnolutska in Kiev at dkrasnolutsk@bloomberg.net

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