Kosovo's Fallout

The war spawns major economic fears

Standing atop his motionless tug, Ukrainian skipper Yevgeny Anyikanov surveys the clusters of Danube river barges around him. Anyikanov had delivered a load of iron ore in Austria and was heading home on Apr. 3 when NATO planes destroyed a large bridge at Novi Sad, in northern Serbia. This blocked shipping traffic on Europe's longest shipping route, stranding hundreds of merchant marine sailors, including Anyikanov, along the Hungary-Serbia border. "I called my wife and told her I won't be home for a while," he says.

The economic fallout of Europe's war stretches far beyond the Danube. Along Italy's Adriatic coast, airports that normally would be gearing up for tourists are now hosting NATO bombers--and closed to civilian traffic. Some 35,000 Kosovar refugees have poured into Western Europe's heartland, taxing social-service networks still struggling to process earlier waves of Bosnians.

Safe in their glass towers, European economists are digesting these developments and revising their forecasts for a continent at war. Figuring on a four-month campaign, Deutsche Bank Chief Economist Norbert Walter calculates that war and reconstruction will shave a combined half-point of much-needed growth off Europe's economies over this year and next. On average, the Continent is expected to grow only 2% this year and 2.8% in 2000.

Indeed, the brutal war just a day's drive from Munich or Milan has transformed a year of triumph into one of deep anxiety for Europe. Instead of the hopes that surrounded the birth of the common currency on New Year's Day, investors are focused on fears. Even before the bombing began, sputtering growth in Germany and Italy was punishing the euro. Looking for better prospects, investors plowed funds into America's booming markets and Japan's nascent recovery. Now the war adds greatly to the doubts surrounding Europe. Down 10% against the dollar so far this year, the euro has been hitting low after low since the air war first thundered over Yugoslavia.

EURO TRAP. Now investors must at least consider the possibility of a ground war. The war itself could cost less than $10 billion for the region if it never involves a NATO ground invasion. But the uncertainties it stirs add to an increasingly gloomy view of the European economy, where growth is lagging at half the rate of its booming U.S. counterpart. In addition, more bad news from Kosovo could push the euro, now worth $1.06, toward the crucial threshold value of one dollar.

Breaking through that psychological trading barrier could sink the euro's short-term prospects of becoming a worldwide reserve currency. Already, European Central Bank President Wim Duisenberg, French Finance Minister Dominique Strauss-Kahn, and Bundesbank President Hans Tietmeier have been trying to talk up the euro, which they nudged up by a cent on Mar. 26. But bad news from the Balkans could quickly drive it down.

The ECB is in a tough position. Raising interest rates to defend the euro would snuff out what little economic growth there is and push Europe toward recession. Economists think it's more likely that the ECB would urge central banks to sell dollar reserves to boost the euro's value. "If we see dollar-euro parity, you could see intervention by the ECB and the Fed," says Robert Parker, deputy chairman of Credit Suisse Asset Management in London.

The euro's strength and credibility are not the only symptoms of battle fatigue so far. In parts of Europe, the war is already causing palpable economic trouble. As gas-guzzling NATO planes refill their tanks, the price of jet fuel has climbed from $10 to $16 per gallon, squeezing margins at commercial airlines that are already losing traffic because of shut-down airports in the south. Italy, for one, predicts that its $12 billion tourist industry will suffer a $2 billion setback this year alone.

SCROUNGING. Business leaders are warning that the war could drag down Italy's economy, already Europe's most sluggish with growth of only 1.5%. In mid-April, the retailers' association warned that Italy would require a tax hike to fund the war and associated costs, which it estimated at $3.5 billion. Consumer fears of a prolonged war and a refugee crisis are already translating into lower spending. Food purchases are down by 5% to 10% since the war started. The highest declines are in the southeastern province of Puglia, where some 1,000 Kosovar refugees arrive by dinghy every day.

The other large European countries remain confident they can bankroll their share of an air war within current budgets. In fact, while European central bankers wring their hands and international investors park funds in the U.S. and Japan, many European businesses and consumers seem undaunted by their neighborhood war. The mood in France is swinging toward spending, and a much-watched German index of business confidence tracked up in April.

Among Serbia's closest neighbors, of course, the picture is far graver. In Hungary, farmers worry the blocked Danube will leave them with hills of unshipped grain later this summer. Steel company Dunaferr, meanwhile, is scrounging to replace the half-million tons of Ukrainian and South African ore it usually ships up the river for its smelters. Bulgaria has also lost key trade routes through Serbia and is seeing foreign investors flee.

Paradoxically, Albania, Europe's poorest economy, stands to benefit in the long run from the war on Serbia. By hosting NATO, the tiny country with a per capita income of only $1,370 is positioning itself for massive aid injections that are sure to follow the war.

The potential costs of reconstructing Albania and other Balkan lands would not significantly hurt the European Union's budget. But they would ignite severe controversy among EU members over where the money would come from. Eric Chaney, Morgan Stanley's Paris-based Europe economist, thinks Europe could afford up to $40 billion worth of reconstruction. But a chunk of that money would have to be diverted from recipients of such EU goodies as agricultural subsidies. How much aid ultimately gets disbursed depends on the length and expanse of the war, and whether bombed-out Serbia ends up as vanquished friend or resolute foe. That's one more mystery in a war that's giving Europe the jitters.

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