How Many Countries Will Need IMF Help?

As the financial crisis spreads, Eastern European economies that have lived off cheap credit are hurting. Many could require bailouts

It's now clear that the global financial crisis has not only crossed the Atlantic into Europe, it has spanned the entire continent.

Just weeks ago the vulnerability that emerged in the United Kingdom and flashed before the world as Iceland's banking sector imploded looked confined to Western Europe. After all, many analysts said, Central and Eastern European economies are little exposed to the mortgage-backed securities behind the meltdown, and for most, their fundamentals and growth are strong.

Then came news at the end of October that the International Monetary Fund was negotiating multibillion dollar bailout packages for Ukraine and Hungary, the latter of which had already received a nearly $7 billion credit line from the European Central Bank. Suddenly, there were murmurs of an Iceland sequel in the east.

The IMF, which has now reached loan deals with both countries, seems committed to restoring confidence in battered economies, so that probably won't happen. But with regional currencies and stock markets from Riga to Budapest to Prague cratering – many down more than 50 percent this year – as panic spreads, it's not unreasonable to start talking about the "Eastern European predicament."

Economically, Central and Eastern Europe is diverse, so the individual symptoms behind the region's larger sickness are many, as are the prognoses for each country. But, ultimately, it's fairly simple: for many years, like U.S. homeowners who took out mortgages they couldn't afford, many of these economies have lived beyond their means on credit.

EAGER BORROWERS

Countries throughout the region used capital inflows from lenders, investors, and foreign governments to build up their economies after the fall of the Soviet Union and, in some cases, in preparation for European Union membership. This was a largely healthy process, but as economies matured and living standards improved, consumption ballooned. In the Baltics, Romania, Bulgaria, or Ukraine, for example, consumption became the main driver of robust economic growth, not manufacturing or exporting, according to Vasily Astrov of the Vienna Institute for International Economic Studies.

This, in turn, led to huge demand for imports. But this was not met – or, ideally, exceeded – by revenues from exports.

"So they had to borrow," Astrov says. "And they became heavily indebted."

Technically, this borrowing was tenable as long as the global financial system was flush with cash. Now it's not; credit, capital, and investors are becoming scarce; and these economies are foundering as panic spreads through stock and currency markets. The Hungarian forint, for example, is down around 30 percent against the U.S. dollar since August.

Economists call this a "sudden stop." It's as if the global economy is saying, "Hey, you know all that money we've been lending you guys? Yeah, we've got cash flow problems at the moment, so you're on your own."

Further exposing many countries are high foreign exchange loan volumes. In recent years many Hungarian homeowners and businesses, for instance, have taken loans from Western banks in foreign currencies at lower interest rates than would be offered domestically, betting that the forint would remain strong.

But with the forint tumbling, repaying those loans has become a lot more expensive – and they account for 90 percent of new mortgages since 2006, according to figures published 23 October in The Economist. This has fomented a nascent currency crisis that has many Western lenders worried about defaults and questioning whether they should roll over loans, even to sound debtors.

That's a major reason the IMF rushed to help Ukraine and Hungary. It's loaning the former $16 billion and, together with the EU and the World Bank, Hungary $25.1 billion, the largest international economic rescue package for an emerging economy since the start of the crisis.

The IMF has also created a $100 billion fund to aid other economies. The question now is, how many East European countries will need similar help?

Romania and Bulgaria likely will, but a lot will depend on whether Western banks, which own much of Eastern Europe's banking sector, keep lending, as The Economist recently pointed out.

Astrov says those economies saturated by large Western banks, such as the Czech Republic, will at least in the short term have fewer liquidity problems than countries with a lower penetration.

"In countries where the presence of foreign banks is more limited, then local banks have to borrow abroad," he says. "If there's a crisis of confidence, [foreign banks] might not lend money to someone who doesn't belong to them."

It's also true that more advanced economies such as the Czech Republic, Slovakia, and Poland appear better positioned to ride this out. The Czech Republic, for instance, has seen the Prague bourse drop around 50 percent this year and the crown lose 20 percent against the dollar since August. But its economy is export-, not consumption-based, and debt and inflation are low relative to many of its eastern neighbors.

Poland and Slovakia appear relatively safe as well, though both Slovakia and the Czech Republic – each car manufacturing hubs and large exporters to Western Europe – should be concerned about the automotive industry's decline and winnowing demand as Old Europe suffers.

After all, this crisis is collapsing on Europe – and no country, no matter how fundamentally sound, will be invulnerable.

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