Cyprus Woes Threaten East Europe GDP, Development Bank Says

Cyprus’s bailout threatens to slow eastern European growth through trade and banking links if it sparks capital flight from the most indebted euro-area nations, the European Bank for Reconstruction and Development said.

Another bout of uncertainty in Europe’s debt crisis may boost financing costs for banks and potentially trigger an outflow of “large” deposits and funding in countries with weaker lenders or sovereigns, EBRD Deputy Chief Economist Jeromin Zettelmeyer said in an April 5 interview in London.

Eastern Europe relied on foreign capital flows and easy access to credit and export markets to fuel growth of more than 5 percent a year before the global crisis of 2008. The Cyprus bailout, in which international creditors forced losses on large depositors in exchange for a 10 billion-euro ($13 billion) aid package, may lead to capital flight and weaker growth in countries such as Italy and Spain, Zettelmeyer said.

“These are very important countries and they are very large, and so if there’s a slowdown in the EU as a result of this it would certainly affect” the 29 eastern European and central Asian countries where the EBRD operates, he said. “The risks are higher than we thought and they are further to the downside than what we thought.”

‘Contagion’ Fears

The Czech koruna, the Hungarian forint, the Russian ruble and the Polish zloty are among the 10 worst performers this year of 25 emerging-market currencies tracked by Bloomberg. The koruna and the forint fell 2.5 percent and 1.8 percent respectively against the euro, while the zloty and the ruble both weakened 0.9 percent.

The benchmark Czech PX Index has fallen 9.3 percent in 2013, while Poland’s WIG has dropped 6.1 percent, Slovenia’s Ljubljana Stock Exchange Blue-Chip Index has lost 8.8 percent and Russia’s Micex Index is down 4.4 percent.

“Most emerging European stock markets and currencies have weakened over the past month on the back of the Cypriot crisis and fears of contagion to the rest of the euro zone,” Neil Shearing, chief emerging-markets economist at London-based Capital Economics, wrote in an e-mailed note today. “This serves as a timely reminder that the crisis in the euro zone is far from over, and that the region’s financial markets are in for a bumpy ride this year.”

‘Terribly Difficult’

The EBRD forecast in January that eastern European economic growth will pick up to 3 percent this year from 2.6 percent in 2012. It will update the projection in early May.

“Our last forecast assumed that GDP in the region was turning around in the first quarter,” Zettelmeyer said. “It is terribly difficult to say whether this was thrown off track by the Cyprus episode or not.”

While concerns by large depositors may be “overdone,” the EU hasn’t done enough to reassure them that the formula used in Cyprus remains a unique solution, Zettelmeyer said.

“This is not something that’s been clarified and it would certainly help to have more clarity on this by the EU,” he said.

While the rescue of Cyprus prompted concern in financial markets that Slovenia, the first former communist nation to adopt the euro, may be next in line for a bailout, the former Yugoslav country may be able to avoid aid “if the government does the right thing,” according to Zettelmeyer.

‘Very Different’

Eastern Europe’s banking systems lack reliance on “a massive volume” of large deposits and that includes Slovenia, making it “very different” from Cyprus, according to Zettelmeyer.

Slovenia, battling its second recession since 2009 and rising bad debts at its banks, is trying to avoid becoming the sixth euro nation to ask for aid. Banks such as Nova Ljubljanska Banka d.d. and Nova Kreditna Banka Maribor d.d. are struggling with surging bad loans after the collapse of the construction industry, which fueled growth before the crisis. Bad loans account for about a fifth of economic output.

Investor concern that the government will fail to implement a 4 billion-euro plan to prop up banks and lose access to financing abroad boosted borrowing costs at a time when the Alpine nation is looking to tap bond markets.

Funding Needs

The country needs about 3 billion euros of funding this year, while banks require an additional 1 billion euros of capital, the Washington-based International Monetary Fund said last month. The previous government of Janez Jansa, which fell Feb. 27 amid a corruption scandal, had proposed the plan to deal with bad assets that Prime Minister Alenka Bratusek pledged to follow with some unspecified changes.

Bratusek, who took office three weeks ago, told parliament March 27 that her government would rebuild ailing banks and press ahead with austerity measures to improve state finances that are in “bad shape.”

The yield on Slovenia’s dollar-denominated bonds maturing in 2022 rose 7 basis points to 5.68 percent as of 5:39 p.m. in the capital, Ljubljana, data compiled by Bloomberg show. The yield has declined 73 basis points since climbing to a record 6.382 percent on March 27.

“It will all depend on the execution and the credibility of that plan,” Zettelmeyer said. “The government is also doing everything it can at this point to avoid requiring EU and IMF assistance. As long as they’re doing the right thing they may well not need it.”