Comstock Partners, Inc.February 26, 2009
Eastern Europe Blowing Up
While investors are correctly paying a lot of attention to the programs being put out by the White house this week, just under the radar is the rapidly developing Eastern European situation that is threatening to exacerbate the world banking crisis. Last week Moody's rattled the markets a bit when it said it was considering downgrading a number of European banks because of severe problems with their loans to Eastern Europe. The concern immediately faded to the background, however, as it was overshadowed by the barrage of news coming out of Washington on the stimulus package, the banking situation, the mortgage programs and the proposed budget. We think that it won't be long before the Eastern Europe economic and financial distress will be a major topic on the front pages and cable news.
What's happening is that the economies of the Eastern European nations and ex-Soviet republics are crumbling at a time when they owe vast sums to European banks. On average, GDP in the Baltic countries is down 17% and their stock markets down 70%. Still, they have raised their short rates by 500 basis points to defend their currencies that are plunging, thereby making the economic situation even worse. In Poland, 60% of the mortgages are denominated in Swiss francs and the zloty has plunged against the franc. Their industrial production has declined 14.9%. In the Ukraine, GDP has dropped 20% year-over-year while industrial production has declined 34%. The Hungarian forint is down 30% against the euro, and almost all of their mortgages are denominated in foreign currencies, making them more difficult to service. The Hungarian stock market is down 60% and auto sales are off by 50%. Other Eastern European countries are facing similar situations.
The problem is that the aforementioned group of nations has borrowed $1.7 trillion from foreign countries, with $1.3 trillion of it from European banks. They must pay back or rollover $400 billion this year, an amount equivalent to one-third of the group's GDP. With credit markets frozen, however, this is an impossible task, and without a massive bailout, these countries will blow up. Especially vulnerable are banks in Austria, Sweden, Greece, Italy and Belgium. Austrian banks alone have exposure of $280 billion to emerging Europe, an amount equal to 64% of its GDP.
The European Bank for Reconstruction and Development (EBRD) estimated that the bad debts of Eastern Europe and the ex-Soviet republics would exceed 10% and possibly be as high as 20%. Hans Redeker, Chief Currency Strategist at PNB Paribas said, "We're nearing the level where things can get out of hand". IMF head Dominique Strauss-Kahn expects a "second wave of countries to come knocking" after prior IMF bailouts of Latvia, Hungary, Ukraine and Belarus. IMF reserves are rapidly running down after a series of aid packages to emerging nations.
Austrian Finance Minister Josef Proll is trying to put together a rescue package before the situation deteriorates further. Der Standard in Vienna said that "A failure rate of 10% would lead to the collapse of the Austrian financial sector". German Finance Minister Steinbruck said that the Western European governments may be forced to bail out Eastern Europe. With Western European economies already in terrible shape, this will not be accomplished without a lot of time and turmoil. It will be exceedingly difficult to get the various nations to agree on a package and the citizens of Western Europe will certainly protest at having to bail out foreign countries when they are having such a rough time themselves. We think this means some more significant downturns for global markets.