“Over the past six months the global credit crisis has been most intense in G7 markets centred around the shocking deterioration of the US banking system. During this time emerging market (EM) policymakers spent considerable resources doing their best to buffer their economies, banking systems and financial markets from these pressures. With financial resources for many EMs dwindling to uncomfortably low levels, ie, running out of bullets, and global pressures set to remain intense, we expect this crisis to rotate into EMs in coming weeks/months resulting in a second, more EM-centric sell-off – which may already be under way,” it stated.
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There’s a vicious circle building as these countries not only border one another but they are trading partners. The fear is that a recession in one leads to a recession in another. It looks a lot like Asia in the late 1990s |
Other banks agreed that the outlook was bleak for numerous emerging markets. “Taking CDS spreads as a guide, several central and eastern European countries seem to be on the verge of collapse,” wrote BNP Paribas in its FX Daily Strategist. Similarly, Commerzbank Corporates & Markets said that things were starting to look terminal for several currencies. “The Eastern European currencies are stuck in a depreciation spiral. At present there are no signs suggesting that the central banks are going to stop this process,” it wrote. Threat to euro
Commerz has been consistent on warning of the threat that this `posed to the euro. “So far markets have largely ignored this fact, but are unlikely to be able to maintain this approach if the weakness of the eastern European currencies continues or the CDS spreads rise further,” it pointed out.
“Eurozone creditors are carrying the main brunt of the rapidly deteriorating creditworthiness of eastern European debtors,” it added. “Japan and the US but also UK banks have hardly any exposure in the area. The collapse of these currencies and rising CDS spreads in eastern Europe is therefore likely to constitute a further risk factor for the euro.”
One analyst says: “There are two dynamics. One is repatriation by investors and the other is a fear of sovereign and corporate defaults. These countries are net borrowers and funding has dried up. There’s a vicious circle building as these countries not only border one another but they are trading partners. The fear is that a recession in one leads to a recession in another. It looks a lot like Asia in the late 1990s. I think the way it will be resolved is through additional funding by the IMF. That may take some time to materialize so they potentially have more weakness in them, but it is moving towards the seventh innings stretch – we’re in the final stage of the crisis.”
Nervous officials
The nervousness has clearly spread to EU officials. On February 18, the EU expressed its concern about the weakness of the currencies of its eastern European members. EU economic and monetary affairs commissioner Joaquín Almunia even went so far as to effectively tell their authorities to stop talking themselves into further trouble. “I am… concerned about the volatility of the exchange rate in EU countries with floating regimes,” Almunia said with regards to Poland, Hungary, Romania and the Czech Republic. “I am also concerned by the possibility that some public statements have accelerated this evolution. I would ask all the authorities… to be careful when they make public statements because the markets are very nervous and sometimes they don’t understand very well some of the statements,” he added.
Delayed EMU accession?
The fall of the zloty – it has depreciated by about 50% against the euro since August – has raised doubts about whether or not Poland would be ready to join the eurozone by 2012. The zloty is scheduled to enter ERM2 in the first half of 2009 but that looks increasingly infeasible. “The conditions for ERM accession is a small deficit and a stable currency. They can’t meet those requirements,” says the analyst.
As well as affecting the euro, the crisis in eastern Europe poses a threat to the EU’s already fragile banking sector. “The Europeans and the Germans specifically have realized that the worse this crisis gets the more it will impact their banks. The governments will get the bill eventually so it is probably better to be proactive and arrange some financing for these countries through the IMF or bilaterally,” the analyst warns.
