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Crunch time for emerging Europe

A reduction in foreign capital flows means that many banks in eastern Europe are indirect victims of the credit crunch.

The US and western Europe are not the only regions facing a credit crunch. Parts of central and eastern Europe are undergoing financial stresses of their own – and in some cases the situation is getting very ugly.

As the IMF’s recent Global financial stability report makes clear: eastern Europe includes several countries that have been heavily dependent on foreign capital flows, largely debt, in financing big current account deficits, and they are now acutely vulnerable.

To make matters worse, many of these countries have seen strong credit growth over the past few years. A dramatic slowdown in private flows to the region could lead to a painful adjustment.

The banking community remains optimistic. The Institute of International Finance, for example, is forecasting only a moderate reduction in capital flows to the region this year, although, as the US sub-prime crisis has demonstrated, bankers can get it wrong.

The Baltic states, Romania, Bulgaria and Turkey have most to worry about. Each has unique problems: falling property prices in the Baltic states, political tension in Turkey, muddled economic policies in Romania and Bulgaria.

They have a number of challenges in common too, including big current account deficits, weak currencies, financial assets undergoing a repricing and, with the possible exception of Turkey, fragile banking systems.

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