Rising economic woes test Europe's leaders

Year by year, banks in Germany, Austria and Switzerland loaned billions of dollars to Eastern European households and businesses, which were drawn to euro-denominated loans by low interest rates. Today, those banks have $1.7 trillion in loans outstanding to borrowers in the East with $400 billion in short-term debt due to be paid off or refinanced this year, says Stephen Jen, managing director at Morgan Stanley in London. That $400 billion amounts to roughly one-third of the region's annual economic output. And that's where the real problems begin.

As investors rediscovered risks of all kinds amid the global financial crisis, currencies in the ex-communist states paid the price. Since last July, the Hungarian forint, for example, has lost 28% of its value against the euro. A 1,500-euro monthly mortgage payment that used to require 342,240 forints now costs 474,750.

Corporate borrowers, meanwhile, are being hit twice. Along with the exchange rate impact, their sales have been hammered by the intensifying slowdown in the West, which accounts for at least half their export revenue. The drop-off leaves Eastern companies with insufficient cash to service their debts, Jen says. As global demand for steel has collapsed, Ukraine, for example, has seen about one-quarter of its export sales vanish.

About three-quarters of Eastern Europe's foreign cash comes as bank loans, according to Morgan Stanley. The global crisis now is pinching the flow of foreign capital that countries in Central and Eastern Europe depend upon.

Today's difficulties were foreseen by some. An IMF team last summer warned Romania that by shifting to more short-term loans, the country was "increasing debt rollover risks." Now, Romania is in talks with the IMF about a possible multibillion dollar financial bailout.

Capital flows into eight Central and East European nations peaked at $388.2 billion in 2007 and are expected to sink to just $6.7 billion this year, according to the Institute of International Finance, an association of banks and other financial institutions. Excluding Russia and Ukraine, which are both forecast to see net outflows of capital to repay foreign lenders, the falloff is less dramatic, though still worrisome. Flows into Poland, the Czech Republic, Hungary, Romania, Bulgaria and Turkey totaled $180.9 billion in 2007 and will be $59.5 billion this year, the IIF said.

"Eastern Europe is going to collapse in the next phase of the crisis," says Tim Lee, an economist at Pi Economics in Stamford, Conn.

Lee, who has been warning of gathering problems in the region for years, says the financial contagion ultimately will infect countries that have remained relatively unaffected so far, such as Turkey and Poland.

Analysts from Danske Bank, Denmark's largest financial institution, warned clients recently of the "very clear risk of an Asian crisis-style meltdown," a reference to the 1997 episode that spread from Thailand to topple all the region's vaunted "tiger" economies.

Officials from the region, however, insist the danger has been exaggerated. On March 4, six central bank chiefs from Central and East Europe (CEE) pushed back at market speculation about an inevitable regional crisis. Such arguments were "simplified and misleading, and could have negative implications for banks operating in these countries," their statement said.

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