BY RUCHIR SHARMA"Troubled Baltic and balkan economies are simply too small to bring down the rest of the world"
IN FINANCIAL CIRCLES, the mere mention of Eastern Europe these days conjures conjures up images of collapsing banking systems, currency instability, and capital flight. The travails of the Baltic states have come to symbolize all that has gone wrong with Eastern Europe's high-growth economic model. Some analysts even believe that the region is now the weakest link in the global economy and could be the source of yet another financial contagion.
At the center of the storm are small countries like Latvia, now paying the price for the heady growth of the past few years, which was fueled by unbridled household consumption and property investment. With capital flows drying up of late, Latvia is under pressure to break the peg with the euro and devalue the exchange rate -a move that could lead to widespread losses for many of its households and banks, as the country's debt is largely held in foreign currency.
Latvia is trying to stick with the peg, relying on billions of euros' worth of assistance from the International Monetary Fund and European Union, which come with the usual strictures of fiscal discipline entailing painful spending cuts. The suspense relating to the fate of Latvia's peg is indeed intense, because any devaluation of the lat would make currency pegs in nearby Estonia, Lithuania, and Bulgaria more vulnerable.
Yet even if this happens, the size of the problem won't match the hype. These are $25 billion to $50 billion economies, which means that the repercussions for the world economy will be limited. Western European banks, which own nearly half of Eastern Europe's banking assets, have the most to lose. But assuming the value of nonperforming loans in all of Eastern Europe totaled 10 percent of the region's total economy, parent banks in Western Europe would suffer losses of only about $60 billion@less than a quar ter of those incurred from their exposure to toxic U.S. banking assets.
The key reason that Eastern Europe's problems aren't quite as serious as generally believed is that the bigger economies in the region never got caught in the credit boom-bust cycle. The $500 billion-plus Polish economy -which is the biggest in Central and Eastern Europe- has no banking problems, and didn't rely on hot money to rapidly boost consumption growth. Instead, Poland spent much of the past decade reforming and instituting Western European laws, which subsequently helped pull large amounts of foreign direct investment into its manufacturing service sectors.
The Czech Republic, which at $220 billion is the region's second-largest economy, didn't overextend itself either. Credit penetration in the Czech economy remains low, at 50 percent of GDP, and the pace of credit expansion during the boom years of 2003-07 was well below the 20 to 25 percent annual rate that usually leads to trouble over time.
Both Poland and the Czech Republic have the competitive advantage of a well-educated and highly skilled workforce, which supports strong productivity growth. This, along with substantial foreign direct investment, has historically played the most important role in a nation's long-term economic development. Furthermore, both Poland and the Czech Republic have flexible exchange-rate systems, and their currencies have already fallen to fairly competitive levels. Once global credit conditions improve, these economies should be able to resume the natural growth path that will eventually put them in line with richer Western European counterparts.
However, smaller countries in the Baltic and Balkan areas face a prospect similar to that of the heavily indebted East Asian tigers in 1997-98. Their growth will continue to be severely crimped as the overextended banking sector shrinks and badly scarred foreign investors are reluctant to return. These smaller economies will also have to rethink their development model, now that the road to riches based on easy money is no more.
All these developments have a political fallout. The bigger powers of Western Europe will probably be less inclined to further integrate their smaller, beleaguered neighbors into the euro zone. This marks a major change from the rapid accession path of so many Eastern European economies over the past few years, a path that significantly increased their per capital income levels. That shift will have a major impact on the wealth and the future of the smaller nations in the region. But it's hardly an earth-shattering event for the rest of the world, given that the affected economies are only a tiny fraction of the global economy. Despite all the talk about weak links, the current fuss over the region far outweighs the size of the problem.
SHARMA is head of emerging markets at Morgan Stanley Investment Management.
No comments:
Post a Comment