Eastern Europe Has The Shakes

15th June 09 - Eastern Europe has the shakes

This diary entry leans heavily for its factual content on a piece by Ambrose Evans-Pritchard of the Daily Telegraph and for which full credit is given. Latvia has become the first EU country to face a sovereign debt crisis. A $100m treasury auction failed totally. Bartosz Pawlowski of BNP Paribas said "Latvia may be a small country but it has vast repercussions for the region. If the currency breaks in Latvia , it is likely to break in Estonia and Lithuania as well, and perhaps Bulgaria, with effects on other countries like Romania." The situation in Latvia is that the central bank has been using its reserves to defend the lat in the ERM but the markets seem to doubt that there is the will to carry through the draconian cuts in spending that are needed.

It is as much the knock-on effects of such a currency failure that is the major worry. Swedbank, SEB and other Swedish banks have collectively $75bn of exposure to the Baltic states and face catastrophic losses if the currency peg fails. The shakes have hit Swedish bank shares and set off a sharp fall in the krona. For West European banks as a whole, there is thought to be 1.3 trillion euros exposure to the ex-Communist bloc. Latvia blazed the trail of euro, Swiss franc and yen mortgages and Fitch Ratings says foreign debt maturing in 2009 is equal to 320% of foreign reserves.

Some of the consequences of the over-borrowing by little Latvia are eye-watering. GDP is forecast to fall by 18% this year, house prices have fallen by 50%, a third of the country’s teachers are being sacked and public workers’ salaries are being cut by up to 35%. All this to meet the bail-out conditions imposed by the IMF and the European Commission. Tim Ash of RBS said the crisis was playing out much like the final days of the Russian debacle in 1998 and the end of Turkey’s crawling peg in 2001, with momentum building until a critical point of no return.

It’s either the Latvian economy or Swedish banks. What a weird choice: who would have thought the credit crisis could lead to this?