Finance: Eastern Europe’s Response

The EU summit on 19-20 March doubled, from €25 to €50 billion, the amount in a facility now dedicated to the 11 EU countries that at present do not use the euro, but which was established two decades ago to address balance-of-payments problems. The grouping also decided to contribute €75 billion more to International Monetary Fund (IMF) lending programs on the condition that the sum is targeted at EU members having financial difficulties.

Last month, the EU leaders had turned down suggestions for a blanket bailout of Eastern Europe, catalyzing another wave of euroskepticism. (At the time, Hungary had been advocating loans to the region amounting to €180 billion and suggesting an accelerated accession to the eurozone.)

German Chancellor Angela Merkel forthrightly declared that a US-style spending stimulus should be limited and that all aid should be channelled through international financial institutions such as the IMF. Simon Tisdall of the Guardian external pagequotedcall_made the Centre for European Reform’s Katinka Barysch sensitive observation that the East Europeans’ “immediate feeling of helplessness … is compounded by a more profound sense that their post-cold war growth model is broken, [while] … the EU, which acted as an anchor for reform, has lost clout and credibility.”

Still, reports emerged indicating that the East Europeans themselves spoke against a blanket package out of recognition of diversity of conditions from one country to another in the region. There was a legitimate fear all around that such an approach would encourage foreign observers, especially bankers and ratings agencies, to lump all the Eastern countries together despite wide qualitative as well as quantitative differences among them. Even so, there remains the danger of a contagion with knock-on effects that could tar such economically and politically stable governments as Slovakia and the Czech Republic with the same brush; and West European banks are on the hook for loans to the East on which they do not wish to see defaults.

Turmoil deepens in the East

The global financial crisis has claimed its second East European head of government.  Hungarian Prime Minister Ferenc Gyurcsány external pageannouncedcall_made to a surprised Hungarian Socialist Party convention on 21 March his intention to resign albeit without apology:  “I have erred concerning our strength and capabilities and at the critical moment have been guilty of clear statements, as a result of which my credibility has been substantially damaged.”

Last year, Hungary external pagereceivedcall_madeapproximately €20 billion (US$27 billion) from the IMF, the EU and World Bank, and a few days prior to the prime minister’s announcement said it would have to draw about €2 billion (US$2.7 billion) more credit from the EU by the end of the month. There had been numerous demonstrations against the government, in which the prime minister's party still hopes to continue to participate in a broader coalition while boasting less political, more technocratic ministers. The maneuver avoids parliamentary elections and permits Gyurcsány to retainhis post as Hungarian Socialist Party chairman.

The Hungarian prime minister's resignation follows by one month the collapse of the government coalition in Latvia despite its having received a €7.5 billion (US$10.1 billion) assistance package from the EU, the IMF and other sources. Within days of the fall, ratings agencies downgraded the country’s sovereign credit ratings to junk status, joining Romania, along with stating a negative prognosis into the future. The country’s Finance Ministry, which had expected the national economy to contract by 5 percent in 2009, has altered its prognosis to a 12 percent drop, which some observers believe to be still too optimistic.

Lithuania and Estonia may follow Latvia in the near future, requiring multilateral assistance packages to combat the effects of the global financial crisis even if the present governments survive. Estonia is in better shape than Lithuania, with a best-case scenario of 5 percent decline in 2009 economic activity, whereas Lithuania’s best-case scenario is a 10 percent decline. All three Baltic states are also in still more vulnerable situations due to the dominance of foreign banks in the domestic banking sector.

All three Baltic countries also peg their national currencies to the euro and have been looking forward to joining the eurozone in a few years’ time. The Lithuanian government had unofficially floated the idea of finding the economic solution to some problems through joining the eurozone more quickly. This would probably have required devaluation but would also have had delayed negative economic effects on countries already in the eurozone.

That will not happen, primarily for political reasons, but also in order not to create a precedent for circumventing the established procedures. As if confirming this consensus,Standard & Poor’s Rating Service external pagecutcall_madeLithuania’s rating on 24 March to reflect “concerns about the sustainability of Lithuania’s current fiscal and monetary mix during a protracted period of declining domestic and external demand,” while deeming it unlikely that Lithuania would join the eurozone before 2012.

As a result, still further dedicated funds will be required to retain the link between the Baltic countries’ currencies and the euro. Nevertheless, their currencies and those of Eastern Europe more generally are in much better shape than those of the Asian countries during the 1997-98 crisis. This is thanks principally to the quality of the underlying physical plant and distribution of economic activity across sectors, giving a firmer grounding in the real economy to support an eventual recovery.

Other vulnerable East European economies include Romania and Bulgaria. Romania external pageannouncedcall_madethat it may require as much as €20 billion (US$27 billion) for a rescue package similar to Hungary’s, and the IMF replied on 25 March by saying it would lead with a bail-out loan of nearly €13 billion, with the EU and other bodies supplying the remainder. The country’s currency has depreciated 20 percent over the past year, and the stability of its German-style “grand coalition” government is uncertain in the run-up to presidential elections in November. Bulgaria has been hit by domestic economic protests but elections are expected sometime in summer, so the current government is likely to remain in power until then, when most observers at least for the present expect it to be overturned by the voters.

“Old Europe” problematic as well

Yet the larger western EU members have their own problems as well. A special procedure is legally necessary within the EU to allow them to exceed their permitted government deficit levels. 

As for Germany, an internal report from the Finance Ministry external pageleaked to the presscall_made on 24 March increases the official prediction of an economic contraction from 2.25 percent to between 4.0 percent and 4.5 percent. According to the Wall Street Journal, the German bank Commerzbank deems even this figure too optimistic, and external pageforeseescall_madea 6 percent to 7 percent shrinkage of the country’s GDP.

At least at present, it seems that the greater division may not be between East and West Europe (respectively the “New” and “Old” Europe of former US defense secretary Donald Rumsfeld) but rather between Europe and the US. 

The recent EU summit not only dealt with the current situation on the continent but also was explicitly and self-consciously a European preparatory meeting for the London external pageG-20 conferencecall_made in April. In the run-up to the Brussels EU summit, the German political leadership and Chancellor Merkel in particular opposed US pressure to increase the spending in stimulus programs, external pagestressingcall_made instead the need for much stricter regulation of financial markets.

The concluding document of the European Council summit external pageendorsescall_madethese positions with particular reference to the G-20 meeting in London. This is a significant victory for Germany’s leaders, who will follow through with it, knowing from the recently concluded Brussels summit that even the strongest advocate in Europe of the US-style stimulus-oriented strategy, the British government, has moderated its support for such a program.  

In light of the unified and distinctly different position recently adopted at the EU summit, UK Prime Minister Gordon Brown has now stated that he external pagewill seek tocall_made conciliate the positions of the US and European representatives at the G-20 meeting.