beyondbrics

Contagion is the word on everyone’s lips as the European Union tries to manage the  Greek debt crisis.

But it is not just the eurozone that is at risk. The European Bank for Reconstruction and Development warned on Friday that an escalation of the Greek debt crisis could have a knock-on effect eastward on countries in “emerging” Europe.

The multilateral bank for central and eastern Europe said in its latest economic assessment:

The recovery in south-eastern Europe which is still weak, is most directly threatened by the financial instability related to the Eurozone turmoil, as significant parts of the region’s banks are owned by Greek banks.

In the event of an escalation of the crisis, some of these banks could require financial support and might struggle to keep up their lending to the local economies. This could contribute to a notable downturn in economic growth in southeastern Europe.

Being deeply-integrated with Western European markets, Central Europe and the Baltics would be exposed to disruptions in the European financial markets, increases in bank funding costs and a slowdown in Eurozone growth.

But is the EBRD – which is expecting growth in the region to hold steady at 4.8 per cent this year – being overly alarmist in its outlook? After all, this is not the first time that alarm bells were rang over the risk of a Greek contagion spreading to the CEE. Similar warnings were raised last year during the first Greek debt crisis.

Tim Ash, head of emerging markets research at Royal Bank of Scotland, for one thinks that talks of a contagion are overdone. The banking channel that the EBRD has identified as the main source of contagion is limited he argued.

As beyondbrics noted earlier this week:

Sovereign debt [in central Europe] averages only about 40 per cent of gross domestic product – half the European Union average, and far below the 120 per cent-plus levels of Greece or Italy.

The problems that hit some countries in the region during the 2008-09 financial crisis were essentially an issue of liquidity, not of solvency, Ash argues: CEE countries had underdeveloped domestic capital markets and limited access to international capital markets, even before international capital flows seized up. Countries have built up their fiscal defences since then, and in many cases still have access to multilateral financing, making them a bit less susceptible to a new liquidity squeeze.

Romania and Bulgaria, two countries with particularly strong business ties to Greece, have so far emerged relatively unscathed. Both the Romanian leu and the Bulgarian lev are holding their own in the forex markets. The Bucharest stock market, in spite of the recent ups and downs, is up more than 16 per cent over the past 12 months. The BG40 index – which tracks Bulgaria’s top 40 companies – is up 25 per cent over this same period.

Bond market investors also appear relatively sanguine on the risk of a Greek fall-out. The credit default swap spreads on Romania’s 5-year US dollar bond, which gauge the cost of insuring against a debt default, have fallen by over 130 basis points since last September. At 263.5 basis points, they are also lower than that of Italy and Spain.

Indeed, such is the confidence in Romania that Fitch Ratings upgraded the country’s sovereign debt to investment grade earlier this month.

But CEE bulls would be wise not to be too complacent in their view that emerging Europe should be able to avoid the contagion. As the aftermath of Lehman Brothers’ collapse underscored all too painfully, the spores of contagion are hard to track, let alone quantify. So while we might not be seeing the discounts in the markets yet, that doesn’t mean we won’t.

As the EBRD pointed out, the region is only slowly recovering. Given CEE’s financial and economic ties to the eurozone, a crisis in the eurozone won’t be helping this recovery speed along.

Related reading:
Dominoes to fall in CEE? Not yet, beyondbrics
Eastern Europe feels chill of eurozone crisis, FT
CEE banks pass European stress tests, beyondbrics
Greece: CEE weathering the storm, beyondbrics
Guest post: CEE lessons for Greece, beyondbrics
CEE: weathering Mediterranean storm, beyondbrics