CEE: contagion risk from Cyprus?

The crisis in Cyprus has renewed concerns about the stability of the EU’s emerging markets, potentially ending the region’s recent run of good luck when it comes to market sentiment.

Poland, the Czech Republic and even Hungary have been able to borrow at very low rates, while the region is showing signs that the economy bottomed out towards the end of last year and should recover by the second half of this year.

While CEE fundamentals look sound, the shock, as is the case over the last few years, is coming from outside the region.

As Wood & Co., a investment bank, noted:

We believe that the higher chances of a Cyprus bailout vs. the lower likelihood of a Cyprus EU exit, as well as the pledge of the ECB to support the EUR and the low exposure of EME-5 [Poland, the Czech Republic, Hungary, Russia and Turkey] companies towards Cyprus, may limit the negative impact of the Cyprus turmoil on our EME-5 markets.

Nevertheless, we cannot rule out that the threat of a deposit tax in Cyprus might have negative impacts on the EU periphery banking system, in terms of the potential deposit flight, which could also lead to negative sentiment towards the EME-5 banks.”

Countries like Poland and the Czech Republic have very solid banking systems, completely unlike the situation in Cyprus – and there is no sign of a banking run. The most exposed are Hungary and Slovenia, but even they are a world away from Cyprus’s situation.

From Danske Bank:

Cyprus is not the only country in Europe that is in trouble. Hungary has also been making headlines recently, especially due to its controversial new constitution and the appointment of former economics minister Matolcsy as the new central bank governor. The forint has weakened significantly in recent weeks as a consequence of these worries. However, while we remain deeply sceptical about the conduct of economic policy in Hungary and about the Hungarian government’s interventionist and populist stance, we nonetheless believe that the forint is now trading at quite cheap levels against the euro.

And there’s this from Standard Bank:

Perhaps first in the firing line/spotlight is Slovenia, which is also currently grappling with its own banking sector crisis, and trying to fend off a Troika bailout.

But Slovenia’s banking sector is much smaller as a proportion of the economy – 130 per cent of GDP – than in Cyprus, where it came to an eye-watering 710 per cent of GDP. Slovenia also has a smaller level of bond redemptions coming due than Cyprus.

Nomura noted:

Slovenia has not asked for a bailout and been strenuously denying that the government would ever need one, specifically playing down the possibility that the banking sector would need one in the short to medium run.

Despite the differences between Cyprus and the CEE, markets are a little nervous, with the zloty and forint losing a bit of ground against the euro and the dollar on Thursday.

Cyprus is also having another impact on the region; many companies and investment funds operate through Cyprus-registered companies because of the island’s low corporate tax rates (as well as an opaque banking system).

For now, companies are continuing to function normally, but they are very wary.

“Cyprus offered extremely good financial services, part of its British heritage, and a good palette of double taxation treaties,” said Lambros Anagnostopoulos, the CEO of Secure Group, a private equity fund investing in real estate in south-eastern Europe. “We have accounts we cannot use, but assuming the banks exist next week we will be back in business. If that doesn’t happen we will have a much more serious issue.”

Related reading:
Guest post: Turkey to the rescue?, beyondbrics
Cyprus: Prokhorov to the rescue? beyondbrics
In depth: Cyprus bailout, FT
A Cypriot precedent series, FT Alphaville