PRAGUE, Feb 20 (Reuters) - Concerns that the European
Union's eastern members could see a broader economic crisis rose
this week as ratings agencies and mainstream western media
warned over plummeting growth and financial imbalances.
The region's economists and governments have cut growth
outlooks sharply in recent months, with the worst off economy,
Latvia, set to contract by double digits this year and the best
off, Poland, hoping to eke out an expansion of just over 1 pct.
The gloom has sparked a selloff of Czech, Hungarian, Polish
and Romanian assets, cutting up to a third off their currencies,
and also caused some contraction in financing from the big
Western-owned banks that are the region's main lenders.
But economists also say the dire warnings may be overplayed,
and stress the importance of differentiating between countries
-- mainly in the Baltics and the Balkans, plus Hungary which has
had an IMF rescue -- with big external exposure and those that
will be hit but should avoid balance of payments or banking
crises.
They say Poland and the Czech Republic, which have kept
relatively low external and budget deficits, have the best
chance of riding out the storm although the chances of any
country returning to 5-percent economic growth in the next few
years are low. Policymakers also stress that EU membership
differentiates the region from Russia and Ukraine.
Following are good, middle and worst-case scenarios for how
the crisis and policy response could play out.
GOOD CASE
In the best-case scenario, banks manage to contain rising
default risks and continue lending. Companies manage to pay
debt, stay afloat and households tighten their belts but stave
off mass problems with repaying foreign-currency mortgages or
other debt.
Currencies stabilise in the next few weeks and European
Union policymakers and the International Monetary Fund take
steps to shore up the worst hit economies and, if necessary,
back big foreign banks.
Either way, analysts say more funds will be needed to shore
up the banking sector by raising liquidity and making other loan
facilities available, boosting confidence and telling western
banks they must keep lending both in home countries and abroad.
Most say that would best be a unified response.
"It would have to be very soon, or we'd flip into the
negative scenarios very quickly," said Koon Chow, strategist at
Barclay's Capital.
There would be capital injections into banks, swap deals,
and other liquidity measures from the European Central Bank and
the European Bank for Reconstruction and Development -- some of
which have already been floated.
It would require broad, EU-wide political backing. There
would be no outright bailouts but if a bank did have trouble,
there would be quick action to shore it up.
The measures would give time for countries to adjust,
possibly including consumers and firms switching to
domestic-currency loans from euro and Swiss franc loans, and
possibly for governments to create new bankruptcy laws to allow
for an orderly unwinding of bad loans and assets.
MIDDLE BAND
In the middle scenario, the EU and its eastern newcomers
would avoid a serious crisis but constrained lending from the
West and wide imbalances would force the EU and International
Monetary Fund to extend loans to several countries.
"Forget the total meltdown. It's going to be a
muddle-through situation, with the length of the crisis
depending on the timing of the policy reaction," said Simon
Quijano-Evans, CEE economist with C.A. Cheuvreux.
Economies would slow more sharply than currently expected,
current account gaps would shrink. Currencies could fall
further, forcing central banks to defend their currencies with
high interest rates and other measures, exacerbating the
slowdown. Western-owned parent banks would stay in the region --
seeing it as more profitable to ride out the storm -- but could
reduce balance sheets in the countries seen as most risky.
Central banks would inject liquidity and possibly reduce
reserve requirements to free up more funds for lending, while
slowly weaning borrowers off loans in foreign exchange.
Governments would have to pay higher yields, and euro zone
ambitions could move to the sidelines while governments ramp up
debt and budget deficits to pay for more spending and keep their
economies sputtering along.
WORST CASE
Most analysts expect policymakers to step in before the
region gets anywhere near this scenario.
In the worst case, debt-refinancing grinds to a halt,
defaults rise sharply, causing companies to go bankrupt and
households to fail to cover mortgages, thanks in part to further
currency falls. Banks hit serious difficulties, creating knock
on effects for parent institutions or vice-versa. Countries are
unable to agree on a coordinated response, and take a range of
independent action which fails to stave off further trouble.
Foreign parent banks would not roll over debt for their
subsidiaries in the region and credit growth would be negative,
hurting households and companies, and exacerbating the economic
slowdown and a selloff of regional assets.
Loan default risk would rise, hitting bank capital and
increasing the risk of failures. Some banks in the EU would have
to be nationalised and their governments would ask them to use
capital injections only for domestic lending.
That could trigger failures or bank runs on subsidiary banks
in the most exposed economies and could cause EU newcomer
governments, already struggling with financing, to have to seek
ways to save the banks or let them fail. The EU and the IMF
would mop up the damage only after the crisis starts.
Currencies would fall, and those countries with currency
boards might have to abandon their pegs to the euro due to the
high cost of bailouts.
"To assume that a group of states with 600 million people
goes bankrupt because it can't refinance its debt anywhere in
the world no matter at what price -- that to me is an
exaggeration," said Matthias Siller, Fund Manager Emerging
Markets, Barings Asset Management.
"If it's not possible to refinance emerging Europe's
short-term debt then we'll have a global problem that will end
in a global catastrophe. If that were to happen, Italy is next
in line and you'll find no credit anymore, anywhere."
(Reporting by Michael Winfrey and Boris Groendahl; editing by
David Stamp)
