European emerging markets suffer most

By David Oakley Published: January 20 2009 16:30 Last updated: January 20 2009 16:30 It has been a bad start to the year for the markets of eastern and central Europe. After a dire 2008, the new year has brought little relief for these emerging economies as their equity and currency markets have been the laggards, underperforming developing markets in other parts of the world. EDITOR’S CHOICE Ukraine economic concerns grow - Jan-21Record bond yield gaps highlight alarm at fiscal strains - Jan-14With every kind of economic data deteriorating across the globe in what has been described as the most synchronised recession since the 1930s, no market is safe from the general malaise. But in eastern and central Europe the pain has been greater as investors continue to head for the exits amid growing fears that one of their faltering economies could default. Stock markets in Russia, Poland, the Czech Republic and Hungary have fallen by 15 per cent on average since the start of the year, while their currencies have tumbled about 12 per cent against the dollar. The Turkish stock market has fallen about 12 per cent. In Asia and Latin America, by contrast, stocks and currencies have by and large held their own. Chinese stocks have outperformed, rising by around 9 per cent since January 1, while the Brazilian Real is only a touch down against the dollar. Nigel Rendell, senior emerging markets strategist at RBC Capital Markets, says: “It is a very nasty world at the moment. There are few, if any, markets that investors like in this environment. But eastern and central Europe are suffering the most.” This is because the region took on vast amounts of debt before the financial crisis blew up in August 2007, leading to unsustainably high current account deficits and ballooning foreign debt payments. Such were the difficulties in Hungary and Ukraine that they had to be rescued by the International Monetary Fund. In a risk temperature gauge tracking the biggest emerging market economies published by RBC Capital Markets this week, the top 10 economies most likely to default all came from eastern and central Europe, with the exception of Iceland. The risk calculations were based on current account deficits, the amount of debt held by banks and companies in the particular countries and their capital adequacy ratios. Deutsche Bank research this week also showed the combined current account deficits and debt of eastern and central European countries is around 18 per cent of gross domestic product compared with only 8 per cent in Asia and Latin America. Countries with the highest ratios of external debt include the Baltic republics of Estonia, Latvia and Lithuania, according to Deutsche. But it is the bigger economies that worry analysts most because a default could have serious repercussions for their neighbours. Many of these economies have to repay billions of dollars of their debt this year, which is putting yet more pressure on them because of the continuing difficulty in accessing the credit markets. Russia, which has seen the rouble fall about 12 per cent against the dollar and about 5 per cent against the euro this year, has to renew about $500bn, according to ING Financial Markets. Ukraine and Hungary have debts to roll over of about $30bn and $15bn this year respectively. RBC Capital Markets last week said the emerging world of the 16 biggest economies was now in recession, after seeing a combined contraction in the fourth quarter of last year and forecasts of a further contraction this quarter. Fears of further sovereign defaults have also risen with some analysts warning that Ukraine, with its high level of short-term debt and one of its banks running out of cash at the end of last year, could default, in spite of the IMF help. So far, only tiny Seychelles and Ecuador have defaulted on their sovereign debt since the credit crisis started in August 2007. Even Iceland managed to avoid a sovereign debt default, in spite of a collapse in its banking system, as international agencies came to the rescue. Arend Kapteyn, chief economist of the Europe, Middle East and Africa region at Deutsche bank, says: “Global trade is collapsing, confidence is plummeting and the credit and industrial production data have been horrible. Trying to call the bottom here is a bit like trying to catch a falling knife. Price volatility in equities and currencies is being exacerbated by market illiquidity, which itself is a good indication of the stress and uncertainty still in the system.” There are some rays of hope in the Latin American and Asian markets, although pessimism surrounds the Middle East because of the low oil price, while Africa remains a bit of an enigma with political uncertainty in many countries. It is China, the biggest emerging market, where hopes mainly rest. It has started rebounding after suffering heavy losses in 2008. Consensus forecasts for growth in 2009 are around 8 per cent as it is expected to benefit from a massive stimulus package. Brazil, with its solid public finances, is also seen as a good bet by some investors. Its stock market is up on the year so far, in spite of continuing worries over commodities. However, the weakness of the US economy remains the biggest drag on any chance of recovery in the emerging markets, with the so-called decoupling theory completely debunked. “Decoupling is just a distant memory,” says Mr Rendell. “Even China with exports making up 35 per cent of its GDP, which mainly go to the US and Europe, is reliant on the US consumer.”