Banks Reel On Eastern Europe's Bad News

By MARC CHAMPION, JOANNA SLATER and CARRICK MOLLENKAMP Fears of a full-blown economic crash in Eastern Europe shook the region's currencies and the share prices of Western banks doing big business there, helping to spur a new shock to financial confidence around the globe. Some market analysts warned of a regional economic collapse on the scale of the Asian crisis in the late 1990s, as a report by the Moody's ratings agency warned it may downgrade banks active in Eastern Europe. The cost of insuring government debt from Poland to Russia rose further, while currencies fell. The Hungarian forint slid to an all-time low Tuesday against the euro. Poland's zloty fell to a near-low against the euro, and is down by a third since August, prompting Warsaw to announce Tuesday it would intervene to prop up the currency if it fell further. The euro itself fell 1.33% against the U.S. dollar to $1.26. The new evidence of enduring problems for Western banks -- and for the emerging markets they've invested in -- helped markets tumble around the globe, with financial stocks leading the way down. In the U.S. the Dow Jones Industrial Average fell 3.8% and the more financial-heavy Standard & Poor's 500-stock index dropped 4.6%, both nearing recent lows. The STOXX Europe (600) banking index shrunk more than 6%, and banks with heavy Eastern Europe investment dived as much as 10%. Asian shares slid Tuesday as well. Bad news among ex-communist nations came from as far afield as oil-rich Kazakhstan in Central Asia -- treated as part of the same emerging-market region as Eastern Europe -- where the country's biggest bank faced a run by depositors. Ukraine posted a 34% drop in industrial output for January compared with a year earlier, and a 16% drop from December, in part a result of the gas-pricing dispute with neighboring Russia. After years in which Eastern Europe attracted investment for its fast growth and increasing financial ties with Western counterparts, the region's fortunes have abruptly reversed -- largely the result of oversized dependence on foreign-currency loans that now are leading to rising defaults, and fast-dwindling demand by its Western neighbors for its exports amid the global slowdown. "To us this looks like a market meltdown on the same scale as occurred during the Asian crisis of 1997" that began with the devaluation of the Thai baht, said Lars Christensen, chief analyst at Denmark's Danske Bank Group, in a research note Tuesday. Mr. Christensen wrote a paper in 2006 accurately predicting the eventual meltdown in Iceland. "Doubtless the markets have decided that the region is the subprime area of Europe and now everyone is running for the door," the note said. The volume of capital flowing into emerging European economies is expected to fall to just $30 billion in 2009, from $254 billion in 2008, according to Institute of International Finance, an association of the world's largest banks. The group called the swing "unprecedented in scale." It expects foreign bank lending to swing to the negative by $27.2 billion in 2009, meaning banks will collect more than they loan. Deep slides in currencies raise the prospect of widespread defaults on foreign-currency loans marketed by a growing roster of foreign-owned banks and taken out by businesses and individuals, who were attracted by better interest rates offered in euros and Swiss francs. Now those troubled loans are boomeranging on the Western banks that charged into the region in the past decade, competing heavily to buy up local banks and establish subsidiaries in what was Europe's biggest growth area. Austria-based banks, for example, had some €278 billion in exposure to emerging Europe, according to September statistics from Bank for International Settlements. That equals nearly two-thirds of Austria's gross domestic product. A "special comment" published Tuesday by Moody's Investors Service Inc. warned that euro-zone banks -- notably in Austria, France, Italy, Belgium, Germany and Sweden -- with significant exposure to East European economies may be downgraded. The Moody's report said economies across Central and Eastern Europe, the Balkans and the ex-Soviet bloc "have now entered a deep and long economic downturn." The economic distress and currency tumbles in Eastern Europe will "trigger a write-down into the Western European banking system," says Hans-Guenter Redeker, a currency strategist at BNP Paribas in London. "The question is how much." He says a conservative estimate would be about 20% of the total invested by such banks in the region. Moody's estimated the total at $1.3 trillion at the start of 2008. The Moody's report said parent banks might now reduce support for subsidiaries in Eastern Europe, a move that could further hit growth. But Italy's UniCredit SpA, which was down 7.4% at €1.12 a share on Tuesday, said fears of imminent disaster are overplayed. "We won't come short on our funding to Central and Eastern European subsidiaries," said Federico Ghizzoni, who runs UniCredit's emerging-markets division. UniCredit's 2008 profit in Central and Eastern Europe, to be released with group results next month, was above target, he said. Shares in Austria's Raiffeisen International Bank-Holding and Erste Group Bank AG fell 8.3% and 7.5% on Tuesday, respectively. Also hit were Belgium's KBC Group, whose shares slid 13%, and France's Société Générale SA, off 9.6%. The Moody's report spilled over to the government bond markets, where investors already were demanding ever-higher yield premiums to hold debt issued by countries other than Germany. The yield premium for 10-year Austrian bonds widened to 1.27 percentage point, from 1.17 percentage point Monday, meaning the price rose to insure sovereign debt against default. The developments come as growth forecasts for 2009 across Europe already have been plummeting, along with exports and domestic demand. In Poland, where Finance Minister Jacek Rostowski in October called his country "immune" to the global financial crisis, the government has slashed its 2009 growth forecast to 1.7% from a range of 4.6% to 5%. Many economists believe its economy actually will contract in 2009. Polish Prime Minister Donald Tusk sought Tuesday to put a floor under the zloty, saying his government would use European Union funds to support the currency if it fell below five zloty to the euro. Poland is budgeted to receive €67 billion from 2007 to 2013 in EU aid. Poland, like several other ex-communist bloc countries that joined the EU in recent years, is committed to adopting the euro. That expectation has helped fuel foreign investment, and also tends to make euro-denominated loans look less risky, as countries need to push their currencies into a band against the euro in the two years before joining. For Poland, that would start next year. But to join the common currency, countries also have to stay within a budget deficit limit of 3% of GDP -- a tall order for developing countries and even tougher as governments try to spend their way out of recession. —Chris Emsden, David McQuaid, Katharina Bart and Sara Schaefer Muñoz contributed to this article. Write to Marc Champion at marc.champion@wsj.com, Joanna Slater at joanna.slater@wsj.com and Carrick Mollenkamp at carrick.mollenkamp@wsj.com