Policy-makers across central and eastern Europe can be
forgiven for feeling a hint of schadenfreude when they look at
the travails of their western neighbours.
A year ago financial markets were betting on which CEE
government would be the next to seek help from the IMF. Twelve
months later and bets are on which of the so-called eurozone
PIGS Portugal, Ireland and Spain will follow
Greece in seeking an IMF bailout to avert default.
But one of the ironies of financial globalization is that
systemic failure for the euro could wreak havoc on CEE
countries. As significantly, the crisis has dampened the
enthusiasm among countries for joining a currency union that
has lost its lustre.
According to leading economists, a crisis in western Europe
would deliver a double whammy to the EBRD region in the form of
a slump in economic demand and a fresh banking crisis.
Willem Buiter, a former chief economist of the EBRD,
says CEE countries will be affected despite having stronger
sovereign debt positions. They should be worried about
the health of the European banking system, he told
Emerging Markets while on a visit to Athens.
Thats the main thing. Their banks are largely
branches or subsidiaries of western European banks, and a lot
of those are still in a very bad shape.
The threat of a hit to economic growth is equally worrying.
The Economist Intelligence Unit (EIU) expects the eurozone to
post GDP growth of just 0.8% this year, worse than any
comparable region. The main reason is that fiscal
consolidation tax hikes and spending cuts
undertaken by Greece and other, larger economies, to cut their
deficits will act as a drag on growth.
While Greece itself accounts for less than 3% of eurozone
GDP, the concern is that the state of the public finances in
other member countries is too fragile for comfort,
according to the EIU. This has manifested itself in a blowout
in the premium governments must pay investors to take on their
debt when compared with the interest rate on the benchmark
While Greeces 10-year bond spread peaked at 852 basis
points (or 8.52%) just before the EU/IMF bailout, Portugal was
not far behind on 2.84% while Irish, Italian and Spanish
spreads have all risen. Until last November the spread on Greek
debt over the previous five years had averaged 0.65%.
This points to the nub of the issue: while the euro protects
its members from currency attacks, markets will find other ways
to punish them for policy failures.
Jan Randolph, director of Sovereign Risk Country Analysis at
IHS Global Insight, says the problem for the PIGS is not just
high public debt but large private debt taken on after they
joined the euro. At that point their interest rate
migrated down to the German level, and they benefited from a
triple-A credit rating, he says. So everyone
embarks on this big party, asset prices go up and households
take on heavy debt burdens.
The ensuing slowdown in growth will harm the prospects for
the eurozones eastern neighbours. Growth in the
eurozone is incredibly important for our region, Erik
Berglof, chief economist of the EBRD, says. Local
business sentiment is so closely tied to what is happening in
the eurozone. The euro area will have a slower, more fragile
recovery than many other parts of the world, and that is what
is affecting our region negatively. It dominates any other
PROJECT IN PERIL
But all economies recover from downturns eventually.
The larger question is whether the Greek drama has undermined
the whole single currency project. The euro has been
damaged by the [crisis] as a broad project and has shown some
weaknesses, Berglof says.
Others are gloomier. Stephen Lewis, chief economist at
brokerage Monument Securities, believes a break-up of the
eurozone is the only logical development. The
argument regarding whether the eurozone is an optimal currency
area has been settled: it is not, and that has serious
implications, he says.
At the heart of the problem is the public row between
Germany and France, the largest countries in the zone, over how
to resolve the issue of countries that got into fiscal
difficulties. Germany insisted the IMF be part of a bailout to
ensure that the money came for Greece with the sort of tough
terms on budget cuts the IMF traditionally applies to a
troubled emerging market. France on the other hand wanted a
euro-led aid package to allow Greece to get its house in order
without disturbing the unity and reputation of the
Germany won a partial victory, with the result that Greece
secured a E110 billion bailout on 2 May that included E30
billion from the IMF and much tougher conditions than
originally envisaged by EU leaders.
Lewis sees the eurozone ultimately splitting into a
hard euro area led by Germany and a
soft euro tilted towards the southern states.
One can imagine the Czechs feeling that their economy was
so tightly meshed with Germanys that it should enter a
union with a hard euro, he tells Emerging
Markets. Others might see themselves better aligned
with a soft euro.
He says the only alternative is for the zone to
struggle on for years with member states becoming
impoverished as they go through reforms aimed at
reducing their labour costs to German levels.
Jan Randolph says Greece and Portugals debt
problems have become an existential question for
the euro. Europe is having an identity crisis, he
tells Emerging Markets. If you were a
policy-maker in eastern Europe, you would be watching very
carefully because the crisis is testing what the euro means in
terms of solidarity.
Since the Second World War, Germany has always
bankrolled integration as it pursued bigger goals of
reunification. But this time it is almost as if they are saying
weve got what we wanted, and now we are not going
to pick up the bill or be the final bulwark behind these
Simon Johnson, a former chief economist at the IMF, points
out that Ireland and Italy must be kicking themselves for
embarking on austerity measures rather than waiting for a
bailout. There seems to be no logic in the system, but
perhaps there is a logical outcome. Europe will eventually grow
tired of bailing out its weaker countries, he says.
When the plug is finally pulled, at least one nation will
end up in a painful default. Unfortunately, the way we are
heading, the problems could be even more widespread.
Johnson says that if crisis takes hold it would be too large
for the European Central Bank or the German government to
solve. The eurozone will be at risk of collapse, he
says. He estimates a bailout of the four weakest economies
Greece, Portugal, Spain and Italy could cost $1
Berglof plays down fears of a collapse of the eurozone but
agrees its recent troubles have altered the way it is seen by
its neighbours. The whole region is going through a
reassessment of the euro in the sense that, particularly early
on, there was this feeling that being part of the euro was a
very important protection when the global crisis hit, he
The fact that countries closely tied to the euro seemed to
withstand better the impact of the crisis actually fuelled
moves to speed up the entry process, he says. What has
happened now that people are a little bit further away from the
precipice, is that it has dawned on them that actually there
was some advantage to have the flexibility of an exchange
rate, he says. For the countries that did have the
flexibility, they used it to some effect. Poland is the primary
example, but Hungary and the Czech Republic benefited to some
The problems hitting Greece and Portugal have reminded
countries they must ensure that they do not join prematurely
and that they join at the right exchange rate. That
debate will not go away and will have got new fire,
Berglof says. That debate has come back in a sense
because we have seen some of the dangers of joining too early
or joining at the wrong exchange rate.
The first major test of the regions warmth towards the
region will be Estonias application to join the single
currency. Its government has taken very tough measures to meet
criteria on budget deficits, public debt, inflation, long-term
interest rates and currency stability.
The European Commission and the European Central Bank are
expected imminently to release an assessment result on
Estonias eligibility for membership. If the result is
positive, the EU Summit will make the political decision on it
in June. In principle the view that has emerged is that
Estonia is ready for accession, and I think it is incredibly
important for the role of the project of euro accession in our
region that Estonia is not denied membership, says
However, it hardly looks like a frantic race to the
finishing line. Latvia and Lithuania are on track for
membership in 2014 while Poland, which once pencilled in 2012,
now sees 2015 as the earliest date.
Randolph says there has been a marked waning of enthusiasm.
A lot of policy-makers in eastern Europe Poland,
Latvia, Romania, etc. thought they had the assumption
that they wanted to be a member of the euro, he says.
What has happened with Greece has got them thinking that
the benefits are not as clear as they thought.
The reality is that euro accession is less sexy than
achieving membership of the European Union. EU accession
was broadly very popular, says Berglof. There was a
political aspect and a dignity aspect, and it touched
peoples lives in so many different dimensions so people
were broadly behind it. The euro has never been like that as
the euro was held by a small narrow technocratic
But he insists that people also realize that actually
the euro is quite important whether for their business or
for the interest rate on their apartment. If we can today
make sure that we create certainty about this process, about
what needs to be done, and if they do what they are asked to
do, then they will become members at a certain point in