Après Moi Le Deluge

The condition of Spain’s economy is now deteriorating markedly and rapidly by the month. The recent bout of extreme financial turmoil is only likely to make things even worse in this regard. Output is down, domestic demand is down, exports are struggling, and unemployment is up. The tumultuous events of late August and early September in the global financial markets are now evidently making their presence steadily felt on the real economy. And since Spain’s banking and financial crisis continues to trundle on, with no effective remedy whatsoever being offered, the worst is, most definitely, still to come. This is going to be a long hard road to travel for what was once the blue eyed boy among the eurozone economies. Continue reading →

Hungary’s agony has continued during the week with both currency and stock markets falling sharply while bankers continue to report acute credit shortages. At the same time contagion has started to extend its ugly reach right across eastern Europe, with Ukraine, the Baltics and Serbia (at a minimum) all in ongoing negotiations with the IMF, as the credit crunch which followed in the wake of the latest bout of global financial turmoil really starts to bite.

“Many central and eastern European countries simply don’t have either the financial strength or the technical expertise to bail out banks,” said Lars Christensen, a senior emerging-markets analyst at Danske Bank A/S in Copenhagen. “It’s like an Iceland look-a-like contest and there are a number of candidates looking very fragile at the moment.”

The ECB announced this morning that is to extend a helping to the suffering Hungarian markets, providing up to EUR 5bn of liquidity to the Hungarian central bank (MNB). This move will surely help boost the MNB’s defence of the forint. Hungary’s FX reserve is at present EUR 17½ bn. This equals less than 3 months of imports, which is normally considered to be the critical level for FX reserves. Among the EU8+2 countries, Slovenia (euro member), Lithuania, Slovakia, the Czech Republic and Estonia have similar small FX reserves.

Emerging-market banks plunged yesterday after Standard & Poor’s warned that Korea’s lenders will struggle to refinance debt, raising pressure on developing nations to bail out their own institutions. Standard & Poor’s has announced that it placed its ‘BBB+/A-2’ sovereign credit rating on Hungary on CreditWatch with negative implications. S& P has also placed the following ratings on Ukraine on CreditWatch with negative implications: its ‘B+/B’ foreign currency and ‘BB-/B’ local currency sovereign credit ratings on its global scale; and its ‘uaAA’ ratings on its national scale. Hungary has a ‘BBB+’ rating at Fitch and ‘A2’ at Moody’s.

In Budapest on Wednesday the forint fell 5.3 per cent to Ft266.09 to the euro and the BUX leading stocks index closed with a fall of 11.9 per cent, dragged down by a 15 per cent per cent fall of shares in OTP, Hungary’s biggest bank. Currencies and stock markets have also been falling in Poland, the Czech Republic, Romania and Ukraine.

The European Central Bank also announced yesterday that it will support the Hungarian central bank’s money market operations with as much as 5 billion euros ($6.7 billion) to help it ease the present financial tensions. The agreement will provide the central bank with a facility to borrow up to 5 billion euros in order to provide additional support to the central bank’s operations, the ECB said in a statement this morning. The move will support the Hungarian central bank’s “instruments of euro liquidity provision.” This move is an important “first”, since Hungary isn’t a member of the 15-nation euro region, a may well set a precedent which will need to be followed as more and more of the walking wounded limp over and present themselves at the Kaiserstrasse front door, before being politely shown round the back to the overnight lending window.

According to Portfolio Hungary:

Chaos rules among institutional investors, as well, at least the majority of the investment fund managers polled by Portfolio.hu on Wednesday admitted, speaking on condition of anonymity, that they have absolutely no idea about the possible outcome of the current financial crisis. A number of them noted they are at a loss as to what to do with their portfolios in the current situation. Interestingly enough, the only parallel the respondents were able to draw between the present predicaments and the 1998 Russian economic crisis was the mass unwinding of leveraged positions.

As one fund manager interviewed said “From this perspective, the current situation is the same as in 1998 only to the second power. Margin calls are being received, you gotta put in the deposits but as there’s no money you have to execute brutal sales irrespective of the price of assets…..Frankly, I haven’t got a clue as to when and how this would end, I’m just staring into empty space.”

One of the main problems Hungary is facing right now is that if foreign currency lending continues to be discontinued in Hungary on a “sudden stop” basis, then this will mean that domestic economic activity will slow sharply and capital inflows will be considerably reduced which is bound to cause one hell of a problem since at the present time these capital inflow amount to about €3-€4bn a year, and are close to providing the cover needed to fund the ongoing current account gap. Continue reading →

“Many central and eastern European countries simply don’t have either the financial strength or the technical expertise to bail out banks,” said Lars Christensen, a senior emerging-markets analyst at Danske Bank A/S in Copenhagen. “It’s like an Iceland look-a-like contest and there are a number of candidates looking very fragile at the moment.”

As rumours abound about the imminent formal “bankruptcy” of the Hungarian economy – the BUX stock index fell as much as 11.9 percent yestoday, while the forint slumped 5.3 percent against the euro and liquidity in the foreign exchange market more or less evaporated – many commentators are asking the impertinent sounding question: “will Hungary be the next Iceland”. To that question I will answer with a categorical no. But not for the reason that most standard commentators offer, that, for example Hungarian private sector credit is at 62 percent of GDP, compared with 407 percent in Iceland, or that short-term external debt obligations are at 112 percent of reserves, compared with 1,705 percent in Iceland. Continue reading →

Serbia has also decided to ask the International Monetary Fund for additional support, according to a stament from senior government officials last Monday cited in Reuters.

“We are certainly not in a group of emergency cases, such as Hungary,” a senior official who asked not to be named told Reuters. “But we need the agreement for longer-term stability.”

So, to be clear, Serbia is not an “emergency case”, like Hungary for example – although it should be noted that the Hungarian government are stating that they are not an emergency case like Iceland, who are themselves not an emergency case, like Ukraine, for example, who are in no way to be considered as being in need of support in the way in which, let us say, Latvia is. And Latvia according to Prime Minister Ivars Godmanis is not any kind of case at all, and certainly not one to be compared with Serbia.

Well, make of all that what you will, but one thing is for sure, and that is that experts from the International Monetary Fund are going to have a role in drafting Serbia’s 2009 budget. And how do we know that? Well Serbia’s Prime Minister, Mirko Cvetkovic, told us, today. Strange isn’t it, but still, this hand in the budget drafting process should not be considered to be, bla bla bla.

Meantime Serbia’s currency (the dinar) has fallen 4 percent and the main stock indexes 30 percent in the last 10 days.

Serbia’s case is a little different from most of the others we are seeing since Serbia has only recently terminated an earlier arrangement with the IMF (which lasted from 2002-2005), and what is involved really is agreeing to a renewal of the previous arrangement, a move which the Serbian central bank had already been urging on the government in an attempt to improve Serbia’s credit rating. Since any IMF terms for additional support will likely result in tighter budgetary constraints, this is also to the central bank’s liking, since central bank Governor Radovan Jelasic has been a strong critic of recent government fiscal policy.

Only last month the IMF urged Serbia to aim for a balanced budget in 2009, to restrict public spending, to tame inflation and to cut its current account deficit from the present 18.5 percent of GDP to 10 percent in the medium term.

One local Serbian personality is, however, reported to be working on a formula which he feels might help his country in these difficult times. World Testicle Cooking Festival champion Ljubomir Erovic is apparently seizing the moment to spread his enthusiasm for his favourite food by issuing a new recipe book.

“I wanted to make something that we could be known by…to make a Serbian brand, not to be famous only for bombs, sanctions or corruption,” Erovic said at a friend’s inn in the wooded hills of central Serbia. Erovic’s electronic cookbook subtitled “Cooking with Balls” offers suggestions on how to cook on a grill or stove with various spices such as fresh rosemary, yarrow, thyme and basil, grapes and wine.

Sounds like something out of a Kusturika movie, doesn’t it?

Those of you with the stomach for reading something just a little bit stronger than testicle stew recipes, and with the curiousity to learn why it might be that what we are seeing happening now in Serbia was more or less inevitable, should enjoy reading my Serbia, Must What Goes UP Really Come Down post, written at the time of last November’s elections. Continue reading →

Ukraine has joined the growing list of Eastern European countries who have now entered some form of “consultation” process with the IMF and today formally requested “systemic support” and “active cooperation” from the fund. The government will meet with IMF representatives in the “coming days,” according to a statement from First Deputy Prime Minister Oleksandr Turchynov. He declined to give further details about Ukraine’s request.

“Now, the IMF is coming and the Finance Ministry is starting to work with them actively,” Turchynov said. The IMF will meet the Prime Minister Yulia Timoshenko “to discuss the financial system’s stability.”

Contracts on Ukraine’s debt were today being traded at 1,500 basis points,as compared with 440 on Russia and 337.5 on Hungary, according to CMA Datavision in London.

Even as late as yesterday central bank Governor Volodymyr Stelmakh had been saying IMF help wasn’t needed. The banking system is “normal and reliable,” he said in an interview.

All the relevant background and analysis to this situation can be found in this post which I put up on Sunday.

Well, the Icelandic authorities seem to have bitten the bullet, and after some coming and going agreed to accept assistance from the IMF. An IMF mission is on the island preparing a plan which will then be put to the Icelandic government (protocols here are important). Under negotiation are the terms of any possible loan. According to Einar Karl Haraldsson (a political adviser to the Icelandic government) the plan is expected to be finalized in the next few days, after which the government will have to decide whether to accept the aid and the terms under which it is being offered.

Meantime a growing number of countries now seem to be at risk of following Iceland and Hungary into the arms of the IMF, with the Baltic republics of Estonia, Latvia and Lithuania now looking particularly vulnerable, according to a warning from the International Monetary Fund itself yesterday.

Dominique Strauss-Kahn, managing director of the IMF, which was formally approached yesterday for assistance by Hungary as well as Iceland, said: “The fallout for most banking systems in emerging and developing economies has been limited so far but signs of stress are growing, ” Strauss-Kahn said some banks in eastern Europe have become increasingly exposed to struggling property markets, having raised funds on international money markets in the same way as the ill-fated Icelandic banks.

For the time being the various national governments are denying the possibility, with Edgars Vaikulis, spokesman for Prime Minister Ivars Godmanis, being quoted in Bloomberg as saying “There is no reason to speak of threats to the Latvian financial system……Latvia’s situation is different from some of the eurozone members.”

I’m sure that the latter statement is true, even if not in the sense that Vaikulis meant. Nonetheless the Latvian government has taken the step of raising guarantees on all bank deposits to 50,000 euros ($68,225), in line with an earlier decision by European Union finance ministers.

In my view the threat to the Baltic financial systems is real, as is the threat to the Bulgarian and Romanian ones. Action, of some form or another needs to be taken, and soon. Latvia and Estonia are now in deep recessions, and Lithuania, while still clinging on to growth, can’t be far behind. Basically it is hard to see any revival in domestic demand in the immediate future, which means these countries now need to live from exports. But with the very high inflation they have had it is hard to see how they can restore competitiveness while retaining their currency pegs to the euro. The IMF will almost certainly insist on a currency float as a condition of rescue, and if you look at the speeches of Lorenzo Bini Smaghi and Jürgen Stark over the last year, it is clear that thinking at the ECB runs along pretty much the same lines. So better get it over and done with now I would say, and take advantage of the shelter offered in the arms of the IMF. Indeed the more I look at what is happening, the more it would appear that a division of labour was agreed to in Paris last weekend, with the EU institutional structure sorting out the mess in Ireland and the South of Europe, and the IMF taking care of all that broken crockery out there in the EU10.

In what is likely to become a sign of the times Hungary’s MKB Bank announced that yesterday that it is going to stop providing euro- and Swiss franc-denominated loans until further notice. In defence of its decision MKB said the huge volatility registered in the value of forint in recent weeks, and especially the strong depreciation at the end of last week, make the outlook on the currency extermely uncertain. Most other Hungarian banks are expected to follow MKB’s lead. This practice of bringing an end to the extremely dangerous practice of offering foreign exchange denominated loans in countries running large external deficits is now likely to come to a screeching halt all across the CEE and CIS economies, and bit by bit the IMF will have to be brought in to offer support during the transition back to reality.

For a full and thorough analysis of the current threat to the Baltic economies, see this whopping post this morning from Claus Vistesen.

Well, Europe’s leaders have finally bitten the bullet. Faced with what IMF head Dominique Strauss Kahn warned could turn into a global financial meltdown, our leaders have risen to the challenge, at least to a certain extent. The details of what has been agreed continue to remain vague, but obviously I think it is a good FIRST move. More will now almost inevitably follow, but our reluctant leaders have finally got their feet wet, and the bathing costume is on. Now it is only left for them to dive into the ocean which lies in front.

And, of course, the situation was not without its theatricals. Initially billed as a “eurozone only” meet-up, Gordon Brown was ultimately summoned, a move which was not totally essential, but since he was the only one with a real “going plan” on the table, the invitation made sense. Of course Brown himself has been relishing it all, proudly proclaining that Britain will “lead the way” out of the credit crunch, and adding in true Churchilian style that “I’ve seen in the cities and towns I’ve visited a calm, determined British spirit; that, while this is a world financial crisis that has started from America, Britain will lead the way in pulling through.”

Well, we will see.

While the details at present remain vague the important point would seem to be that Europe’s leaders have made a commitment not to allow any systemic bank – in Western Europe (the guarantee does not extent to Hungary which today had to turn to the IMF for support) – to go bust, and it will now be hard for them to go back on this without losing all credibility. The deposit guarantees – which may be useful in terms of reassuring the general public – would now seem to be largely redundant, since if the large banks, and their debts, are to be guaranteed, then logically the deposits themselves are safe. And while Europe itself will underwrite the systemic banks, the national governments will be able to handle the smaller ones (Spain’s regional cajas etc) at local level.

So government finances will guarantee the banks, but who will guarantee the government finances? This, at this stage may seem to be an idle question, since none are under direct threat, but I think we need to be clear here, the money which will now need to be spent – and it is way too early to start trying to put precise numbers – will have to come from somewhere, and by and large this will mean the national governments issuing debt, but if we come to individual national governments like Greece or Italy – where debt to GDP ratios are already over 100% – it is not clear how much paper they can actually issue without seeing what is know as the “spread” on their bonds increasing significantly. So while it is certainly time to breath a sigh of relief, we we far from being able to whistle the all clear. And of course the real economy consequences of what has just happened are pretty serious, and the funds which will be spent propping up the banks will not be available for fiscal stimulas packages, so the bottom line is that we, in the OECD world, may well be in for one of the longest and deepest recessions since WWII. Continue reading →