D2193695
Safeguarding Eastern Europe’s Economy
04 May 2009
Craig Mellow
The EBRD wants to safeguard economic progress in Central and Eastern
Europe.
Until recently, the European Bank for Reconstruction and Development
seemed in danger of obsolescence. Founded in 1991 to blaze a trail for
private investment in the formerly Communist countries of Eastern Europe
and Central Asia, the multilateral development bank nearly succeeded in
driving itself out of business. Private foreign investment flooded into
the bank’s 30-nation theater of operations. Economic activity
took off, with growth averaging more than 6 percent annually from 2004
to 2007. Like Greece and Spain before them, countries such as Estonia,
Hungary and Poland appeared destined to catch up to Western European
living standards while the former Soviet republics further east made
great strides of their own.
Now that progress stands imperiled. The region’s economic
revival came shuddering to a halt after the worldwide credit crisis
intensified last year. Severe recessions in Western economies and a
decline in global trade have caused output to drop across much of the
region, while financial market turmoil has sparked an outflow of capital
and undermined many countries’ currencies. Governments have
fallen in the Czech Republic, Estonia, Hungary and Latvia. Western
European banks, which control 80 percent of the region’s
banking, could face pressure to cut back in the East and focus on their
domestic economies after receiving hundreds of billions of euros in
government bailouts and debt guarantees. Two decades after the fall of
Communism, a new wall threatens to rise and erode years of hard-won
economic progress in Central and Eastern Europe.
Suddenly, the EBRD finds itself with a renewed sense of purpose. The
bank is stepping up its lending and devoting more of its resources to
combating the crisis in new European Union members like the Baltic
states and Hungary, areas from which it had largely withdrawn in recent
years. Just as important, considering the bank’s relatively
modest budget, the EBRD is acting as a catalyst for wider efforts
involving the EU and other multilateral lenders like the International
Monetary Fund, which has already extended multibillion-dollar assistance
programs to Hungary, Latvia, Romania, Serbia and Ukraine.
Bank president Thomas Mirow is determined to step up the EBRD’s
efforts to combat the crisis and preserve the economic and social gains
made since the collapse of Communism. `Looking back two years
ago, the need for all international financial institutions was subject
to question,’ Mirow tells Institutional Investor in a recent
interview at the bank’s London headquarters. `Now it has
been shown that you don’t abolish the fireman even if you
don’t have a fire.’
The magnitude of the crisis in Central and Eastern Europe is hard to
exaggerate. Banks in the region will need to refinance more than $130
billion in debt this year, EBRD chief economist Erik Berglöf
estimates. The world’s eight most indebted emerging markets,
relative to GDP, are all in EBRD territory. Latvia is the champion, with
combined public and private sector debt equal to 120 percent of gross
domestic product. Governments in the region have been reasonably sober
in their own financial behavior, with the notable exception of Hungary,
but they turned a blind eye as the private sector went on a credit
binge.
Compounding the problem is the fact that half or more of all bank debt
in key markets like Hungary, Romania and Ukraine is denominated in
euros, Swiss francs or dollars, and the real cost of servicing it has
soared as local currencies have plunged. The Romanian leu lost 13
percent of its value against the euro from late September to April 30,
the Hungarian forint fell by 16 percent, and the Ukrainian hryvnia
cratered by 34 percent.
National treasuries, excluding Russia, with its oil-fueled reserves,
have few of their own resources for bank bailouts or stimulus packages.
`Of all the regions of the world, emerging Europe is the worst
prepared for the global crisis,’ says Reinhard Cluse,
UBS’s London-based senior economist for the area.
The EBRD, which owns stakes in about 100 banks in the region and lends
to some 200 others, is rushing to shore up the financial sector in the
hottest trouble spots as fast as its resources and sometimes cumbersome
internal procedures allow. `We are looking to assist banks that
are systemic on the one hand and viable on the other,’ says
Varel Freeman, first vice president for banking.
In April the bank bought 25 percent of Latvia’s No. 2 lender,
Parex Bank, for =82¬106.2 million ($140.9 million). Parex, formerly
owned by a Russian-Latvian entrepreneurial team, was taken over by the
government in November after clients, spooked by its =82¬775
million in eurobond debt due this year, rushed to withdraw deposits.
In December the EBRD pitched in to bolster Ukraine’s
second-largest bank, Raiffeisen Bank Aval, providing a $75 million,
ten-year subordinated loan after the bank’s Austrian parent
poured in $160 million in fresh capital. EBRD staff are also seeking
board approval for a $250 million, ten-year subordinated loan to
state-owned Ukreximbank, the No. 5 lender. Mirow says the bank plans to
devote more of its resources to Ukraine.
The EBRD is also trying to douse fires in Romania. It is awaiting board
approval to lend =82¬100 million each to the country’s
largest bank, Banca Comerciala Romana, a subsidiary of Austria’s
Erste Bank, and the No. 5 lender, Banca Transilvania, which is 15
percent owned by the EBRD. In Georgia the development bank plans to
funnel as much as $70 million in debt and equity to the second-ranked
lender, TBC Bank, as part of a $161 million package that includes
financing from the Netherlands Development Finance Co. and the
International Finance Corp., the World Bank’s private sector
lending arm.
In all, the EBRD aims to raise financial investments this year by 50
percent, to =82¬3 billion from =82¬2 billion, as part of an
increase in overall lending, to =82¬7 billion from =82¬5.1
billion. The bank has the wherewithal to step up lending without tapping
its 62 governmental shareholders for more capital. Although the EBRD
posted a record loss of =82¬602 million last year because of
unrealized losses on equity investments, and expects to be in the red
again this year, it generated earnings of =82¬5.8 billion in the
fat years of 2005 to 2007.
Mirow insists the bank is not loosening investment standards, but it is
visibly shifting emphasis. Before the crisis hit the region, the EBRD
tended to provide financing with relatively few strings attached; in
February 2008 it extended a =82¬350 million facility to a dozen
Russian banks to help them `continue expanding their
operations,’ as the bank put it. Recent interventions have been
focused on recapitalizing banks, such as Raiffeisen Bank Aval, or
enabling them to provide small-business lending. That was the purpose of
the credits to two Romanian banks and a $150 million loan announced in
March to VTB24, the retail arm of Russia’s state-owned VTB
Group.
The EBRD has also postponed the so-called graduation of most Central
European countries. Three years ago the bank decided to stop new
investments by 2010 in the Czech Republic, Hungary, Poland, Slovakia,
Slovenia and the three Baltic states, all of which entered the EU back
in 2004. Those countries received just 6 percent of EBRD loans in 2008.
This year, however, the bank has already pledged at least =82¬500
million, or 7 percent of its projected lending, to financial
institutions in those countries.
In addition to providing critical care for wounded banks, Mirow and his
team clearly see a role for themselves as advocates for trans-European
solidarity during this first serious test of the expanded,
post-Berlin Wall continent. The banker is happy to explain why
Western European taxpayers should pay, if necessary, for bad loans
extended in Poland or Bulgaria. Part of the reason is pragmatic: Eastern
Europe has already become the euro area’s top export market,
surpassing even the U.S. But Mirow stresses a moral imperative too.
`Twenty years after the peaceful revolution in Central and
Eastern Europe, we should not send a signal that we don’t
care,’ he says.
When it comes to promoting European brotherhood, the bank has had mixed
results. National governments, led by Sweden and Austria, have been
generous in allowing banks to channel bailout funds to their Eastern
subsidiaries, something the EBRD has championed. `The risk of
having aid targeted for use domestically is small today,’ says
EBRD chief economist Berglöf. `It was huge last
fall.’
The $200 billion in guarantees offered by Sweden, where banks like
Skandinaviska Enskilda Banken and Swedbank underwrote the Baltic credit
bubble, amounts to roughly 40 percent of Sweden’s annual GDP.
Austria, whose Raiffeisen International Bank-Holding and Erste Bank led
the charge elsewhere in the East, has put as much as =82¬100
billion, or 35 percent of GDP, at the banks’ disposal.
Unicredit, an Italian bank that expanded east largely through its
acquisition of Germany’s HVB Group and HVB’s Bank
Austria subsidiary, announced in March that it would seek a =82¬4
billion capital injection jointly from the Italian and Austrian
governments.
Herbert Stepic, chief executive of Raiffeisen International, says
there were `no strings attached’ prescribing the bank’s use of a
=82¬1.75 billion capital increase that the Austrian Treasury extended
to his bank’s parent, RZB Group, in early April. With this backing,
Raiffeisen has committed itself to staying the course in Ukraine and
16 other former East Bloc countries. `I still consider this region as
the No. 1 growth market open to us,’ says Stepic.
The EU and the European Central Bank have turned a deaf ear to EBRD
proposals that Central and Eastern European countries be offered a
fast-track route for adopting the euro or at least for linking their
currencies to the euro in the EU’s exchange-rate mechanism. EU
officials have firmly backed ECB president Jean-Claude Trichet’s
stance that prospective euro countries rigorously fulfill the
requirements of low deficits, inflation and exchange-rate volatility
laid down in the Maastricht Treaty. Mirow and Berglöf have also
made no headway with their calls for the ECB to provide currency swap
facilities to central banks in the East, similar to arrangements that
the U.S. Federal Reserve Board has made with Mexico and Brazil.
But Mirow, 56, keeps making his case, employing his favorite word,
`cooperation,’ every few sentences. `The
situation is serious but manageable if the public sector in the Eastern
countries, the public sector in Western Europe and the private sector
continue to cooperate,’ he declares.
The EBRD chief is aptly cast in the role of consensus builder. He was
born in Paris, where his father was a diplomat at the German embassy.
Mirow worked across the spectrum of German politics. He started out in
1975 as an aide to Social Democratic leader and former chancellor Willy
Brandt, eventually becoming his chief of staff. He moved into the civil
service in the city-state of Hamburg in the 1980s, rising to the post of
state minister for economics from 1997 to 2001. Mirow dabbled in the
private sector from 2002 to 2005, holding advisory roles at accounting
firm Ernst & Young and Hamburg-based private bank M.M. Warburg & Co.
Chancellor Angela Merkel, a conservative, tapped Mirow as her director
general for economic policy in 2005, before moving him later that year
to the Finance Ministry to serve as state secretary for international
issues. He took the top job at the EBRD a year ago, replacing veteran
French financial official Jean Lemierre. Mirow’s ability to
work with a variety of different parties is crucial for the development
bank, which typically invests alongside a number of international
financial institutions and governments to maximize its impact. That
consortium approach is particularly vital today, given the scale of the
crisis affecting Central and Eastern Europe.
A blueprint for the intricate cooperation that the EBRD would like to
see has already been sketched out for the badly overextended Baltic
countries of Estonia, Latvia and Lithuania, chief economist Berglöf
says. The IMF, the EU and Scandinavian countries collaborated on a
=82¬7.5 billion adjustment loan to the Latvian government.
Meanwhile, the government of Sweden, whose banks own most of the
Baltics’ financial sector, guaranteed more than $200 billion in
new bank debt, most of it implicitly earmarked for recapitalizing the
Baltic subsidiaries. The Swedish central bank also agreed to a 10
billion koruna ($1.1 billion) currency swap with its counterpart in
Estonia, effectively adding to that beleaguered country’s
exchange reserves and rekindling its hopes of maintaining its currency
peg to the euro. And the EBRD pitched in with its investment in
Latvia’s Parex Bank.
All told, Berglöf reckons, nine different treasuries and banking
regulators and at least four supranational players have so far been
involved in salvaging the three Baltic states, whose joint population
amounts to about 7 million. All that remains is to scale that effort to
the rest of the EBRD zone, which, even leaving aside giants Russia and
Turkey as special cases, encompasses two dozen nations and more than 150
million people.
As one means to this end, the EBRD advocates picking up the pace of
euro-zone expansion, a process that both present and prospective members
approached skeptically during the good times. Only two small states in
the region, Slovakia and Slovenia, have been allowed to join the common
currency. The EU rejected Lithuania in 2006 because its inflation rate
was 0.1 percentage point above the prescribed norm. `Some of the
problems we’re seeing result from countries being integrated in
terms of markets, but not in terms of currency or other
institutions,’ Mirow says.
The IMF endorsed the EBRD’s integrationist call; a recent Fund
report suggested that the ECB might allow Eastern countries to use the
euro but not join the central bank’s governing board. But ECB
officials have dismissed the idea. `European monetary union has
very clear rules, and these rules have to be followed,’
governing council member Ewald Nowotny said last month.
EU leaders have taken a stingy line on requests for direct aid from
CEE governments. In March, Merkel rejected a proposal from
then-Hungarian Prime Minister Ferenc Gyurcsány for a =82¬180 billion
regional rescue fund, an idea that even the EBRD’s Berglöf describes
as `a bit premature.’ But the EU has found other ways to assist the
region. It has more than quadrupled its balance of payments facility,
an emergency credit line for non-euro-zone members, from =82¬12
billion to =82¬50 billion in the past six months. Already, Hungary has
tapped the facility for =82¬6.5 billion, Romania for =82¬5 billion and
Latvia for =82¬3.1 billion. In February the European Investment Bank,
an EU development bank, allocated =82¬11 billion to investments in
East European banks over the next two years and promised to coordinate
its efforts with the EBRD. The World Bank added =82¬7.5 billion to the
initiative.
EU countries are also helping the region through the IMF; they agreed at
the Group of 20 summit meeting in London last month to contribute $100
billion in additional resources to the fund. The IMF in turn has been
pouring assistance into Eastern Europe, extending bailouts to EU members
Hungary, Latvia and Romania and offering similar aid to Armenia,
Belarus, Georgia and Ukraine. Poland last month became one of the first
countries to tap the IMF’s new flexible credit line, a kind of
insurance line of credit, for $20.5 billion.
About 15 European countries, including Turkey, will seek IMF
intervention before the current financial plague subsides, predicts
Anders Aslund, an East European specialist at the Peterson Institute for
International Economics in Washington.
The EBRD’S ultimate goal is to keep the economic panic from
decoupling Western and Eastern Europe and throwing two decades of
Continental integration and rising prosperity into reverse. The
bank’s mission is to keep Eastern financial systems sufficiently
intact so that most of new Europe can resume growth when its Western
customers do. Are the various aid streams enough to achieve this? Mirow
is guarded in his optimism. `My guess is yes, there will be
sufficient funds available,’ he says. The near-term outlook
remains rocky, EBRD banking chief Freeman cautions. `There is a
lot of negative momentum. The risks are still on the downside,’
he says.
As for longer-term prescriptions, the EBRD brain trust insists that the
region’s dependence on Western capital remains the right
strategy, but Berglöf argues for a `new financial
architecture’ that would allow home and host countries of the
major international banks to work together to curb credit excesses.
`Host countries could not regulate effectively because banks
could circumvent them by using their home office, and home countries
don’t know what is going on in the host country,’ he
says.
EBRD officials also defend the extension of foreign-currency-denominated
loans in many Central and Eastern European countries and reject the idea
of imposing limits on them. Rather than proscribing activity, bank
officials are working to develop deeper local currency capital markets
to give borrowers a wider choice of options. In Russia, for instance,
the EBRD helped design a ruble interest rate mechanism called MosPrime
in 2005. It has since supported the widespread use of that rate by
launching four floating-rate bond issues worth a total of 32.5 billion
rubles ($979 million) that are linked to it. The bank has also extended
85 billion rubles in loans pegged to MosPrime to Russian banks and
companies. MosPrime’s success is a big reason hard-currency
loans in Russia account for only one quarter of all lending,
Berglöf contends. The bank has similar spadework under way in
Ukraine.
Banks meanwhile are cutting back on hard-currency lending because of the
risks that devaluations pose. Raiffeisen International has stopped
making Swiss franc loans in Central and Eastern Europe and is cutting
back on euro-denominated lending to individuals, says CEO Stepic.
The EBRD’s work, combined with the support of other
international financial institutions and Western governments, is
beginning to have an impact. Western banks and the governments that
stand behind them have continued to invest in the East’s
long-term promise.
In addition, devaluations and the flexibility of the region’s
young industrial complex could spur a sharp rebound in the financially
healthier states. Czech carmaker Ë=87Skoda Auto, for instance, took
quick advantage of neighboring Germany’s `cash for
clunkers’ program, which gave consumers subsidies for scrapping
old cars and buying new ones. Ë=87Skoda, which is owned by
Germany’s Volks-wagen and had cut working time in response
to a drop in demand in September, returned to a full workweek in March
and reported sales rising from a year earlier. `The Czechs and
Poles have made more positive transformations on the supply side of
their economy than, say, Italy or France,’ says Iain Begg, a
research fellow at the London School of Economics’ European
Institute.
Although governments have fallen this year in several countries in the
region, their successors look more sober and just as committed to
European integration as their deposed predecessors. `The crisis
has made politicians in the region value euro access and other
integration steps more as a light at the end of the tunnel,’
says Jon Levy, an analyst at Eurasia Group, a research and consulting
firm in New York. Unless things get much worse, today’s crisis
increasingly looks like a contraction that Europe will struggle through
together and not an historic cataclysm that will tear the Continent
apart.
`These countries are still privileged, in a way, to be so close
to the European Union,’ says Berglöf. That optimism sounds
less incongruous than it did a few months ago.