By Adam Jasser
For once, being a laggard is a boon rather than a drawback for ex-communist central Europe as it weathers the global financial storm engulfing western bastions of capitalism.
While the world's top central banks pump billions into the financial sector to help it unwind losses made on sophisticated market instruments, their counterparts in new European Union members from the East have been sitting tight.
Economists attribute this to the region's relative backwardness despite a huge dose of modernisation and progress towards fully fledged capitalism in the last 20 years.
Simply put, plain vanilla banking in the region's rapidly growing economies has been profitable enough not to lure banks into more risky assets such as mortgage-backed securities.
Credit expansion, rapid in the last few years, is low by Western standards and has to a huge degree been funded by deposits. So although liquidity has been squeezed, it remains sufficient to keep the financial system stable.
"Banking systems in countries with relatively low loan-to-deposit ratios such as Poland, Slovakia and the Czech Republic are less exposed to the risk that foreign funding dries up," Christoph Rosenberg, the regional representative for the International Monetary Fund told Reuters.
Even though the tone in the media is often alarmist, the region's governments have not yet come under pressure to act. Consumers, hardened by the turbulent transformation from communism to capitalism over the last 20 years, remain sanguine.
Luck also seems to have played a part, as none of the big international banks which together own nearly half of the local banks in the region has so far been hit directly by huge losses related to the sub-prime mortgage lending.
HEALTHY BANKS
The health of the banking sector is key. Poland, which contributes almost half of the region's economic activity, has a loan-to-deposit ratio of close to one. The total volume of credit in the economy is just 24 percent of GDP. Both measures are well below Western levels.
A recent study by Italy's UniCredit, a leading investor in the region's banks, shows the financial system's balance sheet in Central Europe is roughly equal to total gross domestic product, a safe level by any standard.
In the euro zone, the financial system is double GDP. Additionally, most central European banks have strong capital adequacy ratios and no exposure to "toxic" assets such as mortgage-backed securities.
This and still growing economies underpin investor confidence, and the most liquid markets in the region, Poland, Hungary and Czech Republic, have held up relatively well.
Their currencies have so far traded higher this year, even though dominant financial stocks took a beating along with their western peers.
Still, the sell-off was nowhere near as dramatic as in Russia, where share indices are down over 40 percent since the start of the year compared to about 20 percent for central Europe.
Poland's declaration this month that it will seek euro zone membership in 2011 also boosted confidence in the entire region.
Consumer confidence remains strong and billions of euros in EU structural funds flowing into the region as it plays catch-up with the rest of the bloc provide extra liquidity.
SLOWER GROWTH?
But access to portfolio capital as well as interbank funding from abroad is already tighter, putting brakes on the growth of buoyant mortgage lending and the booming housing market.
Shares in some construction companies in Poland trade at a quarter of their value before the crisis as hundreds of flats stand empty and construction of new projects is on hold.
This will bite into growth, although not in the same way everywhere. UniCredit sees Poland, the Czech Republic and Slovakia slowing only marginally but the Baltic countries, Romania and Bulgaria could slow in a more pronounced way.
The Baltics and Bulgaria are especially vulnerable to the credit crunch because they depend on foreign inflows to finance their current account deficits and loans and because their economies were propelled almost exclusively by the housing boom.
The four countries have pegged their currencies to the euro, which on the one hand reassures investors and households but which prevents a gradual adjustment of the exchange rate.
In a worst-case scenario, this could lead to a haemorrhage of foreign reserves and shock devaluations, setting the stage for a hard landing and distress for households heavily exposed to foreign lending.
In Latvia alone, around 70 percent of household debt is in hard currencies. It is 60 percent in Hungary, about 50 percent in Romania, 28 percent in Poland and close to zero in the Czech Republic, according to UniCredit. (Reuters)
