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Event risks to fore in E.Europe as crisis bites

  The combined weight of plummeting economies and rising political discontent has banished the one-way convergence bet in emerging Europe and investors are now treating the region more like a traditional emerging market.

Latvia, Lithuania and Bulgaria have all seen street violence in the last month reminiscent of the scenes that brought down Iceland Prime Minister Geir Haarde at the beginning of the week, upping interest in political risk across the region.

These once stable and high-flying economies now likely face recession in the first half of this year, slumping asset prices and potential negative feedback cycles that could prolong a crisis that was unthinkable six months ago.

All that has refocused attention on the solidity of governments and willingness to make painful fiscal choices, as rising unemployment ups the stakes for populations whose race to catch up with the West is about to hit an enormous speedbump.

“There’s no question that Eastern Europe is suddenly much more vulnerable both economically and politically then several months ago, even relatively stable countries like Poland,” said Joanna Gorska, deputy head of the Eurasia desk at risk consultancy Exclusive Analysis.

Whereas Iceland has long been much wealthier, the former communist countries of Eastern Europe had also seen several years of surging incomes and standards of living before the turmoil begun by Lehman Brothers’ collapse last September. Not even the most exposed -- Ukraine is top of the list -- are likely to suffer a similar financial implosion to Iceland.

But the worry is that the first recessions to hit the region in a decade may spark political upheaval, a swing to the left, and the loosening of fiscal screws. The Czech Republic on Friday underlined the risks to public finances by almost doubling their forecast for the 2009 public sector shortfall to 3% of GDP.

TRIGGER FACTOR

The last decade has seen investors buy and hold assets in these countries, safe in the conviction that the value of property, bonds and companies would converge with Western Europe, and that any losses would be only blips on the road. But Commerzbank head of emerging research Michael Ganske said the recent rise in risk is prompting banks to reverse the shift of Central Europe’s biggest economies from emerging markets desks to mainstream sovereign teams.

“It means that these are being seen as conventional emerging markets again,” he said. “They are seen as places where investors have specific event and political risks.” Greater government intervention and growing popular discontent have made politics more closely watched than in the boom years stretching back to the Asian financial crisis.

Ukraine’s ruling coalition was in trouble well before Lehman’s collapse, and the rush to hoard cash at the expense of emerging markets late last year sent its currency and economy into freefall. But the wider market impact of a further crisis there would pale in comparison to that of trouble in one of the more mainstream investment destinations.

Royal Bank of Canada strategist Nigel Rendell believes regional currencies have further to fall and debt insurance premiums further to rise. Czech, Polish, Hungarian and Romanian currencies have fallen between 3.8 and 11.6% since the beginning of January, adding to double digit retreats in the last few months of last year. Some analysts say currencies could fall 10-15% further across the region within months.

Latvia’s Lat has performed relatively well this year after an International Monetary Fund deal, but in the longer term some analysts say its currency peg and band may be taxed to destruction as the crisis bites.

ICELAND’S EXAMPLE?

Latvia’s president has said expanding his centre-right coalition is the only way to regain public confidence after riots on January 13, which came after the launch of an austerity plan agreed under its near $10 billion IMF loan deal. But the first opposition party approached rejected the offer and said the coalition had led the state to bankruptcy, demanding a new prime minister.

The shaky position of the Czech Republic’s minority coalition government has raised concerns whether it can survive until an election scheduled for mid-2010, although most observers do not expect a cabinet collapse before June when the country completes six-months in the European presidency.

In Hungary, the Conservative opposition is expected to heavily defeat the current government in polls next year, while Bulgaria’s sleaze-tainted coalition government is expected to be ejected at an election later this year, and policy under a new government clouded by doubt.

Romania’s elections last year led to a large but conflicted government that has failed to deliver the fiscal restraint wanted by markets ahead of presidential elections late in 2009. All that is still a long way from Iceland, where Haarde’s fall itself has had a minimal market impact -- largely because the volcanic north Atlantic island has almost no markets left.

The krona (ISK) currency effectively ceased trading internationally after the crash last year. “Investors are looking at Iceland not so much for the market impact as for the implications elsewhere,” said Rendell. “Both the risks of governments collapsing and sudden moves to the left are very much there in other countries as well.” (Reuters)