When the leaders of the G20 sat down to their Jamie Oliver dinner at Downing Street last week there was a ghost at the feast. As they munched their way through Shetland salmon, slow-roasted shoulder of lamb and Bakewell tart, Gordon Brown, Barack Obama, Angela Merkel, "Lula" and the rest of them may have noticed a slight coldness in the air. Somewhere at the back of their minds may have arisen the chilling question – where will the next financial shock come from? Who is next?
If they had bothered to read their briefing papers they would be only too well aware of the unholy spirit stalking the world – the fragile economies of eastern Europe. They are the weakest link in the international financial chain. But why should we in the West give a fig about Bulgaria and its lev, say? Simply because Western banks have lent that nation, and those like it, too much money, and are now in danger of making further huge losses on these exposures. Think of it as sub-prime, Balkan-style. By now, we should all know what happens when our banks have to write off huge losses from bad debts; they stop lending to the rest of us. So Bulgaria does matter.
The good news is that the G20 did do something about all this last week. The leaders were obviously well briefed. The one concrete result of the summit was the massive increase in funding for the IMF, as it will have to go in and rescue these soon to be stricken economies. The increase in resources, though subject to the usual double counting, multiple announcement and spin, remains substantial – a trebling to $750bn. That ought to take care of the bills from eastern Europe. The leaders, though not many have acknowledged this, were not doling out their cash to the IMF out of sheer altruism; it was part of a hard-headed calculation of the risk of further international turmoil that will make citizens from Canada to Korea much the poorer. The G20 recognised that another financial panic sparked by the failure of an Austrian or Swedish bank, say, with the contagion rapidly passing through the globalised financial system and markets could bring the twist to the recession that turns it into a slump. So they stumped up.
Is the threat that real? Yes and most observers did regard it as a matter of if rather than when such a crisis would arrive, that is before the G20 took evasive action. The IMF warned as much, in unusually explicit terms, in its preparatory note for the meeting. Despite the ghoulishness of the fund's warnings, few gave them the attention they deserved, though the G20 leaders did take note. The IMF's staffers couldn't have been scarier if they'd dressed up in white sheets and haunted the ExCeL Centre.
The fund wrote: "Emerging and developing economies continue to face acute external financing pressures. This is particularly the case for emerging economy corporates facing large rollover requirements, threatening large-scale private sector defaults that could potentially undermine growth prospects. This in turn would worsen prospects in the advanced economies and trigger a vicious spiral."
So there was more than one ghost at the Downing Street feast – Turkey, Ukraine, Serbia, Latvia, Romania and others are already zombie states, in the process of receiving IMF assistance to rescue their finances. More will surely follow. The IMF says that some Western banking systems are peculiarly exposed to the potential trauma. How big? Well, analysts at Capital Economics say that about $500bn (£335bn) of maturing debt is due to be rolled over this year, of which the $100bn emanating from Russia can be discounted, given her vast foreign currency reserves. So that leaves about $400bn, and if the losses on that debt spiralled to say 50 per cent that leaves an exposure of $200bn, some way less than the extra resources the IMF has been promised.
Who is threatened, precisely? Here again the IMF was unafraid to name those at risk: "the vulnerabilities of banks with substantial exposure to central and eastern Europe are raising perceptions of sovereign risk in advanced economies. Many banks' exposures are high relative to their home country's GDP. Austrian banks' exposures, for example, amount to about 75 per cent of Austria's GDP. Other countries with relatively high exposures include Switzerland, Belgium, the Netherlands and Sweden". (See chart) Note the two eurozone member states. After the downgrading of Irish, Spanish, Portuguese and Greek sovereign debt by the ratings agencies you can see the dangers for the credibility of the euro if those nations too see their ratings trashed.
Apparently, in some sort of modern day economic version of the Austro-Hungarian empire, the Austrian banks have taken on the task of financially supporting their Danubian neighbours. The Swedes similarly decided to demonstrate their Nordic solidarity by doing business in Estonia, Latvia and Lithuania. No doubt their executives thought they were being good neighbours. It certainly came at a price.
But before we declare the crisis fully averted, we should also note what the G20 did not do for the east Europeans. They did not, it must be stressed, do anything concrete to lessen the risks of protectionism, to which these states are peculiarly vulnerable. Think of the champion exporting nations of the world, and how much they earn from the goods and services they sell abroad. The Germans are top among the older established large economies; 30 per cent of their income derives from exports. In Japan it is a surprisingly low 10 per cent: in the US and UK around 15 per cent. Now consider how much eastern Europe relies on exports. The Czechs' reliance on exports – 80 per cent of GDP – makes most countries look isolationist (see chart). The Hungarians and Poles are also heavily reliant on trade. So the 13 per cent decline in world trade predicted by the OECD will have a potentially devastating impact on those already bruised economies.
True, imports will also be depressed, but such a loss of foreign earnings is doubly unwelcome when Western banks are no longer willing to plug the gap. Look too at the countries of fast-growing Asia – with Malaysia's exports exceeding 100 per cent of GDP. Most of the east Asian powers have built up large foreign exchange reserves so their crisis will not be so severe. Even so, the protectionist polices increasingly being pursued by the G20 are the biggest single threat to these nations trade and, thus, to the immediate financial stability of the world. The G20 have promised the IMF the resources to rescue these economies; but avoiding protection might be the more rational and cheaper answer to the challenge of keeping Bulgaria and the others solvent.
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