Eastern Europe Carry Trade

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fujisan's picture
fujisan
Status: Gold Member (Offline)
Joined: Nov 5 2008
Posts: 296
Eastern Europe Carry Trade

Eastern Europe Blowing Up

Quote:

Last week Moody's rattled the markets a bit when it said it was considering downgrading a number of European banks because of severe problems with their loans to Eastern Europe.

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What's happening is that the economies of the Eastern European nations and ex-Soviet republics are crumbling at a time when they owe vast sums to European banks.  On average, GDP in the Baltic countries is down 17% and their stock markets down 70%.  Still, they have raised their short rates by 500 basis points to defend their currencies that are plunging, thereby making the economic situation even worse. In Poland, 60% of the mortgages are denominated in Swiss francs and the zloty has plunged against the franc.  Their industrial production has declined 14.9%.  In the Ukraine, GDP has dropped 20% year-over-year while industrial production has declined 34%.  The Hungarian forint is down 30% against the euro, and almost all of their mortgages are denominated in foreign currencies, making them more difficult to service.  The Hungarian stock market is down 60% and auto sales are off by 50%.  Other Eastern European countries are facing similar situations.

The problem is that the aforementioned group of nations has borrowed $1.7 trillion from foreign countries, with $1.3 trillion of it from European banks.  They must pay back or rollover $400 billion this year, an amount equivalent to one-third of the group's GDP. With credit markets frozen, however, this is an impossible task, and without a massive bailout, these countries will blow up. Especially vulnerable are banks in Austria, Sweden, Greece, Italy and Belgium.  Austrian banks alone have exposure of $280 billion to emerging Europe, an amount equal to 64% of its GDP.

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Der Standard in Vienna said that "A failure rate of 10% would lead to the collapse of the Austrian financial sector".  German Finance Minister Steinbruck said that the Western European governments may be forced to bail out Eastern Europe.  With Western European economies already in terrible shape, this will not be accomplished without a lot of time and turmoil.  


Tension Boils Over Swiss Franc - Forbes.com

Quote:

Switzerland faces the prospect of national bankruptcy because of its exposure to Eastern Europe, putting the currency under huge risk of devaluation, an economist Artur Schmidt warned in an article in Switzerland’s Tagesanzeiger daily newspaper on Thursday.

$200.0 billion of the foreign currency loans made to Eastern Europe have been in Swiss francs -- and a significant portion comes from Swiss banks, argues Schmidt. Should the central bank be forced to come to the rescue of the banks which account for 8.3% of gross domestic product -- UBS and Credit Suisse -- that would put pressure on the economy and currency, he said.


World Bank, EBRD to Give East Europe $31 Billion Aid (Bloomberg)


Quote:

The EBRD will provide about 6 billion euros, the EIB about 11 billion euros and the World Bank about 7.5 billion euros, the statement said. The aid will take the form of equity and debt financing, credit lines and political risk insurance.


East European nations are struggling to refinance foreign- currency loans taken out by borrowers during years of prosperity through 2007, when economic growth averaged more than 5 percent. The International Monetary Fund, which has bailed out Latvia, Hungary, Serbia, Ukraine and Belarus, warned on Jan. 28 that bank losses may widen as “shocks are transmitted between mature and emerging-market banking systems.”

SkylightMT's picture
SkylightMT
Status: Silver Member (Offline)
Joined: Sep 30 2008
Posts: 125
Re: Eastern Europe Carry Trade

If Eastern Europe, or much of Eastern Europe, does collapse, would the effect be contained or would it cause a global chain-reaction collapse? The collapse of iceland didn't seem to have affected things much globally. Would this be different?

fujisan's picture
fujisan
Status: Gold Member (Offline)
Joined: Nov 5 2008
Posts: 296
Re: Eastern Europe Carry Trade

I'm not expert, but I understand it would be mostly contained within Europe, although some banks are international.

The GDP of the whole European Union is (a bit) larger than GDP of USA. Call this "local" if you like, but it accounts for about 30% of wordwide GDP.

That said, they will try to avoid this collaspes at all costs. The "Too Big To Fail" syndrome. Some of the banks have huge exposure, in Austria in particular. Some banks have huge leveraging. The question is how much billions of Euro will be needed to fill the potential losses. Some individual EU member states cannot afford to bailout their banks, so this was done at supra-national level :EIB, EBRD, Word Bank, IMF...

The other problem is the carry trade itself. Loans denominated in Euro and Swiss Franc have been made to Eastern & Central European countries which national currency is falling against the Euro and Swiss Franc. IOW borrowers see their debt raising in their own national currency.

Here's another paper dated a few months back:

HOW SAVE IS MY BANK? The World's safest Banks - Facts and figures about European and American Banks

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