Niall Green
Global Research
October 24, 2008

The economies of central and eastern Europe are being rocked by the crisis of world capitalism, compounded by the corrupt and pro-big business policies of their local elites.

Defying many economists and commentators, who had forecast that the region would be well placed to deal with the credit crisis due to the lower relative weight of finance capital within their national economies, much of Eastern Europe stands on the verge of insolvency and deep and protracted recession.

Following the collapse of the Soviet Union and the Stalinist states, central and eastern Europe provided global capitalism with vast new sources of cheap labour and raw materials. In the early 1990s the recession affecting the Western economies, accelerated the flow of capital into the former-Soviet countries, with transnational corporations seeking to cut costs by outsourcing to this newly opened-up low tax, cheap labour areas.

Major global manufacturers such as General Motors, Volkswagen and Nokia invested hundreds of millions of dollars into new factories, taking advantage of the large pools of highly-skilled and educated workers, many of whom had lost jobs in the old state-owned industries that were closed following the restoration of capitalism. Western financial institutions profited from financing the development of new industrial plants, as well as property speculation among the new bourgeois elite and foreign investors in major urban areas like Prague, Warsaw and Bratislava.

Business consultancy, Capital Economics, reports that 17 years after the restoration of capitalism and four years after most joined the European Union (EU), wages in the eastern EU states are still only one fifth of the average of those in Western Europe.

An estimated five million workers have left the eastern European countries for Western Europe between 2004 and 2007. The mass migration from the ex-Soviet states has left key sectors of the economy and public services such as healthcare critically short of skilled workers. Poland and Ukraine almost had to abandon their status as co-hosts of the 2012 European Football Championship due to the chronic shortages of labour needed to renew facilities for the competition.

Only a few months ago, a recession in Western Europe was viewed as a potential boon to overheated Eastern Europe economies. Inflation, running at 15 percent in Russia and Latvia, seemed to be the greatest threat. However, as the full impact of the global crisis unfolds, the alleged ability of Eastern Europe to weather the storm relatively better than its Western counterparts has been thrown into question.

All the economies of the eastern European region are highly dependent on credit from the international markets. The Institute of International Finance has estimated that total private capital and credit flows into eastern Europe, the former USSR and Turkey, are likely to fall from nearly $400 billion in 2007 to an estimated $262 billion next year, a figure which may fall even further as it is based on optimistic forecasts of the effectiveness of the international governmental bailouts of the banks.

Erik Berglof, chief economist of the European Bank for Reconstruction and Development, stated that the eastern European countries, “could deal with rising borrowing costs and an economic slowdown coming from the US and Western Europe, but a complete shutdown of international borrowing—nobody can withstand that.”

The International Monetary Fund forecasts a fall in the growth rate for gross domestic product (GDP) for central and southeast Europe from 5 percent this year to 3.5 percent in 2009. For Russia and the former Soviet Union, it predicts growth of around 7 percent for this year and 5.5 percent for 2009.
Emergency bailout for Hungary

Even these figures fail to show the full impact of the economic crisis on countries whose economies are heavily dependent on exports to the wealthier western EU.

The impact of a recession in France, Germany and Britain will be acutely painful to the eastern economies of Europe. The Czech Republic, for example, relies on exports to the wealthier euro currency zone for 40 percent of its GDP. As the British magazine, the Economist, stated, “If Germany gets a headache, eastern Europe gets a migraine.”

On October 16, the same day countries across the EU pledged to shore up the banking system with a package whose total could exceed €2 trillion, the European Central Bank (ECB) granted Hungary a bailout worth €5 billion, saving its economy from a financial meltdown.

The International Monetary Fund (IMF) is poised to offer the country a further, and probably much larger, bailout loan.

Last week, Hungary put tight controls on foreign exchange lending in an effort to stabilise the country’s troubled financial sector. This prompted a massive drop in the value of the Hungarian currency and stock market, quickly followed by sharp rises on the news of the ECB bailout.

• A d v e r t i s e m e n t

Hungary has a very high level of foreign public debt—60 percent of GDP—meaning that the country is less attractive to foreign investors and less creditworthy to private and international lenders. Global credit ratings agencies Fitch and Standard and Poor’s have lowered Hungary’s rating to BBB+ , the third lowest investment grade offered to any country.

In addition, many ordinary citizens and local firms have loans with Hungarian banks that have been packaged in complex schemes based on the speculation that the Hungarian forint would stay on the same exchange rate as the euro. That situation is likely to change as Hungary’s high budget and current account deficits pressure the devaluation of its currency, which is now trading at a two-year low, further destabilising its banking system.

The government of Prime Minister Ferenc Gyurcsany has reduced its official GDP growth forecast for 2009 from three percent to just 1.2 percent, and has acknowledged it is planning a budget based on a zero percent growth rate next year. The Hungarian government has pledged to cut its budget deficit, meaning that public services spending and wages will be driven down.

Nick Chamie, of RBC Capital Markets, has warned that much of eastern Europe is ill-equipped to bail out the financial system and may suffer the same fate as Iceland, whose financial system has seized-up with the collapse of its three major banks.

“The three Baltic states along with Ukraine, Kazakhstan, Bulgaria and Romania—and of course Iceland—are top of the list,” of those vulnerable to an investment exodus, Chamie warned.
Baltic states in crisis

Latvia and Estonia are officially the first economies in the eastern EU to fall into recession. Lithuania, whose growth has been slower than its Baltic neighbours, is likely to officially enter a recession in early 2009 and has been forced to guarantee the deposits of savers up to the value of €100,000, double the average EU guaranteed amount.

The Lithuanian prime minister was forced to appeal for calm in early October, stating that “There is no danger for any Lithuanian bank to go bankrupt. We monitor the situation constantly.” The country’s banking sector is dominated by the Swedish bank SEB.

The heads of government of all three Baltic states issued statements October 10 insisting that their countries were not headed for insolvency. “It is impossible to compare Lithuania with Iceland,” Prime Minister Gediminas Kirkilas told a joint news conference with his Latvian counterpart.

Reinhard Cluse, “emerging Europe” economist for Switzerland’s UBS bank, was more cautious, stating in response to the financial situation in the Baltic states:

“Iceland was a special case, but the same rising waters that flooded Iceland first are a problem for others, too.”

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