Monday, February 22, 2010

Weekly Hurriyet Column: Quiet before the storm in the Balkans

Below is the unedited version of my column for this week. You can read the final version at the Daily News website. No cheesy references this time around as well; that makes two in row. I think I am losing my touch:)

As for the column, there are a couple of very interesting comments, posted to the spoiler for the column, so have a look there.

When the Greek crisis hit, the biggest concern of economists following the region was Greek contagion. With their significant trade, foreign direct investment, or FDI, and banking exposure to Greece, the Balkans looked particularly vulnerable.

Those concerns have eased for now. But a closer look at the region reveals that there are significant risks of contagion from the financial sector and fiscal problems although real sector linkages do not pose a significant threat.

Take the trade channel. Even for Bulgaria, only 8 percent of exports are to Greece and 4.8 percent of imports from there. Given that trade makes up slightly less than a third of Bulgarian GDP, contagion through this channel would be very limited even if Greece were to have a deep recession.

Similarly, Greece’s FDI share in most Balkan economies is below 10 percent. Moreover, FDI is not expected to be a major driver of growth in the region this year, so the response of Greek companies will not matter much. It is also interesting to note that the bulk of the Greek FDI figure of 6 billion dollars (2002-2008 cumulative flows) to Turkey is due to the acquisition of a single Turkish bank.

And that brings me to banking, arguably the most dangerous contagion link. Turkey, where the Greek banking market share is only 4 percent, is the exception rather than the rule, as Greek banks have significant presence in most of the Balkans, rendering the region vulnerable to adverse shocks associated with funding problems in Greece.

The Vienna initiative, which entails rollover and recapitalization commitments from parent banks to their subsidiaries in five countries with IMF-supported programs, provides some cushion for Albania and Romania. Bulgaria, on the other hand, with 30 percent Greek market share, could see a sharp credit contraction if Greek banks were to shrink their balance sheets.

But one thing going for Bulgaria is its sound fiscal position. The debt to GDP ratio was 15 percent as of end-2009, and the government is sitting on fiscal reserves of 12 percent of GDP. Despite last year’s 6.2 percent contraction, it managed to keep its fiscal accounts almost at balance. If push comes to shove, Bulgaria has a lot of flexibility to adopt counter-cyclical fiscal policy or jump-start troubled banks. Romania’s IMF-EU program is helping the country to gain its fiscal health, but others are not as lucky.

In fact, although the Greek crisis erupted over fiscal concerns, the fiscal complexities in the Balkans are being overlooked. One interesting case is Turkey, the region’s new poster-child despite a challenging debt outlook. It is often ignored that gross issuance and redemptions as a share of GDP this year are higher than the ill-famed PIGS, under the rosy assumption that local banks will be able to absorb with ease whatever the Treasury has to offer.

But such concerns seem to be limited for now, not just for Turkey, but for the region as a whole. Once global risk appetite is accounted for, there has been almost no contagion from Greece until now. Nonetheless, there are valid reasons to be cautious, particularly if another bout of global risk aversion were to strike.

Such a feeding frenzy could expose the Achilles’ heel in each Balkan country. While most countries in the region would suffer from the funding problems of Greek banks, Turkey’s fiscal vulnerabilities could be highlighted despite the country’s sound banks. Even Bulgaria might not be fail-proof: Despite its strong fiscal position, its external accounts are problematic, and the currency board is depriving the country from exchange rate flexibility.

The current calm in the Balkans is highly illusionary; it could as well be the quiet before the storm.

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