With so many analysts caught off guard by so much of the 2008 financial crisis – Lehman Brothers, anyone? – doomsday scenarios for the European sovereign debt crisis are proliferating. “Europe’s Next Nightmare,” reads the headline of a 9 November Project Syndicate piece. Its author, Harvard’s Dani Rodrik, argues that the political fallout from an unruly Greek default and eurozone breakup could eclipse the economic ramifications by emboldening Europe’s rising radical right as confidence in centrist politics erodes: ”The nightmare scenario would be … a 1930s-style victory for political extremism.”
While extreme, Rodrik’s thesis – and my knee-jerk skepticism to it – reminds me of how generally unprepared we were in 2008, how the prescient Nouriel Roubinis of the world were “alarmists.” TOL’s coverage area, especially, was thought insulated from the brewing crisis until the collapse of Lehman Brothers panicked global markets, undermined cross-border capital flows and exposed critical vulnerabilities like high foreign currency lending. This “sudden stop,” as economists call it, threatened the very foundation of several regional economies, including Hungary’s, toppled governments, and cast much of post-Communist Europe and Central Asia into recession or stagnation.
Where are the vulnerabilities, the nightmare scenarios, in our coverage area today? Obviously, most TOL countries are exposed to eurozone volatility in one way or another. Slovenia, Slovakia and Estonia are eurozone members, several other Central European countries have euro pegs ahead of membership, and states like Kosovo and Montenegro use the currency. As export economies, the Czech Republic, Slovakia and Romania are highly vulnerable to instability and downturns in Western Europe, as are many countries in the Balkans, Eastern Europe and Central Asia because of high remittances.
The Balkan nations, however, are “particularly vulnerable to eurozone stress,” according to the European Bank for Reconstruction and Development’s (EBRD) October report on post-Communist Europe, Central Asia and Turkey. This is especially true now that Italian bond rates have just crossed 7 percent, the threshold at which smaller eurozone countries needed bailouts. Problem is, as the currency union’s third largest economy, Italy is too big to bail out. It is also too big to fail.
These new developments have critical ramifications for the Balkans, where Italian and Greek banks are entrenched. In Albania, for instance, 94 percent of banks are foreign owned, with Italian and Greek sovereigns dominating the market. In the EBRD’s worst-case scenario, several large European banks go insolvent as the debt crisis spreads to larger eurozone members — which is happening with Italy — leaving their subsidiaries short of cash as sovereigns protect themselves first. Given the shakiness of Greece and, in particular, Italy, the Balkans are extremely exposed to the economic spillover from this “crisis transmission channel,” as the EBRD puts it.
Of course, that’s worst case. Europe could stabilize. And, in any case, sovereigns don’t exactly have much to gain by abandoning their own holdings, and the solidarity foreign banks showed their Central European subsidiaries in 2008-2009 is cause for optimism. On the other hand, Italy is teetering, the European Union’s new two-year economic forecasts paint a bleak picture, and, as Rodrik points out, French presidential contender Marine Le Pen recently said “the eurozone probably won’t exist” by the time the votes are counted next year.
I’m guessing the EBRD will have more on the vulnerability of Southeastern Europe and other insights in its upcoming Transitions Report 2011. I will review the report here next week, so stay tuned.
Photo from Wikimedia Commons