Global Policy Forum

Global Economic Crisis Rescues European Bank


By Nicholas Kulish

October 7, 2009

As recently as last year, the European Bank for Reconstruction and Development seemed like a relic of the post-cold war era. One of the nations providing the bank's financial backing, Australia, asked for its money back, while one of the new European Union members, the Czech Republic, became the first country to leave its lending programs.

But the bank, which helped shepherd Soviet-bloc eastern European command economies into the free-market era, has found a renewed sense of purpose in stabilizing these economies and protecting their hard-won progress.

The instability of the region, even amid a general nascent rebound, was highlighted Wednesday when an auction of Latvian treasury bills failed to attract any bidders. The failed auction increased the likelihood that Latvia would have to devalue its currency and roiled currency and financial markets.

It is just the latest in Eastern European woes.

The breakneck growth of recent years turned out to be unsustainable, relying too heavily on capital flows from abroad that have dried up.

As a result, 2009 has been one of the busiest years in the history of the European Bank for Reconstruction and Development. Now, it is seeking an increase in financing to help combat the effects of the global crisis on the region, which has crushing debt denominated in other currencies, like euros, Swiss francs and Swedish kronor.

(As fears grew that Latvia would devalue its currency, the kronor fell, for instance.)

The bank injected money into financial institutions lending in the region. In May it said that it would pump $578 million into Eastern European subsidiaries of the Italian bank UniCredit, the largest banking group in the region.

In a letter to member countries, including the United States, last month, President Thomas Mirow asked for an additional $14.6 billion to offset the flight of private capital that has made the region one of the world's most vulnerable to the recent economic turmoil.

Bank experts predict that economies across the territory spanning the former Soviet Union and former Warsaw Pact will contract an average of 6 percent in 2009.

"It would be premature to say that a general turnaround has begun," Mr. Mirow said in the letter.

In the former Communist states, the fear is that economic problems will be followed by political and social instability. "Setbacks in transition have generally been limited, but some of the tenets of free-market reform will now be under scrutiny," Mr. Mirow said.

Indeed, government leaders have fallen this year in Hungary, Latvia and most recently Romania. Though last week's collapse of the Romanian governing coalition had more to do with politics than economics, the country is mired in recession and, like the other two, was forced to accept a bailout from the International Monetary Fund.

The region now finds itself in the early stages of what could be a recovery, or an intermission before a renewed downturn. "Despite the fact that the days of panic are over, we're not completely out of the woods," said Marcello Zanardo, a Central and Eastern Europe banking analyst with Keefe, Bruyette & Wood in London.

Mr. Zanardo said that he expected to see the value of nonperforming loans rising "well into 2010," and that the region was vulnerable to a renewed slowdown in the global economy, the so-called double-dip recession.

So far, Poland has been the exception, managing to avoid recession, and the government expects growth of around 1 percent in 2009. Meanwhile in Hungary, the International Monetary Fund forecasts a contraction of 6.7 percent, with some economists estimating even worse.

The fund estimates that the Latvian economy could end up contracting by 18 percent this year. And Ukraine, also politically troubled and outside the European Union, will most likely drop 14 percent.

Bank officials hope that, shortly before the 20th anniversary of the fall of the Berlin Wall, countries like the United States, France and Germany will prove ready to help Europe's young democracies even in the face of their own needs at home and the rising deficits exacerbated by stimulus spending.

Founded in 1991, the European Bank for Reconstruction and Development had a clear mission in its early days. The economies emerging from behind the Iron Curtain were hobbled by central planning, and the bank said its job was to "foster the transition towards open market-oriented economies."

Josué Tanaka, now a corporate director, was in the first group of employees to join the bank, before they had computers or even tables at their London headquarters. "We opened a map and it was, literally, 'What do we do first?'" Mr. Tanaka recalled.

Olivier Descamps, who joined the bank in 1993 and now works as its business group director for southeastern Europe, Central Asia and the Caucasus, recalled: "No one else had the risk appetite. All the banks were completely scared about this melting territory."

But in recent years the region had become a popular place to invest. By 2007, the bank's former Communist clients were growing at a rapid 7 percent a year clip, and the Czech Republic became the first to leave, with the expectation that the other new European Union members would follow suit as they were strong enough to attract foreign investment.

Australian officials said in 2008 that they would withdraw their stake in the bank to invest in poorer neighbors in the Asia-Pacific region. Meanwhile, the bank announced that it would begin operations in Turkey, a country that was never part of the Soviet bloc.

Instead, the credit squeeze that came on the heels of the collapse of Lehman Brothers last autumn proved that some of the growth in the region was probably unsustainable, and that the bank had a role to play in sheltering its charges and consolidating their gains.

"An institution like the EBRD has collected lots of skills," Mr. Mirow said. "My sense is the world is in great need of those skills."



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