World and Nation

As It Falters, East Europe Raises Risks

Since the fall of the Berlin Wall, the countries of Eastern Europe have emerged as critical allies of the United States in the region, embracing American-style capitalism and borrowing heavily from Western European banks to fund their rise.

Now the bill is coming due.

The development boom that turned Poland, Hungary and other former Soviet satellites into some of Europe’s hottest markets is on the verge of going bust, raising worrisome new risks for the global financial system that may ricochet back to the United States.

Last week, Wall Street plunged after Moody’s Investor Services warned that Western banks that had recently beat a path to Eastern Europe’s doorstep now faced “hard landings,” spooking investors with new fears that the exposure could spread beyond Europe’s shores.

“There’s a domino effect,” said Kenneth S. Rogoff, a professor at Harvard University and former chief economist of the International Monetary Fund. “International credit markets are linked, and so a snowballing credit crisis in Eastern Europe and the Baltic countries could cause New York municipal bonds to fall.”

The danger is on several fronts. The big European economies, including Britain, France, Germany and Spain, are already in recession, and many of their largest banks have curbed lending at home and abroad.

For Central and Eastern Europe, which enjoyed breakneck growth thanks to a wave of credit from these banks, the squeeze could not have come at a worse time. Already bruised by the global downturn, they are on the verge of a downward spiral as the flow of credit dries up. Average growth among countries in the region slid to 3.2 percent last year, from 5.4 percent in 2007. This year, it is forecast to contract by 0.4 percent — and likely more.

“These numbers will be coming down,” said Charles Collyns, deputy director of the research department at the International Monetary Fund.

Add to that a new worry: International finance officials fret that the worst regional economic crisis since the Wall came down could spark a contagion among the region’s currencies, with echoes of the Asian financial crisis of the late 1990s. Then, emerging markets like Thailand borrowed in foreign currencies to fuel growth, but suddenly owed more than they could afford to pay back once their own currencies lost value.

Since peaking last summer, Poland’s currency has slumped 48 percent against the euro; Hungary’s 30 percent and the Czech Republic’s is off 21 percent. “Very simply, Eastern Europe has become Europe’s version of the subprime market,” said Robert Brusca of FAO Economics in New York.

On Monday, the central banks of Poland, Hungary, Romania and the Czech Republic sought to restore calm by issuing statements arguing that the recent sell-off was not justified by economic fundamentals.

In addition, Western banks could likely suffer a further increase in non-performing loans.