The new report brings together information on external imbalances, the composition and payment schedules on external debt, and FX exposures, and makes base line projections for CADs and roll-over rates on external debt to analyse external financing risk and potential gaps facing the Czech Republic, Hungary, Poland, Estonia, Latvia, Lithuania, Bulgaria, Romania, Croatia, Macedonia and Serbia.
Lower global capital flows mean countries face a challenge in financing and unwinding unsustainable CADs. Although this process is underway, the global recession and fixed exchange rates, where applicable, will make it difficult to rebalance and recover through export growth, which was the 'release valve' in the Asian crisis. Therefore most countries face a severe contraction of domestic demand and GDP. Fitch views this "current account rebalancing risk" as greatest for countries with the largest imbalances and lowest capacity to adjust (including those with exchange rate pegs). This includes Bulgaria, Latvia, Lithuania, Romania and Serbia. The Czech Republic is the least exposed.
Although exchange rate devaluation can support macroeconomic rebalancing, there is a risk it could precipitate financial instability if a country has sizeable FX debt on its balance sheets. Borrowers with un-hedged FX debt would face problems meeting obligations and banks would face elevated credit losses. Such concerns could create a negative feedback loop to net capital inflows. Countries with high net external debt and/or bank lending in FX are most vulnerable to this "foreign currency risk". These include Bulgaria, Estonia, Hungary and Latvia. The Czech Republic and Poland are the least exposed.
Countries in CEE face a "gross external financing risk" from not only financing CADs, but also from refinancing existing maturing medium- and long-term and short-term external debt. Fitch estimates these are over 300% of foreign exchange reserves for Estonia and Latvia, and over 200% for Lithuania. Only in the Czech Republic is the ratio below 100%. A vital factor partly mitigating gross external financing risk in CEE is that a high proportion of debt is owed to foreign parent banks and companies, increasing the likelihood of high roll-over rates rather than a sudden stop to capital inflows.
Nevertheless, the scale of external financing needs means Fitch believes there is a reasonable likelihood that Bulgaria, Croatia and Lithuania will seek IMF-led programmes to help meet potential financing gaps and give breathing space for necessary adjustment to take place. Hungary, Latvia and Romania have already secured such programmes and Serbia is negotiating one. "The increased firepower of the IMF, supported by other international financial institutions and the EU, and action to 'bail-in' western parent banks is playing a vital role in supporting banking systems, external finances and ratings in the region, and should help forestall a severe region wide financial crisis," says Mr Parker.
As the report sets out, CEE is not a homogenous region and it is important to differentiate between countries within it. Since the onset of the credit crunch in August 2007, Fitch has downgraded the Long-term Foreign Currency Issuer Default Ratings of Bulgaria, Estonia (by two notches), Hungary, Latvia (by four notches), Lithuania (by three notches) and Romania (by two notches); while the only upgrade has been the Czech Republic. Seven of the countries are on Negative Outlooks (Bulgaria, Estonia, Hungary, Latvia, Lithuania, Romania and Serbia); while no countries are on Positive Outlooks.
