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One commentator today noted that “in many ways, what’s happening now across Eastern Europe – including Russia – is reminiscent of the Asian economic depression that began in Thailand in July 1997.”  Foreign currency loans taken out during the boom years through 2007, when economic growth averaged more than 5% (“mainly from Austria and other EU members that included leveraged mortgage loans tied to low interest rate currencies like the Swiss franc”), coupled with precipitously falling local currencies and low currency reserves, has spelled disaster for even Eastern and Central Europe’s largest economies, which serve as core manufacturing hubs for Western Europe, as well as for Balkan states and the Baltic Republics.  The IMF, which has already bailed out Latvia, Hungary, Serbia, Ukraine and Belarus, warned last month that bank losses may widen as “shocks are transmitted between mature and emerging market banking systems.”

One reason to bet against a complete and utter collapse of the East, however, is the fact that the de facto foundation for the EU–Germany and, to a lesser extent, France–have quite a vested interest in its survival and long-term health.  Over 25% of Germany’s exports head to Eastern Europe, and particularly in regards to those countries that are already part of the single currency euro-zone–continued solvency is a must for the Euro’s continued viability and also for its members relatively low financing costs.

Moreover, some commentators say the fear of collapse is overstated.  Concerns that east European borrowers will default on foreign-currency loans, triggering bankruptcies among western lenders that have caused a sell-off of emerging- market assets are “overdone,” said a UBS report published on Tuesday.  Per the report:

More than half the outstanding short-term external debt is owed by larger countries such as Russia, Poland and Turkey, which are less impaired due to a lower rate of leverage in the economy and better growth prospects.  [However], smaller economies such as Lebanon, Latvia, Estonia and Bulgaria face the highest repayments in the coming 12 months, each at more than 40% of their GDP.

Standard & Poor’s, while admitting that the effects will differ country-by-country, warned of especially dire consequences for the Baltic’s Latvia, Estonia and Lithuania, as well as Bulgaria, Hungary and Romania.  S&P contrasted their positions with that of the Czech Republic, Poland and Slovakia, for instance, which it argued are better placed to emerge “stronger and more competitive” from the crisis.

With this in mind, punters interested in the Polish or Czech debt market, or even its default swaps, may be rewarded.  The cost of protecting payment on Poland’s debt has risen more than six times in the past six months, credit-default swaps show, which is roughly the same as on contracts linked to Serbia, which is rated three levels below investment grade at BB- by S&P.  And both Polish and Czech government debt, among the highest rated in emerging markets, has already been downgraded by bondholders.

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Bloomberg reports that “some euro-region members now pay more to borrow than emerging markets such as Poland and the Czech Republic. The spread between a Czech 10-year sovereign note and the German bund was 78 basis points, less than Italy, Spain, Greece, Portugal, Belgium and Ireland.”  The Czech Republic is rated A at S&P, and Poland A-.

Prices now reflect odds of between 10 percent and 20 percent that the euro-region will disintegrate following a series of credit downgrades from Standard & Poor’s this month, according to BlackRock. The difference in yields, or spreads, between [Greece, Spain and Italy’s] 10-year bonds and those of benchmark German securities was close to the widest today since the euro’s debut in 1999.

JGW

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