TALLINN - The risk of a drastic economic downturn has increased in the Baltic states as a result of the expanding global financial crunch, the International Monetary Fund wrote in its latest Global Financial Stability Report.
Liquidity problems in major international banks could pose a threat to the group of Scandinavian banks that have invested heavily in the Baltic markets, the report said.
"A soft landing in the Baltic states and southeastern Europe might be jeopardized if external financial conditions force parent banks to reduce lending in the region. Swedish banks might come under pressure, and they are the main suppliers of finances to the Baltics," the report said.
According to the fund's experts, the extremely high current account deficits in several Eastern European countries, especially in Latvia, where it reached 22.9 percent of the gross domestic product last year, are mainly financed by foreign direct investments and other capital.
"A global slowdown, or a sharp drop in capital flows to emerging markets, could force painful adjustment [in the Eastern European region]," said the fund.
Baltic governments are aiming for a soft landing, which generally prescribes annual GDP growth of 6 - 7 percent. A hard landing, by contrast, would see growth plummet to less than 2 percent.
In Estonia, the government is bracing itself for GDP growth of some 3.5 percent, coming after 11.2 percent in 2006, and approximately 7 percent last year. This could, according to some economists, qualify as a hard landing.
Latvia is facing the same situation, with GDP growth this year expected to be 3.5 's 6 percent (see story Page 12).
The IMF named Danske Bank, Swedbank, Handelsbanken, Nordea, SEB, Dexia, Natixis, Raiffeisen, Intesa Sanpaulo and Rabobank as the likeliest banks to have problems, stressing that these banks attract more than 30 percent of their resources in international capital markets.
IMF analysts said that the Swedish banks are most vulnerable as their average maturity term is less than four years.
Meanwhile, financial institutions in Eastern Europe, particularly in the Baltics, have created "large negative net foreign positions" via parent banks and international lenders, as credit growth has far outpaced growth in domestic deposits.
"Liquidity for these banks has all but dried up, and spreads have widened 500 basis points," said the bank.
According to the IMF, personal lending rose 45 percent in the Baltic states, 62 percent in Bulgaria, 60.4 percent in Romania, 55.2 percent in Kazakhstan, and 39.4 percent in Poland. In all countries lending growth exceeded safe levels, the bank said.
In its outlook report, the IMF forecast that GDP growth in the emerging European region will slow to 4.4 percent in 2008 and 4.3 percent in 2009, reflecting a slowing both of domestic demand and of export growth resulting from lower demand from Western Europe.
The risk of contagion could spread to the region.
"Contagion could occur either directly if banks cut back lending to cover losses from the subprime fallout, or indirectly if a higher cost of capital and wider risk spreads induce banks to extend fewer loans to emerging Europe and/or to offer less favorable terms," said the bank's outlook report.