Defenses boosted

VILNIUS - The European Union’s eastern members are bolstering the economic defenses they have set up over the last two years to guard against growing contagion risks from the United States and the eurozone, reports Reuters. Despite the recent agreement on a second bailout for Greece, persistent doubts over the solvency of the euro area’s periphery and uncertainty over the U.S. debt-limit showdown before an agreement to raise it was finally reached have put investors on edge.

They have a right to be skittish. After the 2008 fall of Lehman Brothers, a subsequent flight from risky assets knocked a quarter or more off the value of currencies across the region versus the euro and drove debt yields to multi-year highs.
It also shut off credit flows to many banks, forced Latvia, Hungary and Romania to accept emergency bailouts, and threw every country in the region into recession save Poland.

This time around, countries from the Baltics to the Black Sea are better prepared, having secured rainy-day financing, cut budget deficits, and taken other anti-crisis precautions. But the contagion channels - sovereign financing, banking sectors, asset flight, and trade - still pose threats.
“There will be a contagion effect on central Europe. The issue is on what channels that comes through,” said Neil Shearing, an economist at Capital Economics.

“And that will depend on how the crisis in the eurozone plays out,” the economist stated.
The most immediate fear is that deterioration in the eurozone periphery or a U.S. default would prompt investors to dump risky assets, driving up debt yields and hammering currencies.
A similar event after the Lehman collapse wiped 30 percent off the zloty per euro and drove Hungarian two-year bond yields to 14.25 percent, from 8.6 percent before the crisis.

The region is better defended against sovereign financing and banking risks, because of relatively low debt levels and fiscal tightening that has cut budget deficits to near the EU’s prescribed ceiling of three percent of gross domestic product.
Poland, Romania, Lithuania, Latvia and Bulgaria plan to hit that target next year and the Czechs in 2013, while Estonia and Hungary expect surpluses this year.