Eastern Europe: Financial Experts Warn Of Currency Crashes



Prague, 22 October 1997 (RFE/RL) -- International financial analysts are warning their clients about the likelihood of currency crashes in Ukraine, Slovakia, Lithuania, Latvia, Estonia, Romania, Russia and Poland.

The early warnings are being given to policy makers as well as investors, so A-L-L of Eastern Europe's governments have time to avoid a crisis. But, as The Economist magazine noted in its most recent edition, it is easier for governments to hope for good luck and publicly deny the warning signs than it is for them to take the painful steps of budget cutting and monetary tightening.

In fact, The Economist says that government denials of the problems may be the most reliable indicator of future exchange rate turmoil in emerging markets.

The international securities firm Deutsche Morgan Grenfell this week published a report that creates a new statistical method to measure currency risks in Eastern Europe. The report says Ukraine and Romania are the most likely to experience a month-to-month currency devaluation of at least 15 percent within the next year. It says there are moderate risks of a 15 percent depreciation in Slovakia, Russia and the Czech Republic.

The creator of this methodology, economist Elke Speidel-Walz, told RFE/RL that the risk for Romania is high because of poor scores in three out of five economic indicators used in her formula. She said that in Romania's case, the rapid expansion of credit to the private sector has exacerbated the risk factor. She said risk of a currency crisis also is high because of a projected decline of three percent in Gross Domestic Product (GDP) this year, along with a real appreciation of the leu in recent months. Another problem in Bucharest is a high ratio of short-term-debts to reserves. By using these indicators as a guide, Speidel-Walz calculated that there is a 42 percent probability of a currency crash in Romania during the next year.

But it is in Kyiv that alarm bells are being sounded the loudest. Trading of the hryvna has been kept within a fixed range (eds. note: 1.7 to 1.9 hryvna per USD) since April. In the aftermath of hyper inflation, the government has praised itself for this record. It says currency stabilization has been a major achievement of President Leonid Kuchma's administration.

But analysts note that Ukraine's central bank was forced to intervene in the forex market last month after the supply of dollars at Kyiv's main exchange was nearly exhausted. By loaning $185 million to the finance ministry, the central bank also violated Ukraine's agreement with the International Monetary Fund. That has further raised speculation of an impending currency crash.

Jurgen Conrad, an analyst with Deutsche bank Research, told RFE/RL that Ukraine's fixed exchange rate regime needs to be changed soon to lessen the risk of a crash. He says the government should announce the implementation of a currency corridor for next year, which would allow the currency more flexibility within preset limits.

Deutsche Morgan Grenfell's new methodology also shows that Bulgaria's lev is at a high risk of crashing within the next 12 months. But in Bulgaria's case, the findings have been skewed by the implementation in July of a currency board regime. In reality, the currency board has greatly strengthened confidence in the lev -- both in Bulgaria and abroad.

Estonia's currency board also is considered more solid than the exchange rate pegs used across most of eastern Europe. Still, analysts say problems in the banking sector could put additional pressure on Estonia's kroon and Bulgaria's lev.

In Lithuania, the failure of the government to back its currency board with tough fiscal policies has raised concerns about an impending currency crisis. The Economist predicts that the government may face difficulties in keeping the exchange rate stable if it goes ahead with plans next year to scrap the currency board.

The Latvian government has managed to balance its budget. But analysts are concerned about the country's shaky banking system and a current account deficit that runs at about 10 percent of GDP.

Slovakia also faces a current-account deficit this year of more than 10 percent of GDP. Only one-tenth of the deficit is expected to be covered by direct foreign investment. Meanwhile, the Slovak crown has remained pegged to a combination of foreign currencies. As a result, it has lost competitiveness against both the German mark and the Czech crown. A budget deficit of almost five percent of GDP is another warning sign in Bratislava. The Economist says new measures that would weaken the independence of the central bank have failed to instill confidence in the Slovak crown.

In Prague, a currency crisis last May brought an end to the Czech Republic's economic boom. Some analysts say that by abandoning its currency peg after that crisis, officials in Prague may have lessened the chances of another crash in the near future.

Financial analysts say that a crisis is N-O-T inevitable in any Eastern European state. Predictions of possible crashes in the region often are based on comparisons to the economic patterns in the emerging markets of South-East Asia and Latin America.

That means that recent crises in Thailand, Malaysia and Mexico can offer valuable lessons to Eastern European leaders. Perhaps the most disturbing cause for concern is that many Eastern European politicians and policy makers do N-O-T seem interested in learning from the mistakes of Asia and Latin America.