East Europe Growth Faces Risk From West

(Bloomberg) -- The Greek debt crisis that’s threatening to break up the euro zone may spill over to Eastern Europe and spoil the region’s fragile recovery, the European Bank for Reconstruction and Development said.

The London-based EBRD, a development bank that helps former communist states in eastern Europe and central Asia transform their economies, raised its 2010 economic growth forecast for the 30 countries it invests in to 3.7 percent on average from 3.3 percent predicted in January. Still, it warned that the struggle to contain a debt crisis in western Europe may stall the region’s growth, especially in the Balkan peninsula.

“We have the Greek crisis and it poses a risk in particular to southeastern Europe,” said EBRD Chief Economist Erik Berglof today in Zagreb, where the bank’s shareholders are holding their annual meeting. “But there is a broader risk for the region. Clearly this is something we are very concerned about.”

The former communist countries in Europe and former Soviet central Asia are recovering from the deepest recession since switching to free-market policies two decades ago. Challenges for the 30 economies the EBRD invests in include adjusting to a slower pace of growth as the European Union, the largest export market for most of the region, grapples with mounting fiscal problems.

The euro fell 3.1 percent to $1.2358 this week, from $1.2755 on May 7. It traded as low as $1.2354 yesterday, the weakest since October 2008.

German Chancellor Angela Merkel said Europe is in a “very, very serious situation” despite a rescue package for the region’s most indebted nations. Meantime, El Pais newspaper reported that French President Nicolas Sarkozy threatened to withdraw his country from the euro. Finance Minister Christine Lagarde and other government official denied the report.

Euro Defense

EU Monetary Affairs Commission Olli Rehn told participants at the Zagreb conference that “it is important that markets read our package and see that we are serious about our defense of the euro area.”

The euro region’s tensions may affect eastern Europe through “a disruption of capital markets” as well as “a decrease in import demand from countries like Germany or France to which most countries are important exporters,” EBRD President Thomas Mirow said. “There are potential risks that can be channeled through the subsidiaries of Greek banks. Up until now we haven’t seen this materializing. We have to watch and encourage policy makers to bear this risk in mind.”

‘Uncertain’ Outlook

The EBRD raised the forecast for Russia to 4.4 percent from 3.9 percent. It also revised higher outlooks for Turkey, Poland, Hungary, and Ukraine, while it lowered earlier expectations for Romania and Bulgaria. Even so, countries in the east need to monitor statements and actions by western European leaders.

“The outlook remains very uncertain because of a shift in risks from the domestic to the external,” said Berglof. “External risks have risen dramatically.”

While the EBRD now expects most countries where it operates to recover, the rebound will be protracted, it said. Growth rates will remain below pre-crisis levels and former drivers of expansion, such as investment from abroad and consumer spending, will remain subdued. The region was growing at an average 5 percent a year before 2008.

The EBRD’s shareholders at their meeting also increased the bank’s resources for the next five years. They approved increasing the bank’s capital 50 percent to 30 billion euros ($37.2 billion) enabling it to invest about 52 billion euros until 2015, more than the bank’s combined investments since its 1991 inception.

Local Currency Support

It also announced a plan to limit foreign-currencies by Eastern Europe banks, after they brought some countries to verge of default during the global credit crisis.

The bank stepped up efforts to wean the region off foreign- currency financing and encourage banks to lend in local currency.

Underdeveloped financial markets, low saving rates and high local interest rates contributed to a surge in foreign currency loans during the boom years, the EBRD said.

East European banks and their parents in Austria, Italy, Germany and Sweden struggled to refinance foreign-currency mortgages, car and consumer loans.

Corporate Support

The bank’s 63 shareholders then pledged to support an EBRD program focused on helping companies as well as enabling countries with excessive reliance on raw-material exports, such as Russia, or few manufactured goods, such as central Europe, to diversify production and become more competitive.

The EBRD helped limit the impact of the financial crisis, which hit emerging Europe the hardest, by persuading western banks to remain in the region and providing them with funds to lend to businesses.

The bank has devoted 47 billion euros to the region in equity investment and development loans since it was established in 1991. The London-based board of directors approved the capital boost in March and has proposed that the rise is accepted.

The capital increase will open the way to investments of 9 billion euros in each of the next two years and 8.5 billion euros in the succeeding three years. The bank this year will spend 8 billion euros on loans and company stakes. Funding reached 1.76 billion euros in the first quarter, 60 percent more than in the same period last year, the bank has said.

The EBRD, owned by 61 countries and two intergovernmental institutions, was created in 1991 to invest in former communist countries from the Balkans to Asia to help them transform their economies.