Eastern Europe may become eye of 2nd financial storm

Special Report:Global Financial Crisis

BEIJING, Feb. 25 (Chinese media) -- The financial and

economic situation is worsening in Eastern Europe, where bank risks, withdrawal

of foreign capital, plummeting exports and devaluation of currencies, seemingly

threaten a new financial storm.

In hindsight, the woes have been long-rooted because

of Eastern Europe's high dependence on foreign capital, exports and heavy

foreign debts.

In the first few years after the EU's expansion,

Eastern Europe moved onto the express road of economic development. With robust

economic growth, the thriving new economies attracted swarms of investors from

Western European banks, thus creating a new "gold rush" in the region.

In 2007, Eastern Europe's emerging markets attracted

the most foreign investment, replacing Asia. During the year, 365 billion U.S.

dollars out of a total of 780 billion dollars of global investment in emerging

markets went to Eastern Europe, most of which was used in purchasing such

financial products as bank bonds.

However, Western Europe's heavy investments have now

become a curse to the economies of Eastern Europe in the current financial

crisis.

In order to deal with the financial and economic

crisis at home, many Western European countries have withdrawn their investments

in Eastern Europe, causing serious capital flight, and thus triggering a

systematic risk to the financial markets in Eastern Europe.

Besides the heavy reliance on foreign funds,

dependence on exports is also taking its toll on Eastern Europe's economy.

Because of the sharp fall in external demand, especially the demand from Western

Europe, exports, which once fueled Eastern Europe's economic growth, has

slumped.

What is more, the heavy debts accumulated during the

boom times have become another cause for concern.

During the good times, Eastern European countries

introduced high interest rates, and failed to stem domestic enterprises and

individuals from borrowing in cheaper foreign currencies at the time like the

euro and Swiss franc, which resulted in astronomical foreign debts.

It is estimated that last year, all Eastern European

countries' foreign debts exceeded 50 percent of their GDP, a far cry from other

emerging markets.

High trade deficits and low foreign exchange reserves

is another cause for concern. According to statistics, the average ratio of the

trade deficit in some Eastern European countries rose to 9 percent of their GDP

in 2007 from 2 percent in 2000, and the ratio is as high as 18.5 percent in some

of the Baltic countries.

Due to the withdrawal of foreign capital and the

bleak economic outlook, all the major currencies of Eastern Europe have been

devalued. Since last summer, the value of the Polish zloty dropped one-third

against the euro, the Hungary forint 23 percent, and the Czech crown 17 percent.

This has put the Eastern European countries in an

even more awkward situation. On one hand, in order to check the foreign capital

flight and alleviate the pressure of depreciation, the governments need to raise

the interest rates of their home currencies, but on the other, in order to

bolster the national economy, interest cuts seem necessary.

Another fallout of the currency devaluation is the

surge in the cost of loans in foreign currencies, which also means greater

credit risks. And because of that, analysts warn that Eastern Europe could

become the subprime of Europe and one of the biggest threats to financial

stability in the Eurozone.

Credit rating agency Moody's Investors Service

recently issued a warning that the banking system in Eastern Europe was

increasingly vulnerable to the economic crisis, because of an increasingly

tougher operating environment in the region as a result of the steep and long

economic downturn coupled with macroeconomic vulnerabilities.

As Western European banks have invested heavily in

Eastern Europe and hold huge amount of bonds, once the financial system in

Eastern Europe slumps into a crisis, there is no way the Western banks will be

able to escape unscathed.

Therefore, there are grounds to worry that without

effective actions taken, Eastern Europe might become the eye of a second

economic storm, from which at least Europe could suffer.