The Baltic States May Soon Follow Hungary Into IMF Receivership

Well, the Icelandic authorities seem to have bitten the bullet, and after some coming and going agreed to accept assistance from the IMF. An IMF mission is on the island preparing a plan which will then be put to the Icelandic government (protocols here are important). Under negotiation are the terms of any possible loan. According to Einar Karl Haraldsson (a political adviser to the Icelandic government) the plan is expected to be finalized in the next few days, after which the government will have to decide whether to accept the aid and the terms under which it is being offered.

Meantime a growing number of countries now seem to be at risk of following Iceland and Hungary into the arms of the IMF, with the Baltic republics of Estonia, Latvia and Lithuania now looking particularly vulnerable, according to a warning from the International Monetary Fund itself yesterday.

Dominique Strauss-Kahn, managing director of the IMF, which was formally approached yesterday for assistance by Hungary as well as Iceland, said: "The fallout for most banking systems in emerging and developing economies has been limited so far but signs of stress are growing, " Strauss-Kahn said some banks in eastern Europe have become increasingly exposed to struggling property markets, having raised funds on international money markets in the same way as the ill-fated Icelandic banks.

For the time being the various national governments are denying the possibility, with Edgars Vaikulis, spokesman for Prime Minister Ivars Godmanis, being quoted in Bloomberg as saying "There is no reason to speak of threats to the Latvian financial system......Latvia's situation is different from some of the eurozone members.''

I'm sure that the latter statement is true, even if not in the sense that Vaikulis meant. Nonetheless the Latvian government has taken the step of raising guarantees on all bank deposits to 50,000 euros ($68,225), in line with an earlier decision by European Union finance ministers.

In my view the threat to the Baltic financial systems is real, as is the threat to the Bulgarian and Romanian ones. Action, of some form or another needs to be taken, and soon. Latvia and Estonia are now in deep recessions, and Lithuania, while still clinging on to growth, can't be far behind. Basically it is hard to see any revival in domestic demand in the immediate future, which means these countries now need to live from exports. But with the very high inflation they have had it is hard to see how they can restore competitiveness while retaining their currency pegs to the euro. The IMF will almost certainly insist on a currency float as a condition of rescue, and if you look at the speeches of Lorenzo Bini Smaghi and Jürgen Stark over the last year, it is clear that thinking at the ECB runs along pretty much the same lines. So better get it over and done with now I would say, and take advantage of the shelter offered in the arms of the IMF. Indeed the more I look at what is happening, the more it would appear that a division of labour was agreed to in Paris last weekend, with the EU institutional structure sorting out the mess in Ireland and the South of Europe, and the IMF taking care of all that broken crockery out there in the EU10.

In what is likely to become a sign of the times Hungary's MKB Bank announced that yesterday that it is going to stop providing euro- and Swiss franc-denominated loans until further notice. In defence of its decision MKB said the huge volatility registered in the value of forint in recent weeks, and especially the strong depreciation at the end of last week, make the outlook on the currency extermely uncertain. Most other Hungarian banks are expected to follow MKB's lead. This practice of bringing an end to the extremely dangerous practice of offering foreign exchange denominated loans in countries running large external deficits is now likely to come to a screeching halt all across the CEE and CIS economies, and bit by bit the IMF will have to be brought in to offer support during the transition back to reality.

For a full and thorough analysis of the current threat to the Baltic economies, see this whopping post this morning from Claus Vistesen.