The Crisis Phase 2: Eastern Europe

12 မတ်လ 2012

During the second phase of the crisis in Europe, the attention has almost exclusively been focused on the Southern euro zone countries. However, Eastern Europe is affected as well though in an uneven way.


The industrial exporters of the region with their close links to the German export industry are mainly hit by the renewed downturn of German exports while the development models of Hungary, the Baltic and Southeast European countries are extremely vulnerable to renewed credit restrictions.

This divide is very similar to the first phase of the crisis. When the crisis began to hit the German export industries in autumn 2008, the export downturn produced a severe recession in the Czech Republic, Slovakia and Slovenia and a significant slowdown of growth in Poland. Credit restrictions, however, did not have a deep dent on business in the Czech Republic, Poland and Slovakia since credits and deposits were more or less in line and credits were denominated in the official currency. Slovenia fared worse because the right-wing government of Janez Janša had built up a huge real estate bubble between 2004 and 2008 which was financed by a rapid credit expansion.

During the first phase of the crisis, the governments of these countries did not adopt highly restrictive policies and even took some measures to support growth. The Polish government even pursued a rather expansionary fiscal policy until the governing Platforma Obywatelska (PO) had won both the presidential and parliamentary elections. Thus, the government of Donald Tusk (PO) only switched to its ideological ideal recently. It is focusing particularly at making drastic changes in the pension system like increasing the pension age from 60 for women and 65 of men to uniformly 67 years. Shifts to the right in the composition of the governments had already produced governments in the Czech Republic and Slovakia which instituted austerity policies and amended labour laws to the detriments of workers and trade unions. These policies are in line with exports strategies built on cheap labour and little technological development.

While the right-wing coalitions could build on a consensus on making the poorer sections of the population pay for austerity, they were plagued by internal differences on EU policies. Due to Slovakia’s euro zone membership, the Slovak government faced starker choices. In the end, it split on the issue of the EU rescue mechanism for the euro zone periphery. The Czech government shows internal rifts on whether the Czech Republic should seek further rapprochement with the core of the EU or not. While Občanská demokratická strana (ODS) is rather opposed to this, TOP 09 is in favour. This issue openly crept up with the question of the fiscal pact. The rather EU-skeptical ODS opposed signing it and prevailed. It opposed the pact because of the restrictions to national sovereignty, not because of the restrictions to democratic budgetary decision-making. Czech and Slovak social democrats support the fiscal pact out of a general (and uncritical) pro-EU stance though the fiscal pact will severely curtail the budgetary decision-making powers of parliaments and will impose permanent austerity. The highly export-dependent East European economies will clearly feel the negative effects of generally depressed demand in the EU.

In Hungary, Southeastern Europe and the Baltic states, the crisis has been more dramatic. Growth had been dependent on imports and had been mainly fuelled by external credits. Much of the domestic debt was denominated in euros or Swiss francs. When external credits dried up in 2008, their growth models collapsed. Hungary, Latvia and Romania were the first EU countries to seek loans from the International Monetary Fund (IMF) and the EU. The main priority of the then governments was to avoid or limit devaluations. This was in line with the desires of Western banks which did not want a depreciation of their assets in these countries and the middle strata with high foreign exchange debts. The European Commission and governments of Western European countries with a high banking exposure in these countries (like Sweden or Austria) proved to be even more dogmatic on the issue of the exchange rate than the IMF. Since de-euroization and devaluation which might have created conditions for recovery were treated as a taboo, extremely strict austerity policies were adopted. These policies focused on cutting social expenditure, public employment and wages. The cuts were particularly brutal in Latvia and in Romania. Latvia is presented as a model case now. During the crisis, the GDP declined by more than 20%, in 2009 alone by 18%. Unemployment more than doubled within a short time. The extreme recession reduced imports drastically, the current account improved. Given the weak manufacturing sector, it is, however, unclear how Latvia will service its huge external debt in the medium run.

The harsh austerity policies have solved neither the problems of excessive (private) foreign exchange debts nor the problems of weak productive structures. This group of countries continues to be highly vulnerable to restrictions to external credits. This issue has become a topic of public debate towards the end of 2011. In November 2011, the Austrian National Bank and the Austrian financial supervisory board announced new lending guidelines for Austrian banking business in Eastern Europe. Inter alia, the guidelines limit credits to 110 % of the deposits in the East European countries. In countries like Romania or Hungary, Austrian banks significantly had surpassed this limit before. Though the policy will have effects on these countries, the Austrian government did not consult the countries concerned. The lack of consultation was severely criticised. The measure as such, however, seemed overdue. If such a guideline had been passed a decade ago, a lot of harm would have been avoided. In Southeastern Europe (e.g. Bulgaria, Romania and Serbia), Greek banks are major players. The (possible) impact of the Greek crisis on the neighbouring countries is hardly discussed. The second phase of the crisis lays bare the vulnerability which the high reliance on external banks and credits produces.

First rifts between Western banks and an East European government have surfaced after the election of the national-conservative Fidesz government in Hungary. This government is clearly focused on the promotion of the Hungarian upper middle strata. It is strongly anti-labour, but it has adopted some policies that are not favourable to external capital as well. Inter alia, it introduced temporary special taxes for the banking and some other highly monopolised sectors and reversed the privatisation of the pension system. It has been on these issues plus so-called central bank independence, not on the hollowing out of democracy, that the criticism of the European Commission has been focused. At the end of February 2012, the European Commissioned threatened Hungary with freezing 495 million euros of the cohesion funds that are earmarked for this Central East European country if Hungary will not adopt more stringent austerity measures. It is not the budget deficit per se, but rather specific policies which are the target of the EU criticism. Thus, the EU deflects the debate away from questions of democracy to adhesion to economic orthodoxy.

In Romania, social limits of austerity became visible in the early months of 2012 as well. A further privatisation measure in the health sector sparked wide-spread street protests. The protests were strong enough to make the Prime Minister resign. A fundamental change of policies has not ensued, only some tactical amendments. Thus, the fundaments reasons for social protests continue to exist – not only in Romania. The legitimacy of the political establishment is clearly eroding.

Joachim Becker is an associate professor for economics at Wirtschaftsuniversität Wien in Vienna, Austria.