OREANDA-NEWS. September 22, 2008. A year ago, EBRD Chief Economist Erik Berglof spoke about the nascent credit crunch and its implications for the EBRD’s countries of operations. Twelve months later, he provides an assessment of what impact the financial crisis has had on the region and what have we learned, reported the press-centre of EBRD.

How has the credit crunch affected the EBRD’s countries of operations and how is it linked to jitters in the region’s biggest economy, Russia?

The world economic situation has not helped our region. The credit squeeze has moved into a new phase and it is affecting our countries very directly. Those countries and financial institutions that have been the most affected are the ones that have the most ties to international financial markets, such as in Kazakhstan. The effect of the squeeze in credit markets is now amplified by the “flight to quality” as investors are withdrawing capital from risky emerging markets.

In Russia, there has also been a tight liquidity situation for most of the last year. Many Russian private banks have relied on international markets for their growth, so they have found it much more difficult to raise funds. Russia’s central bank has injected funds into the system on several occasions over the last 12 months to alleviate the situation. However, there are also factors specific to Russia.

This summer some statements by the Russian government regarding individual companies, such as Mechel, plus the TNK-BP issue, led foreign investors to question the government’s intentions. Since the beginning of July, this has resulted in falling Russian share prices. The subsequent crisis in Georgia has further focused attention on political risk in Russia and lower expectations about long-term commodity prices. So the liquidity problem has been amplified by political events.

Another source of pressure has been the decision by Russia’s central bank to change its currency regime, allowing for a more flexible exchange rate instead of pegging the rouble to the dollar. This was aimed at tackling Russia’s rising levels of inflation, but it meant that there was no longer a one-sided bet on the rouble and a lot of people got scared, leading to large outflows of capital.

What is the outlook for Russia?
Russia looks quite strong: it has very large currency reserves, worth around US 600 billion, and it can defend its financial system and currency against attacks. But there could still be problems in parts of the financial system, especially among independent private banks and, as we have seen, for the stock market. You can’t rule out a currency crisis or general financial crisis, but it’s unlikely given the extent of Russian reserves.

Russian growth was already coming down, from a very high level, and we expect it to be around 7 per cent over the year. The credit crunch and the current turmoil in equity markets will slow down growth further, but remember that this is compared with very high levels of growth up to this point. There is an upside to this: earlier this year, the Russian economy was overheating so some slowdown is a good thing.

Is the collapse of Lehman Brothers likely to affect the region?
The credit crunch is entering a new phase where it is increasingly difficult to predict the timing and magnitude of events. I have seen two financial crises – the Swedish and the Russian crises - from the inside and had a chance to study them afterwards.

What is striking about these events when you are in the middle of them is how quickly they unfold and how in retrospect the sequence and duration of events seem predictable. What is clear now is that we are facing a period during which it will be even more difficult to raise money.

The global financial system is getting rid of debt, so those who are holding debt face a situation where very few people want to take on debt. This means that for institutions in our region that need to refinance, the situation is becoming more difficult.

What is the regional outlook for the rest of 2008 and early 2009?
One year ago, we said we expected a gradual slowdown. This has proved the case on average, but once you go into detail you see a much more diversified picture. Only the countries in Central and Eastern Europe follow the pattern of a gradual slowdown. Instead, there have been sharp adjustments in countries such as Kazakhstan, and Latvia and Estonia (although for reasons unconnected to the credit squeeze), while countries rich in natural resources have kept growing strongly.

Then there are the countries we call “gravity defiers”, i.e. those most likely to see a significant sharp adjustment, although it is unlikely they will experience a crisis. Ukraine, Romania, Bulgaria, Serbia, Lithuania and Croatia fall into this category.

Is anyone making money from the financial crisis?
The case of Lehman Brothers is one of genuine value destruction. Important brands are being ruined. Some people have speculated on this happening and made money, “going short” and accelerating the process of collapse, but overall there has been a real loss of value in the sector.

What have we learned a year into the credit crunch?
First, foreign banks with local presence have so far exerted a stabilising influence, as witnessed by the contrast between the gradual slowdown in credit in the Baltics and the much sharper contraction in Kazakhstan. Secondly, the EU effect cut both ways. It probably helped protect countries from a sudden stop in capital.

On the other hand, it also contributed to sharp upward adjustments in real wages and house prices, fuelling the consumption boom, and - through emigration - reduced supply growth, laying the ground for the sharp adjustment in the Baltics in the first half of 2008.

Lastly, while growth in some countries has managed to decouple so far, this has come at the price of accelerating inflation, indicating that capacity is stretched to its limits and a slowdown is imminent. The more severe credit squeeze and the global flight for safety will put these countries under renewed stress and no doubt teach us new lessons.