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Household debt in foreign currency drags Europe’s growth engine

Eastern Europe, like other emerging markets, had been investor's darling before the crisis hit in 2008. People bet money on its faster economic growth due to better demographics and cheap labor and resources compared to the more developed Western Europe.

Eastern European countries also liberalized their financial sector and allowed entry of mega European banks from France, Swiss, and Germany.  Since most of these countries are still not part of the Euro-zone, foreign banks only provided credit in foreign currencies, such to Euro and Swiss Francs.  Domestic households underestimated the currency risk – who would have anticipated a big unprecedented financial crisis is coming.

With currencies in these countries plunging, household debt sometimes doubled to the pre-crisis level.  What choices left?  Default and government bailout.   No matter what measures taken, the once growth engine of Europe now became the heavy drag.

Eastern Europe's problem is not unusual.  It drew parallels to the Club-Med (southern European) countries that joined European Union earlier.  Both were huge credit bubbles fueled by optimistic view that the ever integrated European continent will bring tremendous growth opportunities.  The difference in the case of Greece was that joining Euro-zone reduced their borrowing costs significantly for both government and households (compare the credit spreads before and after joining the Euro, you will see).  The much cheaper credit not available before made both people (and governments) think they are now artificially richer.  And boom, they went on spending (and speculation) spree.  A big cause for European housing bubble.

So don't blame Greek or Eastern Europeans, blame the fatally flawed idea of "Europe as ONE".

Now read this fascinating story from WSJ:

BUDAPEST—Dezso Kocs's family restaurant was booming in 2007. To build a bigger kitchen and renovate the dining room, he and his wife borrowed the equivalent of $150,000.

It's a decision they now regret. Like many Hungarians then, they took the loan in Swiss francs, since the interest rate was far lower than if they had borrowed in their local currency, the forint. But after the global financial crisis hit in 2008 and the forint plummeted, the Kocs's monthly payments nearly doubled.

Households and small businesses across Central and Eastern Europe are sinking under the weight of foreign-currency debts.

It's a sign of how the problems facing the region's financial system go beyond the borrowing by spendthrift governments that has been the main focus of investors.

The rising number of borrowers' defaults already has hit bank profits. Ratings agencies warn that the exposure to foreign-currency lending could hurt the creditworthiness of financial institutions in the region.

Hungarian households collectively have about $32 billion in outstanding foreign-currency debt, mostly in Swiss francs and euros, according to the Hungarian central bank. Aside from local players, about a half-dozen foreign banks—from Austria and elsewhere in Europe—have a significant presence in Hungary.

The larger international lenders generally are viewed as diversified enough that troubles in Hungary aren't likely to pose a serious threat. Regulators say banks operating in Hungary have shored up their finances and are in better shape to withstand further shocks than at the start of the financial crisis.


But consumers' debt woes are acting as a brake on the region's economic recovery as households use income to pay off loans instead of spending, damping domestic demand. The foreign-currency borrowings also constrain economic policy makers since swings in interest rates and currency values can drastically change the fortunes of indebted households and companies.

In Romania, one of the European Union's poorest members, more than 60% of household borrowing is in foreign currency. In Poland, the figure is 36%. In the Baltic states, the proportion ranges from 70% to more than 90%.

In Hungary, nearly 70% of the country's total household debt was borrowed in foreign currency. The sharp slide in the Hungarian forint, which since the summer of 2008 has fallen about 20% against the euro and some 30% against the Swiss franc, has meant large increases in the local-currency cost of repaying these loans.

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