Who's after Dubai? The profligate city-state's $59 billion debt deferral late last month sent investors fleeing from nearby markets like Abu Dhabi and Kuwait. But as the dust settles, it's becoming clear the targets are not deep-pocketed Middle East neighbors. Rather, the places in real danger of facing the next credit crunch are the highly indebted economies of Europe's periphery. A quiet crisis is brewing in Eastern Europe, where Bulgaria, Hungary, and the Baltic states face staggering foreign debts in excess of their GDP. While sovereign default is unlikely--having occurred only in Ecuador and Argentina in the past decade--it's increasingly doubtful that these governments and their state-backed corporations could keep up their debt payments.
According to Mohamed El-Erian, CEO of the bond-trading behemoth Pimco, red flags on sovereign balance sheets--short-term loans, insufficient income, and lack of liquidity--suggest the next credit crisis will be in Central and Eastern Europe. "We've just come from a period where so much liquidity has been pumped in that it has obfuscated a lot of the fundamental risks," says El-Erian. "But there are still consequences to last year's crisis." Despite the boom in emerging markets this year, Dubai may mark the final act of the global financial meltdown: an exodus from the sort of struggling second-tier economies that were already hard hit in the panic last fall.
One indication that trouble's around the corner: widening spreads on sovereign credit default swaps, a tool investors use to hedge against the risk of a country declaring bankruptcy. In Eastern Europe, the cost for this insurance has shot up several-fold since last year, with Latvia's rate of 530 basis points approaching that of Dubai's right now. Meanwhile, the previously stalwart economies of Greece, Ireland, and Portugal are increasingly seen as no better than those of their Eastern European counterparts. Greece needs to borrow ¤47 billion in the next year, a possibly insurmountable task given that its public debt load already exceeds 135 percent of GDP, and its 12.7 percent budget deficit this year is the highest in the euro zone. Little surprise, then, that Greece's credit default swap spread has ballooned to the level of Turkey's, which just last year was seen as a much riskier investment. Ireland, with its foreign debt now more than 800 percent of its GDP, is in even worse shape. A few short months ago these countries were riding high, thanks to investors hoping to make a quick buck off the rebound. But Dubai's debt problems exposed the poor fundamentals underlying these struggling economies. Just as previous waves of the credit crunch focused on real estate, banks, and consumers, the final victims may be the sovereigns.
Jerry Guo
in Newsweek, 07.12.2009
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