Christmas Lights Are Up: Don't Bother Investing in Europe For Now

by: Rakesh Saxena

Roberto Baggio (Seeking Alpha, September 24, 2009, Ten Reasons for an Imminent Stock Market wonders if someone has “waved a magic wand and fixed Europe’s problems overnight.” Well, in beautiful Riga, which lays claims to putting up the first evergreen Christmas tree in 1510, the holiday season is already in full gear; nobody in the historic city centre appears too concerned with the fact that Latvia’s economy is facing an 18% decline in 2010.

In fact, the “magic wand” was waved by the IMF and the EU who recently arranged a US$10 billion emergency loan facility for Latvia. Without that money, a significant devaluation of the Lat was inevitable. And, without doubt, devaluation in Latvia would have caused a chain reaction in the Baltics, renewed doubts over the health of more than a dozen Nordic banks and a renewal of uncertainty in other former Soviet satellites and states.

Though Latvia’s unemployment rate is well above 20%, the Christmas lights are already up in Riga and revelers are simply praying that the New Year brings better news. That spirit aptly answers Mr. Baggio’s question: What happened to all the troubles brewing in Europe?

For the present, Europe is hoping that Ukraine, Hungary, Bulgaria, Romania, Moldova, Lithuania, Estonia and, yes, Latvia start showing definitive signs of recovery by early next year. “The transition economies must show viability, otherwise their integration with Europe will turn into a total nightmare,” an EU official warned at a US$25 Billion loan signing ceremony in Budapest last year. As if to confirm her fears, a presidential aide in Kiev disclosed last month that Ukraine had not met conditions imposed by the IMF and, therefore, was unlikely to receive another tranche of its US$16.4 billion rescue package before Christmas.

In this writer’s view, though countries like Germany, Italy, Spain, Ireland and Greece remain embroiled in their own serious problems, the main threat to European economic integration (and growth) emanates from “emerging Europe”. Will the former Soviet satellites turn into failed states? And will the rising real unemployment rates create political and social turmoil? More importantly, will the problems in the East threaten banks and manufacturers in the West, and to what extent?

Last week, at an investment seminar in Singapore, a prominent London-based fund manager touted Poland and the Czech Republic as examples of successful communism-to-capitalism transitions. “Others in Eastern Europe will follow their lead in due course,’ he concluded. The facts, however, fly in the face of such optimism. Firstly, Poland has only been able to stave off a crippling devaluation by securing a US$21 billion credit line from (yes, you guessed it right) the IMF in May. Secondly, and this may shock emerging Europe enthusiasts, the Czech Republic is lining up for its own assistance package.

The Czech budget has sunk into a deep deficit as opposition politicians in Prague warn that the government will have no choice but to seek IMF aid in the very foreseeable future. The country’s export-driven economy contracted by 5.5% in the second quarter of this year, unemployment has surpassed 11.5% and delinquency rates in the mortgage and consumer finance sectors are rising to unprecedented (by Czech standards) levels.

Nevertheless, the common refrain in Czech business circles is somewhat akin to the magic wand Mr. Baggio speaks about: as the global economy recovers, so will we. For now, at least, it is time for merriment, not doom and gloom, in and around the ancient burgher houses of Mala Strana.