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Central/Eastern Europe: Crisis Reduces Private Capital Flows By Third

Washington, 30 September 1998 (RFE/RL) -- The world's financial crisis is expected to reduce private capital flows into Central and Eastern Europe by 35 percent this year.

The global organization of commercial financial institutions, the Institute of International Finance (IIF), says it expects private capital, which had topped $67.5 billion flowing into the region in 1997, to drop to just over $44 billion this year.

It projects that the flows will improve only by $200 million to $44.2 billion in 1999.

Private capital has in recent years become the major source of financing for emerging market economies around the world. In 1997, the private flows into Central and East Europe were eight times the official flows from other governments and international institutions like the IMF and the World Bank.

That was a complete reversal from the start of the decade when official lending was virtually the only source of money in the region.

It was part of a global pattern where in 1996 private flows into emerging market countries around the world exceeded $300 billion, or nearly 97 percent of the total investment and lending money available.

The Asian crisis sent shudders through the world's private investment community, prompting many investors and lenders to begin pulling their money out of emerging market countries.

But Russia's reaction to the ripples it was feeling from Asia -- declaring a moratorium on debt repayment, instituting a forced rescheduling of that debt and effectively devaluing the ruble -- turned the situation into a rout. Private investment money virtually dried up for any developing or emerging market country.

The Institute's Managing Director Charles Dallara told a press conference in Washington Tuesday that this is very dangerous: Dallara says that this lack of appetite for emerging market investment is a challenge to the system. That is why the group has urged investors to differentiate between those countries which are in trouble and those which have been doing a good job. Failure to do this could be a catalyst for a global recession.

The biggest challenge for every emerging market country now, says Dallara, is to help investors and lenders differentiate those which are following the right policies. The other former Soviet republics are not included in the institute's study on capital flows, but Dallara says they can demonstration they are following good economic reform policies:

Dallara says that Russia's action threw a cloud over investor sentiment for a wide range of countries, including those that were part of the former Soviet Union. But some are already beginning to take policy actions that show they can differentiate themselves from Moscow.

The IIF says that while Russia's actions have virtually ended its hope of getting any private capital for years to come, the effect has not been so severe on its old Central European allies. In fact, says IIF Research Director, Kevin Barnes, those countries which have done the most to disconnect economically from Russia and focus on the west are profiting the most:

Barnes says private capital flows are staying firm to central and east Europe, particularly Poland, because of their strong financial situation and ties to Western Europe. It shows, he says, that investors and lenders are differentiating and separating the region from Russia. Turkey, on the other hand, is being strongly effected by Russia's situation because of their broad trade links.

The Institute says the effect on economic output for all of these countries will also show quite a difference too. It is projecting Russia's economic output will fall 3.6 percent this year and perhaps by more than 10 percent in 1999 as economic dislocation intensifies in the face of extremely high inflation and Moscow's external debt position.

On the other hand, the nations of the rest of Central and Eastern Europe are expected to see their growth increase from 3.3 percent last year to 3.5 percent this year. As Bulgaria rebounds, the institute says, growth in the region in 1999 could rise even further to 3.9 percent. Only Turkey's slow-down keeps the figure that low.

The Institute includes Bulgaria, the Czech Republic, Slovakia, Hungary, Poland, Romania, Russia and Turkey in its Central and East European group. Dallara says it hopes to add some of the other former Soviet countries in future years.

The Washington-based IIF has a membership of 300 commercial banks, investment funds, insurance companies and pension funds world wide.