Who Got Hit Worst?

As the US recession is reaching out to the rest of the world, many wonder which countries that more vulnerable to a crisis and painful adjustment.

My sense is that Eastern Europe will top the list of emerging market regions susceptible to a full-blown financial crisis. This is because this region is heavily dependent on external financing and high current account deficits. And with the sharp drop-off in capital inflows to continue this year and strong presence of foreign banking presence, which long hailed as a strength, now increasingly looks like a potential weakness and may possibly trigger a regional domino effect. Estonia and Lithuania seem to be headed down the same path like Latvia due to strong build up of external debt and fixed exchange rate and may be forced to turn to the IMF for help. Fitch put Latvia’s financing needs at around 400% of end-2008 foreign exchange reserves, 350% for Estonia and 250% in Lithuania.

Oil exporters like Russia and several GCC countries are now also facing a reversal in their fiscal and current account balances, which are shifting into deficit territory. Savings from the oil boom will now be drawn to support growth and in many cases to help the corporate and financial sectors pay off their large foreign debts accrued during the boom years. Dubai corporates have been in particularly hard hit by the credit crunch and their exposure to the domestic property markets.

Off the GCC countries, the UAE has the highest short-term debt relative to forex reserves, which leaves it to be highly vulnerable. As a share of total external debt, UAE’s short term is expected to rise to 72.5% in 2009. Kuwait is also vulnerable with its banks struggling to find new sources of finance, as some have already suffered some defaults. The safest among all is the Saudi Arabia with its ample reserves, conservative investment strategy and well-capitalized banking system.

Turning to Asia, China is unlikely to be at risk, but its economic indicators continue to be weak and its liabilities are on the rise. China needs to boost consumption, alleviating domestic and global imbalances and overcapacities by reducing its saving rate and a stronger RMB in real terms, but it will not happen overnight, especially with an estimated 20 million job losses, but these are part of China’s future trajectory.