NEW YORK: The euro's sharp descent against the dollar may have further to run as a potential emerging-market crisis threatens more trouble for European banks, and the euro may even return to parity with the dollar.
Emerging markets, once thought to be immune to the global credit crunch because of improved policies and five years of economic growth, are feeling the effects of the worst banking crisis in industrialized nations in decades as investors pull out of riskier assets across the board.
The meltdown in stocks and currencies from Asia to Latin America has spurred fears about the exposure of European banks, which had been aggressive in pursuing opportunities in emerging markets over the past decade.
"European banks account for about three-quarters of the $4.7 trillion of cross-border loans to emerging markets," said Marc Chandler, global head of currency strategy at Brown Brothers Harriman in New York. "Despite the finger-pointing from Europe as to how irresponsible the U.S. has been, there is a crisis brewing of their own making that may turn out to more destabilizing than the U.S. subprime fiasco."
Some of the most respected banks in Europe, like HSBC, BNP Paribas and Société Générale, have seen their shares plummet in recent days amid deepening gloom about emerging economies, particularly those in Central and Eastern Europe, with which they have close financial and trade relationships.
The euro fell to a two-and-a-half-year low against the dollar Tuesday. The euro has declined 22 percent since hitting a record above $1.60 in mid-July, falling more than 11 percent this month.
The euro has sold off sharply in recent months, with economic growth prospects for the 15-nation euro zone deteriorating sharply after the financial crisis that started in the United States spilled over to the rest of the world.
Several European banks have been bailed out, and fears are growing that the unprecedented efforts by governments to shore up the financial system will not be enough to prevent Europe from falling into recession.
"We see the risk of hitting parity by the beginning of 2009," said Sebastien Galy, a currency strategist at BNP Paribas in New York, referring to the euro and the dollar. "The downside risk to the euro continues to be the financial and economic repercussions of the credit crunch traveling through Eastern Europe."
Stephen Jen, global head of currency research at Morgan Stanley in London, said European banks were five times as exposed to emerging markets as their American or Japanese counterparts.
Bank exposure to emerging markets amounts to about 21 percent of European gross domestic product.
That compares with only 4 percent of U.S. GDP for American banks and 5 percent of the Japanese economy for Japanese banks, a recent Morgan Stanley study showed, citing data from the Bank for International Settlements.
"The emerging market downturn will be the second epicenter of the global crisis, with feedback effects hitting euroland and the U.K. particularly hard," Jen said.
The benchmark MSCI emerging markets index of stocks has lost 62 percent since July, while a number of countries like Iceland and Hungary have turned to the International Monetary Fund for loans.
Emerging market currencies have also plunged relative to the dollar, with the Hungarian forint and the Polish zloty down about 18 percent this month. The Czech koruna has fallen 11 percent in October, according to Reuters data.
"Emerging markets are extremely vulnerable and the situation will likely deteriorate so much that, unless the IMF intervenes on a massive scale, we will likely see a situation that is more severe than any of the crises we have seen in modern history" in emerging markets, Jen said.
Of particular concern, analysts say, would be an implosion in any of the East European economies.
Consumers in Eastern Europe have financed their purchases with foreign currency loans that offer lower interest rates than domestic rates, but now, with local currencies plunging, the fear is that these loans will not be repaid.
"Many emerging-market citizens have loans denominated in euros or Swiss francs. If their currency continues to drop and they can't meet their loan payments, these defaults will certainly affect the euro," Kathy Lien, director of currency research at GFT Forex in New York.
source: International Herald Tribune
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