Haven’t heard enough yet about problems in the world economy? Here’s the latest. It’s not just individuals and companies that are going bankrupt. There are some whole countries that are sinking fast or just barely treading water. This is primarily in smaller emerging markets and the dynamics have been as follows.

Smaller Economies Hit in Two Ways

Smaller emerging economies have been hit in two ways: (1) weaker demand for their export products from industrialized nations that are in recession; and (2) a withdrawal of foreign investment funds due to the flight to safety in the U.S. dollar, a desire to reduce risk by concentrating on activities back home or simply cost-cutting measures across the board until business conditions improve.

The result of point (1) has been to hurt current account balances in the Balance of Payments of the affected nations. Point (2) has meant a withdrawal of previously compensating capital inflows. The combined effect is to seriously reduce the value of the local currency versus either the dollar or the Euro.

The Practice of Taking out Foreign Loans

This problem has been made worse by another practice that was quite common until recently. In many of these smaller emerging countries, individuals, businesses and governments have been borrowing heavily from foreign banks. That is because those foreign banks offered loans in Euros or dollars at lower interest rates than were available locally.

Local interest rates were often elevated due to high inflation. That was one consequence of earlier rapid growth rates. Taking Euro- or U.S. dollar-denominated loans seemed like a good idea at the time. But now, having to repay them in depreciated home currencies is presenting some serious problems.

Seeking IMF Help

At the government level, a default on a foreign loan is a big deal. It ruins a country’s credit rating. Getting additional funding becomes nearly impossible and the only recourse is to seek help from the International Monetary Fund (IMF) or some other world banking organization.

One of the prices to be paid is that IMF rules then have to be adhered to. That means keeping the nation’s deficit below a certain percentage of Gross Domestic Product, taking measures to curtail inflation and generally giving up control over one’s own finances until balance has been restored.

There is another problem. The IMF is running out of lendable resources. It needs more major capital injections from developed nations, which unfortunately have their own set of spending priorities in these difficult-for-everybody times.

The Eastern European Bloc

Most of the countries that are in this predicament are in Eastern Europe. Some of them are in the European Union and some are aspiring to be. Most of them are former Soviet satellites and there are political as well as economic ramifications to be considered in any efforts to rescue them.

This is the next-wave problem in the financial storm. Euro-blanketed nations will be the first to feel the shock waves, but the world is proving to be so inter-dependent that it will be hard to limit the damage. More about this situation will be written and commented upon by the media as events unfold.

Alex Carrick