Central and eastern Europe hasn’t escaped the impact of the latest shocks in the euro crisis which has seen Italy dragged into the financial danger zone.

With Italian shares down by more than 4 per cent on Monday – following a 7 per cent drop last week – it was no surprise to see CEE equities, bonds and currencies sinking in unison.

But investors should keep a sense of perspective. While all the PIIGS are now under pressure, the European Union’s CEE member states are bearing up pretty well, even those such as Hungary which went through the grinder themselves not so long ago.

Monday’s equity market declines of around 1.5 per cent in Poland, 1.7 per cent in Hungary and 1 per cent in Romania were in line with a 1.7 per cent fall in the FTSE Eurotop index of leading European stocks and much bigger declines in the PIIGS – peaking at 4.7 per cent for Portugal.

With leading CEE currencies also down, the dollar-based MSCI EM index for eastern Europe was down 2.7 per cent from Friday.

Investor concern grew as the EU called an emergency meeting of top officials with Greece and Italy topping the agenda amid fears of spreading contagion.

CEE currencies fell against the euro, with the Polish zloty down by 0.7 per cent, Hungary’s forint by 0.9 per cent and Romania’s leu by 0.6 per cent. The Czech crown, generally a haven of stability in the region, slipped by just 0.1 per cent.

According to Reuters, Romania’s five-year credit default swaps hit 263 basis points, up 14 bps from Friday’s close. Bulgaria’s five-year CDS rose 11 bps to 234, Hungary’s 20 bps to 300, and Poland’s 7 bps to 165. But with Italy up 32 bps at 283 and Spain 26 bps higher at 342, the CEE numbers don’t look so high. And that is before taking into account Ireland (on 962), Portugal (1094) and Greece (2297).

The longer-term picture is shown in this chart, put together by the FT’s Andrew Whiffin:

CEE and EU CDS chart
CEE and EU CDS chart

It’s no surprise to see that the stand-out feature is the sharp jump in the risk that investors attatch to PIIGs sovereign debt. But it’s interesting to note that the effects of this are so serious that the whole of ‘old’ EU (before the eastward enlargements of 2004 and 2007) has since late 2010 traded with a bigger risk premium than the ‘new’ EU, composed mainly of the former Communist states.

To be clear, CDS prices are not a comprehensive summary of economic and financial well-being. They measure only investors’ perceptions of the chances of a default. They don’t even do that perfectly, as they are often narrowly-traded and volatile.

But they do highlight the importance to a creditor of the repayment risks. For a sovereign these are based firmly on budget deficits and debt stocks. And on these parameters, CEE states are doing very well as this chart from ING demonstrates:

These numbers highlight that most CEE states with the exception of Hungary have public debt positions that are below the 60 per cent of GDP level required for eurozone entry. So the risks of default are low. Where some countries are vulnerable is on budget deficits – Poland is a case in point.

ING urges investors to keep calm:

…the EU’s gradual determination to deal with the [debt] issues should come as a reminder that the EU is a long-term project that also aims at pulling in and reforming CEE countries. In addition, the more constructive mid-term fiscal backdrop in the CEE region (perhaps with the exception of Hungary – see attached chart) does provide “protection” against the [dangers of a] Eurozone spillover.

CEE isn’t invulnerable. Hungary emerged from an International Monetary Fund rescue only last year; Romania is still under IMF supervision. CEE states need to borrow aborad to finance and refinance their public and private investment plans, which are considerable. Without access to international credit they cannot grow and catch up with western European living standards. But for the moment, they are weathering the PIIGS crisis.

Related reading:
Eastern Europe: An uplift under way, FT

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