However, as the IMF noted in the October 2007 GFSR, there are macroeconomic vulnerabilities in a number of countries that make them susceptible to deterioration in the external environment.
Eastern Europe, in particular, has a cluster of countries with current account deficits financed by private debt or portfolio flows, where domestic credit has grown rapidly. Bulgaria ranks first with a 62.5-percent growth in private credit for 2007 among the countries in Central and Eastern Europe (CEE).
A global slowdown, or a sharp drop in capital flows to emerging markets, could force painful adjustment, the report shows.
There are several distinct risks to emerging markets arising from the current turmoil.
First, mature market banks may pare back funding to their local subsidiaries, particularly
in circumstances where external imbalances are large, according to the IMF (only Latvia has a bigger current account gap than Bulgaria). Balance sheet contraction by global
financial institutions may reduce funding for investments and induce financial stress within some emerging markets.
Domestic banks in Eastern Europe have built up large negative net foreign positions vis-à-vis
parent banks and international lenders, as credit growth has far outpaced growth in domestic deposits, the report states.
Most European parent banks have plans to sustain cross-border financing of their subsidiaries in the Baltics and southeastern Europe, while gradually slowing credit to cool the economies.
A soft landing in the Baltics and southeastern Europe could be jeopardized if external financing conditions force parent banks to contract credit to the region.
In response, local banks are seeking alternative sources of financing and have worked to increase local deposits. In Bulgaria and Romania, tighter credit risk controls by parent banks have not been effective in slowing aggregate credit growth, as new entrants, notably Greek and Portuguese banks, have sought to expand market share.
Since Bulgaria and Romania only recently joined the European Union, they are still seen by many
banks as offering attractive growth opportunities, according to the report. However, there is a danger that local banks may underestimate the deterioration in the quality of loan portfolios that often accompanies rapid credit growth.