A Forex View From Afar

Eastern Europe Debt Cut Lower

Two Eastern European states saw their debt-rating cut lower, near the default risk in the last days. Ukraine and Latvia saw their debt rating downgraded by S&P, to CCC+ and BB+ respectively.

According to the default swaps contracts, the market sees a high probability (above 50%) that Ukraine will default over the next year, reaching a 92% chance that the country will default within the next five years. Currently, Ukraine's debt is the most expensive in the world to protect. Consistent with the default rates study over the last three decades, about 25% or one quarter of the bonds with the C rating default.

How it was said in almost every article regarding the fate of Eastern Europe, the biggest problem in the area is the high degree of debt denominated in foreign currencies. Having the local currencies plunged in double digits percentage, foreign debt is a huge problem. In particular, the Ukrainian grivna has fallen 50% against the dollar in the last few months, multiplying the country’s problems.

The S&P downgrade came even though the IMF said no Eastern European country is near the default level, or in talks with the monetary fund for another loan. However, if Ukraine will default in the next few months, problem will arise for all the Eastern Europe, since investors see a high correlation between the regional economies.

One should asses that, if a country will default on its own debt, it will close the last door that leads to recovery. In addition, the consequences of such an action would be felt for years in row, so practically, the real chance of a country to call for bankruptcy is very small.

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