Ben Aris in Moscow -

As the summer comes to an end and the fourth anniversary of the Lehman Brothers collapse approaches, the black clouds of another financial storm are gathering on the horizon.

For most of the last four years, western governments have done little more than kick the giant debt can down the road, but now they are starting to run out of road. Markets were rallying mildly toward the end of August on the possibility of another round of quantitative easing, but its effectiveness has almost been exhausted.

More seriously, several of the ducks that contributed to the last crisis in 2008 have been lining up again. Specifically, industrial production has been slowing all year and poor harvests in the US and Russia threaten to cause an agricultural price shock this autumn, both of which were big contributing factors to unleashing the last storm. Many of the countries in Emerging Europe have not recovered from the last drenching; if there is another crisis, who is prepared and who will suffer more than before?

Battening down the hatches

"Normal" crises last between three and half to four years, according to a study made by Ukraine's leading investment bank Dragon Capital. But as this crisis' birthday approaches, clearly things are getting worse, not better. "History teaches us that the major ones like the crashes in the USA in 1837 and 1929 last seven to eight years, so we are only half way through this crisis. Russia and many other countries are clearly already preparing for the worst," says Charlie Robinson, chief economist at Renaissance Capital.

The International Monetary Fund (IMF) warned ominously in its last economic report in July that the world has entered a new and critical stage due to the unresolved debt crisis in Western Europe. Robinson believes the next couple of years are crucial and while it is possible for governments to muddle through and reduce their levels of debt, the chance of a break-up of the Eurozone is still very much on the cards: austerity measures have been put in place, but populations will only suffer these privations for a limited time, while countries like Greece are effectively bankrupt and could easily default on their debt. The possibility of serious civil unrest or another financial meltdown remains close to the surface.

Governments in Emerging Europe are now actively preparing for another crash. Russia's central bank widened its ruble trading corridor against the dollar in July to provide more of a cushion should an external shock arrive. At the same time, the government will complete a crisis action plan that budgets for an oil price of $60 per barrel, to supplement the actual 2013 federal budget that assumes a downgraded $109 price.

Likewise, Ukraine reintroduced a mandatory hard currency sale rule that allows the National Bank of Ukraine to force exporters (mainly steel producers) to sell half of their hard currency reserves to the central bank if needed. Widely used in the 1990s by all the cash-strapped governments of Emerging Europe, the rule is a drastic measure that was abandoned by Ukraine back in 2006. Other governments have likewise been scraping the barrel to shore up their fiscal position: the Hungarians even raided their private pension system for funds.

The mood is black. The political agenda for the autumn is already full as prime ministers and presidents scurry around the world trying to thrash out a fix. German Chancellor Angela Merkel - the key player in any workable rescue plan - began the autumn season early, setting off a tour of Central and Eastern Europe (CEE) at the end of August. There is an important meeting of the European Central Bank on September 6 followed by a ruling on the legality of the currency bailout funds by the German Constitutional Court a week later that could block more bailout payments from existing facilities. The Netherlands has a general election the same week where the crisis will be a leading issue and the EU finance ministers meet two days later on September 14. Both Greece and Ukraine could run out of money in the autumn thanks to debt redemptions, perhaps triggering another financial meltdown.

Food and factory woes

Another crisis is not a given - crises are inherently unpredictable - but there exist two serious causes of concern: a severe slowdown in industrial production across the continent began at the start of this year and is getting worse, and poor harvests amongst the world's biggest food producers could cause a spike in food prices this autumn.

Agricultural price spikes are economic and social gelignite. The last one in 2008 not only contributed to setting off the financial crisis, but also led to food riots in 30 counties around the world. Indeed, the high cost of sugar was one of the contributory factors that set off the Arab Spring, according to Renaissance Capital. High food costs are especially painful for emerging markets where food purchases makes up at least a third of the average shopping basket. Droughts and floods in Russia, Kazakhstan and the US this year mean harvests are going to be poor and prices could well spike again this autumn. "Food price spikes are dangerous, not only because of potential social and political unrest, last year's Arab spring being a case in point. Rising food prices also drive inflation, of course, making it tougher for central banks to keep the economic show on the road," says Liam Halligan, chief economist at Prosperity Capital Management.

Harvests are coming in now, so it is not clear just how bad the problem is, but the major producers have all slashed forecasts dramatically in the last few months. In the US, the downgrade was the biggest in 25 years. "Corn and wheat prices for end-of-year delivery have risen more than 40% in just the last month and corn prices are already over their 2008 peaks," notes Halligan.

A severe drought will slash Kazakhstan's 2012 grain harvest to around half the record 26.9m tonnes gathered in 2011 and Russia has downgraded its forecast for this season from the 94m tonnes of grain that farmers brought in last year to between 75m and 85m tonnes this year. Even at the lower end of the forecast, Russia will still have enough to cover its domestic demand of about 60m tonnes, but will not have much left over to export.

Falling industrial production is the second major cause for concern. While a slowdown in manufacturing doesn't necessarily cause a crisis, Carmen Reinhart and Kenneth Rogoff showed in their book, "This Time is Different," that there has never been a crisis where industrial production didn't slow first.

Manufacturing data for August showed the Eurozone's business activity contracting for the seventh successive month, providing further evidence that the Eurozone is likely to stumble into technical recession in the third quarter of the year - a worrying sign for the small open economies of Central Europe that are so heavily dependent on the single currency area for export demand.

Weak manufacturing is already contributing to a slowdown in economic growth. Figures released on August 14 showed that German GDP grew in the second quarter but only by 0.3%. The rest of Western Europe is already on the verge of recession: France had no growth at all in the second quarter, Spain was minus 0.4% and Italy minus 0.7%.

Capital Economics expects most of CEE to go into recession next year as a result, as many of these countries' manufacturing sectors are highly dependent on western demand, particularly Germany's. The economic consultancy says that since the end of 2011 economists have lopped 1 percentage point off the growth forecasts for the Czech Republic and Bulgaria, 0.6 point off Hungary's and a milder 0.3 point off Romania's. Russia is still growing pretty strongly - it put in reasonably strong growth of 0.9% for the last three months thanks to high oil prices - but even here Morgan Stanley was only the latest to cut its forecast for next year from 5% to 3.7% for 2013.

Out of all of CEE, only Slovakia and Poland have consensus growth forecasts higher now than they were at the end of 2011, ie. 0.8% and 0.4% respectively, Prague-based Komercni Banka Bank says. Strong domestic demand supported the Polish economy and net exports helped by the start of new factories boosted the Slovak economy. "The bleaker global economic outlook is weighing on growth expectations for the Central and Eastern European countries and tight EU integration suggests that contagion risks remain high and will persist for longer," Komercni said in a note in August.

Winners and losers

The 2008 crisis was a shakeout for the countries of Emerging Europe. To paraphrase Leo Tolstoy: all healthy economies are alike; each country in crisis suffers in its own way. Those that had pressed their noses to the wheel of reform are reaping the benefits now, while many of the laggards were already facing the possibility of a crisis before the new problems appeared this year.

Surveying the research, it is clear that the standout winners in the region are Poland, the only EU country to avoid recession in 2009, and the Czech Republic. Honourable mentions go to Slovakia, the Baltic states and Turkey, while Russia's failure to integrate more closely with Western Europe or sell much of anything else but natural resources leaves it relatively isolated from the fallout of another crisis.

The losers are Romania, Hungary, Ukraine and Belarus - none of which has made much progress recovering from the last crash. The domestic banking sectors in Romania and Bulgaria are heavily exposed to Greece. Hungary hasn't seen any growth in over six years and is still running a big budget deficit even before this year's slowdown. Ukraine only has three months worth of import cover as hard currency reserves (the minimum economists believe is needed to ensure the stability of the currency) and was already on the verge of a 10-15% devaluation as the year started. And the entire Belarusian economy was knocked sideways by the 2008 crash and is still unsteady on its feet.

Perhaps the most remarkable recovery has been in the Baltic states. Locked into the Eurozone by currency pegs, the classic crisis response of devaluation was not available, so they reduced wages instead - politically impossible for western governments. Their economies quickly started to recover. "What the Baltics did was miraculous, but they were in a much easier position than the governments in Greece and Portugal," says Robinson. "Wages in Latvia have tripled in the last 10 years, so selling the idea of cutting per-capita income from $10,000 a year to $7,000 following the crisis when the people were only making $2,000 in 2000 is a lot easier than asking the Greeks to make a big cut income after their wages have only gone up some 40% in the last decade. Politically you can't do it."

The greatest disappointment has been Ukraine. The administration of President Viktor Yanukovych squandered an opportunity to re-launch badly needed reforms after taking over in 2010. An IMF team are due in Kyiv at the start of September, but they are talking about the same issues - pension reform and domestic gas tariff hikes - as they were four years ago.

Turkey is probably in the most interesting position. The economy is growing strongly thanks to solid consumer demand and banking reforms introduced after the 2001 domestic banking crisis; Turkey was less affected by the 2008 crisis than most of its neighbours. Its Achilles' heel is the country's large current account deficit, largely funded by borrowing on the international capital markets. In theory this makes Turkey vulnerable to another crash. But as most of its current account deficit is due to commodity imports (especially energy), if there is a big crisis, commodity prices should fall, which would reduce the current account deficit. "Turkey has some built-in stabilising mechanisms, so it is not as vulnerable to a crisis as it seems at first glance," says Robinson. "In 2009, Turkey had its lowest current account deficit for years."

Channels of contagion

If a new crisis does break, how vulnerable are each of the countries in Emerging Europe? Ironically, in many cases each country's previous vulnerabilities have been turned into strengths, while the strong countries are more vulnerable. There are three main channels of contagion: banking, trade and dependence on international capital markets.

Problems in the banking sector are the most obvious and immediate channel of contagion. In Central Europe, up to 90% of the banking sector's capital is owned by western banks, according to Capital Economics, and Romania and Bulgaria are especially exposed given the heavy investment from Greek banks. At the other end of the scale, Turkey and Russia's banking sectors are largely domestically owned and so in theory more insulated from a financial crash in the West.

However, in addition to direct ownership of banks, the dependence on local banks on international funding also plays a key role in transmitting a crisis, something Russian banks found to their cost in 2008. However, the Kremlin has successfully switched much of both state and private funding from international markets to domestic borrowing, and the local bond market has been flying as a result. The key number to look at is loan/deposit ratios, where Hungary does especially badly. "In Poland and the Czech Republic, we think interbank loans might be equivalent to around 10% of GDP. And in Hungary in Croatia they could be worth 20% of GDP or so. What's more, a significant chunk of this finance has a maturity of less than one year and therefore needs to be constantly renewed - adding to the risks of a sudden stop in funding," says Neil Shearing of Capital Economics.

Export dependence on the West is another weakness that afflicts Central Europe, where most countries have built up their economies based on the export of low-cost manufactured goods. Countries to the east produce and export little other than raw materials, but the bigger economies of the Czech Republic, Hungary and Poland move almost in lock step with the German economy, which itself is closely tied to the global economy as the export Weltmeister. "Exports to the Eurozone as a share of GDP varies widely," says Shearing. "At one end of the scale, Turkish exports to the euro area are equivalent to just 5% of GDP. Likewise, Russia's dependence on exports to the Eurozone is low and has actually fallen in recent years. But at the other end of the scale, in the Czech Republic, Slovakia and Hungary exports to the Eurozone are equivalent to 45% of GDP. And even in Poland, which is often said to benefit from a relatively large domestic market, exports to the euro area are equivalent to around 20% of GDP."

Finally, much of CEE's growth has been financed by borrowing on the international capital markets - funding that has fallen dramatically since the 2008 crisis broke and will dry up completely if another crisis hits. Russia illustrates the problem: despite its extremely low external debt and over $600bn of hard currency reserves, many important Russian companies and banks were heavily exposed to international borrowing. When that lending was cut off in September 2008, their problems triggered a systemic meltdown that saw the economy go from 7% growth to a 7% contraction in a matter of months. Since then, Russian companies and banks have reduced their borrowing and significantly lengthened their debt maturity profiles, leaving the country a lot less vulnerable to a crash in Western Europe. For Russia, the 2008 crisis was a reality check and steps taken since have left the country in a lot stronger position.

Ironically, Poland is at the other extreme and a victim of its own success. As the only EU country to avoid going into a recession in 2009, Poland has enjoyed substantial portfolio inflows equivalent to 12% of GDP - more than four-times greater than its peers - over the last three years. If there is another crisis, then the Polish zloty could tank as this money flees again.

And then there is the reliance on international capital markets for funding. Hungary is particularly badly off in this regard, with Romania in the second worst position. A financial crisis in Europe would wallop both these countries, while the Czech Republic is the standout winner in this respect and the least vulnerable in the region.

Even if there is no crisis in Europe this autumn, next year is going to be tough and things are unlikely to start getting better until sometime after 2014. Hobbled by massive debt, Western Europe is unlikely to do anything more than recover slowly, but CEE is in a much better position thanks to its growing middle class and all the easy gains from improving productivity. If anything, the crisis will force local governments to concentrate on deepening and diversifying their economies to close the gap with their western peers. Every cloud has a silver lining, but that is little compensation when you are facing four years of standing in the rain.