Ben Aris, Nicholas Watson and Clare Nuttall -

There is a joke doing the rounds in Moscow that neatly sums up the current state of the crisis:

Analyst: "Don't worry, there is light at the end of the tunnel."

Businessman: "That's fantastic news. But tell me, where can I find this tunnel?"

Are we in the eye of the storm now? Countries across Central and Eastern Europe continue to report terrible data: economies are shrinking, industrial production is slumping, and investment plans are being put on ice. However, all these poor results are the result of a slide down to lower levels that reflect the new impoverished state of the world economy following the destruction of trillions of dollars of value that began last autumn. But this slide is not a crisis in the sense of the forced selling and wave of bankruptcies that we saw in September. Governments are working hard to dish out rescue packages and kick start their economies. Pain is omnipresent, but there is no panic at the moment, just an overwhelming sense of pessimism.

That could change in the coming months as the relative calm of the storm's eye passes. A possible collapse of the oil price and a looming CEE banking crisis that could take down with it some western banks is threatening to plunge emerging European economies into a fresh round of turmoil. In the West, the general assumption is that when the eye passes, the economies of emerging Europe will buckle under the renewed battering. Things like a collapse in the oil price could bring even the strongest countries in the region to their knees, causing a pan-regional economic collapse no one will escape from. Prophet of the current crisis, Nouriel Roubini, believes this crisis will continue for as long as another two years.

In the east of Europe, however, there are a number of voices saying enough has already been done to stave of disaster in the strongest countries and the immediate threat of a banking sector collapse or sovereign bond default has passed. Most countries have hunkered down in their storm cellars (ie. devalued their currencies), so will be able to weather the tail end of the storm.

The difference of opinion is also reflected in whom you talk to within emerging Europe. While analysts cite encouraging statistics, businessmen on the ground see little evidence of this progress. One fact serves to illustrate the problem: in Russia, the government has poured some $130bn into the banking sector - about five times more than the pre-crisis liquidity levels of the sector - to prevent the sector collapsing, but of this money only $15bn was extended as loans to companies since November, reports Troika Dialog, a fraction of the normal credit levels. Banking sector liquidity levels look good, but no one is actually getting any money.

And even the increasingly optimistic easterners warn that more trouble could be in store. Countries like Russia look relatively strong thanks to their copious (but dwindling) hard currency reserves. But others like Latvia are teetering on the brink of collapse and need Western Europe to start recovering soon, or at least to stabilise, if they aren't to face further problems. "The crisis will get worse. Compared to Asia in the late 1990s, [the CEE] region looks more vulnerable because of higher loan/deposit ratios, higher spending, the current account deficits are higher and capita inflows higher," says Gunter Deuber, an analyst in the Global Risk Analysis Group/Eastern Europe of Deutsche Bank.

More than money, the region needs a shot of confidence to get it through the next few months. Support from the International Monetary Fund (IMF), World Bank and European Bank for Reconstruction and Development (EBRD) is supposed to provide just this. But the crisis has taken on such all-encompassing proportions that even these international financial institutions won't be able to rescue the whole world at once. A global problem needs a global solution, but the prospects for increasingly inward-looking governments reaching out to help their struggling neighbours look poor.

Europe's divisions

In general, a line can be drawn down the middle of CEE, between the newest and still-aspiring members of the EU and those former Soviet Union states further east.

Within the EU band of emerging Europe, analysts say much depends on the industrial base of the country. The countries that are worse off are those without large industrial bases, but which attracted large amounts of foreign direct investment that was poured into banks, property and other non-productive sectors, as happened in the Baltics, Hungary, Bulgaria and Romania. "There is a clear separation. For example, in Poland, Slovenia and the Czech Republic, what we're seeing is a cyclical downturn," says Deutsche Bank's Deuber. "Unless you subscribe to the theory that Western Europe will go completely bust, then these countries can participate to a certain extent in the stabilisation here... And to a certain extent these countries are free riders on the substantial fiscal stimulus packages that we are preparing in Western Europe."

In the eastern band of countries, the stronger tend to have large hydrocarbon or mineral reserves, and in some cases have already enjoyed a patchy recovery. Their strength is that they used the boom years to build up large currency reserves, they now enjoy low debt and used devaluation to reduce the pressure on their current accounts. The Russian government is confident enough to predict a turnabout in the next few months: Finance Minister and Deputy Prime Minister Alexei Kudrin was predicting that thanks to devaluation, Russia's economy will start growing again in May.

"The global bust was painful, but it will not be long lasting as long as two key conditions are met: exchange rate and macroeconomic stability," top-rated analyst Chris Granville, chairman and founder of Trusted Sources, told an Adam Smith conference in February.

Granville believes that the Kremlin is doing all the right things. Rather than free up fiscal policy and spend their way out of the crisis, the government has been tightening policy to maintain the stability of the currency. It's a trade-off between more cash versus more confidence. Secondly, the state has been using its rainy-day reserve fund to support the economy with investment programmes and guarantee programmes. The benefits of these two initiatives aren't visible yet, as everyone is sitting on what cash they have. But like Kudrin says, once devaluation fears recede, this money should ripple out into the economy. "The reason there is so little movement of money is everyone has been hording working capital, either as they have legitimate concerns about paying off debt or simply to speculate on the falling value of the ruble," says Granville. "But as that process comes to an end, this money will find something more productive to do."

All this can only happen if the oil price doesn't fall further - a big if. Certainly, there is little debate that the long-term trend for oil is up, but in the short term many expect the oil price to fall further, which would cause yet another round of devaluation and so delay the start of a recovery.

Kazakhstan is in a similar position and will be another big winner here after the government was forced to devalue the tenge in February by 10%. But what is equally obvious is that while devaluation led to counties like Russia booming in 2000 (when GDP growth hit a record 10% increase), this time round devaluation won't deliver the same dramatic benefits. "The benefits will be limited in highly dollarized sectors, such as oil and gas," says Michael Carter, CEO of Visor Capital in Almaty. "The big winner in our view is the mining sector, which is less dollarized - it imports fewer materials from outside Kazakhstan and the devaluation will reduce labour costs, since wages are mainly paid in tenge."

One sector in CEE that is already benefiting from the tanking currencies is steel. In both Russia and Ukraine, steel factories' capacity utilisation rates fell to half as big steel plants closed their doors over Christmas. However, with devaluations cutting local production costs in half, the biggest producers were opening their doors again by the end of January and using between 60% and 80% of their capacity by February.

This time round, the region's recovery will probably be longer and slower. In 1999, western markets were largely untouched by the collapse in Asia and CEE and provided a hungry customer for their goods; this time the collapse is global. Last time, CEE economies could grow fast by simply putting more bums on seats, whereas this time most of the economies in the region were already running at full tilt when the crisis hit; further growth means heavy investment in new machines, which are priced in dollars and euros.

And the biggest difference is that none of the former Soviet Union countries could borrow much on international credit markets in 1998, whereas much of the growth over the last decade has been paid for with foreign dollars. "At the start of September, Moscow was full of international bankers peddling Eurobonds and credits to Russians," says Roland Nash, head of research at Renaissance Capital in Moscow. "By the end of October, the only foreign bankers in Moscow were those trying to get their money back."

Still, most analysts say that devaluation means the risk of default on both sovereign and corporate debt has been reduced and takes a lot of pressure off struggling economies. Russia's external debt is almost all corporate now, but each dollar of debt is covered by a dollar of state's reserves, so it should be able to cope. Kazakhstan is in an even more comfortable position. "We believe that with a Brent price of $40, the [Kazakh] government would have had enough reserves to support the currency for at least 16 months. Instead, it made the decision to devalue, so supporting the currency at KZT150/USD is even more feasible," says Visor's Carter.

International rescue

The next big event is a G20 meeting in London in April, which could prove to be crucial in sorting out a speedy and effective response to the current mess. What is needed from the governments attending is a pan-regional rescue plan that helps out not only their home markets, but lends a hand to neighbouring states and beyond in CEE.

Most governments have been turning inwards to help their own, but this leaves those states that need help the most high and dry; to let countries like Latvia or Ukraine collapse is short sighted, as the CEE countries are exactly those that have been fuelling the unprecedented growth rates over the last decade. And this is not counting €500bn of outstanding loans that 17 major Western European banks have in CEE. This money would be lost if the new markets' economies collapse and the size of the debt is large enough to cause a fresh banking crisis in the West, argue some. "There does not appear to be a full appreciation of the fact that the problems [of the emerging markets in Europe, Middle East and Africa] will ultimately feed back into Western Europe via rising default rates on liabilities to Western European banks and through reduced demand for manufacturers from Western Europe," says Timothy Ash, head of CEEMEA research at Royal Bank of Scotland.

This point has been most obvious to Austria, which has been one of the biggest winners from the fall of the Soviet Union. In mid-February, Austrian Finance Minister Josef Proll warned of a "domino effect" of collapse that could undo all the progress of the last 10 years, but more importantly would also badly wound Western Europe's growth prospects. His were the latest in a series of comments by high-level EU officials calling for action that has more recently been joined by the likes of the World Bank and others.

So far, those appeals seem to be falling on deaf ears in places like Brussels and Berlin. National governments feel they have enough on their plate already without worrying about what is happening in Kyiv or Riga. This should come as no surprise: Europe is facing a test of its ambitions to become more like a federated state, a test it will probably fail. As Casper Weinberger, former US secretary of defence, said at the Renaissance Capital summit last summer: "The European Union works well at an economic level, but as a political entity it is still a work in progress."

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