Push for EU aid to struggling economies

By Chris Giles in London

Published: February 17 2009 01:39 | Last updated: February 17 2009 01:39

Austria has stepped up its campaign for the EU to aid struggling eastern European economies, with Ewald Nowotny, the governor of the central bank, telling the Financial Times “I cannot imagine a policy of benign neglect will be the last word” for countries of strategic importance such as the Ukraine.

Keen to downplay the problem as one that will bring down Austrian banks, Mr Nowotny insisted that three-quarters of the loans of his country’s banks were to EU eastern European countries with the biggest share in the relatively stable Czech Republic.

Austrian banks, he said, accounted for only 20 per cent of the exposure of western EU banks to Eastern Europe, so “therefore what is important is to see the exposure to this region as a European problem ... and not only an Austrian problem”.

On Monday, S&P, the credit ratings agency, put Ukraine on negative credit watch, as it waits for clarification of the country’s willingness and ability to fulfil the conditions of its International Monetary Fund loan.

A problem in Ukraine could trigger a “domino effect” of economic difficulties in the European Union, Josef Pröll, Austria’s finance minister warned last week.

But Mr Nowotny tried to press home the positive case for engagement with eastern European EU members, saying this would be in the collective interest of western European economies, Germany in particular. “Old Europe,” he said, had a €60bn ($76bn) trade surplus with member states further east, which was vulnerable if these economies were allowed to falter.

While Mr Nowotny insisted that Austrian banks’ loans to customers in eastern Europe were sill healthy, there is little doubt that compared to the size of the economy, Austria is more exposed to the east than other EU states.

East European loans account for 75 per cent of gross domestic product, followed by Sweden (30 per cent) and Greece (19 per cent).

Austria’s difficulties with its eastern neighbours has raised the borrowing costs of the government with the yield on Austrian 10-year government debt over 1 percentage point higher than equivalent German debt, still far below the spread in Greece, for example.

Mr Nowotny said that while markets had not differentiated different risks sufficiently within eurozone countries in the past, now “I am afraid we are going from one extreme to another”. “Markets tend to overshoot,” he added.

But the market’s assessment of higher risks in funding the Austrian government has not diminished Mr Nowotny’s desire to promote Keynesian economics on the European Central Bank governing council, an area where most other members are much more cautious.

“What we are relearning – because it is an old Keynesian position – is that if there is a deep recession, monetary policy alone is not enough and has to be supplemented by expansionary fiscal policy”.

With almost all EU countries adopting expansionary policies, he added, “the chances to be effective ... are of course much better than if countries went alone and that is one of the reasons, for me, for cautious optimism”.

Copyright The Financial Times Limited 2009