Eastern European Countries Bear Huge Debts amid Russia-Ukraine Conflict

As a result of the Russia-Ukraine conflict, Europe has experienced an unprecedented energy shortage and inflation crisis, and such price increases have been painful for the developed Nordic countries, not to mention the less economically developed Eastern European countries.

According to the data summary, Eastern European countries have accumulated nearly $32 billion in foreign debt this year, three times the size of the debt for the same period last year. Poland ($9 billion), Romania ($6 billion), and Hungary ($5 billion) are among the top five emerging market borrowers in overseas debt markets for the first time in more than a decade.

And with the cycle of interest rate hikes by major global central banks not yet over, interest rates in all countries are above a rare high level, making the interest on the debt of Eastern European countries even larger. Poland, for example, will need to pay 5.5 percent a year for a new 30-year bond issue, 1.5 percentage points higher than a similar debt issue in 2021.

To make matters worse, the stalemate in the Russia-Ukraine conflict means that European governments may need to continue to add more fiscal spending, which could trigger more debt financing. In this scenario, investors in overseas debt markets may not necessarily be willing to continue to purchase new bond issues.

And the first signs of this waning interest have already emerged in the market, with Poland's dollar-denominated sovereign debt now yielding similarly to riskier countries in the market (the Philippines, Indonesia, and Uruguay), showing the market's fear of bond risk in the region.

Debt and deficit
According to market analysis, the Eastern European region's budget deficit is expected to reach 4.3% of its GDP this year, a sharp spike from 1.3% in 2021.

Daniel Wood, portfolio manager of fixed income at William Blair International, said the Russia-Ukraine conflict has hit these countries' fiscal numbers in two ways. First, economic growth in Eastern Europe has slowed, thereby reducing government revenues, and second, the rising cost of living has required governments to expand fiscal spending to help the affected populations there weather the storm.

In addition, Europe's cut-off of Russian energy supplies has caused inflation in some Eastern European countries to soar above 20%, which in turn has driven local interest rates up far more than in other countries.

According to Zoltan Kurali, head of Hungary's debt management agency, foreign currency debt is cheaper compared to borrowing in Hungarian forints and allows for the diversification of investors. Hungary is no longer able to raise all the money it needs in a single market.

But there is another risk in the overseas debt market: if the local currency depreciates against the dollar, then Eastern European countries have to bear another exchange loss in addition to interest.

The Polish Ministry of Finance explained that in the long run, given the fundamentals of the Polish economy, the exchange rate of the Polish currency, the zloty, should appreciate to reduce the debt burden. But the other side of currency appreciation is often accompanied by some negative effects, such as weakening export competitiveness.

The huge fiscal pressure led the Eastern European countries to seek assistance from EU funds, for which the Hungarian and Polish governments even loosened their lips and were willing to address the issue of democratic system reform proposed by the EU.

But one of the features of the EU is that the demands are numerous and fragmented, and the allocations are slow and difficult. This has led to a long wait for allocations and the need for Eastern European governments to still seek support from the bond market, thus stacking up a higher and more dangerous tower of debt.