$60 billion and counting: Carry trade-related losses and their effect on CDS spreads in Central and Eastern Europe

Raphael Auer and Simon Wehrmüller try to answer how big are Western European bank exposures in Eastern Europe in Vox EU:

Driven by the desire to catch up with Western Europe in terms of investment and consumption, and deceived by the low nominal interest rates on the Swiss franc, the euro, or the US dollar, households and non-banking sector firms in several Central and Eastern European (CEE) economies have accumulated the equivalent of $250 billion worth of debt denominated in a foreign currency. In Austria, mostly due to its proximity to Switzerland and the significant interest rate differential between the Swiss franc and the euro, total foreign currency exposure is equivalent to well over $100 billion.

What was advertised by both local and international banks to be a bargain has turned out to be a costly lesson for the entrepreneurs and households that took out these loans. For example, over the course of the last 6 months, the Swiss franc has appreciated by 31% against the Polish zloty, while the Hungarian forint has lost 14% against the euro. Given the large financial positions, these sharp currency appreciations have led to enormous aggregate losses for the borrowing nations.

Private households and firms have suffered a large part of the losses, but much of the currency exposure is concentrated in households and firms that are better equipped to bear the risks, thus somewhat mitigating the adverse real effects of these exposures (see Brown et al. 2008, Beer et al. 2008). Yet market participants anticipate that the government will ultimately bail out the private sector vis-à-vis its resident banks, thus also strongly affecting the outlook for public finances and market perceptions of sovereign default.