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According to Citi Investment Research, the story leading up to emerging Europe's crisis has parallels with the buildup to the financial crisis that hit the "Asian 5" economies in 1997, particularly in terms of the scale of the precrisis capital inflow, and the way in which this increased each region's depend¬ence on external financing.

Asian 5 refers to Thailand, Indonesia, Malaysia, Philippines and Korea.

One clear parallel between Asia and emerging Europe lies in the scale of the capital inflow, and the way in which this increased each region's dependence on external financing.

According to Citibank's research, foreign banks' claims on the two regions increased in the run-up to their crises.

In the case of the Asian 5, crossborder claims by foreign banks rose to 4550 per cent of these countries' GDP at the point of crisis, almost doubling in five years.

The accumulation of crossbor¬der liabilities to banks in emerging Europe has been similar - gross international claims rose from 20 per cent of emerging Europe's GDP in 2003 towards 40 per cent in 2007.

Yet it is also clear that the absolute numbers involved are much higher in emerging Europe.

"International" claims - that is, crossborder claims plus the value of local claims by foreign subsidiaries in foreign exchange - rose to only US$274 billion (Bt9.8 trillion) at their peak for the Asian 5, but rose to over $773 billion for emerging Europe (excluding over $205 billion for Russia).

Both in Europe's case and in Asia's the share of shortterm claims in the total was around half.

"Emerging Europe's external vul¬nerability has evolved in a way sim¬ilar to the Asian 5 - rapid GDP growth accompanied by an increase in current account deficits (particularly in the case of emerging Europe), together with a rise in the real exchange rates for each region," Citi Investment Research said.

The main consequence of this story is a rise in external vulnerabil¬ity, which is measured simply by adding a country's current account deficit to its stock of shortterm external debt, and dividing that number by each country's stock of foreign exchange reserves.

There are, clearly, some impor¬tant differences between Asia's experience and that of emerging Europe. The most obvious difference is the nature of the exchange rate regimes in existence.

While the Asian 5 operated more or less pegged exchange rates, a much greater variety of exchange rate regimes can be seen in emerging Europe.

These include more or less pure floats (Poland, Czech), banded exchange rates (Hungary, until February 2008), currency boards (Bulgaria, and to some extent the Baltics), and de facto pegs (Ukraine, Kazakhstan until recently).

The difference in exchange rate regimes between the two episodes is important, because it means that the currency mismatches that were built up have different explanations.

In Asia's case, the currency mismatches that grew on corporate balance sheets are easy to explain in the context of pegged exchange rates, which encouraged borrowers to forget that currency risk existed, and therefore created strong incentives for short forex positions.

For a country like Hungary, however, the incentive to borrow in foreign exchange resulted not so much from the disappearance of currency risk, but from the conviction that the economic convergence process guaranteed an appreciation of the local currency against that of its trading partners.

However, despite their similar vulnerabilities, the chances of emerging Europe enjoying a Vshape recovery like the Asian 5 is quite low, according to the paper.

The Asian 5 went through a deep recession in 1998, when GDP contracted on average by almost 8 per cent, but their recovery was rapid and sustained.

Among the factors that supported this rapid recovery were very sharp real exchange rate depreciation, an exportoriented economic structure which allowed these economies to take advantage of a very favourable international environment, efforts to stabilise the financial system, and a loosening of policies by most Asian 5 governments during the course of 1998.

Emerging Europe's chances of a Vshaped recovery are constrained by the contraction in external demand and a very weak international financial sector.

"With this in mind it is worth noting that the exchange rate depreciation that has taken place so far in emerging Europe has been rather modest by the standards of the Asian crisis," the bank said.

Emerging Europe's currencies have depreciated by much less since the crisis began than the "Asian 5" currencies did. On average, the peaktotrough move in Asian currencies was, in real terms, over 40 per cent.

By contrast, the average move in emerging Europe's currencies was under 20 per cent, and many currencies remain at stronger levels than their longrun average.

Meanwhile, the more financing from either the IMF or EU that's available, the less a country needs to shrink its need for financing.

How much would be enough? Calculating the external financing requirement this year for emerging Europe is simply a matter of summing up the current account deficit, the rollover of shortterm debt, and the repayment of medium and longterm debt coming due.

If financing isn't available on this scale for these countries, then the only options are further adjustment - implying greater recession and further exchange rate depreciation - or some form of default on capital payments, whether through debt restructuring, capital controls or both.

"If that is the result, then the evolution of emerging Europe's crisis might end up having more in common with the Latin American debt crisis of the 1980s than with the Asian crisis of the 1990s," Citi Investment Research said.