Cyprus’s bailout threatens slowing eastern European growth through trade and banking links if it sparks capital flight from the most indebted euro-area nations, the European Bank for Reconstruction and Development said.

Another bout of uncertainty in Europe’s debt crisis may boost financing costs for banks and potentially trigger an outflow of “large” deposits and funding in countries with weaker lenders or sovereigns, EBRD Deputy Chief Economist Jeromin Zettelmeyer said in an April 5 interview in London.

Eastern Europe relied on foreign capital flows and easy access to credit and export markets to fuel growth of more than 5 percent a year before the global crisis of 2008. The Cyprus bailout, where international creditors forced losses on large depositors in exchange for a 10 billion-euro ($12.8 billion) aid package, may lead to capital flight and weaker growth in countries such as Italy and Spain, Zettelmeyer said. 

“These are very important countries and they are very large and so if there’s a slowdown in the EU as a result of this it would certainly affect” the 29 eastern European countries where the EBRD lends, he said. “The risks are higher than we thought and they are further to the downside than what we thought.”

The EBRD forecast in January that eastern European economic growth will pick up to 3 percent this year from 2.6 percent in 2012. It will update the projection in early May.

“Our last forecast assumed that GDP in the region was turning round in the first quarter,” Zettelmeyer said. “It is terribly difficult to say whether this was thrown off track by the Cyprus episode or not.”

While concerns by large depositors may be “overdone,” the EU hasn’t done enough to reassure them that the formula used in Cyprus remains a unique solution, Zettelmeyer said.

“This is not something that’s been clarified and it would certainly help to have more clarity on this by the EU,” he said.

While the rescue of Cyprus prompted concern in financial markets that Slovenia, the first former communist nation to adopt the euro, may be next in line for a bailout, the former Yugoslav country may be able to avoid aid “if the government does the right thing,” according to Zettelmeyer.

Eastern Europe’s banking systems lack reliance on “a massive volume” of large deposits and that includes Slovenia, which is “very different” from Cyprus, according to Zettelmeyer.

Slovenia, battling its second recession since 2009 and rising bad debts at its banks, is trying to avoid becoming the sixth euro nation to ask for aid. Banks such as Nova Ljubljanska Banka d.d. and Nova Kreditna Banka Maribor d.d., are struggling with surging bad loans after the collapse of the construction industry, which fueled growth before the crisis. Bad loans account for about a fifth of economic output. 

(Bloomberg)