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On a global scale, Central and Eastern Europe (CEE) is certainly one of the areas most affected by the global credit crisis. The Baltic States are already in recession and Hungary is expected to follow suit.

Thank you, EMU!

Many real estate developers from CEE took out loans in foreign currencies such as euros, Swiss francs and Swedish kroner due to favourable interest rates and thus exposed themselves to exchange rate risk. If their domestic currencies fell, their debt burden denominated in foreign currencies would become heavier.

While most emerging countries have diversified their export exposure in recent years, CEE countries have not. On the contrary, they actually increased their exports to the euro area which made them very vulnerable to a potential recession in the EU.

What seemed a minor risk a couple of years ago, now reveals itself to be a painful mistake. The major swings in exchange rates in recent months have sent the real burden of loans and interest soaring upwards. As a result of this, households, firms, banks and even governments are now having a hard time servicing their foreign currency-denominated loans.

The riskiness of these loans is now coming to light as the global economic recession in both East and West Europe is forcing Western banks to pull back, refusing to renew loans, leaving many real estate developers on the verge of bankruptcy.

Good markets?

The foundations of the crisis were laid years earlier due to an overheated property market, excessive borrowing, and complacent regulators.

While ordinary people can be partly blamed for their naiveté, the governments of those countries bear an even wider responsibility for failing to pierce the bubble when they had the opportunity. At the height of the boom, when those economies were growing by an unsustainable 7 to 11 percent a year, some of those countries were running high budget deficits.

In Hungary, Swiss and Austrian banks heavily promoted home mortgage loans denominated in Swiss francs and euros. Interest rates offered by such financial institutions were significantly lower than the ones offered on the local market resulting in nearly 60% of all mortgages in the country being issued in foreign currencies. The only risk at the time was the devaluation of the Hungarian forint. That is exactly what has happened over the past 12 months as Western banks have dramatically reduced their speculative investments in CEE countries to repatriate capital, where the mother banks have had serious problems caused by the US financial crisis.

Real estate developers and private investors saw the liberalization of the financial sector and the opening of the economy to foreign investment and capital flows from abroad as a great opportunity. Foreign banks muscled their way into the new markets in the East and were able to offer better terms than their domestic competitors. The accession to the European Union by some of the countries and the promise of the accession to the euro area in the near future gave investors and banks a false sense of security. Now, local currencies have lost value and many borrowers including real estate developers and private investors can no longer afford to make their loan payments or request new ones to start further projects.

Is Slovenia safe?

Slovenia, as with other euro area members, can enjoy the full protection of Europe's currency union. The country, however, due to close links with foreign banks that have investments in the East, has not been left untouched by this global credit crisis. Several households and companies have taken out mortgages with Austrian banks. As the latter are struggling to repatriate the badly needed cash, they are refusing to renew or renegotiate loans. Austrian banks alone have lent EUR 230 bn to Eastern Europe, which is equivalent to 70 percent of the Austria's GDP.

In January, a family from north-eastern Slovenia lost their property after being unable to continue servicing its mortgage taken out with Raiffeisenbank. According to some estimates, there are more than 100 individuals who signed loan contracts with Austrian banks through intermediaries. The problem is these loans are resetting to higher interest rates, squeezing households further.

With Western Banks reluctant to give credit and with ratings downgrades becoming endemic, the European real estate sector, once the engine of economic growth of several countries, has become a drag on the economy. This year will more than likely reveal itself to be a very hard one for business.