If the situation in Cyprus is not sorted out quickly, the relative calm with which the markets seem to deal with the situation could vanish, replaced by a "risk-off" trade, according to analysts and strategists.
In the stock markets, the MSCI Emerging Markets Index was down just 0.2% Thursday at noon in London while the FTSE lost 0.7%, the German DAX was down 0.8% and France's CAC-40 fell 1%.
The European Central Bank (ECB) piled more pressure on Cyprus by announcing that its banks will benefit from the bank's Emergency Liquidity Assistance (ELA) only until next Monday.
"Thereafter, Emergency Liquidity Assistance (ELA) could only be considered if an EU/IMF program is in place that would ensure the solvency of the concerned banks," the ECB said in a statement.
Yields on Cyprus's 2-year bond were 12% on Wednesday, as talks between the Cypriot finance minister and Russian officials did not yield any alternative bailout by Russia.
But Russia is not prepared to do whatever it takesto rescue Cyprus, an analyst told Emerging Markets, as politically there is not much incentive to do so for Russian president Vladimir Putin.
The ECB's announcement deals a heavy blow not just to Cyprus but to the wider eurozone.
"The ECB is not in the business of taking risky bets, and it will not lend to any bank unless it sees an assured path to getting repaid," Carl Weinberg, an economist with High Frequency Economics, said.
But, he added: "if the banks are allowed to fail, confidence in the European Monetary Union governments' capacity to deal with banking crises will be undermined."
Peter Brezinschek, global head of research at Raiffeisen Bank, said that the calm in the markets was to some extent "due to ongoing hopes for a positive solution in the next round of negotiations (with the EU or Russia) – something that could still be shattered."
BIGGEST RISK: SLOVENIA
In Europe, one of the emerging countries that would potentially suffer the most because of the uncertainty in Cyprus is Slovenia, Abbas Ameli-Renani, CEEMEA strategist at RBS, told Emerging Markets.
On Monday morning, after the news of the Cyprus bank taxwas announced at the weekend, the biggest impact was seen on Slovenian bonds, as for a long time there had been speculation that it might be the next to need a bailout.
"It's something that the government has said they won't do but from an economic analysis point of view, it's vulnerable to this situation and potentially the next country to seek that," said Ameli-Renani.
Slovenia, however, is in a much better situation than Cyprus and medium-term the Cyprus panic could even be positive for Slovenia, as its politicians might feel forced to deal with the banking system problems.
"In Cyprus, we have a situation where the banks represent 800% of the economy, in Slovenia that's more like 130% of GDP. Compared to emerging markets economies, it's relatively high, but compared to a eurozone economy it's not that high," Ameli-Renani said.
Peter Attard-Montalto, emerging markets analyst at Nomura, also believes that "Slovenia has a path through the crisis, albeit an extremely risk-laden one."
The scenario feared most by the Nomura analysts is that of a "waterfall-like contagion focus and limitations of funding" which could "combine with political difficulties and downgrades to create a perfect storm and become a self-fulfilling crisis."
"The government could then be forced to seek funding for its banking system to continue with its recapitalization program, but a more dramatic loss of market access could require a larger bailout for both the banks and the fiscal," Attard-Montalto said.
The total funding requirement for the Slovenian government for this year is still around 3 billion euros, representing some 8% of GDP, he noted.
And "while the banking sector in Slovenia is much smaller than that of Cyprus as compared with the economy, Slovenia has a much higher loan-to-deposit ratio at 153% in the latest data as compared with 105% in Cyprus," he added.
EYES ON TURKEY, ROMANIA
Another country that could suffer is Turkey, which is looking to raise 150 billion lira (TRY) worth of debt this year, a "significant increase" from last year's 100 billion, said Mohammed Kazmi, emerging markets analyst focusing on cross-asset class research at RBS.
"We already saw at this week's auction that demand at the auction was very poor," Kazmi said.
"If this continues further, demand could be very weak; compare that with other countries in the region: a lot of the other countries had pre-financed for this year so they're quite safe."
Kazmi included the Czech Republic and Poland among the emerging European countries that had pre-financed in order to take advantage of good market conditions and meet their needs.
Romania is another country in south-Eastern Europe that could get hit harder than others if the situation in Cyprus gets worse, Abbas said.
"Romania has one of the highest exposures to periphery banks in the region. Greek banks specifically consist of 15% of Romania's banking sector," he said.
"If you enter a crisis mode, deleveraging situations will be most exacerbated in countries that have the highest exposure to periphery countries. Romania specifically has stable banking metrics but it does have that exposure to the periphery banking system," Abbas added.
EURO EXIT FOR CYPRUS?
For Roderick Ngotho, a foreign exchange strategist at RBS, the issue is that of the bank tax, and solving the Cyprus crisis can only be done by removing it as a condition of the bailout.
"If it gets pushed through, that creates a precedent for the periphery, deposit guarantees lacking any sort of meaning, and that creates your contagion," Ngotho told Emerging Markets.
"In that universe, everything is going to get sold. I can't imagine an emerging market currency that's going to be hanging around and be held because it's got a current account surplus or anything like that going on."
Press reports of talks about Cyprus leaving the eurozone do nothing to calm the markets.
"I think the bigger concern is whether or not [a bailout] doesn't go through and Cyprus falls out of the EU and the euro," said Phoenix Kalen, a trading strategist for CEEMEA at RBS.
"That would lead to a lot of weakness in emerging markets. A lot of weakness will be concentrated in the currency but it would mean selloffs in both credit and local currency bonds," Kalen added.
- Picture by Leonid Mamchenkov
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