The deepening of the financial sector in central and eastern Europe (CEE) over the past two decades has to a large extent been driven by western European banks' willingness to set up subsidiary banks in the region and provide the means for a lending boom. High lending growth was accompanied by strong economic growth, but also by increasingly visible bubbles in the property markets. Now that the bubbles are bursting and the global economic crisis is hitting the CEE countries, there is expected to be a negative spill-back effect on western Europe.

Western European banks are expected to react to the increased risk in the CEE region by withdrawing capital. A sizeable part of the CEE region debt is short term, which makes a major credit contraction even more likely. This puts further pressure on the region. We expect that credit withdrawal will be most pronounced from the countries with the gloomiest economic prospects. Rather than a homogeneous credit contraction across the CEE region, it is possible that we will see a very pronounced credit flight from the most vulnerable countries.

We have looked at three scenarios. A mild scenario, which is comparable to the Swedish banking crisis, in which losses in Sweden added up to about 8% of GDP (maybe it isn't really fair to call this a mild scenario), a hard scenario, in which the hardest hit CEE countries face more substantial losses, and finally an ugly scenario, which is more comparable to the Asian crisis. In the ugly scenario Austrian banks lose USD49bn, or about 11% of Austrian GDP, Swedish banks lose USD31bn (6.1% of GDP) and Belgian banks lose USD20bn (3.6% of GDP). Total losses to western Banks then add up to USD275bn. This is a lot of money - but to put it in perspective the IMF now estimates the total losses on US-originated credit assets at USD2.2bn.

Key events in the coming week

* Final Q4 08 GDP due for release next week in Poland.

* We expect Turkish inflation to drop further in February to 8.9% y/y, down from January's 9.5% y/y (see page 5).

* Plenty of important economic data such as industrial production figures and inflation due for release in Baltics (see page 4).

* We expect Russian inflation to ease moderately in February to 13.1% y/y, down from January's 13.4%.