Of the 32 sovereign states in the emerging Europe region, 19 maintain fixed pegs or heavily managed exchange rate regimes (eight others have floating currencies and five utilise the euro). Thus far, only five of the 19 have made significant devaluations despite a clear regional trend of capital outflows, slowing growth and rapidly declining export earnings. Here is the list:

Russia (RUB/dollar-euro basket): -27.3%
Ukraine (UAH/US$): -79.2%
Belarus (BYR/US$): -27.7%
Georgia (GEL/US$): -19.1%
Mongolia (MNT/US$): -22.7%

The rouble devaluation, in conjunction with the Russian economy’s dominance in the CIS region, is notable and underpins my long held view that a much wider spate of devaluations are on the cards in 2009. Simply put, there is very little incentive for the Central Asian and Caucasus economies to maintain a strong exchange rate. All are heavily dependent on exports to Russia and remittances are a significant factor in foreign capital inflows. Unlike Central and South-Eastern European economies, countries such as Turkmenistan, Tajikistan, Kyrgyzstan and Armenia (among several others), lack a high level of foreign-denominated debt while also overwhelmingly relying on exports of dollar-denominated commodities such as oil, natural gas, gold and copper. In short, I simply cannot see a single one of these currency pegs holding through 2009 when I believe that Russia’s recession will accelerate and commodity prices will fall further.

It’s not just the CIS pegs though which are looking precarious. While no EU-member state’s peg has yet broken, the signs are ominous. All four of the pegged currency economies including Latvia, Bulgaria, Estonia and Lithuania are facing significant contractions in growth, and the drawdowns in FX reserves in their central banks through the third and fourth quarters of 2008 affirm that the pegs are coming under pressure. Latvia is a core example. The country is facing a massive and protracted deleveraging process with gross external debt equivalent to almost 170% of GDP (330% of exports). Moreover, the domestic banking system lacks the deposits to support much of the debt (the loans/deposits ratio is in excess of 250%), and the economy is set to contract by 6.4% in 2009. Under these conditions the capital flow dynamics are only set to worsen further for the lat.

Of course there are several key differences between the CIS and EU pegs and my views regarding the extent and timing of potential devaluations reflect this. Indeed, whereas the CIS peg devaluations seem all but foregone conclusions, the same cannot be said for those in the EU. First, two of the four pegs (Latvia and Bulgaria) are operating under currency board arrangements, meaning that the level of central bank reserve holdings is relatively high. According to latest data for Latvia, FX reserves totalled roughly one-fifth of estimated 2008 gross domestic product while in Bulgaria the ratio is double that at 41%. Second, precedent has been set with large joint EU/IMF bail-out packages in Hungary (EUR20bn) and Latvia (EUR7.5bn), which suggest that there is a high degree of institutional protection for these economies and by extension, multilateral support for the currencies.

As such, while there are severe risks of widespread pegged currency devaluations in the EU, I do not expect a sudden devaluation in the short term.

When and if the devaluations do come though, here’s my odds on which one will be first:

Latvia- The country’s external dynamics remind me too much of a mini-version of Iceland and this is the economy most at risk in the EU of a double-digit contraction in growth. (evens, favourite to devalue first)

Bulgaria- Bulgaria lacks an IMF stabilisation programme and currency appreciation versus key export competitors Turkey and Romania will hit the economy hard. That said, its reserve holdings are not insubstantial and there will be a great deal of political momentum to maintaining the peg. (7/4 to devalue first)

Estonia- Estonia is facing many similar problems as Latvia, though in a mitigated fashion. It won’t go first, but if Latvia goes, there will be severe pressures for Estonia to do the same. (3/1 to devalue first)

Lithuania- Lithuania looks the best of the Baltics, but as with Estonia, it will have extreme difficulties maintaining its peg in the event that the lat and the kroon are let go. (8/1 to devalue first)