It’s tough on Ukraine, but European banks should pull out. It may not be the only Eastern European economy giving its western bankers a headache but that country’s political chaos and weak corporate governance outweigh the prospects of a return to growth.

Hungarians and Romanians, the bulk of whose loans are in foreign currencies, have seen their debts rise as their own currencies fall. And Sweden’s SEB and Swedbank have taken a pasting in their neighbouring Baltic states.

Austria’s Erste Bank managed to make a profit in the Czech Republic, Slovakia, Croatia, Serbia, Hungary and even Romania, (where it lifted bad loan provisions five-fold), albeit at a lower level than last year.

However, like the Swedes, it came a cropper in Ukraine.

The EU and the International Monetary Fund (IMF) have stepped in to the rot, but Ukraine is still floundering.

Its economy is expected to shrink by 10 percent this year and its politics are in chaos. Within the ruling elite, poisonous personal rivalries have prevented agreement on the basic economic reforms that the IMF is demanding before it writes more cheques.

The downturn is hurting the western banks: Erste, Swedbank and SEB all lost money there in the first quarter. Both the Swedes have written down all their remaining goodwill there.

All three are pulling in their horns. Erste has laid off 300 local staff. SEB has ditched its expansion plans. Swedbank concedes that short term growth in Ukraine will be curtailed, although a cheerful message on its website says it hopes “to capture the possibility for long-term growth.”

They should all capture the certainty offered by a near-term exit. Ukraine represents a tiny proportion of all three banks’ assets. The recovery, when it comes, will have only a marginal effect on profits, but in the meantime the country offers plenty of scope for management hassle.

Banks are generally slow to pull out of countries because of the political backlash. They will be accused of abandoning Ukraine when it most needs western support, but that only matters if a bank expects to set up there again. Unfortunately, Ukraine will remain the wild east for some years to come.

The gas dispute between Russia and Ukraine that has left hundreds of thousands of Europeans shivering in the winter cold is bound to accelerate plodding European Union efforts to build a common energy policy.

The cut-off of Russian gas supplies to Europe via Ukraine highlighted how little progress the 27-nation EU has made in connecting national energy networks and diversifying supplies since the first such crisis three years ago.

“A similar situation occurred in 2006 and we Europeans now feel guilty about not having done what we said we would do,” said an EU energy official, who declined to be identified because of the sensitivity of his position.

Unlike 2006, when the Europeans broadly sided with Ukraine’s pro-Western, democratic government, the EU has remained strictly neutral this time in what it regards as mostly a commercial dispute over gas pricing and unpaid bills.

Both sides broke undertakings to Brussels on continuity of supply. The lack of transparency on contracts, the role of murky intermediaries and coalition feuding in Kiev all made it harder to sympathise with Ukraine this time, the EU official said.

“The Russians were having a good gas war until they overreacted by cutting supplies to the EU. As in the war with Georgia last year, they could not resist the urge to teach former Soviet republics a lesson,” he said.

Russian giant Gazprom’s demand for Ukraine to pay market prices is not unreasonable, but television images of Prime Minister Vladimir Putin ordering the company to turn off the taps to Europe belies talk of a purely commercial issue.

Several EU states have increased gas stocks since 2006 and avoided major disruption. But Bulgaria, the poorest EU newcomer, and western Balkans states Croatia and Bosnia were caught with no stocks at all. Supplies to 18 countries have been affected.

That prompted the EU to intervene. Czech Prime Minister Mirek Topolanek, the EU presidency holder, persuaded Moscow and Kiev to sign a deal allowing EU monitors to check the transit of gas across Ukraine to get supplies to Europe flowing again.

MUTUAL MISTRUST

Progress on integrating the European gas market by linking up national pipeline systems has been very slow, partly due to mutual mistrust among EU nations, as well as divergent business interests and political differences on relations with Moscow.

Member states still do not share information with each other about the price their energy companies pay Gazprom for gas. The executive European Commission and the EU Council secretariat have been struggling to collate such data since 2006.

“We preach transparency but we do not practice it among ourselves,” the EU energy official said.
Poland has led a chorus of new members from central and eastern Europe calling for energy “solidarity” within the EU to reduce the former Soviet satellites’ dependency on Moscow, which provides a quarter of the EU’s gas.

But Germany, Europe’s biggest gas consumer, opposes any emergency EU pooling arrangement for gas stocks, arguing that this is a commercial matter for utility companies.

Berlin is keen to manage its energy relationship with Russia without the involvement of Brussels. It resisted any EU involvement in the Ukraine dispute until the leaders of Bulgaria and Croatia appealed personally to Chancellor Angela Merkel.

EU officials say the crisis should spur European leaders at a March summit to put political momentum and public money behind plans to build cross-border energy interconnectors in Europe.

They may also agree on minimum requirements for gas storage as the EU has for national oil stocks.
And they will likely give higher priority to diversifying gas suppliers, supply routes and delivery mechanisms in particular to develop liquefied natural gas (LNG) facilities.

Among suppliers, the EU is eyeing Qatar and Nigeria for LNG as well as Algeria, Norway, Azerbaijan, Iraq and Central Asian countries for piped gas.

Russia is using the crisis to underline the cost for its NordStream and South Stream projects to carry Russian gas directly to European consumers via pipelines under the Baltic and Black seas, bypassing Ukraine, Belarus and Poland.

The dispute will also add political weight to the Nabucco project, backed by both the EU and the United States, to pipe Caspian and Middle East gas to central Europe via Turkey, but there are doubts about finding enough gas to fill the pipeline.

None of these projects offers an early solution, given the long lead times and high cost. EU officials say they are not an “either/or”. There will be enough demand and enough gas to justify all three extra pipelines, they say.

In the shorter term, the capacity of existing pipelines can be expanded. But the main quick gains for European gas security would come from linking national networks into a single market and improving energy efficiency, especially in central Europe.

For previous columns by Paul Taylor, click here.

The European Union is entering a lame duck year just as new challenges are mounting from Israel’s assault on Gaza, Russia’s gas cut-off to Ukraine and the impending inauguration of U.S. President Barack Obama.

The EU’s active crisis management in the Georgia war and the global financial meltdown last year under the energetic leadership of French President Nicolas Sarkozy was an exception, not the dawn of a new, more effective Union.

Europe now faces 12 months of stasis with two peripheral small countries - the Czech Republic and Sweden — holding the six-month rotating presidency, EU legislation on hold because of European Parliament elections in June, and the European Commission winding down to the end of its term in November.

Domestic politics in key member states will also constrain EU initiatives. Germany, the biggest member state, has a general election in September in which the two major parties in its ungainly grand coalition will be fighting each other.

That seems to preclude agreement on bold economic stimulus measures or foreign policy risk-taking.
Europe will also be held in check for most of the year by a second Irish referendum, expected in October or November, on the EU’s Lisbon treaty on institutional reform designed to give the bloc stronger leadership and a fairer decision-making system.

EU leaders will be careful not to do or say anything that could jeopardize the chances of reversing last year’s “No” vote.

LACK OF LEVERAGE

The first few days of the year have highlighted the EU’s divisions and lack of leverage in dealing with Israel, the Palestinians, Russia and Ukraine.

The Europeans exposed themselves to ridicule with two separate diplomatic missions touring the Middle East - an official EU delegation led by Czech Foreign Minister Karel Schwarzenberg and a French one led by Sarkozy, behaving as if he were still president of the Union.

The dual missions also reflected policy differences. While France, Britain and EU foreign policy chief Javier Solana demanded an immediate ceasefire, the Czechs and Germans blamed the Palestinian militant group Hamas squarely for the fighting and showed more sympathy towards Israel.

The EU has little leverage with either side, since the Israelis consider the United States to be the sole power broker in the region, and the Europeans will not talk officially to Hamas, which they have declared a terrorist organization.

The one card Europe can play is the possibility of deploying European monitors to help secure Gaza’s southern border with Egypt and prevent arms smuggling into the Palestinian area.

The offer of an EU monitoring presence helped achieve a ceasefire between Russia and Georgia last August.

France and Turkey have offered monitors to support an Egyptian ceasefire plan put forward by President Hosni Mubarak after talks with Sarkozy.

But there are snags: Israel does not trust the Europeans to enforce an arms embargo, Egypt does not want European forces on its soil, and Hamas does not want its hands tied by Europe.

If the monitors do go in, they could end up caught in the crossfire between Palestinian militants and Israeli troops.

European forces already run that risk in southern Lebanon, where they deployed in a buffer zone in 2006 to help end a conflict between Hezbollah fighters and the Israeli border.

WRONG-FOOTED

The EU has also been wrong-footed by Russia’s gas cut-off to Ukraine, which has now led to severe reductions in gas supplies to EU member states in central and southeastern Europe.

The European Commission and the Czech presidency have so far scrupulously avoided taking sides in what they describe as a commercial dispute.

But Czech Prime Minister Mirek Topolanek said if supplies to Europe were not restored by Thursday, the talks should be escalated to the top political level and the EU would intervene.

While many European governments, especially in former communist central Europe, suspect Moscow is playing with the gas taps to intimidate Ukraine’s pro-western government and send a message to other European countries dependent on Russian supplies, the EU has no common position.

The German election is a factor here too. Foreign Minister Frank-Walter Steinmeier, the Social Democratic candidate for chancellor, is widely seen as sympathetic to Russia, while Christian Democratic Chancellor Angela Merkel is more critical.

The same paralyzing factors may make it difficult for the EU to respond to challenges it is likely to receive from Obama.

Germany seems set to resist joining any massive fiscal stimulus of the kind the U.S. president-elect is planning.

Germany, Italy and Austria, with strong commercial interests in Iran, are unlikely to accept much tougher sanctions against Tehran’s nuclear program, especially without U.N. approval.
Berlin has also made clear it will not send more troops to Afghanistan or commit its forces to frontline combat missions.

The one issue on which a lame-duck Europe will be an eager partner for Obama is in fighting climate change. But EU hopes that the new U.S. leader may join an international agreement on curbing greenhouse gas emissions in Copenhagen at the end of this year may be over-optimistic.

For previous columns by Paul Taylor, click here.