Lithuania, Estonia, and Slovenia. Leverage levels among export-orientated firms and the widespread contraction of export income in the region, suggests, however, that debt overhang in the tradable sector may be an issue for a broader set of countries: Latvia, Lithuania Estonia, Slovenia, Macedonia, Bosnia, Turkey, the Slovak Republic, Serbia, the Czech Republic and Croatia. Finally, our firm-level analysis suggests that despite sharp depreciations in many countries during the crisis, unhedged foreign currency borrowing by firms does not seem to be a source of debt overhang. The countries with a high incidence of unhedged FX loans experienced only minor depreciations during the crisis.

We next examine the potential for **debt overhang in the household sector** by country using data from the 2010 EBRD Life in Transition Survey (LITS). We find that mortgage debt seems to have had a significant adverse impact on household consumption and investment during the crisis. However, due to the low incidence of mortgage debt in the region hardly any country, except Estonia, seems to face a threat of debt overhang. The use of credit cards is much more widespread in the region than mortgage debt. However, credit card use has had a negligible effect on household income and investment during the crisis. It is unlikely therefore that credit card debt may jeopardize future economic activity in the region. Our household-level analysis further suggests that FX mortgages hardly pose a threat to future household consumption and investment. Only a minor fraction of households in the region are exposed to foreign currency mortgages. Moreover those countries in which FX mortgages are most prevalent did not experience major exchange rate shocks during the crisis.

We also assess the potential for **debt overhang in the banking sector** due to the significant loan losses incurred in many countries of the region during the crisis. The strong increase in non-performing loans (NPL) compared to pre-crisis bank profitability suggests that debt overhang in the banking sector is a threat in Ukraine, Latvia, Lithuania, Hungary as well as in Georgia and Albania. In the countries that face the most severe NPL problems, the share of private credit extended to firms (60%) and households (40%) is similar to the sample average. This suggests that debt overhang in the banking sector of these countries is likely to affect both sectors, with firms slightly more affected than households. We further assess the role of foreign banks in mitigating or exacerbating the effects of the crisis in the region. A review of the recent evidence suggests that the financial integration of Emerging Europe has contributed to the transmission of a crisis that had emerged unrelated to the local economic conditions. At the same time, this integration helped the region in managing the crisis by concerted actions of the major players (Vienna Initiative, IMF and EU stabilizing programs).

In the final part of the paper, we examine the policy response in emerging Europe, both in terms of pre-crisis policies and also the policy response during the crisis. We review the lessons from previous crises in terms of dealing with debt overhang issues and offer a brief assessment of current policy measures in emerging Europe.

We find that authorities in most countries have focused on **policy measures to curb FX lending** and cushion the effects of exchange rate depreciations on existing FX borrowers, especially in the household sector. Our analysis suggests that these will have little effect on aggregate investment and consumption in the private sector. While FX lending may be a pressing issue for financial stability, the low levels of unhedged FX borrowing by enterprises and the low incidence of mortgage borrowing among households suggests that this can hardly affect aggregate output.

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