Research Dept. News
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Monthly Report, num 331 - January 2010
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European Union - Emerging Europe
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Emerging Europe: single region, different futures
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Emerging Europe leavesthe worst behind it but its prospects for 2010 are disparate.
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2009 ends much better than it began in emerging Europe. And if the 2010 forecasts remain on track, we'll be able to repeat as much in twelve months' time. Overall, beyond the generally agreed view that the acute phase of the crisis seems to be over, the pace of activity currently enjoyed by different countries and the growth prospects announced are neither similar nor comparable. With regard to indicators that take the pulse of the economy, and looking at one that provides the best summary, namely that of economic sentiment, two large groups of countries need to be distinguished. The first, made up of Poland, the Czech Republic and Slovakia, has been in recovery for more than half a year. In contrast, the group made up of the remaining economies in the region (the Baltic countries together with Hungary, Romania and Bulgaria), hit bottom much later and had fallen further. Since this low point in the cycle, their activity has recovered with a similar intensity to that of the first group although the current levels are lower.
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It will be difficult for Baltic countries to avoid a second year without sharp falls in GDP.
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The current economic situation indicates that this second group of countries is starting from a disadvantaged position, jeopardizing a dynamic recovery. In fact, if current growth forecasts for 2010 are right, this description might even be seen as too benign. One part of the second group (Estonia, Lithuania and Latvia) will continue in sharp recession in 2010, while the other three (Hungary, Romania and Bulgaria) will probably escape a second year with declining GDP by the seat of their pants (and provided there are no nasty surprises). In contrast to such meagre prospects, Poland, the Czech Republic and Slovakia will grow, if not dynamically then at least quite comfortably. So why are there such differences within the region?
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Firstly, we should note the similarities shared by these economies. With few differences, all have benefitted appreciably from recovery abroad which, combined with the drop in imports due to very weak domestic demand, has helped to turn around the huge deficits in current accounts accumulated during the period of expansion. A second aspect in which these economies resemble each other is that the severity of the crisis has allowed them to redirect their previously recorded excessive inflationary tensions.
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If these are the two big similarities, the key differences come from a combination of three factors: the resistance of the national banking system, the monetary policy followed and the fiscal adjustment required. In general terms, the bigger the macroeconomic imbalances accumulated during the period of expansion that ended in 2008, the more complicated it has been to strike a balance between attempting to alleviate the drop in business and sort out these prior excesses. An extreme case of this can be found in the Baltic countries, three economies that combine a weak banking system (seasoned with excesses in household and company debt in foreign currencies), the need to follow a monetary policy of high interest rates to underpin their currency exchange systems and a slight adjustment in public accounts (in the case of Latvia, related to its programme with the International Monetary Fund).
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Given this triple combination of recessive factors, international investors have been very cautious when assessing the risks of the Baltic countries, assigning them the highest country-risk levels of all emerging Europe. As a recent example of this unease, when the news broke of the problems of Dubai's debt on 25 November, two of the three central governments in emerging Europe that suffered an appreciable increase in tension in their CDS (Credit Default Swaps, an asset that reflects the likelihood of non-payment of public debt) were Latvia and Lithuania. With such a frame of mind, improvement in the international scenario will only partially lead to greater activity, and a renewed fall in growth in 2010 cannot be avoided.
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With a bit of luck, Hungary, Romania and Bulgaria may grow again.
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The third country was Hungary. This actually represents several countries found in emerging Europe that have accumulated fewer imbalances and particularly those with a banking system that's under less pressure but which have had to battle fundamentally with the difficulty of handling the recession with restrictive fiscal policy. The extreme case has been, in fact, that of the Hungarian economy, a country that, in full recession, has still been able to post a positive primary public sector surplus, a result that should be interpreted within the context of its commitment to the IMF. Although the cases of Romania (which also benefits from the Fund's financial aid) and Bulgaria are not so extreme with regard to adjustments in public expenditure, all three are economies that will find it hard to grow strongly in 2010.
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Poland, the Czech Republic and Slovakia, clear beneficiaries of a globally balanced macroeconomic situation and of the euro area's recovery.
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The last situation that can be identified in emerging Europe is the one shared by economies with relatively smaller macroeconomic imbalances. This is the situation of Poland, the Czech Republic and Slovakia. These three countriesare in a position to take advantage of the improvement in their key export markets (principally the euro area) without having to page the toll of pro-cyclic monetary or fiscal policy. This will allow them to enjoy positive growth rates of a certain size in 2010.
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