Research Dept. News
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Monthly Report, num 338 - September 2010
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European Union - Emerging Europe
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Emerging Europe: dynamic at present, uncertain in the future
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The worsening global economic outlook raises doubts as to the expansion in emerging Europe.
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Over the summer, a negative state of opinion has been developing concerning the outlook for the world economy in the coming quarters. In its most extreme version, this theory believes that the United States will enter a double-dip recession in 2011, dragging the rest of the economies into a new phase of low growth. Nonetheless, the most usual position is to accept an additional but not excessive economic slowdown compared with the rate of growth some months ago as the most likely scenario. If this happens, will emerging Europe be able to weather the storm?
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First, we should remind ourselves of the region's overall situation. The most outstanding feature is that emerging Europe is immersed in a dynamic economic recovery. GDP growth data for the second quarter have been clearly positive, in most countries surpassing the available forecasts. Consequently, none of the economies in the area regressed in quarter-on-quarter terms during this period, with Slovakia, Estonia and Lithuania achieving figures above those recorded for the European Union as a whole (1.0% quarter-on-quarter) and the Czech Republic just a little behind them. Lacking the figures for Poland (a clear rise in GDP is expected) and Rumania (the only economy in the region that will probably decline compared with the first quarter), the regional balance in growth terms is, as we have already stated, favourable. Particularly because leading indicators for the third quarter show that the accelerating trend in growth is continuing in most of the countries (Rumania and Bulgaria are the most notorious exceptions).
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To date, the pace of business has accelerated significantly.
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To date, this expansion has fundamentally been due to foreign demand and, to a lesser degree, trends in stocks, with consumption and investment still weak. Although trends in household expenditure are varied, indicators such as retail sales suggest that a first group of countries made up of Poland, Hungary and the Czech Republic is the most advanced in terms of their consumption recovering, while the Baltic countries and Rumania continue to be extremely fragile in this respect.
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Whether this recovery continues depends on foreign demand and international financing.
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From a financial point of view, inflows of foreign capital have also picked up significantly, funding the expansion, although in May these inflows reflected the increased uncertainty caused by the sovereign debt crisis in the euro area, a situation that eased subsequently. In spite of the recently improved economic vigour, the low degree of production capacity utilization and the already mentioned weakness in domestic demand have contained prices, in turn providing room to manoeuvre for a lax monetary policy. Lastly, the drop in business before the current recovery has notably affected public finances, although the starting point was, in most cases, healthy, so that the levels of public deficit and debt are not alarming.
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The recovery in emerging Europe will largely depend on expansion in the euro area.
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From this superficial review we can conclude, almost directly, that the region's recovery depends critically on economic and financial trends outside its borders. Specifically, it depends on the notable recovery in foreign demand continuing and on public and private international funding continuing to flow towards emerging Europe. Given the nature of the region's trade and financial links, in practice both these issues boil down to one: emerging Europe's recovery will only continue, beyond its current inertia, if the euro area avoids a double-dip recession. Should this negative scenario arise, we'll see a rapid drop in activity in these countries. However, if European growth slows up but doesn't go under, this being our main forecast scenario, the region's perspectives will not be affected to any great degree.
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One of the aspects that could alter the possible impact of a slowdown (or recession, in an extreme scenario) in Europe is national economic policy and, in particular, how budget policy is handled, given the sensitivity shown by international investors to sovereign debt since last spring. In this area, three general trends can be seen in the region. The first is a budget adjustment that cannot be postponed, such as the one carried out by the Baltic countries and Hungary, or the one currently being undertaken by Rumania.
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How budget policy is handled continues to attract attention.
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A second option is to delay the adjustment. This is the option being taken by Poland, which is benefitting from having been the only European country to avoid recession in 2009, and Hungary. In the Hungarian case, unfortunately, although the decision to relax its fiscal consolidation targets and particularly not to negotiate a new monetary agreement with the International Monetary Fund have broadened the field of play for populist policies, this has been done at the cost of a higher country risk premium and a deterioration in its currency, which will lead to lower growth in the future.
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Fiscal consolidation might help to provide greater protection against possible monetary disturbances.
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Lastly, the third option is the one being followed by the Czech Republic, undertaking clear fiscal consolidation without direct international financial pressure. Although it's difficult to suggest optimum patterns in this area, given the recent trends in indicators it seems as if the options to consolidate are providing greater returns in terms of lower risk premiums for the countries that have chosen them. Consequently, and returning to the initial question of the role of national economic policy, fiscal reform is probably an advisable strategy in order to provide a degree of protection for the economies of emerging Europe should the financial storms get worse, or provide them with the margin to implement an expansionary economic policy should business fall off.
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