Research Dept. News
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Monthly Report, num 350 - October 2011
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European union - Emerging Europe
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Change in direction in emerging Europe
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Emerging Europe is embarking on a more prolonged and sharper slowdown than expected...
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In the last few months, what in principle seemed to be a temporary slowdown in activity in emerging Europe has become a more significant development. At the beginning of this year, in the five economies we usually analyse in this report, namely Poland, the Czech Republic, Hungary, Slovakia and Romania, the indicator of economic sentiment, which summarizes the cyclical point of economic activity, was at its highest since the crisis of 2008-2009. From this point on, the indicator started to enter a more volatile phase, embarking on a noticeably downward trend from the second quarter of the year and even more clearly in July and August.
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Economic growth figures for the second quarter, recently published, have confirmed the diagnosis suggested by the economic sentiment indicator: emerging Europe is completely immersed in a phase of slowing activity. Given this situation, the immediate question is whether this trend looks like continuing. With the information currently available, the answer is in the affirmative.
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...which, added to the downturn in the euro area, means that its growth forecasts for 2011 and 2012 must be revised downwards.
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Firstly, the indicator's rate of decrease suggests that the decline in the economy is gaining in intensity, so that this process is unlikely to end suddenly. Moreover, if we consider that the main reason underlying the loss in economic dynamism is the economic downturn in the euro area, the main destination for the region's exports, then we must also rule out any fast improvement in this area, as current forecasts point to growth in the euro area over the next few quarters being less than had been expected before the summer. All this points to the need to revise downwards the economic growth forecasts we were applying for emerging Europe.
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Necessarily involved in this downward revision are national factors that, in themselves, lie behind the current cyclical situation of the five economies in question. Given its economic weight and recent good performance, it is appropriate to begin our analysis with Poland. Unlike its neighbours, Poland is still benefitting from a more dynamic domestic demand, a trait that gives it more leeway to withstand weakening exports. This explains, for example, why its economic growth remained unchanged in the second quarter. We believe this inertia will continue for some time and that it won't be until 2012 that the slowdown in activity will make its presence fully felt. A certain adjustment in fiscal policy will also contribute to this lower growth, very necessary after years of relaxation in this area. In short, we expect Poland to grow by 4.0% in 2011 and afterwards by 3.3% in 2012.
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This revision is little in the case of Poland, protected by a resistant domestic demand.
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The Czech Republic and Slovakia, however, are already suffering from a decline in their exports. For both countries we have notably revised downwards our growth forecasts for 2011 and 2012. In the case of the Czech economy, we now expect GDP to remain stuck at a growth rate of just above 2% annually for both years, while in the case of Slovakia this will fluctuate around 3.5% (above, in 2011; below, in 2012). As a reference, it should be noted that, before the summer, we expected the Czech Republic to grow in the region of 3% and Slovakia by 4%.
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In the Czech Republic and Slovakia, the brake on exports has worsened their prospects.
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Nonetheless, the least advantageous economic situation will be the one suffered by Hungary and Romania. These two countries have stumbled upon unfavourable international financial developments just as it seemed that the worst of the fiscal adjustment from years before lay behind them. In the case of Romania, Greece's financial tensions have had a notable effect, as suggested by the rise in country-risk indicators. This is a logical precaution taken by investors as the country's financial links are appreciable (especially through the significant banking presence of Greek banks).
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In the case of Hungary, the punishment being doled out by investors is down to a different reason, namely the loss of credibility suffered by the country's fiscal policy over the last year and a half. This erosion has come from the combination of a communication policy that has sometimes surprised investors, economic policy decisions that are not very propitious for long-term growth (the most recent, a measure that would allow bank credit granted in foreign currencies to be paid off in advance at an exchange rate that would notably penalize financial institutions) and its difficulties in accomplishing the budget control plans announced (more due to negative economic developments than public apathy, it must be said).
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Hungary and Romania are forced to carry out further fiscal adjustment measures, a situation that will hinder their growth in 2012.
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Within this context of certain financial punishment and an economic scenario that is increasingly less propitious, the response of both countries must include reinforcing fiscal orthodoxy by means of restrictive fiscal policy for 2012. This measure is necessary but will hinder the growth expected. Should our scenario come about, Hungary would grow slightly above 1% in 2011, picking up marginally in 2012, while Romania would go from growth scarcely above 1% in 2011 to somewhat above 2% in 2012. In conclusion, emerging Europe seems to have embarked upon a phase of slower growth for the next few quarters. Nonetheless, and to end on a less circumspect note, we should be consoled by the fact that inflation, which had clearly become threatening in the first half of 2011, is now moving away from alarming levels. At least, although the slowdown might strangle the economy, inflation shouldn't suffocate it.
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