CEE Financial Economy: Taking Stock

13/05/2010 | Sid Verma

For emerging Europe’s politicians, the task of recovering from recession just got harder. A sovereign debt crisis in the eurozone could derail the region’s return to a degree of economic and financial stability

This time last year, emerging Europe was teetering on the edge of an abyss.

Although global authorities acted swiftly to put a floor under the crisis, which hit the region disproportionately hard, growth looked set to languish for years ahead as debt-burdened businesses and households struggled to regain composure, and western European demand for the region’s exports crumpled.

Then came a new year, and with it seemingly brightening prospects, in part thanks to a world economy on the mend, but also on account of a raft of belt-tightening measures taken by authorities across the region.

The IMF predicted in April that central and eastern Europe will grow by 2.8% in 2010 and 3.4% in 2011 – more than the US and the eurozone, though still lower than most other emerging regions.

Manfred Schepers, vice-president at the EBRD, notes that although much of the region has experienced “political crises or change amid serious economic troubles”, government policies have “very proactively tackled the economic problems, nonetheless”.

Capital has been pouring in, coming to the rescue of public- and private-sector borrowers while freeing central banks to cut interest rates without causing runs on their currencies. Thanks to IMF bailouts and the so-called Vienna Initiative, whereby foreign lenders vowed not to abandon their regional subsidiaries, not a single foreign bank has so far pulled out.


But for emerging Europe’s politicians, the task of recovering from recession has just become trickier.

Global markets have been battered in recent weeks by worries that Greece’s debt crisis could spiral out of control and that eurozone sovereign debt burdens are similarly unsustainable. And fears are now growing that contagion will spill into emerging Europe.

To date, markets had begun embracing the region’s sovereign borrowers once more, thanks to a resurgence of cheap global liquidity and general perception that central Europe’s levels of government debt to GDP are manageable.

But markets may soon start demanding higher risk premiums for many eastern European countries with large deficits, led by Hungary, Poland and the Baltic countries, says Julian Jacobson, an emerging markets fixed-income portfolio manager at Fabien Pictet & Partners.

Provided the Greek crisis doesn’t cascade into a broader calamity for the eurozone, eastern European governments may be able to ride out the volatility in the near term, thanks largely to having front loaded much of their sovereign borrowing needs for the year.

But the threat of a collapse in cross-border bank lending could return to haunt the region once more. Greek banks hold 30% of the Bulgarian banking system and have significant exposures in Romania and across the region.

If Greek – or western – banks recall funding from their cross-border subsidiaries, especially in the event of a eurozone debt crisis, the supply of credit to region, not to mention its currency stability, could be imperilled.

A fiscal crisis in western Europe could also delay – or even scupper – eurozone convergence for the region, assuming the single currency area survives, as governments deal with fires in their own backyards.

The eurozone crisis, no matter its scale, is likely to affect euro adoption plans in Estonia and especially Latvia, where an IMF adjustment programme hinges on speedy euro adoption.


For now, market consensus does not foresee a dramatic slowdown in eurozone growth in the wake of a proliferating Greek crisis.

David Lubin, chief EMEA [Europe, Middle East and Africa] economist at Citigroup, says that in the grip of the crisis last year, many commentators tarred much of emerging Europe with the same brush, despite the diversity of economic systems and growth models.

He notes that Slovenia and Slovakia are in the eurozone whereas the Czech Republic and Poland avoided a debt-induced hangover unlike their Baltic counterparts that binged on cheap credit during the bull run.

Moreover, high government debt burdens in western Europe stand in contrast to relatively less indebted eastern Europe as a whole – despite the negative taint from debtor nations such as Hungary, which has led to a widespread perception of the region as chronically indebted. Hungary’s projected government debt to GDP is at 80% in 2011, whereas the average for emerging Europe as a whole is closer to 40% on average.

But Lubin notes that the region’s healthier state of public finances relative to western Europe should serve to discredit emerging Europe’s doomsayers.


While spending cuts and wage freezes have sparked riots in Greece, emerging Europe has, in general, bitten the fiscal bullet.

Michael Marresse, head of economic research and strategy for emerging Europe at JP Morgan, says that decisive government action has helped stem the bleeding in much of the region. “In many cases, countries such as Hungary did the heavy lifting before the global crisis intensified, and governments have introduced an enormous number of public service cuts,” he says.

The Hungarian and Latvian governments have argued that unpopular cuts – at least in the near term – are needed to bolster investor confidence. Romania, Serbia and Bulgaria, among others, have frozen public-sector wages and pensions, while controversial layoffs of public-sector workers have caused outrage among the public across the region.

Whatever the case, the fact remains that governments are now waking up to the post-crisis reality. Across the region, growth rates have dropped significantly relative to pre-crisis levels. Meanwhile, lower productivity growth compared to Asian competitors and a prolonged period of subdued western consumption are likely to weigh heavily on growth prospects for years to come.

What’s critical now – for market confidence as well as sustainable growth – is that economic authorities look to their home turf for new opportunities. Says the EBRD’s Schepers: “Governments now need to pursue domestic driven growth, through the creation of local pools of equity capital, better social security and infrastructure investment.”

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