Eastern Europe slowdown warning belies recession risks
The European Bank for Reconstruction and Development forecasts 3.1% GDP growth in the region in 2012, but warns that any worsening of the eurozone crisis could trigger recession
Economists have always been fond of scenarios. But the extreme uncertainty hanging over the eurozone, and the global economic outlook as a whole, has prompted number-crunchers to map out dozens of hypothetical outcomes for 2012.
These have ranged from wildly optimistic best-case outcomes (the eurozone crisis is fully resolved, US growth surprises to the upside, Chinas economy continues on a very-soft landing trajectory) to the doomsday scenario (disorderly breakup of the eurozone triggering a renewed global financial crisis, European and US recession, Chinese hard-landing).
Within this range of possible outcomes, the baseline scenario should be that which the forecaster believes is most likely to occur. If this is the case, then the European Bank for Reconstruction and Development (EBRD) appears to be looking at the eurozone crisis through somewhat rose-tinted spectacles.
Although the development bank has revised down its growth outlook for central, eastern and south-eastern Europe in its latest Regional Economic Prospects report, published this morning, the headline growth forecasts remain surprisingly resilient.
Under its baseline scenario, the EBRD is forecasting 3.1% GDP growth across its 29 countries of operation in 2012, down from 4.8% in 2011, with all but two Hungary and Slovenia posting positive GDP growth this year. By region, it now forecasts growth in central Europe and the Baltic at 1.4% this year, down from its previous forecast of 1.7%, published in October 2011; southern and eastern Europe growth at 1.0%, down from 1.6%; eastern Europe and the Caucuses at 2.6%, down from 3.2%, and Ukraine at 2.5%, down from 2.5%. Its GDP growth forecasts for Russia and Turkey 4.2% and 2.5%, respectively remain unchanged from its previous forecast.
So far, so relatively benign (at least in view of the risk backdrop and last week's stark recession warning from the World Bank. But a closer read reveals what the bank is assuming as its baseline scenario:
|The projection assumes a baseline scenario of a slow and uneven progress towards containment of the current turmoil. The Euro areas GDP is projected to decline by 0.5 per cent in 2012, implying mild recessions in the first half of the year, due to the short-term impact of fiscal adjustments and a period of instability both for the governments on the Eurozone periphery and the financial sector across the currency union. Real activity will suffer as credit growth declines, yet avoids a crunch thanks to the more accommodative monetary policy stance of the ECB. |
As in 2008-09, international coordination between governments, international agencies and banks, most likely in the context of a new Vienna 2.0 framework, is assumed to manage the deleveraging process and forestall disruptive moves by individual bank groups or governments.
Clearly the EBRD is not alone in assuming such an outcome. The market rally during the first few weeks of 2012 suggest that many market players are now banking on a similar outcome in which eurozone leaders muddle through to a resolution, buoyed by the ECBs deep pockets. As such, it is perhaps unfair to criticize the EBRD for using this as their base case.
But there is plenty of evidence to suggest that the outcome could well be very different to this.
To name but a few: Greek debt talks appear to have hit an impasse and even if they do reach agreement, will do little to improve Greeces fiscal or growth crises beyond the immediate term; there are mounting rumours that Portugal may require a second bailout; Spain and Italy already appear to be in recession by many economists reckoning; much of Western Europe, as well as the EFSF faces a major risk of multiple credit rating downgrades this year; European banks are struggling to raise additional capital and, as the EBRD readily acknowledges elsewhere in the report, there are clear signs that significant deleveraging from central and eastern Europe is already underway; these banks failed to attend talks earlier this month aimed at drawing up a new Vienna 2.0 framework, amid growing signs that they are much less willing to guarantee support to their CEE subsidiaries than they were in 2008-9 ... the list goes on.
In fairness, the EBRD acknowledges all of these substantial risks in the 30-page report.
To quote from the Outlook and Risks section:
|Any worsening of the situation beyond the baseline assumptions will have serious negative consequences for growth across the entire transition region. In a downside external scenario largely unchanged from last October, the Eurozone troubles become much worse before they are ultimately resolved. In particular, the crisis is not contained before spreading to larger single currency area members, which in turn may render several large European banks insolvent. Major parent banks would accelerate deleveraging in the region, triggering a credit crunch and recession in emerging Europe. Nation-based policies would intensify and left uncoordinated, with significant negative cross-border spillovers.
This scenario implies a prolonged market turmoil and a severe western European recession with negative spillovers for the global economy, resulting in a standstill in the US and subsequent lower commodity prices. A negative Eurozone crisis scenario would affect especially CEB and SEE countries via the same channels as in the baseline, including depressed exports and FDI and financing inflows, only more severely.
Credit crunch and recession? Suddenly, the outlook appears much, much less benign.
And, as if to underline the fact that the EBRDs baseline scenario in fact seems to resemble what most observers at this stage would call best-case, the baseline is right at the top end of probable outcomes, even by its own assumptions. The baseline scenario is right at the top end of the 50th percentile of probable outcomes for 2012. At the bottom end of the 50th percentile: outright recession across the EBRDs countries of operation (see chart).
All of which is not to sound overly gloomy. There is a good chance that events in the eurozone play out according to the EBRDs baseline. But there is a good chance that they do not, and the risks appear almost entirely to the downside.
If the latter scenario plays out, then we may look back on the headline of this EBRD report, Eurozone Crisis Takes the Steam out of Emerging Europes Recovery, as a quaint relic of a pre-recession era.
Regional Economic Prospects in EBRD Countries of Operations: January 2012 the full EBRD report
Message from Vienna: time is running out
CEE: hostage to eurozone fortunes
World Bank issues emerging market recession warning