In a new report on the prospects for its countries of operations, the EBRD downgraded its growth estimates for the region - which includes Central and Eastern Europe and the Balkans, Russia and Central Asia and four countries in the Southern and Eastern Mediterranean – to 2.7 percent for this year and 3.2 percent for next year, from 3.1 percent and 3.7 percent it had forecast in May.
The EBRD’s slashing of its growth estimates for Russia to 3.1 percent this year from the previous forecast of 4.2 percent and to 3.3 percent for next year, a full percentage point lower than its prediction in May, was the main driver for the deterioration of the region’s outlook.
“Growth in countries across the transition region slowed down markedly as a result of the widening spillovers from the eurozone crisis,” the EBRD’s report said.
In European Union member states in Central Europe, most countries saw slower expansion, with only Poland and Slovakia “the two brighter spots in the region, with continued healthy growth as their first-quarter performance surprised on the upside,” the bank said.
The bank slightly upgraded Poland’s growth prospects for this year to 2.9 percent from the 2.7 percent it was forecasting in May, and Slovakia’s to 2.6 percent from 2.2 percent.
But it warned that in Poland public infrastructure spending will be reduced because of fiscal adjustments, “just as some social transfers are being scaled back.”
POLAND ‘CANNOT DEFY GRAVITY’
Agata Urbanska, an economist with HSBC, said that Poland “cannot defy gravity.” In a note to clients, Urbanska pointed to the slowing pace of real wage growth and to a downtrend in investment growth as negative factors for the economy’s prospects.
“Falling public investment will be the key factor,” she said. “Given the fiscal tightening plans, public investment growth should turn negative in the second half of 2012 and there is an increasing risk that private investment growth will not compensate for this.”
“Prevailing uncertainty about the health of the global economy is the second key factor likely to weigh on investment activity,” Urbanska added.
In eurozone member Slovakia, growth “remains resilient given additional foreign direct investment in productive capacity,” according to the EBRD report.
But Hungary appears “slightly worse” than expected in the last forecast in May, with the bank now seeing an even deeper recession there – a contraction of 1.3 percent this year versus a shrinking of just 1 percent forecast in May.
The EBRD said contraction in domestic consumption in Hungary is the main factor in the recession this year, while deleveraging by Western-owned banks operating in the region “will further hold back growth.”
“Sentiment in the sector was not helped by a newly-adopted financial transactions tax that adds to the already high tax burden in the industry,” the report said.
‘HIGHLY UNCERTAIN’ PROSPECTS
In mid- July, Hungary started negotiations on getting financial support from the International Monetary Fund (IMF) and the European Union and this can “raise expectations that fiscal and external vulnerabilities would be addressed, though the multiple tax and regulatory issues will pose formidable challenges to an early completion of the discussions,” the EBRD said.
HSBC’s base scenario is that an agreement with the IMF will be reached in the autumn and it will pave the way for monetary easing, to boost the economy.
“However, we remain cautious. One risk scenario is still that the negotiations could drag on. A mix of improvements in the eurozone situation, global risk appetite and Hungary’s economic performance could prompt the government to take a hard negotiating stance,” Urbanska said.
The prospects of countries in south-eastern Europe are “highly uncertain,” with the biggest risk being the financial sector, as the vast majority of their banking system is foreign owned and the countries rely heavily on funding from abroad, the EBRD’s report also said.
“Growth in the region for the whole year is likely to be minimal at best,” it said.
EU member Romania, the biggest in the region, is suffering because of the slowdown in the eurozone and continued deleveraging by Western banks that make up almost all its banking system, but also because of a domestic political crisis which pushed the leu currency to record lows against the euro.
ROMANIA POLITICAL CRISIS
At the beginning of the month, the centre-left parliamentary majority launched impeachment proceedings against centre-right President Traian Basescu, and a referendum will be organized on July 29 to decide whether he will remain in power.
“The impeachment comes in an environment that has raised EU concerns about the rule of law in Romania,” Urbanska wrote. “The government has rushed through changes to electoral law ahead of the upcoming parliamentary elections as well as to the impeachment referendum rules.”
The EBRD downgraded its growth forecast for Romania to 0.8 percent for this year from 1.2 percent in May. It kept its forecast unchanged for EU member Bulgaria at 1.2 percent and it cut the growth outlook for Bosnia and Herzegovina and for Macedonia.
The bank said Turkey was heading for “a substantial slowdown in growth” because of sharply declining domestic demand and spillovers from the eurozone crisis. However it slightly upgraded its forecast to 2.7 percent growth for this year compared with May’s 2.5 percent prediction.
Turkey’s manufacturing PMI data for June showed “a marginal improvement in business conditions, but a sharp decline in new export orders,” according to Melis Metiner, an economist with HSBC.
“As domestic demand is also slowing, a weaker export performance in the second half of the year could pose downside risks to Turkey’s growth,” Metiner said.
RUSSIA OUTLOOK SLASHED
The EBRD’s slashing of Russia’s growth forecast dragged down the outlook for the whole region. The bank said Russian GDP growth would likely be affected by higher inflation and a poor harvest in the second half of the year.
HSBC economist Alexander Morozov said the Russian economy entered “a challenging period” from the second quarter.
“Despite the low level of public debt, Russia cannot use additional fiscal stimuli to boost the economy because of its limited capacity to absorb market debt and the heavy reliance of its budget on high oil prices,” Morozov wrote.
On the plus side, the country should be shielded from abrupt external shocks by solid macro-prudential indicators, with strong public and private debt indicators, banking sector leverage and balance of payment and fiscal accounts, he said.
“Of course, the country is far from being a safe haven, but it appears to be much better off from a macroeconomic perspective than some of its European neighbors,” Morozov pointed out.
“Arguably, a combination of high inflation and subdued growth should be negative for Russian financial markets. However, on a comparative basis, things may not look so negative,” he added.