Conventional wisdom used to be that in Central, Eastern and South-Eastern Europe, the countries closer to the eurozone (or already in it), had the best prospects, those to the south-east were catching up somewhat but were still lagging, Turkey was clearly the standard-bearer for growth.
Now only the last part of that argument still holds true: Turkey, with its exports diversified away from the eurozone to the fast-growing countries in the Middle East, Africa and Asia, its unorthodox monetary policies and weaker economic and banking links with the European Union, is still the darling of investors and analysts. But when asked about the rest of emerging Europe (apart from resource-rich Russia and the Commonwealth of Independent States), analysts cannot agree on which countries have the best (or worst) outlook.
Benoit Anne, head of emerging markets strategy for Société Générale, is, in his own words, “not very sanguine” about growth in emerging Europe. “This year continues to be a year of downside risks, especially in the context of the eurozone showing no signs of tangible recovery,” Anne tells Emerging Markets. “The eurozone is entering a recession, and while we were betting on a recovery trajectory earlier this year, this has not materialized. This economic crisis is dragging on, and it is really putting some risks on Central Europe.”
He says the crisis has now caught up with Poland – initially the most resilient country and the only one in the region not to have recorded a recession in the dark year of 2009. But a “significant softening” of data in Poland has Anne worried, although he still hopes that “we will see some turnaround in economic activity” later in the year.
“As usual, I think the more open economies are facing the brunt of the economic shock; that would be the Czech Republic and Hungary,” Anne says. However, he is more optimistic on Romania and Serbia, which he believes “are on a different trajectory, and they are less vulnerable to swings in investor sentiment.
“I like the environment in Serbia, and I like the fundamentals story in both Romania and Serbia: they’re doing the right thing; they’re trying to get an IMF programme back on track or back on the table. In Serbia there are some major developments with Kosovo that might pave the way for the initiation of discussions with the EU. These are really good signals,” he says.
Peter Attard Montalto, emerging markets economist and strategist for South Africa and emerging Europe at Nomura, sees things the other way around. In terms of potential for pent-up demand, he sees Poland as having big chances on that front, as well as the Czech Republic, which would pause its fiscal consolidation drive to encourage economic growth, according to remarks by Finance Minister Miroslav Kalousek to Reuters at the end of last month. The northern emerging European countries, which are much more exposed to Germany and countries in northern and western Europe, benefited from much more external demand support, and those countries are recovering marginally faster, Montalto tells Emerging Markets. “Countries more exposed to the [eurozone] periphery and southern Europe, such as South-Eastern Europe in particular, see a much slower recovery.”
While Hungary “is very much held back by domestic policy choices”, Romania, Serbia and soon-to-be new EU member Croatia have “a lot of deleveraging, a lot of structural reform to do”, he says.
STRIKING BACK
Deleveraging by western European banks that expanded rapidly in the region during the boom years is indeed the biggest headache for policymakers in emerging Europe. Few countries – Turkey, the Czech Republic and Poland among them – can say they escaped relatively unscathed.
The boom-bust experience of the 2008–09 recession in the region has shown, for banks, “the inferiority of the fully centralized approach of international banking”, according to a new IMF paper published in April under the title The evolving role of banking systems in Central, Eastern and South-Eastern Europe. Before the crisis, western banks would pour funding into their credit-hungry eastern subsidiaries, which would then lend it on to individuals and companies at much higher interest rates than in western Europe – therefore reaping much larger rewards but running higher risks. However, “the more decentralized approach is now taking hold, with subsidiaries much more self-reliant in terms of funding,” the IMF paper says.
Policymakers in the region have started to take measures to prevent foreign funds from retreating too fast, which could cause big problems to their economies – but these measures can actually hinder economic growth, Herbert Stepic, the CEO of Raiffeisen International, the second-largest bank in CEE, tells Emerging Markets. After a “very liberal” regulatory environment in the two decades since the fall of communism, “the regulatory pressure is overwhelming and is hindering banks from concentrating on their normal business,” he says. His bank, which is present in 18 countries in the region including Austria, is “burdened” by regulation, sometimes being “double or triple taxed”, as it has to “pay specific banking taxes out of our already taxed results, which of course is not very advantageous [when it comes] to building your own capital base.
“So I would say the [regulatory] pendulum is striking back vigorously and very cruelly, and we have to mainly concentrate our activities to meet regulatory requirements, and we cannot concentrate on doing our normal business,” Stepic says.
This situation, says Aasim Husain, deputy director of the IMF’s European department, can be solved by policymakers’ efforts to “facilitate an orderly transition to a more stable funding model”. The introduction of an integrated European financial system would reduce swings of foreign funding, would improve cooperation between home and host countries for multinational banks, and would ensure more extensive recourse to a coordinated macro-prudential policy in the region, according to Husain.
Another measure that policymakers across the region could take to “at least partly offset the economic headwinds” would be to tackle the thorny issue of non-performing loans in the region, which in some countries have still not peaked, he says. Governments could do that by removing legal obstacles that hinder seizing collateral for loans that have gone sour, relaxing rules on the execution of such collateral or changing the tax treatment for the loans, Husain adds.
IMITATING TURKEY
But despite the relatively bleak picture, some countries in emerging Europe are advancing towards a recovery of their own, taking a leaf out of Turkey’s book when it comes to foreign trade. Research published in mid-April by the biggest bank in the region, UniCredit, shows “some impressive diversification of export partners”. The countries have started to trade more among themselves, Russia’s share of trade has grown dramatically for some of them since the onset of the crisis, and “there are signs that industry has reached bottom and is beginning to edge higher.”
Another research paper into the issue, by Société Générale, also shows diversification of export markets and products in some countries, but warns that failure to improve competitiveness could be a “hidden menace” for some economies in Central and Eastern Europe. In Poland, the research shows, the share of exports to Germany fell from 34.5% in 2000 to 25.1% in 2012 although it has remained relatively constant during the crisis. Since 2007, the share of exports to Russia and to other countries outside the eurozone and the EU has increased slightly. The kinds of products that Poland sells abroad have diversified as well, with food exports increasing in terms of value as a result of “modernization and significant investment in food-processing plants”, with the most modern being dairies and meat processing plants. Reliance on food exports means Poland is less exposed to cyclical swings, as this category is more likely to be among the last to be cut by consumers in the event of an economic downturn.
For the Czech Republic, “Asia and especially China are getting to be more popular markets”, but the share of developing countries in its overall exports is still relatively small, and diversification of products is not that great, the research shows. Slovakia, heavily dependent on the highly cyclical electronics and auto sectors, still relies mostly on exports to Europe, but there is “a gradually rising interest, especially from Asian markets”, in its foreign trade. Romania has a low degree of trade openness relative to regional peers but the most diversified exports in terms of products, according to Société Générale; although most of its exports still go to the EU, Romania’s exports to emerging Africa have grown more than two-fold compared to 2007, and exports to Russia “accelerated substantially” in the period.
The Société Générale analysts looked at different competitiveness measures to gauge how six countries in CEE have fared in terms of competitiveness since the beginning of the global financial crisis. The measures included the real effective exchange rate (REER), the current account deficit or surplus as a percentage of GDP, the competitiveness ranking according to the World Economic Forum and the share of the world export market. In their ranking, Romania seems to have improved the most over the period, followed by Poland, Bulgaria and Hungary; the Czech Republic and Slovakia actually lost out in terms of competitiveness during the period.
But the timid diversification of exports away from the eurozone noticed by some analysts is not enough for these countries to break free from the risks they still face because of the crisis in the single currency area. “Of course a diversification of the export structure would be advantageous for the countries in Central and Eastern Europe,” Stepic says.
But for that they would have to break through into remote locations such as China, south-eastern Asia or the US in a meaningful way. “That is still difficult,” Stepic says. “There is a big difference between organizing your exports into neighbouring countries on the same continent, in contrast to conquering countries in the Far East or the US. Usually, that takes years.”
While admitting that over the short term the outlook for Central, Eastern and South-Eastern Europe is not very bright because of the troubles in the eurozone, Stepic is upbeat over the longer term and says his bank is still pursuing opportunities for growth, mostly organic, in the region. “If I compare having Eastern European assets in my book, in contrast to other European assets, I’d rather have Central and Eastern European assets. That is why the performance of RBI was much, much better than most of our peers’,” he says.
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