The reform fatigue that has paralysed Central European economies in recent years could spell disaster for the region if the global economic climate takes a turn for the worst, analysts have warned.
Following the release of a report by Standard and Poor’s yesterday highlighting the region’s flagging credit quality, Frank Gill, credit analyst at the ratings agency, said that time is running out for Hungary , Poland , Czech Republic and Slovakia to put their fiscal houses in order.
“These countries have been leveraging in good times but are not seeking to improve their underlying fiscal position,” he said. “They need to follow pro-cyclical fiscal policies, because if there was an external shock such as a Eurozone slowdown then you will see the region greatly suffer.”
The report slammed the state of public finances in the region and the poor policy responses which will see all four new EU entrants flout Maastricht deficit targets of 3% GDP. The agency noted that there has seen been very little appetite for structural reforms following elections across the region.
The central concern is how the region will cope with a spike in global risk aversion. Lars Christensen, senior analyst at Denmark 's Danske Bank noted that although budget deficits in the region are helped by low interest rates, “the major risk is how these countries would react in a global volatility shock. High bond yields will lead to pressure on their currencies leaving the region’s major financing requirements dangerously exposed.”
Christensen also noted that populist agendas were taking precedence over structural reform in all four countries. “In general windfall gains and higher growth which has allowed loose fiscal policies,” he said.
He noted that the EU was no longer a spur for reform. Moreover, a benign global backdrop has blinded politicians to the risks of inaction, he said: “There is a general feeling that we have arrived where we wanted to get and it is hard to convince people to do more.”
Christensen said Slovakia ’s example is indicative of the reform fatigue in the region. “ Slovakia is keeping up the reform rhetoric but keeps on taking a step backwards. Privatisation is going back, labour unions are strengthening, and regulation is increasing.”
The S&P report drew attention to Poland , where despite a manageable headline deficit, the impact of policy remains a key risk. “The PLN 30 billion state deficit cap will prove very unhelpful (and tempting to overshoot) in the event of a downturn,” Gill noted.
The analyst also cited moves by Polish authorities to accelerate the indexation of pensions, the absence of offsetting measures to fund proposed cuts to social security contributions and poorly targeted social transfers (the proposal to hike pro-family benefits) as unhelpful.
Nevertheless, the report notes that Hungary is on course to continue its fiscal consolidation reform program through 2008, despite a weakened government.
Christenson, however, was sceptical of the country’s progress: “ Hungary is one of the countries that have done something because their reforms are several years behind the others [CEE-4]. But despite their best efforts it may be too little to late: if the global environment changes soon, Hungary could be in real trouble.”
Hungary 's budget shortfall could reach 4.9% of GDP as opposed to the planned 4.3%; Poland 's budget gap could hit 3.3% against the planned 3.1%; and the Czech Republic 's deficit could notch up to 3.6% of GDP above the planned 3% this year, according to the European Commission.
Despite the reform fatigue, S&P notes that the region will continue to enjoy solid growth rates with Slovakia growing fastest at 7% this year. Hungary ’s growth is expected at a paltry 2.4% this year as the austerity program kicks in.