Fitch Ratings says in its first emerging Europe Sovereign Review issued today that the region is relatively well placed to absorb the impact of deteriorating global economic and financial conditions.
The report, issued to coincide with the forthcoming EBRD meetings, explores the outlook for the region's economic growth, as well as external financing needs and market risks, and highlights the improvement in sovereign creditworthiness witnessed in recent months. It also looks at the process of real economic convergence, outlines key country-specific developments and takes a closer look at flat taxes and the forthcoming French referendum on the EU Constitution.
The global economic environment is looking less supportive in 2005 for the emerging European countries, and while Fitch continues to expect a global soft landing from last year's near-record growth, the risks are on the downside. Much of the euro area did not share in the fast global growth of 2004 and there is little indication of improvement in 2005. This does mean that there is no pressure on the ECB to raise interest rates, even if US rates continue to move up as Fitch expects. But the risk remains of a more aggressive correction of the US dollar, which could trigger more dramatic US interest rate changes and increasing risk aversion. This would have repercussions for many of the countries within emerging Europe. Signs of growing risk aversion are already increasing, with US high-yield and emerging market assets undergoing some correction in recent weeks.
Emerging Europe seems well placed to navigate these tougher global economic conditions. Growth will slow relative to 2004, but should remain a fairly solid 5.2%. A soft landing for the global economy will support continued strong oil and commodity prices, underpinning favourable developments in the CIS. Central Europe will see growth decelerate as the euro area disappoints, but activity will nonetheless be respectable as export market share expands and investment improves. The second-wave EU accession countries should enjoy solid growth, driven by robust investment and consumer spending.
Emerging Europe is relatively well insulated from a more difficult external financing environment. External financing needs are moderate for many and well supplemented by foreign direct investment (FDI). Planned external sovereign bond issuance is similar to 2004 levels, and over 75% had already been carried out by early May. Large current account deficits across many of the second-wave countries raise some medium-term concerns, necessitating measures to raise private sector savings, but Fitch is not overly concerned at this stage. Strong non-resident participation in local government debt markets in countries such as Hungary, Poland and Turkey potentially heightens their vulnerability to rising interest rates and risk aversion. Poland, however, is supported by an improving macroeconomic situation, though Hungary, which continues to run sizeable twin deficits, is at some risk of financial market volatility. Turkey is the most vulnerable in view of the large current account deficit, reliance, albeit diminishing, on external debt financing and heavily-indexed government debt.
Despite the obvious risks, emerging Europe sovereign credit fundamentals continue to improve. There have been seven rating upgrades since September 2004 (three to investment grade), while six countries are on Positive Outlook. The emerging Europe region now enjoys an average (un-weighted) credit rating of 'A-'(A minus).