2012 – Eastern Europe will suffer from the euro zone recession

Posted on 07/01/2012 by


The recovery in east European economies is losing impetus. Growth in many countries in the region has slackened since the first quarter of 2011 and is expected to weaken further in the fourth quarter. Exports and industrial output are still growing, but at much lower rates than earlier in the rebound. The impact of renewed global turmoil would be less severe on these countries than in 2008, as most have closed or considerably reduced large external imbalances. However, the troubles in the euro zone have begun to jeopardise the recovery in eastern Europe. Currencies and stockmarkets across eastern Europe have suffered sharp falls in recent months. Business and consumer sentiment in the region is fragile, and its currency and bond markets are vulnerable to further contagion from euro zone turmoil and heightened risk aversion. A credit event involving the Spanish or Italian markets would hit banking sectors across the region through the impact on west European parent banks. The 2012 recession that we forecast in the euro zone, eastern Europe’s key export market, will take a significant toll on the region’s growth.

Euro zone plans to strengthen their banks’ capital adequacy ratios pose an especially serious threat to countries in eastern Europe. Most banks in the region are owned by financial institutions in western Europe, which will be required to produce significantly higher capital ratios to weather the threat from defaults of sovereign bonds. Euro zone banks are expected to do this through a mixture of fund raising, asset sales and reduced lending, which, according to the European Bank for Reconstruction and Development, would lead to “considerable deleveraging” in central and eastern Europe, along with “disinvestment” as euro area banks sell or close their subsidiaries in the region.

Within the region continued progress on balance-sheet consolidation will provide some support for recovery, as will slowing inflation. Higher inflation in 2011 has dampened the fragile recovery in private consumption, although the rise has been muted in comparison with other emerging regions, as demand is weak, unemployment high and there is still some excess capacity. However, the negative impact of the euro zone crisis will be greater and we now expect growth in the transition economies to slow from 3.5% in 2011 to 2.3% in 2012, with risks firmly on the downside. Final demand in euro zone trade partners will contract, and there is now even less prospect of a strong rebound in foreign direct investment and external bank loans. Credit conditions, which had been recovering, will tighten again. There is a risk of a renewed credit crunch in the region owing to financial strains in west European parent banks. This would hit growth prospects further and raise the spectre of another recession in eastern Europe.

In addition, the question of the sustainability of public debt continues to loom large. The economic crisis revealed structural weaknesses in public finances, and budget deficits widened sharply. Fiscal consolidation is well under way, but might have to be accelerated as market sentiment towards the region sours. Concerns remain about the impact of the financial and economic crisis on medium-term growth potential, and expansion in 2013-16 will remain slow by pre-crisis standards, at an average of 3.8% annually.

Poland is more vulnerable than in 2009 and Hungary’s weak recovery will falter.  Poland has again been one of the EU’s strongest performers in 2011, growing by 3.8% in 2011, but we forecast much slower growth of 1.5% in 2012. Lower exposure to international trade than other countries in the region reduces its vulnerability to external developments, and it was an exception to the region’s poor performance in the last downturn. However, this time round the government is pursuing fiscal austerity rather than fiscal stimulus, owing to the large budget deficit. Recent large inflows of portfolio capital are resulting in some volatility as market sentiment turns. In 2013-16 growth will strengthen, but will still be slow by pre-crisis standards, reflecting continued high unemployment and tighter government spending. Slovakia’s large automotive sector has been performing well, but fiscal austerity and weaker external demand will limit growth to 0.8% in 2012, following growth of 3% in 2011. The Czech Republic’s recovery is proving sluggish, owing to subdued prospects for its more diversified exports in its mainly west European markets and fiscal austerity. Growth will slip to 0.5% in 2012, from 2% in 2011.

In Hungary, notwithstanding some revival in consumer spending, weakening external demand and investor sentiment mean that the economy is forecast to tip back into recession in 2012, after weak growth of 1.5% in 2011. Despite progress on correcting budget and current-account deficits, Hungary continues to face strains because of high foreign-currency debt exposure—for both Hungary and Poland a high share of Swiss franc borrowing has created problems because of the elevated value of the safe-haven Swiss currency. Levies on large corporations in the financial, retail, energy and telecommunications sectors and the diversion back into the state budget of employees’ contributions to private pension plans until the end of 2011 have raised concerns. Although the government is likely to maintain a restrained budget stance, its policies have left it particularly vulnerable to worsening sentiment.

The Baltic states are posting robust rates of growth in 2011 as they continue their rebound from deep recessions in 2009, with Estonia and Lithuania growing by around 7.3% and 6% respectively—likely a post-crisis peak for the forecast period for these countries—and Latvia by 4.6%. %. Growth will slip back to around 2% for the group as a whole in 2012. Latvia has made progress on “internal devaluation”, cutting wages and costs, which has reduced the risks to its currency peg to the euro. Estonia joined the euro zone in January 2011, but wide fiscal deficits, and perhaps inflation, will rule out meeting the criteria for euro zone entry until at least 2014 for Lithuania and 2015 for Latvia, with a strong chance of further delay.

The Balkans have returned to growth, albeit weak, in 2011. However, continued external imbalances mean that a number of Balkan economies remain vulnerable to a new global crisis. The Balkan countries are also significantly exposed to fallout from Greece’s problems because of investment, trade, and remittance and banking links. Romania faces tough austerity measures; we expect only 2% growth in 2011, slowing to 0.5% in 2012. Resistance to cuts could create instability. Bulgaria is likely to stagnate in 2012 after a modest expansion in 2011. The lev’s peg to the euro has limited policy flexibility, forcing it to maintain a tight fiscal stance.

Russia’s growth will remain below pre-crisis standards. Russian growth prospects will continue to depend on world commodity prices, especially for oil and gas. Although elevated international oil prices are favourable for Russia, investment has been sluggish, and we expect GDP growth of 4% in 2011. Growth will slip to 3% in 2012 as oil prices fall, although election-cycle spending will provide some support. Given structural problems, growth will stay below pre-downturn levels in the medium term. Impediments to faster growth include sluggish energy output growth, a weak banking sector, insecure property rights, a low share of fixed investment in GDP and bureaucratic interference. Russia was the hardest hit among the G20 economies by the crisis of 2008-09, in part because of its heavy dependence on oil and gas. But it also suffered because of the presence of considerable financial leverage and a lack of readiness for the impact of the unexpected credit crunch. Now, banks and non-financial corporations are less extended, which means that Russia would suffer less badly in another downturn.

Steel exports and a good harvest boosted the Ukrainian economy in 2011, with growth estimated at 4.7%, but it is set for much slower growth in 2012, forecast at 2.5% owing in part to weaker steel prices. Ukraine remains vulnerable to an external financing squeeze and may be forced into an even more severe slowdown in order to rebalance its burgeoning current-account deficit.

Sursa: The Economist Intelligence Unit