Emerging Europe: Economic Review June 2011
Thomas White International
July 12, 2011
In an update to its Global Economic Outlook published in April, the International Monetary Fund (IMF) sounded a cautionary note on the global economic recovery due to the slowing growth in the U.S. and the Euro-zone debt crisis. The Washington-based lender said it sees global activity slowing in the second quarter of 2011, though a rebound is expected in the second half of the year. Despite this forecast, the IMF exuded confidence that the strong growth in Germany, Italy, and France would offset the economic slackening in the U.S. and Japan. The agency was also upbeat on Central and Eastern Europe, forecasting a GDP growth in the region that is higher than its April estimates, led by strong growth in Turkey.
Overall, there seem to be no serious concerns regarding economic recovery in countries such as Russia, Turkey, Poland, Czech Republic, and Hungary. In Russia’s case, the big political question of a probable rift between President Medvedev and Prime Minister Putin has been dominating the public space in the last few months. While Putin is widely seen as a champion of the old economic model powered by the country’s rich natural resources, Medvedev has always advocated the need to develop a knowledge-based economy. Though Turkey is bogged down by its booming current account deficit, the re-election of the Erdogan government has ensured that significant changes to the country’s economic policy are unlikely. While inflation still remains a concern in Poland, it remained subdued in Hungary, and just touched the central bank’s target rate in Czech Republic. Notwithstanding the widespread protests against fiscal reforms being implemented in some of these countries, the respective governments are going ahead with the measures that are supposed to benefit these economies in the long run.
At a Glance
- China: In June, the country’s central bank hiked the bank reserve requirement ratio for the 6th time to 21.5 percent. Property prices in nine major cities trended downwards.
- India: The rise in borrowing costs is affecting Indian industry. The number of capital projects put on hold rose substantially causing industrial production to fall 6.3 percent.
- South Korea: Booming export industry helped unemployment fall from 3.6 percent in April to 3.3 percent in May. However inflation jumped to 4.1 percent.
- Indonesia: Headline inflation fell for the fourth straight month in May due to a stronger domestic currency and fuel subsidies. But core inflation inched up to 4.64 percent in May.
- Taiwan: Lukewarm demand from Japan and the U.S. caused export growth to fall to 9.4 percent in May from 24.6 percent in April.
Any development that will have a bearing on global oil prices would naturally be of paramount importance to big energy producers such as Russia. The debate on the impact of global energy prices on the economic recovery has taken a new turn with the International Energy Agency (IEA), which represents the large oil consuming nations, confronting the might of the oil producers’ cartel, the Organization of Petroleum Exporting Countries (OPEC). Though Russia is not a member of OPEC, the decision to release reserve emergency oil stocks by the IEA, which immediately pushed down oil prices by 7 percent, is likely to have repercussions on its economy. However, Russia’s former satellite state Poland seems to be treading a different path, as it seeks to generate additional revenues from licenses issued to big energy producing companies to explore for shale gas in the country.
Russia: Spotlight back on the oil and natural gas sector
The opening session of the St. Petersburg International Economic Forum, Russia’s annual investment conference, appropriately dwelt at length on global energy demand and how it is going to affect the domestic economy. The International Energy Agency’s projection that the European demand for Russian natural gas is stagnating was greeted with shock by industry captains and those at the helm of affairs. Regarding oil, the agency said though a hard landing for the global economy is unlikely, the situation is reminiscent of the oil price shock of 2008. However, more shocking was Russia’s failure to reach an understanding with China over the pricing of natural gas. A price agreement could have opened up a new lucrative market for the Russian state-owned natural gas monopoly in light of the slowing demand from Europe. The discussion once again highlighted the widely held perception that the Russian economy is still largely dependent on its flagship oil and natural gas sector.
Still, the showcase event witnessed the signing of some deals in the auto sector. German carmaker Volkswagen agreed to assemble cars at a facility owned by Russian automaker GAZ. Nissan and Renault also looked set to take a majority stake in Russian car maker OAO Avtovaz. However, Russia’s reputation as an investment destination has taken a backseat, with net capital outflows coming to $34 billion during the five months of the year so far. Making matters worse is the fact that the continuing Euro-zone debt crisis has hindered most of corporate Europe, the major source of foreign direct investment in Russia over the past decade.
On the economic front, Russia’s plans to boost defense spending pose another budgetary dilemma. If the proposal, which has the backing of Prime Minister Vladimir Putin, is accepted, Russia’s budget could be balanced only if oil prices average $115 a barrel, according to the Russian finance minister.
Meanwhile, the successful listings of two Russian Internet companies, search engine Yandex on the Nasdaq and Mail.ru on the London Stock Exchange, reminded investors that there may be more to the Russian economy than just natural resources. The spectacular show by these firms also lends credence to President Medvedev’s plans to develop Skolkovo as Russia’s answer to the Silicon Valley. The Kremlin seems to be serious about building a high-tech city, already enlisting the support of overseas groups such as the Massachusetts Institute of Technology and Cisco for the project.
Meanwhile, Russia’s bid to gain entry into the World Trade Organization (WTO) this year hit another roadblock recently when the country banned the import of vegetables grown in Europe, citing fears of E.coli contamination. Predictably, the protectionist move provoked an angry rebuke from the European Union envoy to Moscow. Russia only recently lifted the ban on grain exports, which was imposed last year in the wake of the country’s severe drought.
Turkey: Vote for continuity in economic policy
Turkey’s election results came along predicted lines with the Erdogan government receiving a nod of approval. This seems to be good news considering the fact that the administration has been credited with steering the economy in the right direction. However, economic challenges facing the country are too big to be ignored. The country’s current account deficit touched $64 billion or about 8 percent of the GDP in April. Going by the trend, as an FT report points outs, the figure is likely to reach the range of $70-$75 billion by the end of the year, which would be over 9 percent of the GDP. The article notes that to bring down the current account deficit to the sustainable levels of between 5 to 6 percent of the GDP, the country would have to endure several quarters of slow growth. However, at this stage of the country’s economic recovery, reversing the growth strategy may be a sort of political suicide for the Erdogan government.
The Turkish central bank decided to leave interest rates low despite soaring inflation levels, which touched 7.2 percent in May compared to 4.3 percent in the previous month. However, the central bank is expected to heed the growing demand for raising interest rates and tighten fiscal policy toward the end of the year. Turkey is already reeling under scorching domestic demand, aided by a credit boom, sparking fears that the economy may be headed for a hard landing.
In what is widely perceived to be a subtle sign of a robust economy, Turkish retail major Migros Turk recently sold off its discount store chain SoK for $382 million to a consortium that consisted of another Turkish food manufacturer and some foreign investors. The deal was also an indicator of the increased investor interest in Turkey’s fast-growing retail sector.
Poland: Fourth rate hike in a year
As expected, the Polish central bank raised interest rates for the fourth time this year to 4.5 percent in June in response to the rising inflation levels that touched an annual 5 percent according to the latest data. The central bank governor hinted that the bank may take a pause to assess the impact of rate hikes on the economy. According to data from the statistical office, the economy grew 4.4 percent year-on-year in the first quarter. However, the economy minister changed his tune when he said the rate hikes may be harmful for the economy, and probably were not necessary now as Russia’s ban on vegetable imports from the EU is likely to bring down food prices.
Polish retail sales growth slowed in May, kindling hopes that the central bank will not raise interest rates further in the coming months. On a year-on-year basis, sales rose 13.8 percent in May, compared to an 18.6 percent increase in April, according to a data release. The country’s soaring unemployment rate also showed signs of easing, with the measure indicating that the jobless rate tumbled to12.2 percent in May compared to12.6 percent in April.
The privatization program initiated by the Donald Tusk government to reduce state ownership in a number of key companies seems to be making steady progress. The proposed initial public offering of coking coal miner Jastrzebska Spolka Weglowa SA has elicited an upbeat reaction from Polish investment bankers despite the poor track record for most recent European IPOs.
Amid rate hikes and slowing retail sales, Poland seems to be pinning high hopes on revenues from licenses issued to big corporations such as Exxon Mobil, Talisman Energy, and Chevron Corp. to extract shale gas from the country. Poland’s shale gas reserves look promising as the U.S. Energy Information Administration says it would be enough to satisfy 300 years of domestic consumption. Moreover, the companies have started work only on a tenth of the total exploratory wells. According to the Polish economy minister, the country has ambitious plans to build a sovereign wealth fund akin to Norway, which benefited from taxes on oil and gas extraction and ownership of oil fields.
Hungary: Inflation lowest in five months
Hungary’s inflation rate came down to 3.9 percent in May compared to 4.7 percent in April, according to a Bloomberg report. The Hungarian central bank, which targets an inflation rate of 3 percent, had left the interest rates unchanged at 6 percent when they met last month. However, economists point out that the fall in inflation has more to do with the base effect: the comparison with May of last year when the fuel prices had gone up significantly.
Meanwhile, the Organization for Economic Cooperation and Development (OECD) has forecasted economic growth at 2.7 percent in 2011. The OECD said the Viktor Orban government’s fiscal reforms were the need of the hour.
In another positive development, rating agency Fitch revised its outlook on Hungary’s debt to “stable” from “negative “, according to a report in the FT. The rating change also increased confidence that the Hungarian government would be able to reduce the budget deficit to below 3 percent of GDP by 2012.
On the corporate front, Hungary has reached an agreement to buy back more than one-fifth of oil and gas producer MOL from Russian energy group Surgutneftegaz, marking a happy end to a protracted share purchase deal that had strained Budapest-Moscow relations.
In another interesting development, the Hungarian parliament approved a new tax on unhealthy food items, dubbed the “hamburger tax.” The tax, to be levied from September 1, will cover foodstuffs that contain high amounts of salt, sugar, and carbohydrates. Chips, salted nuts, chocolates, cakes, and jams would come under the purview of the new tax, according to a WSJ report.
Czech Republic: Growth propelled by export demand
The Czech Republic’s GDP rose an annual 2.8 percent in the first quarter of 2011, higher than the 2.7 percent recorded in the final quarter of last year, according to a Bloomberg report that quoted data from the Czech Statistical Office. Inflation rose to 2 percent in May, touching the central bank’s target rate. However, in its recent meeting the central bank decided to keep the interest rates unchanged, as cuts in government spending have affected domestic demand and the euro debt crisis has cast a shadow on the economic recovery. Some economists have pointed out that the recent spike in inflation is the result of higher food and energy prices, holding the view that demand-driven inflation does not exist.
According to a forecast from the Organization for Economic Cooperation and Development (OECD), the Czech economy is expected to grow by 2.4 percent in 2011, helped by strong export demand, primarily from Germany. The economy of the Czech Republic is heavily dependent on the foreign demand for its goods, especially automobiles, as exports contribute about 70 percent of the country’s GDP. The agency also projected a 3.5 percent growth next year as the domestic demand picks up speed. However, the OECD cautioned that the government’s budget tightening will affect growth this year. The OECD said headline inflation will rise in 2012 as indirect taxes go up, but core inflation would remain low.
In the first major protest against the fiscal reforms being implemented by Petr Necas’ government, the country’s transport unions managed to shut down the Prague underground railway recently. The unions were protesting the government’s move to raise the retirement age, increase taxes, and curtail welfare benefits.
(c) Thomas White International