Emerging Europe: Economic Review March 2011
Thomas White International
By Team
April 2011
Upbeat forecasts from the European Commission as well as stable financial and economic conditions in emerging European economies indicated that the recovery is on track in the region despite the tragic developments in Japan, skyrocketing oil prices, and the continuing political unrest in the Middle East and North Africa (MENA) region. Equity markets also seem to be signaling that the sustained pace of global economic recovery will more than offset these unforeseen developments. The recent decision by seventeen Euro-zone governments to strengthen the €440 billion rescue fund and to lower interest rates on Greece’s bailout fund helped allay fears of a lingering sovereign debt crisis. As far as emerging European economies such as Russia, Poland, Turkey, Czech Republic, and Hungary are concerned, the overall sentiment remained positive though the rising inflationary levels are a worry for some of these countries. It is widely believed that the European Central Bank will increase interest rates in the Euro-zone soon and some of the central banks in these emerging economies may follow suit.
The crisis in the MENA region has offered Russia an opportunity to bolster its position as a reliable energy exporter among the group of oil producing nations that have not been affected by geo-political disturbances such as Nigeria and Angola. While rising oil prices, if sustained, will prove to be a windfall for Russia’s budget deficit and boost the country’s GDP growth, oil importers such as Turkey will feel the pinch. Barring Russia, the other emerging economies will face the heat from rising oil prices as most of them are dependent on oil imports for their energy needs. The bigger risk will be the rise in consumer prices which will fuel inflation. Among these economies, Turkey and Czech Republic are known advocates of nuclear power. Turkey’s big nuclear push has come under a cloud in the aftermath of the leakage at the Japanese nuclear facility, while the Czech Republic has not been swayed by Germany’s decision to shut down its nuclear facilities. Russia, which has been witnessing good fund inflows for almost fifteen weeks, saw some outflows during the week ended March 18 due to the situation in Japan, according to a report from Financial Times.
At a Glance
- Russia: Surging energy prices are estimated to boost the country’s GDP growth by one percentage point this year. The windfall oil revenues could also help wipe out its budget deficit. Russia decided to ship additional supplies of LNG to help Japan make up for its power shortfall.
- Turkey: Industrial production data for January showed a whopping 18.9 percent increase on the year. The scorching pace of growth has spurred talks of an interest rate hike. But Turkey’s dependence on imported oil is a dampener on the country’s economic growth.
- Poland: Helped by demand from the Euro-zone, industrial output in Poland increased 10.7 percent in February, the fourth month in a row, compared to 10.3 percent growth in the previous month. The government also decided to launch new pension reforms to bring down the country’s public debt.
- Hungary: The new fiscal reform plan proposes to increase labor participation from the current rate of about 55 percent of the country’s population to the EU average of 65 percent. Hungary also plans to limit government debt to 50 percent of the GDP, a tighter cap than neighbor Poland’s 55 percent threshold.
- Czech Republic: The proposed pension scheme will give government employees the option to voluntarily move out of the current system. The government said a portion of the 28 percent social security tax will be diverted to the new privatized pension system.
The former Soviet satellite states of Hungary, Czech Republic, and Poland depend on Germany for much of their trade. Powered by the strong economic recovery in Germany, industrial production in these central European nations has been increasing for the last few months. Exports contribute 70 percent of the Czech Republic’s GDP, while the country’s manufacturing sector is dominated by production of cars and machinery. Interestingly, German automobile manufacturer Volkswagen’s Czech unit Skoda Auto is the country’s biggest manufacturer and exports 90 percent of its production. Likewise, Polish companies are known for supplying components to German manufacturers, though unlike its neighbors, growth is also driven by domestic demand. Undoubtedly, the strong growth in Germany’s purchasing managers’ index, combined with Euro-zone and domestic demand, has made Poland the fastest growing economy in the region. Hungary’s economy, which is also heavily reliant on export of automobiles and auto parts, continues to benefit from growth in Germany. Understandably, the EU27 group of nations, which includes Poland, Hungary, and Czech Republic, recorded a 6.4 percent rise in seasonally adjusted exports during January 2011 compared with the year-ago period, according to data from Eurostat. True to its observation that growth in the EU area will remain uneven, the European Commission forecasts that Germany will lead the recovery in the Euro-zone, while outside the currency bloc, Poland is expected to grow at the rate of 4.1 percent during the year.
Encouraged by the bright prospects for the global economy and the strong EU business sentiment, the European Commission says the EU recovery is likely to gain momentum in 2011. Among the emerging European economies, the Czech Republic, Hungary, and Poland are members of the European Union, while Turkey anxiously awaits membership. The agency also says the recovery in these economies, now driven mostly by exports, will be powered more by domestic demand this year. Private consumption, the EC said, will get a boost from a stabilized labor market and a pick-up in lending to households. The Commission also revised its forecast for the year slightly higher, with the EU area GDP expected to increase 1.8 percent. Taking note of the higher energy and commodity prices, the EC also revised its inflation expectations higher. It now anticipates headline inflation will reach 2.5 percent in the EU area. However, the agency expressed hope that subdued wage growth and constant monitoring by central banks will keep inflationary pressures under check.
Russia: Oil price surge a boon and a bane
The developments in the Arab world come as a double-edged sword for Russia. While the spike in oil prices will fill the coffers of one of the world’s leading energy exporters, it may affect Russia’s overall economic growth in the long term. Encouragingly, surging energy prices are estimated to boost the country’s GDP growth by one percentage point. Russian Finance Minister Alexei Kudrin recently said if oil prices average $115 in 2011, the country’s budget deficit, which had swelled during the crisis, could be wiped out. Yet, as a report from FT points out, the new-found oil wealth may lead Russia into a state of complacency, which made the country vulnerable when the financial crisis struck in 2008. With Russians going to the polling booths in December to elect their Parliament and again in March 2012 to vote for President, the government may use the money to hike pensions and wages, which could affect the country’s competitiveness and further increase its dependence on oil prices.
Like the Smolensk plane crash which helped mend frosty bilateral ties between Russia and Poland, Russia has reached out to Japan in its hour of need. Though Russia and Japan are partners in energy trade, the relationship has remained strained for several decades due to territorial disputes over the Russian occupation of a group of islands during World War II. Rising to the occasion, Russian President Medvedev has ordered additional supplies of LNG to help the island nation make up for its power shortfall following the accident at the Fukushima nuclear plant. With hardly any oil resources to bank on, Japan is dependent on nuclear power to meet one-third of its energy needs. The Fukushima nuclear accident could boost demand for Russian oil and gas exports to Japan, while Russian steelmakers stand to benefit from post-quake reconstruction work.
The Russian government seems to be serious about its plans to expand in the nation’s investment banking sector. Sberbank, the government-owned savings bank, has decided to acquire the privately-owned investment bank Troika Dialog for more than $1 billion. Sberbank must have taken a cue from the success of VTB Capital, the investing banking arm of its rival VTB. According to a WSJ report, the deal is a win-win situation for both parties concerned, as Troika will gain access to Sberbank’s corporate clients, and Sberbank will be able to tap Troika’s international clients.
Turkey: Rate hike on the cards as economic growth gathers pace
Turkey’s rapid industrial growth has been instrumental in bringing about the country’s rebound from recession. But industrial production data from January, which showed a whopping 18.9 percent increase on the year, caught even analysts by surprise. Industrial production contributes almost 25 percent of the country’s GDP. Significantly, the manufacturing boom was led by automobile production, which rose 30 percent year-on-year. Turkey produced a total of 1.13 million vehicles in 2010, making it one of the top car makers in emerging Europe. Yet, the scorching growth also brings along attendant problems, such as an overheated economy and the current account deficit. Unrestricted lending, increasing domestic demand, and surging oil prices may force the central bank to raise the interest rate eventually. Rating agency Moody’s also echoed the sentiment, saying that Turkey’s monetary policy needs to be tightened to allay concerns over the current account deficit.
While Turkey has remained immune to the political developments sweeping the Middle East, its dependence on imported oil is a dampener on the country’s economic growth, as rising oil prices add to inflationary pressures. Emerging markets equity funds have seen redemptions to the tune of about $23 billion year-to-date so far. However, inflows to Turkey-focused equity funds hit a 20-week high during the week ended March 18, among the few funds to attract new money, according to a MarketWatch report.
The Turkish government’s goal of meeting 20 percent of its energy requirements from nuclear power by the year 2030 may come under scrutiny in the aftermath of the recent developments in Japan, especially since Turkey is prone to earthquakes like Japan. Though Turkey’s energy minister sought to allay these concerns, it will be hard to convince the Turkish people, especially with national elections around the corner. Turkey has already signed an agreement with Russian state atomic agency Rosatom to construct a nuclear plant at Akkuyu on the Mediterranean. Talks were being conducted with Japan to build a second nuclear plant on the Black Sea coast when the Fukushima incident occurred.
Poland: Interest rates may be hiked
Helped by demand from the Euro-zone, industrial output in Poland increased 10.7 percent in February, the fourth month in a row, compared to 10.3 percent growth in the previous month, according to data from the Central Statistical Office. Though inflation remains a worry for Poland, the consumer price index for the month of February increased only by 3.6 percent year-on-year. The rise in CPI came in below analyst expectations due to a lesser-than-expected increase in food prices. However, the central bank of Poland is not ruling out a hike in interest rates, which currently stands at 3.75 percent. The central bank said the inflation rate, though below market expectations, is still above the target rate of 2.5 percent.
In a separate quarterly report on GDP and inflation, the central bank sees a slowdown in Poland’s economic growth over the next three years due to weakness in consumption and investment. The bank forecasts GDP growth of 4.2 percent in 2011, 3.6 percent in 2012, and 3.1 percent in 2013. Rising oil prices will be a dampener on new investments and is likely to discourage fresh hiring by companies, the bank said. Funding from the EU is also expected to decrease in the coming years, which will hamper public investments, such as the building of roads and public infrastructure.
Meanwhile, Prime Minister Donald Tusk formally declared the government’s decision to implement the much-debated pension reform. The move will funnel a major chunk of the employee pension contributions into the government-controlled social security fund, which aims to bring down the country’s public debt.
Hungary: Fiscal reform package unveiled
The ruling Fidesz party government unveiled its fiscal reform plan recently. Ambitious as it may sound, the plan envisages improving efficiency and saving money in the healthcare, transport, education, and pensions sectors of the economy. According to a report from The Financial Times, the scheme proposes to increase labor participation from the current rate of about 55 percent of the country’s population to the EU average of 65 percent. It also plans to reduce the number of citizens claiming disability benefits by identifying those who are really eligible. Hungarian minister Zoltan Kovacs reiterated the government’s commitment to revamp the country’s public finances, saying the new constitution will make it mandatory to limit government debt to 50 percent of the GDP, a tighter cap than neighbor Poland’s 55 percent threshold.
The Hungarian government seems to have realized that some of its recent policy decisions have not been popular with the investment community. Not only was the country’s fiscal situation compared to Greece, a series of misadventures such as the
controversial media law, the extension of the much-criticized bank tax, and government interference in appointments to the monetary policy panel, cast aspersions on the health of the nation’s economic policy. In a damage control exercise, the government hired a London-based financial PR firm to make amends.
Czech Republic: Pushing ahead with pension reform
Charting a different course from its neighbors Poland and Hungary, the Czech Republic plans to introduce a new pension system for the country. The proposed scheme will give government employees the option to voluntarily move out of the current system. Moreover, a portion of the 28 percent social security tax will be diverted to the new privatized pension system. The government hopes to overhaul the country’s finances with the new revenue being generated. Czech public debt currently stands at below 40 percent of the GDP, which is low by European Union standards. However, Prime Minister Petr Necas’ shaky coalition government will find it tough to push the reforms, as public support is limited.
In the aftermath of the leakage at a Japanese atomic reactor, the Czech Republic, a strong advocate of nuclear energy, has refused to toe the anti-nuclear offensive pursued by its chief export partner Germany. On the contrary, the country has joined other pro-nuclear European countries, which badly need electricity generated from nuclear energy to power their industrial growth.
Meanwhile, three Czech central bankers expressed the view that interest rates should be hiked. The rate now stands at 0.75 percent after the slight reduction in May. Central Bank board member Eva Zamrazilova said mounting inflationary pressures due to increasing exports and producer prices call for an increase in the interest rate. Central bank governor Miroslav Singer also underlined the resurgence in the Czech economy, saying the pace of growth could reach the levels seen before the crisis by the end of 2011. Singer also acknowledged that the growth is led by exports and industrial growth.
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