Emerging Europe: Economic Review April 2011
Thomas White International
The International Monetary Fund in its latest report observed that the economic recovery in Europe as a whole is proceeding modestly. However, the agency noted that the pace of growth varied substantially across countries in the region. The large emerging European economies in the region are performing at or above capacity, according to the agency. Preliminary data showed that the Euro-zone economy expanded at a better-than-expected pace in April, allaying concerns that the recent rate hike by the European Central Bank would strengthen the euro and slow down German export growth. Germany is the major trading partner for some emerging European economies such as Poland, Hungary, and Czech Republic.
At a Glance
- Russia: With elections coming up in a year, the Kremlin has proposed some populist measures such as new pension schemes and subsidies for farming, banking on the new money flow from surging oil prices.
- Turkey: The International Monetary Fund observed that the swift economic recovery is expected to continue in Turkey, helped by strong credit growth and robust private demand. Meanwhile, the new central bank governor appears to be continuing the low interest rate policy.
- Poland: The Polish government faces a dilemma as inflation rises to an annual 4.3 percent in March. While raising interest rates may derail the economic recovery, strengthening the zloty is likely to lessen the pressure of inflation.
- Hungary: Strong growth in Germany, which brought business to manufacturers, and the interest rate hike implemented by the central bank, both helped the Hungarian forint appreciate 2.6 percent against the euro in March.
- Czech Republic: Inflation came in at 1.7 percent in March, below the central bank’s threshold of two percent. The central bank deputy governor said the fiscal crisis in the Euro-zone may boost the Czech koruna, which could delay any hike in interest rates.
Emerging European economies such as Russia, Poland, Turkey, the Czech Republic, and Hungary all seem to be in good financial shape, going by the latest data emanating from these economies. Russia, Hungary, and Turkey appear to be the favorite destination for investors, according to data. However, inflation remains a worry in the broader Euro-zone, as well as in these emerging European economies. As data from Eurostat showed, annual inflation in the EU area rose to 3.1 percent in March 2011 from 2.9 percent in February. Underlining the trend shown by the Eurostat data, inflation levels have risen in economies such as Russia and European Union member Poland, while inflation remains below targeted levels in the Czech Republic. The consensus opinion at the recent Washington meeting of 187 IMF nations voiced the concern that rising inflation in emerging economies poses a threat to developed nations too.
Thanks to windfall revenues from selling oil amid the continuing crisis in the Middle East and North Africa (MENA) region, Russia looks stable at least in the near term despite slow industrial production in March and concerns about rising food prices and inflation. Poland, the shining star among the central European economies, seems to have lost some of its glitter as the country’s recovery is estimated to remain more subdued this year. Poland, the top performer in the European Union last year with a growth rate of 3.8 percent is seen lagging its neighbors such as Hungary. Poland had a budget deficit that came in at 7.9 percent of GDP in 2010, and this year too debt is projected to remain at 5.6 percent of the GDP. The saving grace for Poland is that domestic demand has remained strong, which is not the case in Hungary. Though both Poland and Hungary are equally dependent on exports to Germany, Hungary has overtaken its bigger competitor in exports in the first two months of the year. For Hungary, which was reeling under the impact of the combined IMF/EU rescue and issues related to governance, investor attention has come as a pleasant surprise at the turn of the year. Strong exports and positive investor sentiment bode well for the Hungarian economy at least in the near term.
Bringing more cheer to the some of the emerging European economies, a recent World Bank report said that 10 EU members, including the former communist states of Poland, the Czech Republic, and Hungary, will grow by 1 percentage point to 3.1 percent in 2011 and 3.8 percent next year. The report said these eastern European economies would also benefit from the opening up of labor markets in Germany and Austria in May. Poland, which has a large migrant population working in Germany, is seen to benefit the most.
Russia: Standing on a slippery ground
The importance of the oil and natural gas industry to Russia’s economy is evident from the fact that the sector brings in 30 percent of the country’s GDP and 60 percent of its export earnings. Currently, the country is relishing the huge inflow of money, thanks to the recent surge in oil prices. However, Russia would do well to realize that any substantial fall in energy prices would likely affect its economic growth. In this context, it would be interesting to know what Russia currently plans to do with its oil revenues. With elections coming up in a year, the Kremlin has proposed some populist measures such as new pension schemes and subsidies for farming. An FT report mentions the finance ministry’s recent decision to allocate $14.4 billion in extra budgetary spending for the current year and an additional $30 billion for 2012. Russia’s dependence on oil prices could be further explained by the steady increase over the years in the country’s “break-even point”, which is the price per barrel of oil at which Russia is able to balance its budget. Currently, the figure has been put at $115. To sum it up, Russia has based its additional budgetary allocations for the years ahead presuming that oil prices will remain at least at $95 a barrel. The FT, in its report, estimates that at $95 a barrel, the country’s fiscal deficit will be about 3.5 percent of GDP, which would double to seven percent if oil prices plummeted to $60 a barrel. The fast-dwindling reserve fund saved from the former oil boom years, which stands at $26 billion currently, offers little solace as it is already being tapped to fund the pension system and other social spending schemes.
The Russian central bank and the International Monetary Fund seem to differ sharply on the question of inflation, which has been ravaging the Russian economy for several months. Russia’s official stance is that price growth will substantially reduce in the coming months, which will lead to a manageable inflation rate of seven percent for the year. On the contrary, the IMF has raised its inflation projection for the country to 9.3 percent, blaming Russia’s poor track record in implementing monetary policies and consistent high food prices following the severe drought that hit the country last year. However, the Russian central bank may have an ace up its sleeve- a significant hike in the deposit rate, the rate of interest the Bank of Russia pays on deposits held on behalf of commercial banks. Economists believe increasing this rate would arrest money supply growth and reduce consumer prices. However, concerns about derailing Russia’s nascent economic recovery may dissuade the central bank from raising the deposit rate. Meanwhile, Russian industrial production grew at a slower pace in March compared to the previous month, in a reflection of the growing producer prices, which force companies to cut production.
In an effort to boost private investments in Russia, government-owned OAO Sberbank and Credit Suisse Group AG decided to launch a $1 billion private-equity fund. The fund, which will have an initial contribution of $100 million each from both the banks, will be set up during the year. The launch of the fund follows the recent establishment of a $10-billion fund by the Russian government to attract foreign investments. In what seems like a reaction to the growing prominence of state-owned banks in Russia, HSBC has decided to wind up its retail operations in Russia, close on the heels of a similar decision by U.K.’s Barclays. Apart from the dominance of the government-owned behemoths, these relatively newer entrants had to jostle with competition from the likes of well-established foreign players in the Russian market, such as Citigroup, Raiffeisen, and UniCredit.
Turkey: Change of guard at the central bank, but rates left unchanged
In a recent report, The International Monetary Fund observed that the swift economic recovery is expected to continue in Turkey, helped by strong credit growth and robust private demand. The IMF also attributed the continuing growth to the central bank’s accommodative macroeconomic policies.
However, contrary to expectations of a hike in interest rates amid scorching economic growth, the new central bank governor Erdem Basci signaled that he would more or less toe his predecessor’s policy of maintaining low benchmark rates. This is the third consecutive month when the rates were left untouched. The central bank may have also taken into account the record-low inflation rate of 3.99 percent recorded in March. Turkey’s monetary policy is at odds with other emerging markets, which face the same issues of overheating and speculative inflows. Most of the emerging economies have stressed the importance of tackling inflation and have raised interest rates consistently. However, the Turkish central bank decided to hike reserve requirements for commercial banks to hamper lending growth. Over the last several months, the central bank has been leaving no stone unturned to stem the flow of short-term investments, which are seen to threaten the country’s economic stability. Meanwhile, an FT report showed that funds flows to Turkey were clocked at $74 million for the week ended April 20, making the country the fourth hottest investment destination after China, South Korea, and Russia.
For a country which imports 87 percent of its gasoline, a 20 percent rise in energy prices this year would sound like a sure recipe for trouble. However, a WSJ report points out that the effects of the spike in oil prices may not trickle down to the real economy for at least a year. However, a surge in oil prices could derail the fast-growing economy next year, as it could unleash a wave of inflation and worsen the country’s current account deficit.
Poland: Inflation spurs debate on rate hike
The Polish government seems to be caught between the horns of a dilemma over concerns of inflation, which touched a two-year high of 4.3 percent annually in March. Understandably, the producer price index showed an annual 9.3 percent increase in March, which was higher than what economists had projected. The Polish central bank has been following a tightening cycle this year, increasing the interest rates twice so far. However, a member of the rate setting committee has warned against any impending rate hike, saying it would dampen the country’s economic growth. Average wages in Poland grew at a rate slower than the rate of consumer price inflation, which also makes the case against a near-term hike in interest rates. Moreover, the government is treading cautiously ahead of the parliamentary elections due this autumn. The Polish currency zloty soared recently after the government said it would make use of euros received from the European Union to purchase the zloty on the open market. While a strengthening zloty is likely to lessen the pressure of inflation, it may also mitigate the danger of the country’s public debt crossing the threshold of 55 percent of the GDP, as much of the debt is taken in euros and dollars.
Poland’s recent overtures toward Germany underscore the former Soviet satellite’s understanding of the importance of aligning its interests with those of its biggest trading partner. Unlike the previous government which wanted to strengthen ties with Washington, the Donald Tusk administration has steadily followed a pro-Germany approach. Poland will likely be counting on the crucial German support once it becomes a Euro-zone member.
Close to 90 percent of Poland’s electricity is generated from coal, which many environmentalists consider a polluting fossil fuel. In order to reduce its dependence on coal and to conform to the European Union standards of carbon-dioxide emissions, Poland has carved out a goal to generate 8.85 percent of its energy from renewable sources in 2011 and about 17 percent by 2019. The European Union mandates that Poland should be equipped to produce 15 percent of its energy from renewable sources by 2020. The country says it will start work on necessary legal amendments required to boost energy production from renewable sources soon.
Hungary: Forint scores amid controversies
Though dogged by controversies, Hungary had something to cheer about in terms of the strength of its currency, the forint, which was up 2.6 percent against the euro in March. The strong growth in Germany, which encouraged manufacturers to increase production, has been the main driver of currency appreciation in central European economies such as Poland, Hungary, and the Czech Republic. The interest rate hike implemented by the Hungarian central bank also helped the forint appreciate, which fosters carry trade by investors. The bottom line for Hungary is clear- in the short term, the country is progressing on the fiscal stability and current account fronts; but the long-term view remains blurred, as domestic demand remains weak.
The heavy corporate taxes imposed on businesses in selected industries last year was a big blow to companies doing business in Hungary. However, the firms which had pinned their hopes on the government announcement of possible cuts in the corporate tax rate were in for a disappointment. The only solace is that the corporate tax has been cut from 19 percent to 10 percent for small businesses with annual revenues of less than $2.7 million. Christened “crisis taxes”, the taxes were slapped on banks, and the telecommunications, retail, and energy sectors to increase government revenues by about $2 billion a year. Multinational corporations, including firms from Germany, the biggest contributors of foreign direct investment in Hungary, plan to take up the issue with the Hungarian government soon. The Hungarian central bank recently acknowledged the damage being done to the banking sector when it said the bank tax is hampering growth as it discourages lending. Under pressure from industry groups, the European Union is examining if the additional levies violate the rules laid down by the 27-member group.
On April 18, Hungary’s Parliament approved a new constitution that has stirred up controversy among some EU member states. The new draft proposes to curtail the powers of the constitutional court with regard to budget and tax, and vests the president with powers to dissolve Parliament if the budget does not meet with his approval. Germany, a major trading partner, has criticized the new constitution, especially the provisions related to the controversial media law. But Hungary has disagreed with Germany’s stand in the matter.
Czech Republic: Inflation remains below central bank’s target
Inflation in the Czech Republic came in at 1.7 percent in March, below the central bank’s threshold of two percent. The central bank deputy governor said the fiscal crisis in the Euro-zone may boost the Czech koruna, which could delay any hike in interest rates.
The World Bank recently said growth in the Czech Republic would be at a slower pace as the economy is more developed compared to some of its peers. The finance ministry also said it sees economic growth slowing to 1.9 percent in 2011 compared to 2.2 percent last year, due to the effect of the government’s austerity measures. Domestic demand in the country has fallen below expectations since February, according to a senior central bank official.
Meanwhile, the country’s three-party coalition government headed by Prime Minister Petr Necas survived a political crisis recently after it was rocked by a corruption scandal involving a minister from a junior coalition partner. The government also emerged unscathed in a no-confidence vote presented by the opposition on the same issue in Parliament on April 26th.
The Czech central bank does not seem to think that joining the Euro-zone is the panacea for all ills plaguing the eastern European economy. The vice-governor of the central bank recently said the nation’s autonomous monetary policy and sovereign currency would hold the country in good stead, and not necessarily joining the currency bloc. Despite the dissenting note, the top official acknowledged that it may be only a matter of time before the country joins the Euro-zone, as the Czech Republic is not entitled to the opt-out option enjoyed by other countries such as Britain.
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