Emerging Europe: Economic Review May 2011
Thomas White International
June 13, 2011
According to data from EuroStat, inflation in the Euro-zone touched a 30-month high of 2.8 percent in the month of April as prices of fuel, electricity, and housing continued to soar. In line with the broader trend, the inflation gauge in the 27-member European Union, which also includes Poland, the Czech Republic, and Hungary registered an annual 3.2 percent in April, a touch above the 3.1 percent recorded in March. Among the east European economies, the Czech Republic recorded the lowest rate of inflation during the month.
The International Monetary Fund recently said growth in eastern Europe would be marginal in 2011 as Euro-zone troubles, inflation pressures, and wide budget deficits will weigh on the economic recovery, notwithstanding the pick-up in domestic demand. The Washington-based lender foresees growth in the region at 4.3 percent this year and next, compared to 4.2 percent growth last year. The IMF sees an inflation rate of 7.3 percent this year, which is expected to come down to 6.2 percent in 2012. For the banking sector in the region, the IMF said the close economic ties with Euro-zone members such as Germany could expose the segment to a contagion effect from the escalating debt crisis. If Western banks, which have a significant market share in most of the eastern European nations, are affected by the crisis, they would immediately curb lending in these countries. In country-wise forecasts for the region, the agency sees Russia growing at the rate of 4.8 percent in 2011, followed by Turkey at 4.6 percent, Poland at a flat rate of 3.8 percent, and Hungary at 2.8 percent.
At a Glance
- Russia: Despite the hike in the interest rates by the central bank in the last week of April, inflation rose to 9.6 percent in the month, compared to 9.5 percent in March, due to the increase in energy and food prices.
- Turkey: The European Bank for Reconstruction and Development has observed that credit growth is recovering in Turkey. A private equity fund, with initial capital of €100, was also launched during the month.
- Poland: Contrary to expectations, the Polish central bank raised interest rates to 4.25 percent in May, which sent the currency zloty soaring against the euro and dollar. Meanwhile, inflation in Poland shot up to 4.5 percent in April, the highest in about two and a half years.
- Hungary: Buoyed by strong growth in Germany, Hungary’s economy expanded at the rate of 2.4 percent in the first quarter, the fastest growth in more than four years. However, household debt, which still remains high, is a concern.
- Czech Republic: Helped by one of the lowest inflation rates among the eastern European countries, the Czech economy managed to expand 0.6 percent in the first quarter, a tad above the analysts’ view of 0.5 percent percent growth.
The European Bank for Reconstruction and Development (EBRD), which was established primarily to help Russia and the former Soviet satellite states in their transition to market-based economies, has painted a slightly rosier picture for the eastern European region, which includes the likes of Russia, Turkey, Poland, the Czech Republic, and Hungary. In fact, the London-based bank revised its January forecast upward and now sees a GDP growth rate of 4.6 percent for the region this year, saying domestic demand is also helping the recovery, besides the exports-led rebound. However, the bank too sounded a heads-up for challenges posed by inflation and Euro-zone debt issues, saying that growth will moderate to 4.4 percent next year. The multilateral bank also said despite the improvement in the labor market, leading regional economies such as Poland are still reeling under high unemployment levels.
Economists may try to seek refuge in decimals to decipher a growth story, but merger and acquisition activity is widely considered to be a good indicator of the region’s standing in the global business world. The total value of M&A activity in Eastern Europe so far this year has been put at $65.5 billion, signaling a ravenous investor appetite for firms based out of the region. An FT report quotes statistics from Dealogic, which ranks Russia as the hotbed of M&A deals, followed by Poland and Turkey. Though the proposed BP-Rosneft deal in Russia did not materialize, others such as oil and gas company Novatek’s agreement with France’s Total SA, and VTB Bank’s takeover of Bank of Moscow were completed.
Russia: Higher oil prices fail to spur GDP growth
The country’s growth rate faltered in the first quarter despite high energy prices, falling to 4.1 percent, compared to 4.5 percent in the fourth quarter. Expansion was weighed down by concerns of capital outflows and stagnation in new corporate investments. The chief executive at the Russia’s largest lender attributed the capital flight, which stood at $21.3 billion in the first quarter, to the political uncertainty ahead of the parliamentary elections in December, and the presidential polls early next year. According to data from EPFR Global, Russia-focused funds lost $353 million in the week leading up to May 18. Domestic demand has also fallen as real wages dropped in March for the first time in sixteen months. The manufacturing index also showed slowing growth in April as demand for exports declined. The Economic Ministry forecasts a GDP growth of 4.2 percent in 2011, making Russia the clear laggard among the BRIC quartet. The slowing economic growth was a clear jolt to the Russian administration, which woke up to the fact that even the highest gain in oil prices in more than two years could not spur the economy.
Perhaps the biggest blow to new capital investment in Russia in recent times was the collapse of the BP-Rosneft share-swap deal to explore for oil in the Arctic sea region. The deal was important for Russia on many counts. First of all, the huge capital investment would have likely helped its flagship and oil and natural gas industry expand production capacity, as most of its traditional oil deposits have run dry. Secondly, a successful deal between a government-run firm and an international oil company may have helped altered the general perception of Russia as a bad investment destination. However, the silver lining is that the door is opened for other oil majors such as ExxonMobil and Shell Plc to dip their toes into the oil-rich country.
Though it may sound puzzling, Russia’s benchmark RTS index rose 15.5 percent in dollar terms during the first quarter despite the big capital flight, according to an FT report. The fact that Russian equities remain the most undervalued among the BRIC-group stocks has helped make the country popular among some stock market investors.
Despite the hike in the interest rates by the central bank in the last week of April, inflation rose to 9.6 percent in the month, compared to 9.5 percent in March due to the increase in energy and food prices. Russia had banned grain exports in the wake of the drought that ravaged the country last year, a move which also contributed to the global rise in food prices. The country is hoping for a good harvest this year, which will enable the country to lift the ban on grain exports.
Turkey: Good tidings
According to an FT report, the European Bank for Reconstruction and Development has observed that credit growth is recovering in Turkey. The country’s growing importance among the emerging European economies was underscored by the recent news about the launch of a private equity fund based out of Turkey. The mandate of the fund, set up with an initial capital of €100 million, is to seek acquisition targets among medium-sized Turkish companies, according to the report. Turkey is no stranger to private-equity buyouts of domestic companies, with standout being the big-ticket acquisition of supermarket chain Migros by BC Partners in 2008.
The new central bank governor has signaled that he will continue to back the bank’s unorthodox policy of hiking reserve requirements for commercial banks to restrain lending growth and cool the overheating economy. However, according to an FT report based on a Citigroup research note, Turkish banks are trying to outsmart the central bank by increasing lending to consumers rather than focus on less profitable corporate lending. The first-quarter results of most banks also demonstrated that they have not been affected by the central bank requirements as much as feared by analysts. Moreover, a Bloomberg report said Turkey is contemplating a move, after the elections to be held on June 12, to impose curbs on credit card borrowing and other consumer loans to keep the current-account deficit under check. The government may also slap higher import duties and hike taxes on luxury items, the report said.
On the corporate front, Turkish financial services company Gozde Finansal Hizmetler AS, a unit of Yildiz Holding AS is slated to buy SoK discount markets from Turkish retailer Migros Ticaret, according to a report in Bloomberg. Meanwhile, U.K. spirits company Diageo Plc’s acquisition of Turkey’s Mey Icki, is yet to be completed.
Poland: Surprise rate hike
Contrary to expectations, the Poland central bank raised interest rates to 4.25 percent in May, which sent the currently zloty soaring against the euro and the dollar. Meanwhile, the Polish inflation rate shot up to 4.5 percent in April, the highest in about two and a half years. Amid the scorching wage growth in Poland, the central bank has already raised interest rates three times since January, in its bid to rein in inflation. The central bank governor said inflation will reach a peak in about two months and expressed confidence that the rate of inflation will reach the bank’s target of 2.5 percent in 2012. The European Commission mandates that Poland should reduce its government deficit to 3 percent of the GDP by 2012. However, the EC recently said that Poland is not likely to meet the deadline, a sentiment also echoed by the central bank governor.
In a recent development which augurs well for the Polish economy, Germany has thrown open its borders to migrant workers from the eastern members of the European Union beginning on May 1. Among these economies, Polish workers will have the biggest incentive to migrate as the country’s rate of unemployment still stands at around 13 percent. Most of these workers are likely to move to western Germany or to the capital Berlin, according to news reports.
According to a Bloomberg report, the Warsaw Stock Exchange has attracted more initial public offerings this year than all neighboring European exchanges combined. The number of IPOs rose to 73, compared to 25 during the same period last year. Significantly, the share of trading by foreign investors on the Warsaw exchange increased to 47 percent last year from 36 percent in 2009.
Meanwhile, Poland has backtracked on its goal of adopting the euro yet again. Polish Finance Minister Jan Vincent-Rostowski recently said Poland may not join the Euro-zone until at least 2019. The task will be made all the more difficult as the current administration does not have the requisite numbers in Parliament to amend the Constitution, which will be necessary for the switch-over to the common currency.
Hungary: Rates left untouched
Despite inflationary pressures, the central bank left the interest rates untouched at 6 percent in May as expected, for the fourth month in a row. The bank hopes that the inflation rate, which stood at 4.7 percent in April, may come down to 3 percent by the end of next year. The decision to hold interest rates may be a signal that the acrimonious relationship between central bank governor and the government is slowly improving. The central bank’s latest policy decision also reflected the increased interest in Hungarian assets among investors, as the Hungarian stock index has gained about 9 percent since January, according to an FT report.
Buoyed by strong growth in Germany, Hungary’s economy expanded at the rate of 2.4 percent in the first quarter, the fastest growth in more than 4 years. However, household debt, which still remains high, is a drag on the country’s economic expansion. According to a European Union forecast, Hungary’s public debt will touch 75.2 percent of GDP in 2011, the highest among its eastern European neighbors.
Meanwhile, the Hungarian government said the long-running privatization of state-run companies has officially ended. The period between 1990 and 2001 marked the privatization of government-owned companies such as OTP Bank Nyrt, Magyar Telekom Nyrt, and pharmaceutical company Gedeon Richter Nyrt. The government said it would endeavor to enhance shareholder value of the companies in which it still holds shares. To rev up the country’s vital automobile sector, the government plans to clamp down on tax evasion and insurance fraud that are rampant in the sector.
Czech Republic: No change in inflation rates
Close on the heels of Hungary, the Czech central bank also decided to leave interest rates unchanged in May as inflation and domestic demand remained low. According to a report from Reuters, the central bank also observed that a proposed rise in the value-added tax would jack up inflation only temporarily. Helped by one of the lowest inflation rates among the eastern European countries, the Czech economy managed to grow 0.6 percent in the first quarter, a tad above the analysts’ view of 0.5 percent growth.
The economy of the Czech Republic garners about 70 percent of its GDP from exports, especially to Germany. Naturally, external events such as the possibility of a Greek debt default will have a significant impact on the country’s growth prospects, as many of its banks, which are majority owned by Western parents, would likely curb lending. Meanwhile, the European Commission cut its growth forecast for the Czech Republic to 2 percent in 2011 from its earlier view of a 2.3 percent growth, as consumer spending remains subdued in the wake of curtailed social welfare schemes.
In the wake of safety concerns after the Japanese nuclear crisis, Czech Prime Minister Petr Necas said the country would remain in control of its energy policy amid reports that the European Union is working out the finer details of stress tests for nuclear reactors functioning in its member states. Czech Republic operates six nuclear reactors.
For a free subscription to this article, or any of our other economic report offerings, please visit our Subscriptions page.
If you are a Financial Professional, we invite you to register here for our exclusive content.
This article is for informational purposes only. This article is not intended to provide tax, legal, insurance or other investment advice. Unless otherwise specified, you are solely responsible for determining whether any investment, security or other product or service is appropriate for you based on your personal investment objectives and financial situation. You should consult an attorney or tax professional regarding your specific legal or tax situation. The information contained in this article does not, in any way, constitute investment advice and should not be considered a recommendation to buy or sell any security discussed herein. It should not be assumed that any investment will be profitable or will equal the performance of any security mentioned herein. Thomas White International, Ltd, may, from time to time, have a position or interest in, or may buy, sell or otherwise transact in, or with respect to, a particular security, issuer or market on our own behalf or on behalf of a client account.
FORWARD LOOKING STATEMENTS
Certain statements made in this article may be forward looking. Actual future results or occurrences may differ significantly from those anticipated in any forward looking statements due to numerous factors. Thomas White International, Ltd. undertakes no responsibility to update publicly or revise any forward looking statements.
(c) Thomas White International