COVER STORY: HARD TIMES
By Justin Keay
A sustainable recovery remains as elusive as ever for
many of the countries of Central and Eastern Europe.
Before the fall of the Berlin Wall and the demise of the Soviet
Union, investors saw the communist bloc as an entity, ignoring the
countries' significant differences. This monolithic approach was
turned on its head in recent years as investors came to regard each
country on its own merit. Today the pendulum has swung back, at
least part way: Piecing countries into regions seems a useful way
to measure their prospects.
Although all are struggling to recover from the worst crisis
since the transition from communism began, Central Europe, the
Baltics, Southeastern Europe and the CIS all have distinctly
different prospects. Analysts agree that although they are over the
worst of the economic downturn-which proved more severe because of
the countries' new openness to global trade and dependence on key
but depressed EU export markets-most countries are not recovering
as robustly as anticipated.
Jon Levy, a senior analyst with the US-based Eurasia Group, says
the region only stabilized as a result of policy actions such as
the sovereign support mechanisms agreed upon by international
financial institutions and the EU and the Vienna Initiative to
sustain interbank lending within the region and prevent a wholesale
bank exodus. Risks remain, argues Levy, and while banking sector
figures suggest that personal and mortgage loan levels are
recovering, business lending is not, opening very real questions
about the sustainability of the recovery taking place.
Analysts are also concerned that the recovery is so patchy. By
late 2010 just about the only apparent commonality between
countries across the region was the stoicism with which people have
endured their new privation, so soon after the massive economic and
social disruption that accompanied the transition to free markets.
As many observers have pointed out, this has been a marked contrast
with Greece and France, where modest government reforms have
resulted in demonstrations and riots.
The European Bank for Reconstruction (EBRD), for example,
reckons GDP across the region in which it operates (from Central
Europe to central Asia) will increase by 4.2% this year and a
similar amount in 2011, following a 5.5% contraction in 2009. But
this figure is distorted by the inclusion of Turkey, where growth
is expected to be 8%, and commodity-rich CIS countries. Gas giant
Turkmenistan will see GDP rise 11%, and most of the other stans are
also booming. Energy-rich Azerbaijan, which last year was one of
the world's fastest-growing economies thanks to large scale
investments in its oil industry and an ongoing construction boom
that is transforming downtown Baku, also has reason to smile. So
too does Ukraine, which is recovering from the 2009 slump more
dramatically than anybody would have dared hope: The expected rise
in GDP of up to 5% this year will go some way toward mitigating the
15% contraction of 2009. Improved relations with Russia and a new
agreement over future energy supplies are further causes for
optimism, although corporate governance issues remain a big concern
for investors.
The more developed countries further to the west are likely to
see growth return, along with confidence, but painfully slowly. "In
retrospect, there was too much growth between EU accession in 2004
and the Lehman Brothers crisis of 2008. Bank assets grew by an
unsustainable 25%, and there was too much credit. Going forward, we
won't see this again," says Andrezj Novaczek, bank analyst at ING
Financial Markets. On the bright side, though, in all regions, the
outlook for the bank sector looks encouraging. "The banks are
edging back to health. Capital levels are rising, loan-to-deposit
ratios are falling, and, for the most part, bad loans are showing
signs of peaking," says Neil Shearing, emerging markets analyst at
London-based consultancy Capital Economics.
According to the EBRD, which in late October updated its
forecasts, Central Europe, dominated by the economies of Poland,
Czech Republic, Slovakia and Hungary, can expect 2010 growth of
2.2%, rising to 3% next year after a GDP decline of 3% in 2009.
Twenty years of reform and western integration have made these
countries an increasingly indistinguishable part of the EU. This
will be reflected in their recovery.
"The Central European countries are well integrated into the EU
supply chain and have been able to benefit fully from the German
rebound: The only real concern is if this falters and impacts on
exports," says one analyst. A priority going forward will be
ensuring that FDI continues to flow into the region, with
governments making whatever adjustments to the investment climate
are needed. There have been some encouraging signs. In late
September, Audi announced plans to invest €900 million ($1.2
billion) in its Hungarian operations just days after Opel announced
plans to invest €500 million, also in Hungary. But future
prosperity in all four countries remains highly dependent on
continued foreign investment.
The other key question is the extent to which growth may be held
back by fiscal consolidation. To date this has been of most concern
in Hungary, which has been struggling to reduce its sovereign and
private debt burden (the latter made much worse by the huge amount
of consumer lending undertaken in euros and Swiss francs, both of
which have appreciated sharply against the forint). Although the
deficit has been reduced sharply from the 9% reached in 2006 to an
expected 3.8% by year-end (and 2.9% next year), growth will be
anemic for the foreseeable future: EBRD predicts just 0.8% this
year and 1.7% next.
With elections now safely behind them, the Czech Republic and
Slovakia will also start taking the axe to spending, although at a
more gradual rate. Poland, facing parliamentary elections in late
2011, will be even more relaxed; despite being the only EU country
to grow through the downturn, with growth projected to continue
this year at around 3.3%, it will nonetheless run a deficit of
around 6.5% in 2011, down from 8% this year.
Compared with Central Europe, the Baltics face a rather bumpier
return to normality. Owing to excessive consumer spending and
overheated property sectors, Latvia and Lithuania were among the
downturn's biggest casualties, with GDP last year contracting
respectively by 18% and 14.8%. To the surprise of many, Latvians in
October reelected the government, despite their country's suffering
the EU's highest unemployment rate (23%) and facing continued
fierce fiscal retrenchment. Seemingly, voters have accepted that
there is no alternative to the austerity. Certainly, the future
looks very different from a few years ago, when the three Baltic
countries were enjoying the EU's biggest boom. The EBRD predicts
this year's negative or flat performance will translate next year
into growth of around 2.5%. Others are more downbeat.
"These countries are looking at an L-shaped recovery-there are
major concerns about the sustainability of their recovery," warns
Shearing, who says the long-term trend for the region is growth at
around 2% a year. He argues that the region faces competitiveness
concerns in its efforts to switch to an export-based growth model,
not least because of the small size of the industrial sectors and
economies.
Southeastern Europe (
SEE
) also faces adjustment problems. The EBRD expects the region's
economy to shrink by something under 1% this year before seeing a
1%-2% rise in GDP in 2011. Of all the region's economies, Romania's
is expected to endure the sharpest contraction this year with a
predicted 2% decline in GDP. Political instability, tough fiscal
and bank sector retrenchment following the 2004-2008 boom and a
collapse in consumer confidence have all played their part, as have
concerns about foreign currency loans. Throughout SEE, proximity to
Greece and a dependence on the country for exports (10% of
Bulgaria's go there, for example) and finance (Greek banks are
active throughout the region) have reinforced the sense of gloom.
"This region is in a real mess. Questions about competitiveness
remain, especially as it seems it is the collapse of domestic
demand rather than a pickup in exports that is behind recent falls
in the current account deficit," says Shearing.
Peter Sanfey, an economist at the EBRD, says continuing investor
uncertainty is a problem. "Investors remain cautious and not
willing to commit to new projects-yet these are needed for economic
recovery to take hold," he argues.
The one good piece of news concerns EU accession: Montenegro,
Albania and Serbia have all been moving fast to prepare themselves,
and Belgrade hopes it will get an invitation as early as
2016-assuming, of course, it can demonstrate cooperation with the
Hague war crimes tribunal. The forthcoming privatization of Telekom
Serbia and other enterprises should also prove attractive to
investors, but over the longer term governments will have to press
ahead with reforms.
"The crisis has revealed a lot of weaknesses in SEE-in
particular, the dependence on foreign loans. Local currency markets
must be developed if this region is ever to realize its full
potential," argues Sanfey.
BANKS BOUNCE BACK
When the credit crunch was at its peak, banks in Central and
Eastern Europe (
CEE
) were beset by fear: that Western European parent banks, which
control some 80% of the bank sector in CEE, would pull the plug on
the region; that local banks would collapse under the weight of bad
commercial or personal debts; and that some banks might be found to
have invested in overly risky property sectors or be laden with
toxic debt. In the end, none of those fears materialized. The
Vienna Initiative discouraged parent banks from withdrawing from
the region, but it may not even have been necessary. Local currency
deposits in many cases actually rose during the downturn, making
this an appealing region in which to have a presence. Almost
everywhere regulation and supervision has been good. Although
short-term external debt remains high in some countries-notably the
Baltics but also Southeastern Europe and Hungary-which will require
a continuing rollover of debt into next year at least, East
Europe's debt crisis really was the dog that didn't bite. And as
recovery slowly takes hold in the wider economy, the region looks
less mangy still.
According to ING's Andrezj Novaczek, banks across the region not
only survived the crisis but emerged without any long-term damage.
Today earnings are under pressure, but there are no serious
liquidity or solvency concerns. Indeed, with property and other
bubbles now burst, many of these banks are actually in better shape
than ever. "Capital adequacy ratios are better than they were,
while loan-to-deposit ratios have improved," Novaczek says.
That said, many things have changed, though probably for the
better. Foreign banks are less aggressive than they were before the
crisis and more focused on building up local deposit bases. Going
forward, banks will almost certainly be more cautious and lend more
selectively. This will be the case especially in countries such as
Romania, where banks were slower to rein in their activities: Many
only started retrenching in mid 2009 and continue to do so now,
which is one reason Romania is expected to be among the last
countries to emerge from recession.
It has also become clear, however, that banks are now highly
vulnerable to developments within the eurozone, where many are
headquartered. This may mean that local subsidiaries of Greek banks
in such countries as Bulgaria and Romania face funding cuts
reflecting the problems experienced by the parent bank.
Large banking groups may also want to tread carefully lest other
countries follow Hungary's June example of imposing a punitive
special bank tax, three times larger than similar taxes being
planned in countries such as the UK and US. The tax is to be levied
at 0.5% on bank assets over 50 billion forint at end 2009 with the
aim of raising an eventual $837 million from financial institutions
to pay toward the fiscal deficit, and will remain in place for
three years. Although three banks have hinted they may withdraw in
protest at the tax, which has been condemned as recklessly high by
the IMF and others, prime minister Viktor Orban seems to have
called their bluff. Unsurprisingly, his argument that banks should
shoulder a heavier financial burden has been well received by
recession-scarred Hungarians.