Analytics, Economics, EU – Baltic States, Financial Services, Investments

International Internet Magazine. Baltic States news & analytics Friday, 29.03.2024, 09:18

Eastern Europe set to be the world's worst-performing region in 2009

Juhan Tere, BC, Tallinn, 27.05.2009.Print version
Investing in Eastern Europe used to be a license to print money, now, emerging Europe is a crisis zone set to be the world's worst-performing region in 2009, BBN/LETA reports.

Even though stock markets have bounced as global risk appetite recovered since March, the regional stock market index is still down by around 60% from its peak.

 

One key problem is the area's dependence on exports, which comprise 80% of gross domestic product in Hungary and the Czech Republic and 50% in Ukraine. On top of this, unlike Asia or Latin America, Eastern Europe is overleveraged. It has "binged on cheap capital from overseas to fund an unsustainable consumer boom", says Capital Economics. Huge current-account deficits (Latvia's reached 23% of GDP in 2007) and rocketing external debt (worth 50% and 37% of GDP in Latvia and Bulgaria respectively) show just how far beyond its means the region has lived.

 

Now capital inflows have ground to a halt. While private flows into the region reached USD 241 billion in 2008, this year will see an outflow of USD 27 billion, says the Institute for International Finance.

 

Banks, which hold most of the external debt and have had difficulty refinancing, are clamping down on credit growth, undermining domestic demand. In some countries the banking system has almost collapsed, necessitating rescues by the International Monetary Fund, which has been called in by Hungary, Romania, Serbia, Latvia and Ukraine.

 

All this explains why first-quarter GDP fell by 6.4% year-on-year in Romania, 5.8% in Hungary, 3.4% in the Czech Republic, 16% in Estonia and a startling 18% in Latvia. If the latter's economy keeps shrinking at its current rate it will almost halve this year.

 

The Baltics are in a particularly nasty pickle. The imbalances were greatest there, so retrenchment is bound to be painful. But what is making things even tougher is the fact that their currencies are pegged to the euro. The Baltics have high levels of foreign currency debt – euro-denominated mortgages in Latvia are worth 40% of GDP – so ending the peg by devaluing local currencies would be "disastrous", causing defaults to sky-rocket, says the Lex column in the Financial Times.

 

This means the region is having to lower domestic demand – in other words, clamp down on wages and prices – to restore its competitiveness. And the economic freefall is set to continue. "We do not see this as the bottom," says Lars Christensen of Danske bank.

 

The good news is that outright disaster seems to have been averted. The IMF's resources have been beefed up to USD 750 billion. This input, along with money pledged by the European Union and the multilateral development banks, seems "more than enough to address the funding problems" in the region and help recapitalize the banking sectors, according to a recent "Bank of America Securities"-"Merrill Lynch" research report.

 

But economic recovery is a long way off. Banking problems are far from resolved, with non-performing loans still around 3% and expected to exceed 10%, according to Capital Economics. The group also notes that the flipside of IMF help is tighter fiscal policy, which will make the slowdown worse. A lasting upturn would require a recovery in the global economy and especially in the eurozone, Eastern Europe's main trading partner, and resumption in capital inflows to bolster growth. The latter seem especially unlikely while the credit crisis grinds on. Do not count on a sustainable bull market in Eastern Europe for the foreseeable future.






Search site