Bloomberg News

Eastern Europe Seeks Growth Drivers as Austerity Cuts Demand

January 15, 2013

Eastern European policy makers are seeking new drivers to spur economic growth as austerity measures squeeze domestic demand, the euro area’s debt crisis slows exports and western banks withdraw funding.

European Central Bank council member Ewald Nowotny, Hungarian central bank President Andras Simor, Latvian Prime Minister Valdis Dombrovskis and Gianni Papa, head of UniCredit SpA (UCG)’s eastern European business, will lead two days of discussion on the region’s economic challenges at a Euromoney conference in Vienna.

“The region needs to think about wholly new growth drivers as the previous drivers, such as foreign direct investment, bank credit, real estate and construction, are dead and unlikely to return soon,” Tim Ash, chief emerging-markets strategist at Standard Bank in London, said by e-mail. “It would be dangerous to rely on a recovery in the euro zone.”

Eastern Europe, where foreign capital inflows and easy access to credit fueled growth of more than 5 percent a year before the global crisis of 2008, is being hurt through trade and banking links to the recession-hit euro area.

Government efforts to bring down debt are curbing consumer demand and credit growth has stalled as western lenders that control three-quarters of banking assets retrench and bolster capital to meet tighter regulatory requirements.

Growth Differential

Eastern Europe’s growth differential to the euro region dropped to less than two percentage points from three-four percentage points before 2008, Nowotny said at a Nov. 26 conference in Helsinki, citing research by Austria’s central bank. That means it will take eastern Europe 50 years to reach the euro-area’s income level rather than 37 years, he said.

“The euro zone crisis has undermined the growth model of the central European countries which is based on exports creation and foreign direct investment,” Murat Ulgen, HSBC’s London-based chief economist for central and eastern Europe and sub-Saharan Africa, wrote in a Jan. 9 report. “Given that we do not expect growth in the euro zone, or developed markets in general, to return to pre-crisis levels, the potential growth rates for” central and eastern Europe “will have to fall.”

To raise long-term expansion, governments in the region must overhaul their economies, including labor and pension rules, to compete globally, rather than only in Europe, according to Ash.

Diversifying Trade

Diversifying trading partners away from the euro region should also “help at the margins,” Ulgen wrote, adding that Poland and the Czech Republic have already managed to increase trade with countries from the former Soviet Union. Polish exports to the Commonwealth of Independent States rose 21 percent in the first nine months of last year and Czech exports increased 42 percent, according to HSBC.

While fiscal stimulus is not an option, there’s also further room for monetary easing in Poland and Hungary, while the Czech Republic, with the policy rate near zero, may need to resort to currency intervention, Ulgen wrote.

The European Bank for Reconstruction and Development said that the 29 eastern European and central Asian countries where it invests will grow 3.1 percent this year, up from 2.7 percent in 2012, according to its October estimates.

Markets Rally

While eastern Europe’s growth outlook remains subdued, bonds and currencies have rallied as investors faced with near- zero interest rates in the U.S. and Europe sought higher- yielding securities in emerging markets such as Poland.

Poland last year raised enough funds to cover about a quarter of its 2013 financing needs. On Jan. 8, it took advantage of record-low yields when it raised 1 billion euros ($1.34 billion) in 12-year notes before the Federal Reserve cuts back on its stimulus program.

Yields on Czech debt also fell to record lows last year as investors were attracted by the government’s continuation of fiscal tightening even with the economy in recession, while the central bank lowered borrowing costs to propel the economy. Policy makers cut the Czech benchmark rate three times last year to 0.05 percent, the lowest level in the European Union after Denmark.

The Polish zloty rose 9.4 percent in 2012, the best performance of all currencies tracked by Bloomberg, followed by the Hungarian forint with an 8.1 percent advance. The Czech koruna pared its 2012 gain to 2 percent after the central bank suggested it may weaken the currency to spur the economy.

Vienna Initiative

Eastern European growth has also suffered because of a withdrawal of funding by the western banks that dominate the market, the Vienna Initiative group of international lenders and regulators said Nov. 9.

Western banks, led by UniCredit, Raiffeisen Bank International AG (RBI) and Erste Group Bank AG (EBS), have withdrawn funds equivalent to 4 percent of gross domestic product from emerging Europe, excluding Russia and Turkey, since deleveraging resumed in mid-2011 until the second quarter of last year, the group said in the study.

Eastern Europe “has been buffeted by rapid deleveraging,” European Bank for Reconstruction and Development President Suma Chakrabarti said at the conference today. “The credit crunch isn’t just a phrase for emerging Europe, it is a destroyer of economic growth.”

While western parent banks have been aiming to increasing financing at their eastern European units from local deposits, these aren’t sufficient to boost lending, Chakrabarti said.

Cross-Border Finance

“Emerging Europe needs cross-border finance,” he said. “While the EBRD strongly promotes the development of local deposit bases, many countries in our region will need access to foreign savings for some time.”

Wilhelm Molterer, vice president of the European Investment Bank, forecasts a reversal in that trend once the global economic outlook improves.

“What we’re seeing in the meantime is that there is greater interest from the banks in global loans, which is a sign that there is more demand on the market,” Molterer said yesterday in an interview in Vienna. “We also noticed in the last quarter that business is picking up not only for global loans, but also for corporate loans. The weak growth was mostly a demand issue. The supply issue played a role in so far as the risk assessment is more important than it was in boom years.”

To contact the reporters on this story: Agnes Lovasz in London at alovasz@bloomberg.net; Radoslav Tomek in Bratislava at rtomek@bloomberg.net

To contact the editors responsible for this story: Balazs Penz at bpenz@bloomberg.net; James M. Gomez at jagomez@bloomberg.net


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