A changing global balance…
Less than a year ago, in April 2013, the IMF forecast accelerating global economic growth driven by the resurgence of the emerging markets. How things have changed: concerns over economic health and political stability in the emerging markets have reached new heights in recent weeks as Ukraine, Turkey and Argentina have all been in the spotlight, leading to falls in currencies and stock markets. Rather than the BRICs being talked about as the source of rapid growth, terms such as the “Fragile Five” are now being used to highlight the challenges facing the emergers.
Meanwhile, the situation in the Eurozone appears stable and certainly confidence is much higher than in the difficult times of 2012. Investors are now reviewing the balance in their global portfolios and, according to surveys quoted in the Financial Times, around half of fund managers want to be overweight in Europe: a major transformation from 18 months ago. Will this surge in financial investor interest translate into corporate investment?
…could be good news for Central and Eastern Europe…
Difficult as it was to imagine less than 2 years ago, Central and Eastern Europe (CEE) is now in position to benefit from its linkages to the Eurozone. At the height of the crisis, these linkages were seen as major sources of weakness as investors worried about collapsing export demand and the potential contagion effect on banks in the region.
Since 2008-9, as the latest EY Rapid Growth Market forecast highlights, the correlation between GDP growth in the Eurozone and the CEE economies has increased. Previously the range of correlations was from 0.03 to 0.8, but today the figure is at least 0.85 in every case and in the Czech Republic correlation is now almost 1. As Eurozone growth returns, this stronger correlation is a positive attribute rather than the negative factor it was seen as in 2012.
…as fundamentals improve…
Exports are starting to rise as Eurozone demand improves. The impact will vary by country with the Czech Republic and Poland likely to be amongst the largest gainers driven by their manufacturing linkages to Germany in particular. Export growth will then feed through into increased domestic demand via the normal multipliers. Both countries appear well placed to benefit from moves by manufacturers in developed markets to “reshore” some production away from China and other Asian markets closer to the destination markets in Europe. The EY 2013 European Attractiveness Survey identified strong performance by Poland in particular.
…although banking remains a risk…
The banking system will be important in providing the funding to allow businesses to respond to increased demand. This is one area where the linkages to the Eurozone may not be positive. Funding remains a challenge in the Eurozone and as banks in the CEE are mostly foreign-owned, 70% of bank assets in Poland, 86% in Hungary, the problems may hamper lending in CEE. The current position of the banking sector in CEE suggests that the Czech Republic and Poland with non-performing loans of around 5% of gross loan compared to 15% in other CEE countries, will benefit first from any increased funding availability, further strengthening their relative economic outlook.
…and once again, investors need to differentiate between opportunities.
The performance of countries within the CEE will vary significantly. On the basis of the analysis in the EY Rapid Growth Markets Forecast, we can expect:
- The Czech Republic to perform relatively strongly, potentially reaching a growth rate of 3% by 2015;
- Poland to also fare well based on export growth and a strong banking system with the potential to grow at 3.5% in 2015 and beyond if consumption picks up to support business growth;
- A slower initial recovery in Bulgaria and Romania but potential from 2015 for these economies to grow in excess of 3% per annum albeit from a lower base than the Czech Republic and Poland in terms of income per head.
- Hungary to begin to recover from its specific policy challenges post the crisis.
Political problems in the Ukraine will shape its economic prospects and also the outlook for Russia. Whatever the outcome of the current crisis, it is likely that recent events will have put heightened concerns over political risk in both countries and this is likely to reduce the flow of foreign investment in the short-term and possibly beyond. Without access to foreign capital and know how, economic growth is likely to be slower than previously forecast.
Time to look again at Central and Eastern Europe
The fundamentals in the region have certainly improved and if the Eurozone can avoid a further crisis and is able to build growth momentum then there will be opportunities. As always in the post-crisis economy, the key is to differentiate between opportunities and countries. The Czech Republic and Poland appear to be ahead of the regional pack but other countries will also come into play if momentum builds and it does appear that relative to other emerging markets, the countries in Central and Eastern Europe do offer growth opportunities.