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Emerging Europe: Regional Economic Review 4Q 2012

January 29, 2013

by Team

of Thomas White International

Emerging Europe: Still Reeling under the Shadow Of the Euro-zone Debt Crisis

As the 2012 year closed, the emerging economies of Europe joined their cousins in the developed world for their share of woes, and in particular, were impacted by the debt crisis in the Euro-zone, their primary trading partners. Though Russia, the biggest of these economies, finally managed to become a member of the World Trade Organization, the resource-dependent economy recorded slowing growth during the third quarter as both household consumption and state spending expanded at a slower pace. While Poland too struggled with slowing growth, Turkey continued to grapple with the current account deficit.

Hungary was beset with its own domestic issues, while the Czech Republic suffered as its manufacturing sector struggled due to weak export orders.

World Bank President Jim Yong Kim shared the sentiment when he told Bloomberg that “the on-going economic and financial instability in Europe continues to threaten growth and jobs, particularly in central and southeastern Europe.” Demonstrating their commitment to Eastern Europe, three international lenders, the Luxembourg-based European Investment Bank, the World Bank, and the European Bank for Reconstruction and Development (EBRD) pledged $38 billion to a number of countries in the region, which include the Czech Republic, Hungary, and Poland, to help them cope with the impact of the Euro-zone debt crisis.

The EBRD, which offers assistance to Russia, Poland, Hungary, and Turkey among the countries covered in this review, recently observed that the governments in Eastern Europe should amend their policies to benefit from a global economic recovery. The bank suggested implementing measures such as selling state-owned assets, improving the business climate, and strengthening legal systems to support the economic recovery in these countries.


Russia’s economic growth slowed down to 2.9 percent during the third quarter as both government spending and household consumption declined. The commodities-dependent economy was banking on consumer spending to boost its economic output. Meanwhile, manufacturing activity contracted in December for the first time in more than a year as external demand from recession-hit euro-zone countries, which are the country’s main trading partners, decreased.

In its recent economic assessment, the EBRD reiterated its call for Russia to diversify, and shed its obsession with oil and natural gas, which account for about 70 percent of the country’s exports. The bank further noted that Russia, the largest country of its operations, needs to revamp its education system and business environment to make it attractive for potential investors. It also listed corruption and the domination of the state in business as hindrances to economic progress. To put things in perspective, Russia invests only one percent of its GDP in research and development, as a Financial Times report pointed out.

Russia’s accession to the World Trade Organization was the most important economic development during last year. The membership bodes well for the economy on several fronts including the potential to increase production in the face of tough competition from rising imports. Thus, Russian companies will be forced to produce more, and hence become more efficient. Still, if the economy is to benefit from WTO membership, the administration will likely need to implement the necessary structural reforms.


Turkey’s economy slowed down to the lowest level seen in three years to 1.6 percent on an annual basis in the third quarter, as growth in the European Union, its biggest trading partner, stagnated towards the end of the year. The economy, which was the third fastest-growing among the G-20 nations in 2011, lost its momentum during the second quarter of 2012 as domestic demand and private investment declined, ending the year with a growth rate of just 3 percent.

Meanwhile, Turkey’s trade deficit narrowed less than expected during the month of November as imports increased for the first time since May, an indicator of the pick-up in economic activity, according to a Bloomberg report. The central bank had tightened monetary policy during the first half of the year to rein in inflation and curb the consumer credit boom.

The Turkish central bank has been trying hard to rebalance the economy by curbing domestic spending on the back of surging exports, according to a WSJ report. The central bank continued to actively intervene in the economy as it cut the benchmark interest rate to a new low of 5.5 percent to boost the country’s faltering growth and to prevent its currency, the lira, from appreciating. It was the first time since August 2011 that the bank reduced its policy rate. At that time, the policy move sparked a consumer lending boom in the $800-billion economy.

On a different note, the country’s annual inflation rate came down significantly during the year, thanks to benign domestic food inflation, a strong currency, and weak domestic demand. The inflation rate stood at 6.2 percent on an annual basis in December 2012, though it fell short of the central bank’s target of 5 percent. However, the burgeoning current-account deficit, which stands at 7 percent of the economic output, remains a worry as it leaves Turkey vulnerable to the fluctuations of global capital flowing in and out of the country.


The Polish economy, which managed to avoid a recession even during the financial crisis of 2009, showed signs of slowing down during the quarter. As consumers in its main export markets were hit by the Euro-zone debt crisis, factory activity in Poland, which is the mainstay of the economy, shrunk with the volume of cars, electronics, and other goods manufactured in the country trimmed down. The Polish Purchasing Managers’ Index for the month of December was clocked at 48.5, while a reading above 50 indicates expansion.

Meanwhile, the Polish administration kick-started the revival of the country’s economic growth with the sale of stakes in some government-controlled companies. On the anvil are the sale of interests in Polish utility PGE, lender PKO BP, insurer PZU, and chemicals manufacturer Ciech. The Polish central bank reduced the benchmark interest rate to 4 percent in January in another bid to boost the country’s flagging growth. Poland’s growth rate has remained steady at 1.5 percent without falling further and the problems in the Euro-zone seem to have stabilized, according to a Financial Times report.

In another move, Polish Prime Minister Donald Tusk highlighted the need for Poland to join the Euro-zone again, stating that the country would not benefit if it chooses to remain on the European Union’s periphery. Poland still needs to meet some of the eligibility criteria though. The EU stipulates that Poland must achieve a budget deficit target, while inflation in the country is still outside the reference range.


As expected, the National Bank of Hungary slashed interest rates for the fifth month in a row to 5.75 percent. The rate had stood at 7 percent before the rate cuts began in August 2012. The central bank also said headline inflation will be within its target of 3 percent by the end of the third quarter of next year, according to a Wall Street Journal report.

The Hungarian government seems to be making an effort to mend fences with big businesses as the relationship became strained after the administration slapped hefty taxes on these firms to boost the state treasury, according to a WSJ report. Under the broad terms of the agreement, multinational corporations that operate in Hungary such as Microsoft and General Electric would commit to maintain operations in the country for the long term, while the government would advise the firms on how to avail themselves of subsidies and other incentives. Domestic companies also stand to benefit from the change in the government’s business policy.

Meanwhile, the Hungarian parliament passed the budget for 2013, which proposes to bring down the budget deficit below the 3 percent target. The administration also said it would tap the foreign currency debt markets during the first quarter of 2013. Hungary, the most indebted economy in Central Europe, is still in muddy waters as Standard & Poor’s cut the country’s credit rating to the “junk” category, citing its weak growth outlook.


The Czech Republic’s gross domestic product (GDP) shrunk 1.5 percent during the third quarter of 2012 as domestic demand remained due to low spending and the Euro-zone debt crisis hit exports, the mainstay of the economy. The austerity measures implemented by the Czech government have hit spending by both consumers and businesses. However, the inflation reading was better in November at 2.7 percent compared to 3.4 percent recorded in October. The central bank said inflation will remain slightly above the 2 percent target in 2013.

Manufacturing activity remained subdued during the quarter, falling to 46 in December compared to 48.2 in November, the lowest reading among the economies of Poland, Hungary, and the Czech Republic. The Czech economy exports cars, auto parts, and electronic goods to the European Union, which accounts for 80 percent of its exports.

Meanwhile, the Czech central bank reduced interest rates to 0.05 percent in an attempt to revive the country’s economic growth as consumer confidence remains at its lowest level in 13 years, according to a Reuters report. The bank also made it clear that interest rates would remain at the current level until inflation rears its head. On the positive side, the Czech Republic’s debt is only 40 percent of its GDP compared with the EU average of 80 percent, according to a WSJ report. The government has said that it aims to bring the budget deficit to 2.9 percent in 2013.

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