Revival of Growth in the Euro-zone Crucial to Its Economic Recovery
Trimming its forecast for global growth, the International Monetary Fund’s mid-year assessment of the world economy highlighted the slowdown in emerging economies such as Russia and recessionary conditions in the Euro-zone. Still, the recent surge in factory production and rise in new orders brought a whiff of optimism to emerging European markets such as Poland, the Czech Republic, and Hungary, which have been reeling under a prolonged downturn due to weak demand from the Euro-zone.
The European Bank for Reconstruction and Development (EBRD) observed that growth is expected to slow in the major regional economies of Russia, Turkey, and Poland during the year. Sounding a cautionary note, the bank said that Russia’s slowdown, triggered by a fall in the prices of its key commodity exports and lower post-election social spending, is much more than a temporary weakening. Though street protests against the so-called authoritarian moves by the Erdogan administration created ripples in the Turkish economy and the stock market, the central bank’s quick intervention allayed the fears of foreign investors. Overall, the EBRD feels that the Turkish economy will experience a soft landing as the credit-fueled boom comes to an end. Nevertheless, despite the investment-grade rating it received toward the end of last year, Turkey is still reeling under a continuing current-account deficit problem, which is far above the stipulated limit.
Poland, the EBRD feels, is in a tight spot as the on-going Euro-zone crisis leaves it with little scope for rolling out any more fiscal stimulus measures. As exports to the currency union are yet to pick up speed, the bank expects the Polish economy will grow at a slower rate than last year, with a dire need to initiate structural reforms.
The Czech Republic and Hungary face similar challenges, with the recession-hit Czech Republic also enduring infrastructure damaging floods. New foreign investments announced for Hungary’s car-manufacturing sector brought cheer for an economy that recently emerged from a prolonged recession. Still, high levels of public and external debt and fresh taxes imposed on foreign investments in sectors such as telecom remain a cause for concern.
RUSSIA: FALLING COMMODITY PRICES HURT ECONOMY
Russia, the biggest among the emerging European economies, experienced a sharp slowdown during the second quarter due to the fall in the prices of commodity exports, the mainstay of the economy. The gradual rollback of social spending, which was launched in the run-up to last year’s presidential polls, also took a toll on the slowing Russian economy. Revising its January forecast for Russia down to a meager 1.8 percent this year, the EBRD pointed out that investor confidence has taken a beating due to what is widely perceived as an unaccommodating stance toward foreign investors. What’s more, the Putin administration’s much-publicized sale of stakes in government-owned companies, which would have brought in considerable budget revenues, also seems to have hit a snag after Prime Minister Dmitry Medvedev came out publicly against the lobbying efforts involved in the process.
The shale gas boom in the United States is understood to be detrimental to the interests of Russia’s lucrative natural gas exports to Europe, its major market. The danger of losing its ground prompted Russia to warm up to Turkey as a possible destination for its gas exports. Nevertheless, with a continuing dependence on oil revenues and weak institutions, rating agency Standard & Poor’s was forced to assign Russia a lower investment grade. Acknowledging the sentiment, President Vladimir Putin said the government would spend about $14 billion on building new infrastructure, mainly rail and road networks, to revive economic growth.
Amid the gloom, Russia had something to cheer about as manufacturing activity recorded a rise for the fourth straight month in June, helped by domestic demand and a rise in new orders. Though industrial production shrank in May, domestic orders made up for the weak demand for Russia’s products from the European Union.
As well, the slight fall in consumer prices in June was welcome news. Though inflation may still be hovering above the Emerging Europe average, the situation bodes well for a cut in interest rates. The change of guard at the central bank, where a close Putin aide has taken over the reins, makes the case for reduction in benchmark rates stronger.
TURKEY: OVER-HEATED ECONOMY SOFT LANDS AS FOCUS SHIFTS TO PROTESTS
Until recently, foreign investors were only too happy to pump money into Turkey, and in the process help the economy balance its huge current account deficit. However, the very factors that attracted foreign money --- strong economic growth, the government’s pro-market approach, and relative political stability – seem to have lost their allure for investors, who were also encouraged by two investment rating upgrades. Though the slowing down of the economy had more to do with external factors such the Euro-zone crisis, the loss of investor confidence was punctuated by the recent street protests and the way the Erdogan administration tackled the situation. Exacerbating the problem, the government moved against one of the largest family-owned conglomerates in the country, the latest in a series of state interventions in business. However, the changes happening in the Turkish economy are also to be seen in the light of the wider churn happening across emerging markets due to Ben Bernanke’s much-misinterpreted statement on the possible winding down of the U.S. Federal Reserve’s bond purchase program.
Any discussion about Turkey’s economy tends to focus on its widening current-account deficit, which currently stands above 6 percent of its gross domestic product. The economy requires about $50 billion a year to bridge its deficit, which mostly comes in by way of foreign investments in stocks and bonds. Against the backdrop of the recent protests in Istanbul, the concern among investors may be justified. More importantly, Morgan Stanley has pointed out that the share of foreign direct investments in Turkey has been falling.
Turkey saw more trouble as the latest inflation report showed a reading of 8.3 percent in June despite core inflation remaining relatively stable. The reasons are not too hard to find, with a rise in the prices of unprocessed foods and oil imports, and a weak currency inflating the country’s energy bill. Still, an interest rate hike seems unlikely as the Turkish central bank has followed a policy of intervening in currency markets to strengthen the lira. Despite the slowdown and social unrest though, Turkey appears to be in a relatively better position compared to its peers as the International Monetary Fund expects the economy to grow at a rate of 3.4 percent during the year.
POLAND: SLOWING ECONOMY CONSTRAINED BY LACK OF FISCAL STIMULUS OPTIONS
The only European Union economy to grow during the financial crisis, Poland now has lost track for more than a year. If fiscal measures implemented during the financial crisis stood the economy in good stead then, Poland appears to have little room to offer any more stimulus, as its exports to the Euro-zone have slowed. Besides this, private consumption, which contributes most of its tax revenues, remains weak due to rising unemployment and stagnant wages.
However, the May reading of retail sales showed an improvement, helped by the sale of pharmaceuticals as well as consumer durables and white goods.
The Polish manufacturing sector, which has been in trouble for several quarters now, received some encouraging news in June when the HSBC Purchasing Managers’ index revealed its best reading in 11 months. Especially noteworthy was the rise in Polish exports, thanks to strong external demand. Together with even more encouraging numbers from its neighbors, the improvement may be a harbinger of stronger growth in central European region in the second half of the year.
In July, the Polish central bank cut interest rates to a record low to revive sagging economic growth, saying the economy is out of the woods. The central bank’s statement, which ruled out any change in the rate until inflation shows a consistent rise, may be viewed both as a sign of optimism over the improvement in Poland’s largest export market Germany and also an acknowledgement that the bank has exhausted all its policy options. In the light of slowing consumption growth and moderate increase in wages, the central bank reduced its growth forecast for the year. On the issue of balancing the budget, Prime Minister Donald Tusk categorically said the economy would not be able to meet the European Union’s budget deficit target of less than 3 percent of Poland’s gross domestic product (GDP) this year. Mr. Tusk also underlined the government’s policy calling for a balance between economic expansion and enforcement of fiscal discipline through spending cuts.
HUNGARY: ECONOMY TURNS A CORNER
The recession-hit economy of Hungary received a fresh lease on life as it posted a quarter-on-quarter expansion of 0.7 percent in the first three months of the year, the first time the economy grew in more than two years. A purchasing manager index also showed a positive reading in June. Though Hungary shares many of the problems unique to Euro-zone dependent economies, it also faces criticism for its perceived unfriendly foreign investor policies. The Hungarian government fired its latest salvo in June when new taxes were imposed on banks and telecom companies, purportedly to balance the country’s budget.
The Viktor Orban administration has also drawn ire for its “interference” in the appointment of central bank governors and judges. Providing some solace, the European Commission allowed Hungary to exit the Excessive Deficit Procedure, aimed at spendthrift countries in the European Union. While the Organization for Economic Co-operation and Development (OECD) expects Hungary’s economy to grow only marginally during the year, it called upon the government to do away with taxes on non-tradable sectors and banks.
Amid the subdued cheer, the country’s thriving automobile manufacturing sector seems to be shining bright. Exports of auto parts and cars are central to this small, open economy, constituting a sizeable chunk of its GDP. The sector was also fortunate to escape the tax burden imposed by the government on foreign investment in areas such as the telecom sector. Needless to say, big-ticket investments in Hungary announced by some multinational car-makers could not have come at a more opportune time for the sluggish economy. What’s more, some policies of the Orban government have proved to be a blessing in disguise for the Hungarian consumer. The lowering of electricity bills has put more money in the hands of Hungarians and has boosted consumer confidence. Expectations of increased farm output this year also bodes well for the country’s economic prospects. As the government tries to kick-start the economy, the Hungarian central bank said it will keep a close watch on inflation. The central bank’s program to provide cheap financing to retail banks was intended to make credit available to small and medium-sized enterprises.
CZECH REPUBLIC: POLITICAL INSTABILITY AND FLOODS ADD TO THE GLOOM
Though the Czech Republic’s manufacturing sector showed an uptick in June, the prolonged economic contraction showed no signs of easing even as Prime Minister Petr Necas had to resign following allegations of corruption against a close aide. Floods that caused extensive damage in certain parts of the country exacerbated the problems. Encouragingly, it was pointed out in a Warsaw Business Journal analysis that the $600-million infrastructure rebuilding fund would help trigger growth and increase domestic consumption, albeit temporarily.
Still, a sustained revival in exports is crucial to rejuvenate the economy, which is reliant on the export of goods and services for a major chunk of its gross domestic product. With 80 percent of its exports headed to European Union countries, especially to relatively better-off Germany, the economy managed to escape the fate of some of its Southern European counterparts. But the need for diversifying the Czech Republic’s export markets has never been felt as dire as it is now. The country’s increasing exports to Russia, which have almost doubled over the years, look like the country’s best trump card against the prevailing slowdown in Western Europe. Though new car registrations decreased during the first six months of the year, retail auto sales recorded a rise, lifting hopes of a recovery in an economy dependent on its automobile manufacturing sector.
The uncertain political situation in the country after the resignation of the premier becomes significant as the economy remains equally wobbly. It appears that the new government, headed by a left-wing independent who may not garner a parliamentary majority, will have a tough task ahead. While the OECD forecasts that the economy will contract during the year, it also urged the Czech central bank to consider quantitative easing measures amid falling inflation and near-zero interest rates.
Central European economies such as Czech Republic have been riding the wave of low wages and high-skilled labor to attract investment from Western Europe. Relative political stability and continuity of investor-friendly policies like in Poland combined with a gradual recovery in the Euro-zone economies appear to be the best possible scenario for a turnaround in Czech Republic’s fortunes.
FORWARD LOOKING STATEMENTS
Certain statements made in this article may be forward looking. Actual future results or occurrences may differ significantly from those anticipated in any forward looking statements due to numerous factors. Thomas White International, Ltd. undertakes no responsibility to update publicly or revise any forward looking statements.
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