COMMENT: Emerging Europe faces more uncertain outlook

By bne IntelliNews May 15, 2007

Fitch Ratings in London -

Fitch Ratings says in a special report that macroeconomic fundamentals in most countries in emerging Europe have continued to strengthen and the global environment remains generally supportive. However, substantial external financing requirements in many countries leave them relatively exposed to a potential abrupt tightening in global liquidity.

"Sovereign credit ratings in emerging Europe have risen further over the past 12 months, with seven foreign currency upgrades and no downgrades," says Edward Parker, head of Fitch's Emerging Europe Sovereign Group in London. "However, upward momentum may be running out of juice, with only three countries - Armenia, Kazakhstan and Ukraine - now on a Positive Outlook and two - Hungary and Latvia - on a Negative Outlook."

Recent upgrades have been underpinned by improving fundamentals such as rising income levels, structural reforms and declining ratios of public debt to GDP and net external debt to exports.

Fitch expects GDP in emerging Europe to grow by a robust 5.7% in 2007 and 5.4% in 2008, after 6.6% in 2006. However, easing global growth, rising interest rates and uncertainty over the direction of commodity prices and risk appetite make the economic and financial environment somewhat less favourable than in 2006.

Low G3 real interest rates have helped to fuel rapid real M2 growth of 22% in 2006 (8% for the world as a whole) and median real bank private sector credit growth of 24%. The main downside risk is an abrupt tightening of global liquidity in the context of sizeable imbalances in many countries, in Fitch's view.

Financial markets in the region have been some of the hardest hit by periodic bouts of global market volatility. In part this reflects emerging Europe's huge external financing needs (current account deficits plus medium- and long-term amortisation), which Fitch forecasts at $217bn in 2007 – by far the largest of any emerging market region. Latvia's current account deficit reached 21% of GDP last year.

Fitch projects emerging Europe's sovereign eurobond issuance at only $16bn in 2007 as issuers continue to switch financing to domestic debt markets. In contrast, the private sector issued some $43bn in eurobonds in 2006 and $20bn in Q107, underlining that the region's credit boom is a private-sector story.

Indeed, Fitch estimates that gross public external debt rose by just $2bn in 2006 and net public debt fell $185bn (as reserves increased), while private gross external debt jumped by $133bn. Nonetheless, as highlighted by the Asian crisis, sovereigns cannot fully insulate themselves from financial distress in the private sector.

Political risks continue to weigh on several countries in the region. In the new EU member states, risks include election uncertainty, weak coalition governments, populism, reform fatigue and euro-scepticism. Event risk is an issue in countries with less established democratic institutions. Russia and Turkey face both parliamentary and presidential elections over the next 12 months, while Romania, Serbia and Ukraine are mired in political crises.

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