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The deepening sovereign debt crisis in the Eurozone is starting to bite in Emerging Europe, with economists downgrading growth forecasts for the region and warning that even the poster boy of the first phase of the crisis, Poland, is now more vulnerable to recession in the West.

On October 5, Raiffeisen Bank International significantly lowered its 2012 growth forecasts for most of the countries in Central and Eastern Europe (CEE), resulting in an average GDP growth estimate of 2.3% for the region as a whole. The 2011 forecast is for 3.2% growth.

"The currently very uncertain situation in the Eurozone - for which the leading indicators are pointing to a period of recession, while the sovereign debt crisis continues to escalate from one episode to the next - also has negative ramifications for CEE," says Peter Brezinschek, head of Raiffeisen Research, in research report published October 5.

Brezinschek says the impact on CEE stems from the region's "lopsided export-orientation" (up to 85% of CEE total exports go to the EU), as well as the mounting pressures within the European banking sector.

Despite the predicted slowdown in CEE, Raiffeisen says the growth rate should be significantly higher than that expected in the Eurozone, which is forecast to grow by 1.6% in 2011 and just 0.2% in 2012. Also, the CEE region is expected to continue its catch-up process towards the Eurozone with a positive growth differential of 1.5 to 2 percentage points per year until 2015.

Within the CEE region, Brezinschek expects the impact on the Commonwealth of Independent States (CIS) to be less pronounced than in Central Europe and Austria, due to the more robust domestic demand in the CIS countries. Raiffeisen expects the CIS region's GDP to grow by 3.6% in 2011 and by 3.0% in 2012. GDP in Southeastern Europe should grow by just 1.6% in both 2011 and 2012.

The World Bank argued in a recent report that while economic recovery is underway in the CEE/CIS region, the evidence signals a lower growth gradient than the pre-crisis rates. Philippe Le Houérou, World Bank Vice President for the Europe and Central Asia Region, put the region's real growth rate at 4.3% in 2011, which is one of the lowest of any developing region. "There has been a noticeable reduction in growth prospects: countries in the region may need to prepare for growth rates that are 2 percentage points of GDP less than what they were before the global crisis," said Le Houérou. "The slow recovery in the region may be establishing a 'new normal' of lower economic growth rates in many of the region's countries."

Slippery Poles

Meanwhile, Capital Economics warns that this time around Poland, the only EU country to avoid recession in 2009, is in many respects now more vulnerable to a recession in the West, predicting Polish GDP will grow by just 1.5% next year - slower than the 1.7% recorded in 2009.

Capital Economics identifies three reasons why Poland escaped recession in 2009: first, it was less dependent on exports than its peers elsewhere in the region; second, the Polish economy, in particular its banking sector, was less dependent on foreign financing; and lastly, policymakers had ample room to respond to the slump in global demand.

Now, though, there's just the smaller dependence on exports to keep the Polish economy afloat. "There is no scope for fiscal stimulus this time around. In fact, debt ceilings enshrined within the constitution mean that fiscal policy will have to tighten next year, even if growth slows. In other words, fiscal policy will now become an additional drain on demand and a drag on growth," Neil Shearing, chief emerging markets economist at Capital Economics, notes.

He also notes there is less scope for monetary policy stimulus today, given currency considerations (the zloty is dangerously weak against the Swiss franc, in which households have borrowed heavily for their mortgages), coupled with the fact that interest rates are already much lower. "There is now less scope for monetary easing. We have pencilled in 50bps of cuts in the benchmark rate to 4.0% next year and would not rule out the possibility that it falls all the way back to its record low of 3.5%. But a repeat of the 250 bps of rate cuts seen in 2008-09 is off the cards."

Shearing concludes: "In short, Poland should still outperform its peers in the region - but the degree of outperformance will be much smaller than in 2009."