EBRD BLOG: No quick turnaround for CEE/CIS

By bne IntelliNews May 10, 2013

Ben Aris in Istanbul -

"The news is not good: there is no quick turnaround in sight." That was the conclusion of the European Bank for Reconstruction and Development's chief economist, Eric Berglof, at the multilateral lender's annual conference being held this year in Istanbul on May 10-11.

The EBRD has downgraded its economic outlooks for almost all the countries in which it operates in Central and Eastern Europe/Commonwealth of Independent States (CEE/CIS) due to the ongoing crisis in Europe. Berglof highlighted the fates of Turkey, Poland and Russia as key to the future of the region; collectively they account for two-thirds of the GDP of the entire region and have become the engines of growth. If they do badly, everyone does badly. And they are doing badly.

Russia is the sickest of the three. Growth was expected to slow going into 2012, but as the year wore on it became clear the Russian economy has not just slowed, it stalled completely in February. Russian President Vladimir Putin has been rushing about, calling meetings and issuing strict orders to all and sundry to pull their finger out and fix the machinery. Few believe that all this noise will make much difference in the short term and the Kremlin has always talked about reform, but failed to do much. The optimists can only point to the fact that the tone is a lot shriller than normal and without the necessary oil revenues as the oil price falls, the Kremlin actually has to produce change this time or face stagnation. To drive the point home, the EBRD issued a press release as its annual meeting got underway that almost halved its Russia growth outlook for 2013 from 3.5% to 1.8%, the biggest downgrade of all the countries in its patch.

Poland too is being affected by the pall hanging over the continent. Famously the only country in the EU to avoid recession in 2009, government debt has been climbing in the intervening years and is approaching the constitutionally fixed 55% of GDP ceiling. That means Poland is fast running out of wiggle room to boost the ailing economy. "The Polish government is running out of room and can't stimulate the economy any more, so growth is slowing," Berglof said.

The country has reported a string of bad figures that are giving rise to concern in the last months, most recently lackadaisical retail figures that show consumption and demand are both falling with little prospect for a turnaround in the short term.

Turkey, host of this year's jamboree, is the one bright spot, but even its economy has been slowing too. However, Berglof said one has to see this in the context of the credit-fuelled consumer boom of last year, so the cooling pace of growth is actually a positive. "This was an economy that was overheating and now they are coming in for a soft landing, which is a good thing," said Berglof.

The turnaround is clearest in Turkey's trade figures: it was running a huge trade deficit until the second quarter of 2011, but as credit was wound down, the flow of goods reversed, putting the country in a much more healthy position. Turkey was one of the only countries in the region where the EBRD expects growth this year to be higher than last year.

Still, the slowdown is squeezing everyone and one place that the problems are already manifest is in the decay of credit quality, said Berglof, hinting that this is the thing that concerns his bank most. Bank loans are starting to go bad and this will eventually lead to a crisis unless the governments of the big three can put their houses in order. Slovenia is already in trouble and on May 9 unveiled a new package of taxes and reforms designed to raise more money that can be used to bail out its crippled bank sector. Happily for Ljubljana, international bond investors are hungry for high-yielding bonds at the moment, so the country has had access to cash. But like everyone else the pressure is on to make effective reforms and put them in place fast. "Rising levels of non-performing loans are very worrying as they are already decaying," said Berglof.

More generally, lending by banks to companies across the region remains weak and is stymieing the recovery. Crediting has been especially weak in CEE, but grew faster in the east and Turkey in particular.

What next?

As traditional methods to stimulating economies are nearly exhausted, governments are turning to increasingly unorthodox measures in the hope of kick starting their economies, such as off-budget investment funds and directly crediting small and medium-sized enterprises (SMEs).

Russia probably faces the biggest challenges, as both consumption and investment is falling. The country began 2012 with just under 5% growth thanks to a boom in consumer crediting, but this failed to spur production nor did it lead to a pick-up in investment, and by the end of last year retail turnover began to fall again.

The country is also facing constrains on the supply side, as the very low investment means factories are running at close to full tilt, which is also reflected in the record levels of unemployment. The state plans to increase spending, especially in infrastructure, but this still doesn't address the fundamental issue of how to encourage private enterprises to borrow and build more capacity. But hope dies last and surveys from across the region show that businessmen are increasingly optimistic about the future. "The rising business confidence suggests that we have passed bottom," said Berglof.

In particular, exports over the last six months have increased from almost all of CEE/CIS, with the notable exceptions of Belarus, Mongolia and Croatia.

Another positive development is that capital flows are back. With yields close to zero in most developed markets, investors have been hunting for returns and snapping up emerging market bonds willy nilly.

As the star performer of last year, Turkey still remains a magnet for investors and has received large, if volatile, inflows. Most of the CEE is also in black. Russia has seen a pick-up in the amount of FDI coming into the country, mainly from retailers, but is still experiencing a net outflow of capital.

However, most countries are being thrown back on their own resources and increasingly turning to unorthodox measures. Poland will dodge its constitutional borrowing cap by launching off-budget investment funds. Hungary has introduced a central bank lending programme and several governments have given more firepower to their development banks. "But there is no shortcut to growth. All the governments need to continue to push ahead with their reform and privatisation plans," said Berglof.

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