Ukraine crisis threatens to stomp on CEE/CIS recovery, EBRD warns

By bne IntelliNews May 14, 2014

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The Ukraine crisis threatens to slow the recovery in Central and Eastern Europe and the Commonwealth of Independent States (CEE/CIS), or even bring it to a complete halt, the European Bank for Reconstruction and Development (EBRD) warned in its latest economic outlook for the region on May 14. The development bank slashed its regional growth forecasts in half.

Concern over the effects of the standoff in Ukraine and sanctions slapped on Russia has been building in recent weeks. Both the International Monetary Fund (IMF) and EU have hinted at worries that the crisis could affect the sluggish global recovery, but with the situation in Ukraine descending into chaos in May, the EBRD is the first to explicitly warn that it could stop growth in CEE/CIS in its tracks.

"Since our forecast in January 2014, events in Ukraine/Russia have significantly increased geopolitical and economic uncertainty, with direct negative effects on the economies of Ukraine and Russia and potentially wider implications for the region as a whole," the report states. That, it says, outweighs positive developments in the reaction to tapering of quantitative easing in the US and gaining momentum in the Eurozone.

Hence, the EBRD now predicts growth in its region of just 1.4% this year, a sharp reduction from the rate of 2.7% it forecast in January. "A modest upturn of 1.9 per cent in 2015 is possible, but is only achievable if the crisis does not escalate," it adds, noting "an unusually high level of uncertainty surrounding the forecasts with major risks on the downside".

The development bank says that under its "most likely scenario," Ukraine will enter recession in 2014, with the economy contracting 7%. It would then remain flat for 2015, while international financiers oversee a major, though gradual, adjustment. 

However, it worries that a "less benign scenario" would send Russia into recession in 2014. Coupled with increased risk aversion in global markets, this would bring growth in the EBRD region to a standstill, it predicts. At this point, the Russia/Ukraine crisis would start impacting the global economy.

"What we are worried about, really, is the potential escalation of the sanctions, particularly on the financial system," EBRD Chief Economist Erik Berglof told a news conference, according to Reuters.

The negative scenario would see even more damage to the Ukrainian economy, the EBRD says, which would presumably at some level involve a debt default, or at least a restructuring. Meanwhile, the Russian economy, which was already struggling before its annexation of Crimea provoked international sanctions, has no more than 0.6% growth to look forward to in 2014. 

"Any further deterioration in [investor] confidence could increase capital flight and lead to even lower investment and slower growth," the EBRD warns. "High inflation and pressure on the rouble could limit the scope for monetary easing while any fiscal response would be constrained by current oil price levels and supply-side bottlenecks."


By way of contrast, assuming no significant deterioration of the Ukraine crisis, the Central European states all saw their forecasts raised, with revived domestic demand adding to the effects of the recovery in the Eurozone - to which they are all strongly linked. Downside risks come from high dependence on Russian energy, while a more general fall in investor confidence could hit the banks and capital markets.

Any specific risks are seen as political, with the struggles of Poland's ruling Civic Platform tempting it to relax fiscal discipline ahead of elections next year. Hungary's ruling Fidesz party meanwhile has just won another landslide, which raises the risk that its unorthodox economic and monetary policy could yet hurt growth.

However, it's the Baltic states with the biggest concerns. The region's huge reliance on Russian gas and power, and high exposure of the economies to Russian trade, saw the EBRD cut 0.3-0.8 percentage point from its January forecasts for Estonia, Latvia and Lithuania. 

At the same time, it suggests Latvia will remain the pacesetter for growth in the EU in 2014 with expansion of 3.8%. However, that didn't prevent Finance Minister Andris Vilks announcing to the EBRD meeting in Warsaw on May 14 that Riga is ready to cut its own forecast by 0.3pp to 4%.

While Southeast Europe's links to the Eurozone have also seen it starting down the recovery track – the EBRD forecasts regional growth at 2.2% in 2014, rising to 2.4% next year – certain countries are also heavily exposed to the fallout from Ukraine. Serbia in particular has strong trade and investment links with Russia, and that saw its 2014 growth outlook cut by 0.3pp to 1%. The economic reforms announced by Prime Minister Alexander Vucic’s new government are also likely to have an impact. 

However, the picture is brighter in Romania and Bulgaria. Romania’s economy is “continuing to accelerate”, says the EBRD, as it raised its growth forecast for this year to 2.6%, although the high level of non-performing loans remain a concern. Bulgaria too is expected to see exports rise and a recovery in domestic private consumption.

While Turkey has not yet significantly suffered, the Ukraine crisis could act as a drag on exports and tourism, the bank suggests. However, Turkey has plenty of its own risk to be going on with in the form of political instability, and growth is expected to slow to 2.5% this year, down from 4% in 2013. 

“Since the beginning of the year the risk premium facing Turkey has increased, in part reflecting high political uncertainty, and the higher cost of finance is expected to weigh on domestic demand and growth,” the report says. 

The EBRD also warns that the country will be one of the first in the firing line if the US Federal Reserve's ongoing tapering of quantitative easing results in a larger-than-expected outflow of foreign funds to emerging markets. “Turkey might take the brunt of the drain in short-term capital flows, with its still large external imbalances mainly financed through this channel,” the reports worries.

However, for knock-on effects from Russia's struggles, Central Asia will clearly bear the brunt; it is hugely dependent on remittances from emigrant workers and trade and investment with the largest economy in the neighbourhood. "A lower growth of remittances will particularly affect Tajikistan, the Kyrgyz Republic, Moldova and Armenia," the report says.

The EBRD notes that the depreciation of the Russian ruble led to the devaluation of the Kazakh tenge in February by 16% which, in turn, dragged on the Kyrgyz some. Meanwhile, Mongolia’s tugrik has also continued depreciating as the economy faces an adverse terms of trade shock and uncertainty regarding major mining projects. "A further lowering of Russian growth would affect several of these countries negatively," the EBRD warns starkly.

However, it's not all doom and gloom, with Chinese demand for raw materials helping to keep things going. Growth has so far remained strong in Central Asia, as large new mining and hydrocarbon extraction projects contributed to grow in Kazakhstan, Mongolia and Turkmenistan. "A number of large natural resource projects will continue underpinning relatively strong growth in Central Asia," the report says. 

Looking longer term, the EBRD says it is upbeat on the impact of the Russia-led Customs Union: "The Eurasian Customs Union is likely to have a more positive role in Central Asia going forward, if reduction in non-tariff barriers and costs of trading across borders."


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