"The worst days are behind us, but then so are the best," was how Gunter Deuber of Deutsche Bank Research put it at the BACEE Country and Bank Conference in Budapest in mid-April.
The scale and pace of the recovery in emerging Europe, though certainly dwarfed by that in Asia and Latin America, has certainly been surprising - an impression given further weight by the release in April of the International Monetary Fund's "World Economic Outlook," in which it forecasts the region's growth in real activity at 3% in 2010, picking up to 3.5% in 2011.
Deuber noted that the ostensible resilience of emerging Europe owes much to Poland, the largest economy in Central Europe, managing to stay out of recession, growing 1.8% in 2009. "CEE had rather a positive performance, with only a less than 4% contraction, which was helped by Poland," says Deuber. "Poland had no pre-crisis economic boom and moderate credit expansion, so the crisis hit the country just at the right time."
What has also undoubtedly done much to help put a floor under the recession and aided the recovery is that the banking systems in emerging Europe, by and large, all remained remarkably profitable. "Despite the adverse conditions, the financial system has remained pretty stable," said Eva Zamrazilova, a board member of the Czech National Bank.
Taking Hungary as an example, one of the worst-hit countries in emerging Europe by the crisis (its GDP contracted by 6.3% in 2009), apart from a few banks most stayed profitable with a return on equity (ROE) of 9.3% even as non-performing loans (NPLs) hit 5.9% of the total at the end of 2009. "The trading profits were quite high and while one-off factors like the rise in the value of government bond holdings will be much lower in 2010 than 2009, Hungary banks have shown they can remain profitable even in tough times. Hungary's banking sector is much more resilient to shocks, much more than in early 2009," said Peter Tabak, director of financial stability for the National Bank of Hungary.
This pattern of rising NPLs, lower lending levels yet still eking out profits was even seen in Latvia, the country most affected by the crisis, where the banking system remained profitable with an ROE of 12.4% in 2009. "We've seen a substantial growth in business volumes in the first quarter and we're heading to get back to pre-crisis levels," says Roberts Idelson of local Parex Banka, which had to be effectively nationalised in late 2008 after a run on the bank, but which in an amazing turnaround could be sold as soon as this year to a strategic investor.
Another major factor has been the unexpectedly quick recovery in Germany, which has had a profound effect on the neighbouring countries in emerging Europe. On April 23, economic research institute Ifo reported that German business confidence experienced a strong gain in April, rising by 3.4 points to 101.6 - its highest level since summer 2008 - as respondents to the survey reported they were becoming more optimistic about current economic conditions.
The upshot is that growth in emerging Europe will almost certainly be stronger than that in Western Europe, with some economists predicting even higher growth than the IMF sees. "So growth will be above western markets, at about 4%, about 2 percentage points of a gap, but the end of the booming growth means we'll remain below pre-crisis levels," said Fabio Mucci, senior economist at UniCredit Group.
Indeed, those levels are far below the roaring economic growth seen before the global economic crisis swept over the continent, something that's unlikely to change over the medium term, and the recovery prospects vary considerably from country to country. "Economies that weathered the global crisis relatively well (Poland) and others where domestic confidence has already recovered from the initial external shock (Turkey) are projected to rebound more strongly, helped by the return of capital flows and the normalization of global trade," the IMF said in its recent report. "At the same time, economies that faced the crisis with unsustainable domestic booms that had fueled excessively large current account deficits (Bulgaria, Latvia, Lithuania) and those with vulnerable private or public sector balance sheets (Hungary, Romania, the Baltics) are expected to recover more slowly, partly as a result of limited room for policy maneuver."
DB Research's Deuber notes that given that the vulnerabilities in emerging Europe at the onset of crisis were comparable to those in Asia in 1997/98, the needed adjustment was comparable. However, a big difference between then and now is that Asia's problems came when the western economies were booming so Asia could export its way out of recession. "There is a weaker backdrop now, so unlike Asia emerging Europe can't export its way out and 2010 will remain challenging," he said, adding that while the region will profit from the German rebound, he remains rather sceptical about the sustainability of Germany's recovery.
The IMF also points out that even though the banks remained in better shape than most would've thought possible in the months after Lehman Brothers went bust, remaining unresolved issues in the banking sector - such as the need for continued deleveraging to rebuild liquidity and capital buffers, the uncertainty about future bank restructuring, and the need to absorb additional write-downs - will continue to hamper the supply of credit. NPLs aren't expected to peak until later this year. "Growth in the medium term will remain below pre-crisis levels due to moderate growth on the lending side," says UniCredit's Mucci.
The risks are such that the Czech central bank's Zamrazilova warns that the possibility of a double-dip recession in 2010 still looms and the main challenge for the Czech government - and others around the region - remains public finance reform. "It's crucial for future governments to take radical steps," she said.
The IMF has noted that several economies outside of the Eurozone have already undertaken early consolidation (Hungary, Iceland, Latvia, Turkey). "However, across most European economies the key fiscal challenge will be to commit, prepare and communicate credible plans for fiscal consolidation. These should involve moving to sufficiently high primary surpluses in order to place public debt on a stabilizing and, eventually, declining path," the IMF said.
The chance of reform, though, remains limited in a year when so many elections are taking place - something that the markets, already jumpy because of the debt problems of Greece, might start punishing, leading to a full-blown sovereign debt crisis. "Central and Eastern Europe will remain the most vulnerable because this debt overhang, especially the external one, must be rolled over," says Deuber.
With the spreads on Greece's five-year credit default swaps - the cost of insuring against default - on April 26 becoming wider than those of Pakistan, the markets seem in an unforgiving mood.
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