Central Europe likely to keep spillover from Russian bloodbath at arm's length

By bne IntelliNews December 16, 2014

bne IntelliNews -


The bloodbath in Russia on December 16 guarantees that its economy will slide into recession in 2015. However, unlike some emerging markets, which are scrambling to avoid following in its footsteps, Central Europe is likely to suffer only limited damage.

The main direct risk for Central Europe comes via trade links to Russia. However, as has been seen from the Russian embargo on food imports, Central European exporters are not heavily exposed to Russia. "The direct impact of the sanctions imposed by Russia is close to zero," note analysts at Erste Bank. 

"Even a sharp decline of exports, i.e. 35% drop of exports to Ukraine and 10% drop of exports to Russia, shaved off only 1pp from the export dynamics," they point out. Slovak export growth came in lowest over the last three months at around 2%; the Czech Republic shrugged off the Russian sanctions to push to a 7% expansion. Thus, Erste appears unconcerned by the "striking implications for imports," of the situation in Russia.

While Poland is by far the biggest exporter to Russia in the region, sales to its eastern neighbour make up little more than 5.4% of total exports. What is more worrying for the country is the effect of a full-blown Russian crisis on sentiment. That effect is widely thought to have been behind the slump the country experienced in mid-2014, which others in the region ignored. 

"The final channel is via a knock to consumer and business confidence, which would cause domestic spending to weaken," William Jackson at Capital Economics notes. "This is, of course, harder to measure. And we will know more in the first half of January, once the first surveys for this month have been published. For what it’s worth, surveys for October and November show that economic sentiment in CEE actually improved, even though Russia was, at the time, slipping into crisis."

Another indirect risk is the effect of the Russian recession on the Eurozone, which is the  major destination for Central European exports. However, the region has shown in recent months a surprising ability to shrug off the effects of a clear slowdown in the single currency area and the poor data out of Germany - to which it is heavily tied through industrial supply chains.

The huge plus for Central Europe is that it is now seeing a change in growth dynamics. Having spent recent years hugely dependent on exports (save Poland), the region's economies have this year seen the return of domestic demand, as consumption rises and investment kicks off. Central Europe has seen GDP growth close to 2pp faster than the Eurozone thus far in 2014, at an average of 2.5% versus 0.6%.

"Growth in CEE is not solely export-driven, as it was in the first stage of the economic recovery," proclaim the Erste analysts. "That increases the resilience of growth in [Central Europe] against potentially worsening external demand."

Narrow financial channels

While sentiment and exports are a concern, the financial channel is not. Direct financial linkages with Russia are small in the region, albeit Latvia's banks are understood to hold a significant chunk of cash from the CIS. 

There was of course some short-term spillover in Central Europe. Currencies showed some weakening during the ruble bloodbath on December 16, but soon recovered their composure. The Hungarian forint hit a three-month low of 312.66 to the euro, but soon stabilized on the back of a central bank meeting the same day at which the MNB held rates for a fifth straight month. 

However, the volatile forint was the hardest hit across the region. Most regional currencies weakened by no more than 1% against the euro. On top of that, even Hungary's exposure was limited. The government bond market remained stable throughout the week, even whilst the Russian car crash was unfolding.

Stocks exposed to Russia also suffered some falls. Hungary's OTP Bank fell over 5% in Budapest, while Austria's Raiffeisen Bank International dropped 9.4%. Indeed, thanks to its strong presence across the region, the Austrian banking sector is seen as one of the main channels via which Central Europe could be hit by greater contagion. 

However, Hungary may be the only one facing real danger from that quarter, with the rest of the markets among the most stable in Europe. "The region [is] vulnerable to strains in the European banking sector, with the most likely trigger being a re-escalation of the eurozone debt crisis, not problems in Russia," suggests Jackson.

Looking longer term, assuming Russia avoids a total economic meltdown, Central Europe has some benefits to reap from the stand off between Moscow and the West. KBC analysts note that low oil prices will have a positive economic impact. Both the region and the Eurozone are energy importers, and cheaper oil and gas should give the economies of both a shot in the arm. 

"Lower oil prices may primarily encourage household consumption and real income," analyst Jan Bures notes, pointing out Hungary especially stands to benefit. Industry should also see a bump up on lower energy costs. While the impact is unlikely to be huge, it may help make up for the effects of reduced trade with Russia. 

Overall, KBC suggests lower oil prices could offer Hungary's real economy a 0.4pp hike, with Poland and the Czech Republic joining Germany in gaining 0.3pp.

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