OUTLOOK 2013: Southeast Europe different but the same

By bne IntelliNews December 4, 2012

Nicholas Watson in Prague -

Southeast Europe can basically be divided into those that have joined the EU and those are still trying to. But regardless of which side of the EU coin a country is on, the economic prospects for 2013 are pretty much the same: low growth if any, with the risk of a regional banking crisis should Greece be forced out of the euro.

Take the banks. This is one of the main channels through which the Eurozone crisis will reach Southeast Europe (the others are trade and the capital markets). Greek banks have been big investors in their Balkan hinterland, enjoying market shares of up to 25% in some countries. The Greek banks are already pulling back funding to subsidiaries in the region, and if this picks up, analysts say it could quickly lead to liquidity problems and, if not inadequately managed by local and regional authorities, a loss of confidence and bank runs.

However, it's the slowdown in economic growth, and in some cases outright recession (Slovenia, Croatia, Serbia), stemming from the problems in the Eurozone that represents the primary source of concern for regional policymakers at this stage.

The last quarter of 2012 has brought little in the way of good news for the region, which overwhelmingly relies on Europe to sell its goods and services. On November 22, Eurozone business surveys showed companies toiling against shrinking order books and service sector firms laying off staff, putting the economies of the single currency on course for their weakest quarter since the depths of the crisis in early 2009.

In October, the European Bank for Reconstruction and Development (EBRD) on Friday released its latest predictions for the economies of Central and Southeast Europe that were lower than previously forecast, reflecting the delayed recovery and stagnation in the Eurozone. The EBRD said it now expects the seven economies in Southeast Europe to grow by only 0.7% this year and 1.7% next, having previously forecast growth of 1.0% and 1.8%. "Most countries in central and southeastern Europe as well as Ukraine will likely see lower growth than previously forecast as the baseline outlook for the euro area has worsened further," the EBRD's economists said. With the Eurozone economy faring even worse than thought, the EBRD may revise that down further as 2013 progresses.

This weakness in industry combines with weak consumers in most cases, reflecting a combination of pessimism, stagnant incomes, rising unemployment and sluggish lending. Slovenia, Croatia and Turkey, for example, have all seen consumption contract so far this year; while in Turkey that can be considered a much-needed pause, analysts say what is happening in Croatia and Slovenia could prove to be a more permanent adjustment.

However, there are bright spots, too. The finances of most of the region's countries are in far better shape than most of those in Western Europe. Sovereign debt as a percentage of GDP, for example, in all the countries is below the 60% threshold stipulated by the EU. Serbia remains one of the most challenged in this area, but even there its debt level is only 57.5% of GDP; compare that with the 100%-plus levels in Greece, Italy, Ireland or Portugal. Likewise, most budget deficit positions in the region are either already below or heading down to the 3% of GDP ceiling. Such solid fundamentals mean the countries are borrowing at rates far below those troubled euro economies.

Unlike their western peers, the region's countries also appear willing and able to make the necessary adjustments and reforms to attract investment. The World Economic Forum's 2012 Global Competitiveness survey showed big improvements in Turkey, Bulgaria, Romania, and Bosnia-Herzegovina relative to pre-2008, while this year's World Bank "Doing Business" survey picked Serbia as among the top 10 economies that have improved the most in the past year.

Marcus Svedberg of East Capital sees a lot of upside from a valuation point of view in frontier markets like Bulgaria and Serbia, which have underperformed this year. "It is obviously more difficult to say when these markets will revalue, but the recent rally in Slovenia (the market gained 20% in September on privatisation rumours) suggests that a revaluation can happen rapidly when there is a general risk-on mood combined with a specific trigger," he says.

Hard slog

Bulgaria and Romania, despite both struggling with political problems and beset by corruption, look best placed to perform well economically in 2013. Bulgaria's economic growth remained lacklustre for most of 2012, but began to show more encouraging signs toward the end of the year. UniCredit Group expects GDP growth of 0.5% this year and 1.5% next year. Romanian GDP growth also showed some strength this year, and UniCredit predicts growth of around 0.5% in 2012, picking up to 1.3% in 2013.

Slovenia, the other EU country in Southeast Europe (and the region's only member of the Eurozone) has much bigger worries. It's one of those stuck in recession (1.1% contraction expected this year) and growth is not expected to get above 1.0% in 2013, if at all. The big weakness here is the banks, most of which are still state owned. Slovenian banks' provisions for bad loans rose 20% in the first nine months of this year, pushing the troubled sector into a loss for the third straight year. Bad loans amounted to 14.2% of all loans at the end of September, 3 percentage points higher than at the start of the year. The government is trying to reform the economy to avoid having to ask for an international bailout; the jury is still out on whether it will succeed.

Croatia is due to become the 28th member of the EU in July 2013, though the dire state of its economy will mean it will be the first CEE country to join the bloc with a deteriorating economic situation. That's a shame, reckons Moody's Investors Service, because "in the absence of pro-growth reforms and improvements in the country's institutional capacity, the anticipated benefits normally expected from EU accession are unlikely to fully materialize." In November, the finance ministry said it expects Croatia's economy to shrink 1.1% in 2012, making it a fourth year without growth, but said there were signs of improvement in the current quarter and expects a return to growth in 2013, forecasting the economy will expand 1.8%.

Serbia, the other big economy in the region, also faces numerous challenges in 2013 - a situation that hasn't been helped by one of the new government's first moves being to sack the central bank governor. This annoyed the EU and IMF, both of which it desperately needs to unfreeze a €1bn stand-by loan and shore up its credit position. The IMF predicts GDP will contract by about 2% this year, with a modest recovery expected in 2013. Underlying this is the fiscal deficit, which widened sharply in 2012 relative to the original budget and last year's level, and is unsustainably large. Public debt has also increased significantly, inflation is volatile and unemployment is high. "Fiscal consolidation is therefore an urgent priority," the IMF said in November.

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