OUTLOOK 2014: SE looking up, but overshadowed by politics

By bne IntelliNews December 20, 2013

Nicholas Watson in Prague -

Growth in the Southeast European region will likely continue recovering in 2014 from the very low levels seen recently, helped by the nascent recovery in the Eurozone, as well as favourable weather conditions that buoyed agricultural output and helped weaken inflationary pressures. In most cases, though, recovery will remain modest, and even the best performers have large question marks hanging over them, mostly due to political risk.

"Industry - especially manufacturing exports and energy - drove the recovery," says Gallina Andranova Vincelette, World Bank economist. "The region experienced a welcome surge in exports in 2013, particularly car exports from Serbia."

According to the European Bank for Reconstruction and Development (EBRD), regional growth should reach an average of 1.6% in 2013 and 2.2% in 2014, which compares with just 0.4% on average in 2012. If you believe the International Monetary Fund (IMF), Moldova and Turkey should enjoy the best of 2014, while Slovenia and Croatia in particular will struggle.

Turkey endured a difficult start to 2013, with the demonstrations that began over the proposed demolition of an Istanbul park and quickly morphed into wider protests against the government's creeping authoritarianism and Islamic bent.

The country faces a crucial 18 months of elections, for which the economy promises to be front and centre. In the coming cycle of local, general and presidential elections, Prime Minister Tayyip Erdogan and his Justice and Development Party (AKP) will stress their stewardship of the economy since coming to power in 2002 as the major reason they should remain in power.

The AKP has indeed overseen a remarkable period of resurgence. Once a byword for instability and crisis, the Turkish economy grew at an annual clip of 5.25% on average between 2002 and 2011. At the same time, the AKP has strengthened Turkey's geopolitical position both regionally and globally.

"Turkey under the AKP's rule is more and more seen as an emerging regional power; stable, undergoing democratisation, with a young society and a growing economy, radiating with a positive example to all the neighbouring regions plunged in problems: the Balkans, the Southern Caucasus and the Middle East," says Marek Matusiak, an analyst with the Centre for Eastern Studies (OSW).

The IMF predicts growth of 3.8% in 2013, dipping to 3.5% in 2014. That said, the government and central bank face a much more challenging environment, both internally and externally, and will need to pull off a tricky balancing act.

At the heart of the problems with the €600bn economy lies the huge current account deficit and rising foreign debt levels. Concerns over these issues will only increase during the election cycle, as the government might be tempted to throw caution to the wind to lure voters.

As Standard Bank puts it: "The administration's focus is now growth". Indeed, it's this focus that has the government leaning on the central bank to keep interest rates down, even though this is hurting the Turkish lira at a time when the currency is already weakened following the protests and the US Federal Reserve's indication it will begin to "taper" its monetary stimulus. Thus the central bank is fighting to bolster the currency, using foreign reserves to buy lira, in order to help it fund that wide current account gap.

Moody's Investors Service projects the current account deficit at 7.5% in 2013, and the associated external financing needs at around 25% of GDP in 2013. "Local markets and the [lira] will likely continue to be the battlegrounds, and we would expect the lira to test new lows - if the [central bank] is not prepared to move to tighten, then the lira will have to take the strain," says Standard Bank.

ON top of that, the IMF in November noted that rising domestic consumption is stoking inflation, which remains "sticky" above 7%, and worsening the current account deficit. As such, the IMF called on the Turkish authorities to "tighten macroeconomic policies and step up structural reforms." The government has made a lot of noises about reform, but the pace is slow. Rather, it has resorted to measures such as cracking down on consumer borrowing by imposing limits on credit cards - not the type of structural reforms required.

Looking ahead, Moody's points out the major challenge for the authorities will be to "continue reducing external vulnerabilities while ensuring healthy and sustained economic growth."

However, that will be made all the harder by the fractures within the PM's hitherto smooth-running, election-winning machine. Since 2002, the AKP has won a series of landslide victories (in 2011 it took 49.83% of the vote), but its support has dropped since the protests, exposing differences between various factions.

"For the first time in a decade, the AKP government is encountering major impediments both domestically and internationally, and the party's image has been tarnished due to doubts as to the authenticity of its commitment to the ideals of a liberal secular democracy," says Matusiak. "This situation is a test for both the government's ambitions and the country's aspirations to become a powerful state."

The other big economy in the region is Romania. It too has weathered a tricky 2013 reasonably well, and is predicted to continue in the same vein in 2014.

The IMF reckons the economy will record growth of 2.0% in 2013 and 2.2% in 2014. While those are hardly Turkey-type levels, they're certainly good on a regional and global scale. Indeed, in the third quarter Romania registered the highest growth in the EU, up 1.6% against the previous quarter.

Analysts put that improved performance down to the contrast between the poor harvest of last year (agriculture was down 30% on the year in the third quarter) and the excellent one in 2013. In addition, industrial production has been driven by auto exports. "Who wouldn't like a Dacia Duster 4x4 at those prices?" says Standard Bank. Others point to the low budget deficit (the target for this year is 2.4% of GDP) and low public debt (38% of 2012 GDP) as key ingredients.

With solid growth and a low fiscal deficit, in November Standard & Poor's, the only agency not to rate Romania at investment grade, improved its outlook on its 'BB+' rating to positive from stable. S&P said there's a possibility it could raise its rating in the second half of 2014 if the government sticks to its fiscal and reform programmes.

"[S&P's] decision was backed by ongoing adjustment of external imbalances, ongoing fiscal consolidation, financial sector stability and prospects for gradual strengthening of economic growth in the following years," notes Raiffeisen Bank International.

However, like Turkey, Romania faces significant political risk - well illustrated by the refusal in December of President Traian Basescu to sign the new Stand-By Arrangement (SBA) that the government had negotiated with the IMF and the European Commission, because he didn't like the fuel duty increase included in the memorandum. "His stance should be understood in the context of forthcoming presidential elections (October 2014)," says Otilia Dhand, vice president at Teneo Intelligence. "The duty increase is highly unpopular and opposing it could help to boost support for the candidate fielded by the opposition."

For many this was a depressing reminder of Romania's previous political spats, which have had the effect of distracting politicians from actually governing. "Just when all looked rather stable in Romania it seems as though the feud between President Basescu and the government is once again playing out in public," says Pasquale Diana of Morgan Stanley, although he adds that while the repercussions are unclear at this stage, they should be contained. "We do not think that President Basescu will want to push this issue too far, given that much worse fiscal tightening was backed by him in the past (including a 5 percentage point VAT hike) Even so, this standoff will likely create some jitters in the near term."

Next year's expected presidential election is picked by Erste Bank as the highlight (or lowlight) of 2014 for Romania "The campaign will probably enter into its home stretch in late November or early December, unless President Basescu exercises his constitutional right to push it back two months," the analysts suggest, adding that while a certain amount of political noise is par for the course, remaining politically stable is an essential prerequisite for keeping investor confidence afloat.

Most economists see the National Bank of Romania (NBR) continuing to cut rates in the months ahead. In November, the central bank cut its benchmark interest rate by 25 basis points (bp) to a record low of 4%, thanks to weaker-than-expected inflation and sluggish domestic demand.

"Looking ahead, we expect inflation pressures to remain subdued, at least until the second half of next year, and we think the recovery in domestic demand will be slow-going. Accordingly, the conditions do seem to be in place for a further loosening of monetary policy," says William Jackson of Capital Economics, who argues that with inflation pressures subdued at least until the second half of 2014, there is probably room for perhaps two further 25bp rate cuts.

For some, like East Capital, Romania represents a "new capital market star". It cites the country's impressive plan for privatisation, with the successful IPOs of Romgaz and Nuclearelectrica in 2013 an important step in the process. "We often emphasise how important a functioning capital market is for a country's growth," says Peter Elam Hakansson. "The superstar when it comes to capital markets in Emerging Europe has been Poland's Warsaw Stock Exchange for many years now. But it looks as if Romania and the Bucharest Stock Exchange have decided to give the Poles a run for their money."

Political risk redux

Political risk also stalks Romania's next-door neighbour Bulgaria, where anti-government protests have continued on a daily basis for over six months. This is making the country virtually ungovernable, the president has complained.

The protests began on June 14 over the abortive appointment of controversial media mogul Delyan Peevski to head the State Agency for National Security. However, that complaint has been superseded by people's general dissatisfaction with the Socialist-led government that took office in May after its predecessor was brought down by earlier popular protests.

With daily demonstrations alleging corrupt ties between politicians and business groups, there appears no end in sight to the demonstrations. None of this is helping the economy, which despite being relatively sound in terms of a low budget deficit and public debt, is only expected by the IMF to grow by 1.6% in 2014, after growth in 2013 of just 0.5%.

On December 12, Standard & Poor's revised its outlook on Bulgaria's 'BBB' rating to negative from stable noting high unemployment and political uncertainty, as well as the poor growth prospects. That indicates at least a one-in-three chance S&P could lower its rating within the next two years if the political environment deteriorates. Bulgaria's sovereign debt is rated 'Baa2' by Moody's and 'BBB-' by Fitch Ratings.

"We expect economic stagnation in 2013, with higher public consumption and net exports almost completely offset by anaemic household consumption and private investment growth," S&P said. "We also believe that the uncertain political environment and the possibility of early elections will slow the adoption of reforms, weighing on potential economic output."

Inevitably, the government wasn't happy, and shot back in an emailed statement that increased net exports and consumption, rising retail sales, and industrial output give reasons to expect higher economic growth, which it forecasts at 1.8% for 2014. "The government adopted a series of measures to reduce the administrative burden on businesses and encourage economic growth after a long period of suppressed investment," Finance Minister Petar Chobanov said.

Even so, none of this will satisfy the thousands of protestors camped daily outside the parliament.

The region's other two EU members - Croatia and Slovenia - both face a dismal year. Slovenia enjoyed some good news in December when an end hoved into view for the longstanding problem of what to do about the country's teetering - mostly state-owned - banks, which have built up bad debts worth €7.9bn, equal to about 20% of GDP.

The much-anticipated "stress tests" on Slovenia's rotten bank system revealed on December 12 that the government needs to inject €3bn into the three largest state banks - out of a total €4.7bn capital shortfall identified throughout the sector. That's just about manageable for Ljubljana, meaning the government should avoid becoming the next Eurozone country to need an international bailout. The amount could be lower if better scenarios play out.

Slovenia's public debt levels are expected to increase to 75.6% of GDP after the recapitalisation of the banks, which is still low by wider European standards. The Eurozone average for state debt is 96%. As such, many analysts expressed satisfaction at the stress tests results.

"It is difficult to pinpoint where exactly market consensus stood with regards to the recapitalisation needs, but figures ranging between €4bn to €5bn from Fitch as well as local media citing official Slovenian and EU sources had certainly pushed upwards the market's tolerance of an ultimately high recap figure," says Abbas Ameli-Renani of Royal Bank of Scotland. "What is certain is that €3bn is considerably below market expectations and will leave the government's fiscal reserves in good shape."

Tim Ash at Standard Bank says it's now up to the Slovene authorities to press on with a broader structural reform agenda. That should include "privatisation, further fiscal consolidation, plus reforms aimed at boosting competitiveness and laying the foundations for growth, to enable the country to grow out of its bank and debt problems," he says.

The immediate outlook for the economy is poor however, with recession set to continue. The IMF predicts a contraction of 2.6% in 2013, which should improve somewhat in 2014 to a contraction of 1.4%. This will make Slovenia and its discredited quasi-market economy characterized by national ownership the out and out loser in the region in the coming year.

A long, hard road lies ahead - although credit analysts, ever the perennial optimists, suggest investors "stay long" on Slovenia. "We think it has been positives all around and there is room for more credit tightening," says RBS.

New guy, old problems

Things look only marginally better for Slovenia's neighbour and EU newcomer Croatia. The country's accession to the bloc on July 1 was a long time coming and broadly welcomed both inside and outside the country, but the subsequent six months of membership have been a damp squib, characterised by further economic decline and rising tensions at home and abroad.

On December 10, data showed that Croatia's GDP shrank by 0.6% on the year in the third quarter, driven by government austerity and the private sector reducing inventories. The IMF predicts a full-year contraction of 0.6%, the country's fifth year of recession, although this should turn around to 1.5% growth in 2014.

Given this weak performance, the budget deficit is expected to rise to 5.0-5.5% of GDP, compared with a 3.6% target. That would take the ratio of public sector debt/GDP above 60%.

The European Commission is threatening excessive deficit procedures (EDP) against the country. "Finance minister [Slavko] Linic has hinted in favour of pushing for a new IMF arrangement, which would presumably be pre-cautionary, as this would anchor reform and financing. His coalition partners in the ruling centre left appear unenthusiastic about going to the IMF without being pushed, and hence it seems that fiscal consolidation will have to await the EU's EDP, with adjustment likely to be much slower," says Standard Bank.

Croatia's weaknesses remain myriad and hard to remedy. Unlike the rest of Central and Southeast Europe, Zagreb has made little progress in reducing the budget deficit, which is seen as due to more the weakness of growth rather than fiscal largesse. As Capital Economics notes, Croatia has strong ties to the Eurozone's weakest members, with 15% of its exports going to the periphery and its banks dependent on credit lines from parent banks headquartered in the same blighted countries. However, "these credit lines have been cut back, which has kept credit conditions tight," it adds.

Furthermore, Croatia I suffering from the credit boom and bust of the last decade with a rise in NPLs to 15% of total loans, and it also appears to be struggling from a serious competitiveness problem, which has manifested itself in a declining share of world exports. "Looking ahead, we think growth should pick up a little as the Eurozone recovers, but it is likely to remain extremely weak nonetheless. Accordingly, Croatia will remain one of the region's underperformers for some time yet," says Liza Ermolenko of Capital Economics.

Best of the rest of the West Balkans

The other big economy in the Western Balkans is Serbia, which is expected to grow 2.0% in both 2013 and 2014 by the IMF. That's not bad comparatively speaking, but it's below the levels of performance it should be reaching, say analysts.

Again political risk stalks the country. Serbia has enjoyed a rare period of political stability since a group of former hardline nationalists created the Serbian Progressive Party (SNS) and won 2012's parliamentary and presidential elections. Forming a coalition with the Socialist Party, SNS set about instituting a broad programme of market-friendly reforms, including encouraging FDI and clamping down on corruption.

The results have been impressive - which is probably why speculation is rife that the SNS now wants to force early elections in the spring to capitalise. "We think the allure of early parliamentary elections will be too much for the ruling SNS, given difficult challenges in terms of fiscal consolidation/structural reform looming for 2014-16, expected near term positives from the start of EU accession talks in January 2014, and likely confirmation of key bilateral credits/investment, plus also the current high poll ratings of the SNS, and its leader Aleksandar Vucic," says Standard Bank's Ash.

The main downside of this is that the country's Fiscal Council has been highly critical of budget plans for 2014, arguing that as much as 1pp of GDP in additional consolidation measures are needed to ensure the budget deficit comes in as planned at 4.6% of GDP. "[The council's] point was that Serbia was already running one of the largest budget deficits in the region, and that this would see the ratio of public debt/GDP rise to 65% by 2014, and only peaking in 2015- 2016, hence there was still little room for complacency," says Ash.

Thus, behind the good headlines such as the start of the construction on the Gazprom-led South Stream gas pipeline, huge investment from China and the United Arab Emirates (UAE), and loans from the World Bank and Russia, lays some fairly dismal economics. If Vucic opts for early elections in March, he may want to finalise agreement on UAE loans before that date to boost pre-election coffers, and to create yet another "feel good factor".

Moldova has also been in the news toward the end of the year as the government signed the same sort of deal that Ukraine failed to seal to bring about closer ties with the EU. Despite Russian pressure in form of another ban on its wine exports, Moldova went ahead and signed an Association Agreement with the EU in November.

Russia's action failed because the situation is vastly different from the last time Moscow had a hissy fit over Moldova. While seven years ago Russia bought 80% of Moldovan wine exports, today it accounts for only 25%; in 2009, the EU replaced Russia as the biggest market for Moldova's goods, taking 55% of exports.

According to the IMF, Moldova is expected to be one of the region's star performers in 2014, with growth of 4.0% to follow a similar figure in 2013. Much of this economic expansion is driven by a manufacturing and trade boom, as well as flattering in comparison with a drought-induced downturn in 2012. These predictions could even be an underestimate; in December, data showed GDP increased by 8% in January to September on an annual basis.

Yet any improvement in Moldova's position comes from a very low base. The country is the poorest corner of Europe, at just €1,590, its per-capita GDP in 2012 was behind several countries in North Africa. As the EBRD notes, Moldova's short-term growth prospects "are uncertain and depend on the evolution of remittances, exports and investment sentiment, while poor corporate governance in banks poses a risk to financial and broad macroeconomic stability."

Gerald Knaus of the European Stability Initiative notes: "There is no room for complacency in either Chisinau or in EU capitals. Moldova's 'success' remains fragile. It has not yet translated into concrete improvements felt by its citizens. Even the [EU] visa requirement has still not been lifted... Moldova's poverty is structural: it is too rural, and produces too few things that people in other countries might want to buy. For it to catch up huge changes are needed - investments in infrastructure, in agriculture, in industry, in the skills of its people. For this to happen there is a need for both confidence in the future and a clear sense of direction."

Albania is looking forward to a better 2014. It has a new government after the previous discredited and institutionally corrupt administration of Sali Berisha was dumped, despite it best efforts to fiddle the parliamentary elections earlier this year.

The new reformist government of Prime Minister Edi Rama has pledged to root out the endemic corruption that blights this Balkan country's economic prospects. A December report from Global Financial Integrity, a Washington-based anti-corruption advocacy group, estimated that illicit transfers of funds out of Albania to offshore havens increased exponentially in 2011 to €201m, equivalent to 8% of GDP.

The World Bank expects the Albanian economy to recover in the coming years with a projected growth rate of 1.3% in 2014. The World Bank country director for Southeast Europe, Ellen Goldstein, suggests "Albania's economic growth will be slow, but sustainable." The IMF is more optimistic, forecasting the economy will expand by 1.7% in 2013 and 2.1% in 2014.

Kosovo should be buoyed by the economic performance of Albania to the south and Serbia to the north. Relations with its former master dominate the new country's prospects, so the huge improvement this year in Serbian-Kosovan relations, overseen by the EU, is a big positive. The IMF sees growth of 2.6% in 2013 accelerating to 4.2% in 2014.

Another Balkan state still feeling the after-effects of the Balkan wars of the 1990s is the divided state of Bosnia-Herzegovina. The economy is actually quite stable despite a political picture fractured along ethnic lines, which sees the country divided into a Bosnian Serb Republic and a Muslim-Croat Federation. Further balkanisation is not beyond the realms of possibility.

As Standard Bank notes, Bosnia's budget deficit is expected to come in at around 2% of GDP in 2013, while the ratio of public sector debt/GDP stands at less than 30%, i.e. half the level of Serbia and Croatia. On the flip side, the current account deficit is large at around 7% of GDP, but is underpinned by a range of FDI and financing from the IMF/EU. As such, the IMF predicts 0.5% growth in 2013 rising to 2.0% in 2014.

Macedonia is forecast to continue its recovery in 2014, with growth reaching a sterling 3.2% according to the IMF. The EBRD says: "Macedonia has shown some signs of recovery... driven primarily by a continued strong rise in investment as well as some recovery of exports in the second quarter. Consumption meanwhile continues to be a drag on growth. Inflation has fallen in 2013. The country continues to make strong efforts to improve the business environment and attract much-needed FDI, which should help growth prospects in the coming years."

Finally, Montenegro, when not falling out with major investors such as Russian oligarch Oleg Deripaska, who used to control the aluminium plant Kombinat Aluminijuma Podgorica (KAP), is seeing its economic recovery gather pace on the back of exports. The IMF sees growth of 1.5% in 2013 rising to 2.2% in 2014.

However, the EBRD notes that the current account deficit, at close to 20% of GDP, remains the highest in the region. "The fiscal position has been weakened by payment of KAP guarantees, and public debt levels have risen sharply in recent years. Credit to the economy continues to contract and NPLs are high at close to one in five loans."

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