CEE 2006 - Business growth across the region
Substantial progress over the last two years was achieved by Central and Eastern Europe, where the markets responded favourably to previous reforms, and by the former Soviet Union, which benefited from political change in some countries. Henry Gibbon reports.
The pace of expansion over the past two years in Central and Eastern Europe, the former Soviet Union and the Baltic States continued to exceed the levels of most other regions of the world. Market reforms have advanced in many countries but economic growth remains below rates witnessed during previous episodes of rapid expansion, such as the growth of Western Europe in the post-war period.
Two years after joining the European Union, the eight countries of Central Europe and the Baltic States continue to experience the benefits from EU accession. An unexpectedly strong export expansion following accession provided a significant fillip to growth in these countries.
Chris Perrin, a member of the group management board at CA IB Corporate Finance, says: “Estonia and the Slovak Republic have gained reputations as dynamic and business-friendly economies, and investors and lenders are responding to improvements in the business environment by increasing their exposure to this region.”
“These capital inflows have also been encouraged by high global liquidity and by low interest rates and risk premiums,” said Bill Watson, chief investment officer for private equity, Eastern and Central Europe at Societe Generale Asset Management.
However, the macroeconomic tests for accession to Economic and Monetary Union continue to pose challenges for the larger Central European countries. The Czech Republic, Hungary, Poland and the Slovak Republic are struggling to improve their fiscal positions in line with EU requirements. Moreover, current account deficits remain substantial in almost all Central and Eastern European countries (except Poland and Slovenia), particularly in the Baltic States and Hungary.
The consensus forecast for the region is for average growth of 5.3% this year (compared with the record 6.6% achieved last year). Domestic demand and, to a lesser extent, net exports continue to drive growth across much of the region.
The strong growth performance of recent years in Central Europe has gone hand-in-hand with rapidly expanding credit markets. While these credit booms contribute to financial development, they can also heighten risks in the financial sector and macroeconomic vulnerabilities. The general view of observers is that these risks are manageable.
Steven Fries, chief economist of the European Bank for Reconstruction and Development (EBRD), says: “Expansion has supported financial intermediation across the region and helped the development of the less advanced economies. However, it has also raised concerns about the quality of loan portfolios and about possible risks to the banking sector.”
While the new EU countries are benefiting from EU membership, South-Eastern Europe remains in the waiting room, with uncertain prospects regarding an accession date for some countries.
Bulgaria and Romania are to join the EU in 2007. Membership talks with Croatia have now started, following a prolonged stalemate over co-operation with the International Criminal Tribunal for the former Yugoslavia in The Hague.
The timing of eventual accession for Albania, Bosnia and Herzegovina, FYR Macedonia and Serbia and Montenegro looks more uncertain. The prospects for further enlargement diminished after the Dutch and French rejection of the new EU constitution in their referenda but were boosted by the subsequent decision to open membership talks with Croatia and Turkey.
Observers point with surprise to progress in Serbia, in particular, where the ruling coalition does not command a parliamentary majority and has an uncertain future.
Despite these uncertainties, South-Eastern Europe has seen robust growth and record capital inflows in the last two years, Heinz Sernetz, a member of the board of Raiffeisen Investment, sees this reflecting an underlying confidence in its future prospects.
“Bulgaria, Croatia and Romania have attracted significant levels of foreign direct investment, and Serbia and Montenegro is increasingly doing so,” Sernetz says.
In South-Eastern Europe, economic growth is forecast at 4.8% this year compared with 6.5% in 2005. Bulgaria and Romania have shown success in strengthening their fiscal positions. Inflation is expected to fall in most countries, although it remains at double-digit levels in Serbia and Montenegro.
The countries of the former Soviet Union have experienced particularly strong growth over the last two years. The recent surge in oil prices has greatly benefited energy-rich countries such as Azerbaijan, Kazakhstan and Russia. This has supported strong growth in output and domestic demand in these countries. However, there have been few signs of sustained reforms and an improved business environment.
Growth is forecast to slow to 6.2% this year from 7.9% in 2005. Although oil prices continue to rise, many of the oil-exporting FSU countries are beginning to suffer from capacity constraints and inadequate levels of domestic investment. Growth in the Russian economy, the region’s largest, is forecast to slip to 6% from 7.1% last year.
Over recent years the Russian government has resumed state control over important assets in the oil sector, and has re-established majority state ownership of Gazprom, the dominant gas producer.
Unlike in Central Europe, investors in Russia and the other energy-rich countries are not so much attracted by an improving business environment as by the profits to be made from natural resources. Consequently, they are less concerned about Russia’s wavering commitment to market reforms and evidence of deterioration in the business environment.
Russia was the only country this year to attract a downgrade in the transition indicators that the EBRD uses to track progress towards open, market-oriented economies. Russia was downgraded in the area of large-scale privatisation.
The EBRD’s Fries qualifies this by highlighting positive elements. Speaking at a press conference, he said: “Russia’s macroeconomic fundamentals remain reasonably sound despite the falling fiscal surplus and rising inflation. There have also been positive developments in the financial sector, with the implementation of deposit insurance reform, strengthened prudential regulation and improved financial reporting and transparency.”
Elsewhere in the former Soviet Union, there have been dramatic political changes that have added new momentum to reform in the region. New leaders have come to power in Georgia, the Kyrgyz Republic and Ukraine, promising to deal with problems of systemic corruption and to reinvigorate reforms.
Greater openness is evident in Georgia and Ukraine. Elections in Moldova resulted in a more reform-minded government and openness towards European integration, despite a largely unchanged leadership.
Average GDP growth in the former Soviet Union region amounted to 7.9% in 2005 and exceeded 10% in Armenia, Azerbaijan, Belarus, Tajikistan and Ukraine. While consensus forecasts expect average growth to moderate this year to 6.2%, the outlook remains generally favourable due to the continued strength of oil prices.
The most significant slowdown is expected in Ukraine, where growth is expected to fall from 12.1% in 2005 to 4% this year. This is due to a sharp drop in external demand for its steel output and a decrease in investment because of continuing uncertainty over the business and political environment.
In Russia, GDP growth is expected to fall to 6% this year from 7.1% as a result of a slowdown in oil production growth and domestic investment.
Political unrest in the Kyrgyz Republic and Uzbekistan has dampened prospects for their economies. In contrast, Azerbaijan is likely to see a doubling of its already impressive growth rate from 10.2% in 2005 to 20% in 2006 following an increase in oil production and the inauguration of the Baku-Tbilisi-Ceyhan (BTC) oil pipeline late last year.
CA IB’s Perrin adds a note of caution: the increased liquidity in the banking system has led to a sharp credit expansion and a rise in inflation. “High commodity prices have generated fiscal surpluses that governments are coming under increasing pressure to spend,” he says.