Published: February 01, 2009
The slump in the global economy has now reached the CEE region. Although the domestic economies in the CEE countries are still supported by private consumption and investments, a gloomier mood is becoming more and more prevalent in all of the Eastern European economies.
During the last three months, the cycle of forecasts has reflected an unprecedented turn for the worse. Channels of contagion included the drastic deterioration in export prospects and the sudden drying up of cheap financing via loans as capital flows fade away. Competitiveness and attractiveness for foreign investment has declined as a result of excessively strong wage growth compared to productivity gains.
In order to exploit the long-term growth potential, an adjustment process has started and its effects will be felt well on into 2010.
In order to exploit the long-term growth potential, an adjustment process has started and its effects will be felt well into 2010. Along with curtailing budget spending, a pronounced reduction in lending activity and declines in real wages are fundamental prerequisites for consolidating the mostly unmanageably high current account deficits in the region.
The most severe downturns are expected in Ukraine and Hungary. Russia is also on the verge of a tangible phase of economic weakness, but has the resources to get back on its feet without outside help.
One positive side-effect of the drop-off in economic activity and commodity prices is the drastic reduction in inflation. This has created leeway to reduce interest rates in almost all of the CEE countries, although attention must be paid to the fragile
development of exchange rates for some of the region’s currencies. Restrictive monetary policy has only been seen temporarily in countries which are suffering from acute depreciation problems (e.g. Ukraine, Russia, Romania). At the same time, rating downgrades and the persistently high levels of risk aversion are keeping yield spreads on CEE bonds high, both for LCY bonds and Eurobonds.
Impact on the equity markets
The GDP forecasts of just 1% growth on average for the CEE region have also impacted the earnings forecasts for 2009. In almost all of the markets, consensus estimates are expecting declines in earnings. Nonetheless, amidst conditions marked by renewed deterioration in leading economic indicators and falling share prices at the global level, the CEE stock exchanges are also being hit. Consequently, we expect to see the cyclical low on the stock markets come sometime during the first quarter. As the mood on the markets slowly brightens, 2009 as a whole should end on a relatively positive note, albeit with a high degree of fluctuation of 30-40 per cent.
Peter Brezinschek is Head of RZB’s Economical and Financial Research, based in Vienna.
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After the record growth of the past years, the Central and Eastern European (CEE) economies face a substantial cooling down. The reason is the indirect consequences of the development on the global financial market, which manifested themselves in the CEE countries over the second half of the year 2008.
Four factors, which have boosted economic growth over the past years, are now tarnishing the growth outlook:
(1) The recession in the US and Western Europe will dampen the demand for exports from the CEE region. This is already clearly visible in the industrial production and trade data from recent months.
(2) Foreign direct investment will slow down significantly. Even if the CEE region could profit from outsourcing in the mid-term as companies in Western Europe are forced to economise, this will not compensate for the investment decline caused by the business cycle in 2009.
(3) The scarcity and cost increase for external financing will cause a reduction of loan growth. Overall it is not unlikely that the total loan volume in CEE could stagnate in 2009, and even a nominal decline cannot be ruled out for some countries.
(4) The financing of current account deficits and short-term debt will remain a challenge due to the ongoing tensions in the global financial market.
Some of the CEE currencies will likely remain under depreciation pressure and it is not out of the question that more countries could seek financial support from the IMF and the EU. With its support for Hungary, the European Union has delivered the important message that it is able and willing to support member countries in times of financial distress.
This should also be valid in the case of the South Eastern European candidate countries, whose economic and political stability are of key importance for the EU. For the CEE economies, we now expect a slow down of the real GDP growth to around 1.0% on average in 2009, down from 6.4% in 2008. This forecast is based on the assumption of a severe recession in the Eurozone (-0.6%) and the US (-1.5%). [[[PAGE]]]
Over the past three months, we have witnessed a virtually constant downgrading of growth forecasts both for the western economies and CEE. In September 2008, at the time of writing our CEE quarterly for Q4 2008, the consensus estimate for the CEE region still stood at 5.8% year on year for 2009 and 0.9% for the Eurozone. Our forecast for the CEE region was on the cautious side of the consensus (although not quite cautious enough) at 5%. The consensus ranged from 4.1% to a high 6.6% at that time. In the latest consensus estimate from 15 December, projections for GDP growth have decreased to 2.1% for the CEE region (-0.9 for the Eurozone).
The range of individual forecasts also widened significantly from a low of -0.4% to a high of 4.2%. Our own forecast of 1% remains on the cautious side of the consensus and we do hope that we will not be forced to continue with another downward revision in a few months time. The reduction of the growth differential between the Eurozone and Central and Eastern Europe to around 1.5 percentage points also reflects the correction of a somewhat overheated development over the past years, which manifested itself in loan growth, real estate prices and current account deficits. This growth differential reached 4.5 percentage points on average in the five years from 2004 to 2008. [[[PAGE]]]
Even if this was partly explainable by the EU entry and the related improvements in the economic and institutional environment as well as additional available funds from the EU budget, the growth differential is likely to settle down at 2.5 to 3 percentage points in the mid term perspective. This would also be necessary to keep the long-term catch up process of per capita incomes (i.e. real convergence) going.
A major consequence of the reduction of loan growth and foreign direct investment should be a decline in imported consumer and investment goods and, thus, an improvement of the current account. This is positive on the one hand, as the current account deficits in some of the CEE countries already reached threatening levels over the past years. On the other hand, the import of foreign savings to speed up the transformation process makes economic sense, both for the CEE and the investors’ countries.
Due to their comparably cheap wages and high educational level, the CEE countries are among the most competitive production locations for the European market. This explains the sizable inflow of foreign direct investment since the start of the transformation. At the same time the import of capital and know-how boosted productivity and incomes in the CEE countries.
The scarcity and cost increase for external financing and the decline in foreign direct investment will slow down this process at least temporarily. This could be partly compensated for, if the countries managed to increase their savings ratios. In fact the preconditions for that appear to be in place if one considers the strongly rising average wages over the past years, recently falling inflation and the persisting economic uncertainty.
An increase in the savings ratios should also lead to a stronger growth of deposits, which would support the stability of the financial sector in a difficult global economic environment.
Walter Demel specialises in Central and Eastern Europe at RZB’s Economical and Financial Research Department.
These articles do not constitute an offer or invitation to subscribe for or purchase any securities and neither these texts nor anything contained herein shall form the basis of any contract or commitment whatsoever.
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US data continues to develop in line with the big picture: contraction in the economy and a steep decline in inflation. Specifically, recent news included data on consumption in December, which continued to fall as retail sales posted an outturn of -2.7% month on month (month on month), and were still -1.4% mom excluding the effect of lower gasoline prices. Moreover, the previous month’s marginally positive growth rate was revised down into negative territory. All of this occurred despite massive easing in burdens on income, thanks to the tangible decline in gasoline prices with an estimated impact of USD 200 billion in Q4, which was swallowed up completely by the rising savings rate. Hence, the upcoming economic stimulus plans will have to be simply huge if they are to have any effect at all. Industrial production, also for December, dropped by -2% mom or -7.8% year on year.
For Q4 2008, our quantitative GDP model, which also includes input from the latest labour market report, points to annualised real GDP “growth” of -8% as an estimate. It depends on inventory increases and a better foreign trade contribution, so the figure could easily be as “high” as -5%. It does not appear that it will turn out to be much better than that - data should be out at the end of January.
But the news is not all bad: the anticipated bottoming out in leading indicators in the first quarter, at recession levels, though, does actually appear to be occurring: The first surveys for January (Empire State and Philadelphia Fed Index) registered strong gains. While this means that they are still languishing at deep recession levels, it is nevertheless an initial sign that the economy will stabilise during the course of this year.
In respect of inflation news, the massive drop in oil prices in year on year terms continues to dominate developments: producer prices were down -1.9% month on month in December and even the annual rate is already negative here (-1.5% yoy). Consumer prices were also down -0.7% mom, with the annual rate hovering at just 0.1% year on year, poised to also fall into sub-zero territory in the first quarter, bottoming out around mid-2009.
Naturally, the developments in oil prices are also having a beneficial effect on the current account deficit, which improved to a 5 1/2-year low in December. One interesting note: the second tranche of USD 350 bn from the TARP funds for supporting the financial system, which up to now has mainly been used for injecting capital into banks, was approved by Congress recently and will be available to the new US president. It is likely that this money will (also) go fast.
As we write, data flow is quite light. Noteworthy releases really only include the NAHB housing market index, a leading indicator with considerable forward-looking scope. The index should begin to recover from its current all-time low sometime in the first half of the year. Along with it, there are data on housing starts and building permits, and in line with consensus, we expect more declines for these figures. Accordingly, there will be little on the table to distract the markets from the grand-stand event: the Inauguration of Barack Obama on 20 January.
For us, this date is mainly important because one can expect that, following the inauguration, we will quickly begin to hear more details on his gargantuan economic stimulus programme and that it will then be passed post-haste by the US Congress. Consequently, we see good chances that the focus of the market may at least temporarily shift away from the current flow of horrible economic data and come to rest more squarely on the hopes for improvement, as the year moves forward. While that would be a welcome development for “risky assets”, it would also be at least a short-term problem for the very expensive bond market, especially as the market will likely also begin to ponder the enormous volume of new bond issues with more than USD 2,000 bn slated for fiscal 2009, equivalent to more than 14% of US GDP.
Naturally, the bond market has a lot going for it: inflation rates will continue to drop sharply, likely slipping below -2% year on year by mid-year and the deep recession will drag on until the middle of the year, but all of this is probably already mostly priced into bonds anyway. Even though we believe that the next major correction on the bond market (it appears most likely to us that this will happen some time in the first half of the year, especially on the US government bond market, which is over-extended compared to the EUR market) will be followed by a rebound in bond prices again, we feel that the correction will be too stormy to try and just sit it out. We would rather close our open long positions on US bonds too early rather than too late, and with this in mind, we change our recommendation from buy to neutral and close our short-term trading idea “Buy US Treasuries” (profit-taking). Price volatility is likely to be extremely high this year, and for us this suggests that a more opportunistic strategy should be pursued (profit-taking after price rallies, buy in the wake of price corrections). [[[PAGE]]]
Although much attention recently was focused on the ECB’s meeting, in our opinion the real fireworks were found elsewhere: in the initial GDP data for Germany. Based on the flash estimate of the Federal Statistical Office for 2008 (growth of 1.0%), this corresponds to a contraction of 1.7% in value added in Q4 compared to the previous quarter. This decline is far worse than expectations and means that significant downward revisions of our GDP estimates for Q4 and for 2009 as a whole will be necessary.
The ECB’s central bankers agreed on a rate cut of 50 basis points (bp), bringing the ECB’s policy rate to 2%. At the press conference afterwards, President Trichet suggested the possibility of further reductions in interest rates, whereby it appears almost certain that there will be no move in February. The big change in the wording used by the head of the ECB was the stress on an “anticipating” decision. This means that the ECB is expecting further slowdown in economic activity and falling inflation rates, and is taking these expectations into account in reaching its rate-setting decision.
In our view, the key rate will fall to a new historical low in Q1 2009 (below 2%), and reach its low at 1.25% around mid-year. The severe recession and the oil price-induced decline in inflation provide the ECB with plenty of room for more cuts in interest rates. Furthermore, the leading economic indicators will still have to bottom out before one can expect to see some stabilisation in the economy. It appears unlikely that any hopes in this regard will be sustained by the purchasing managers’ indices and business sentiment indicators scheduled for release shortly: we expect to see more declines. The ZEW indicator is seen as being the first ray of hope signalling some improvement in the economy in H2 2009. The result of this survey turned out higher recently and we expect to see further progress.
Nevertheless, it is not really possible to discern the timing and scope of the improvement in the economy on the basis of this survey, and hence the bond market will probably shrug off the effect of any increase. On the other hand, bond prices did not ignore the negative rating news on various EMU countries like Greece, Spain, Portugal or Ireland, and spreads over German benchmarks widened significantly once again. Nonetheless, we stand by our opinion: our short-term recommendation continues to be Buy and over the medium term we expect to see substantial outperformance by non-German government bonds on a cash bond basis.
The recent trading week was overshadowed by the starting earnings season (Alcoa, Intel). Moreover the necessary aid package for Bank of America revealed that the financial sector is yet far away from being cured and further bad news will come on the agenda. However, the miserable state of the economy takes its toll and therefore we expect another earnings shock for Q4 and the outlook for FY 09. Subsequently we would bet on further weakness for US stocks.
As I write in mid January, the last week under review showed once more that the situation on the European stock markets is still quite uncertain and that the crisis in the financial sector is far from over. This was especially emphasized by the turbulence at US financials (e.g. Bank of America), predictions that HSBC may need fresh capital and the profit warning of Deutsche Bank. The recently started earnings season in Europe shouldn’t bring much positive news, as we expect that especially the company outlooks will all in all be disappointing. Therefore analysts’ expectations of an earnings growth for the year 2009 seem not to be very realistic. Therefore we expect significant earnings downgrades in the weeks to come, which should weigh heavily on European stock markets especially in the first quarter of 2009.
The latest turbulence in the international financial sector weighed also on the Japanese stock markets recently. Furthermore the drop in Japanese machinery orders once more raised worries about a deepening recession. Still very weak economic data as well as massive earnings revisions to the downside should therefore depress the Nippon stock market benchmark to October levels.
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