Economic outlook darkens for eastern Europe

The economic outlook for much of eastern Europe is continuing to darken as the eurozone crisis refuses to abate and western banks reduce lending in the region, according to the European Bank for Reconstruction and Development.

The bank said on Tuesday that figures from the third quarter of last year showed the first net capital outflows from the region since the 2009 crisis. The western banks that dominate banking in central and east Europe, under regulatory pressure to rebuild balance sheets at home, “appear to be deleveraging since the autumn”.

“The pressures on the banks are very significant and for some of the important banks in our region, the pressure is significantly higher than in 2008-2009,” said Erik Berglof, EBRD chief economist.

In its latest quarterly forecasts, the bank cut its 2012 projected growth for central Europe – including Poland, Hungary, and Slovakia – and the Baltic states to 1.4 per cent this year, from the 1.7 per cent it was forecasting three months ago.

The bank forecasts that Hungary and neighbouring Slovenia will go into recession, although these are the only countries out of the 29 where the bank operates whose economies are seen contracting.

The EBRD, set up two decades ago to help fund former communist states’ transition to the market, now sees growth in south-east Europe at only 1 per cent this year.

In October it forecast 1.6 per cent growth for this area, which includes Romania, Bulgaria and several former Yugoslav states, where Greek banks often form an important part of the banking system.

Russia and other former Soviet states that are less integrated with western Europe, however, are forecast to continue to see solid growth, provided commodity prices remain high.

The EBRD continues to see Russia growing at 4.2 per cent and has raised its forecast for former Soviet central Asia plus resource-rich Mongolia to 7 per cent, from 6.6 per cent in October.

That helped keep the EBRD growth forecast for its entire 29-country region at 3.1 per cent this year – though that remains a significant slowdown from last year’s 4.8 per cent growth.

Its concerns are focused on central and south-east Europe, which rely heavily on the eurozone as an export market, and source of foreign direct investment and short-term financing.

“Substantial risks to baseline growth stem from the possibility of an escalation of the eurozone turmoil, with systemic bank risks for emerging Europe, whose banking sector is deeply integrated with eurozone-based banks,” the EBRD said.

“In this scenario, unco-ordinated banking sector regulations in both home and host countries of cross-border bank groups would contribute to a deeper fall in growth.”

Officials from the EBRD and other international lenders, regulators and governments, met in Vienna last week to launch what has been called “Vienna 2.0”, an effort to co-ordinate bank deleveraging.

The plan aims to repeat the 2009 Vienna Initiative, which helped ensure western banks did not withdraw credit from the region during the global recession.

“We are very concerned about unco-ordinated policy responses by governments that are taking measures that often have a strong ‘home’ bias,” said Mr Berglof.

He added that the EBRD might take equity stakes in more east European banks if the eurozone crisis worsened.

One country hit hard by bank deleveraging has been Hungary, now projected to see its economy contract by 1.5 per cent this year, the most sharply reduced forecast since the autumn, when the EBRD forecast 0.5 per cent growth.

But the bank warned that Hungary had worsened its problems through policy errors.

“Hungary, the most exposed country to the eurozone in the EBRD region, has amplified the impact of external shocks by a series of domestic policy mistakes,” the EBRD said.

It added that these had “unnerved investors, hitting the Hungarian forint and equity markets and increasing sovereign spreads”.

By Neil Buckley, East Europe Editor

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