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Central Europe’s Economies Sputter
As The Euro-Zone Crisis Hits The Region

The news out of Central Europe is bad and getting worse, as the hoped-for economic rebound recedes into the distance and the region is hit by a slump in internal demand and problems in the Euro-zone. Many economists had predicted that the region’s economies would hit bottom in the final months of 2012 and begin to show signs of life by mid-2013. However, that is not happening.

Jan Vincent-Rostowski, the Finance Minister of Poland, the largest Central European (CEE) economy, recently had to downgrade his estimates for the country’s Gross Domestic Product (GDP) growth for this year from 2.2 percent to only 1.5 percent. Slower growth also entails problems for public finances as tax revenues fall and expenditures for social services rise — putting hopes of reducing the budget deficit to 3.5 percent of GDP this year out of reach.

“We have to be aware of falling exports, which is a result of weak demand in our main trading partner in the European Union (EU),” Poland’s Deputy Finance Minister Ludwik Kotecki told reporters when explaining the downgrade in growth estimates. “A second cause is consumption … which is not going to be as strong as we had forecast.”

The problem is that Polish shoppers have shut their wallets. Retail spending, which rose at double-digit rates in the first years of the crisis, was one of the main props of the economy recently, and a key reason that Poland was the only EU country to avoid recession in 2009. But battered by unemployment that is currently at 14.3 percent, consumers are reining in their spending and retail sales are now flat.

The other driver of the country’s lacklustre economic growth prospects is its exports, 80 percent of which go to the Euro-zone. Driven by cars, car parts, electronics and food, Polish exports were up by four percent last year, but the slump in Germany gives grounds for worry.

Economists put a big part of the blame for the grim state of the Polish economy on the country’s National Bank, which surprised markets early last year by becoming the only EU central bank to raise rates, and then held back from reacting while the economy slowed. A recent bout of rate cuts has failed to kick-start growth. “The Central Bank’s reluctance to cut rates is the reason we are having the current slowdown,” says Lars Christensen, chief analyst for Danske Bank.

Poland may seem gloomy, but the mood in the rest of the CEE is even worse.

Slovakia is one of the few countries in the region to have squeezed out any growth at all in 2012.

The country’s economy expanded by two percent, largely on the strength of exports of cars and electronics, but the prospects for this year look bad.

“It is obvious that if we expect a recession of 0.3 percent in the Euro-zone, it has to influence the economy in Slovakia,” says Robert Fico, the country‘s Prime Minister. Estimates for growth this year hover around 0.5 percent of GDP. “But all relevant institutions believe that in 2014 the economic growth of Slovakia should be more than 2 percent — that is very good for us because Slovakia will be among the few countries in the European Union to have any growth at all,” continued Fico.

The news is significantly worse for the Czech Republic, where the government’s fierce austerity program, combined with flat domestic demand and troubled exports pushed the economy into a 1.1 percent contraction last year. The Central Bank has run out of monetary policy instruments, cutting its benchmark rate to 0.05 percent, and there are still no signs of a return to robust growth — the Finance Ministry expects a meagre growth of 0.1 percent this year and 1.4 percent in 2014.

The long-term Czech outlook is also uninspiring. “Most people describe potential growth as being stuck between 2 and 2.5 percent over the long run, which while better than the Euro-zone average (of around 1.5 percent) is still poor compared with the CEE region,” writes Peter Attard Montalto of Nomura, the investment bank.

Hungary’s ongoing political problems as the right-wing government of Prime Minister Viktor Orbán tightens its control over the country are spooking investors and adding to the woes being felt by other CEE economies. “We have been saying for some time that investors need to be aware of Hungary’s regime uncertainty and the risk that Hungary could introduce further business unfriendly policies,” says Christensen. Hungary saw a recession of 1.7 percent in 2012, and the forecast is for no growth this year, followed by a tentative expansion of 1.5 percent in 2014 — the slowest growth in the region.

Bulgaria and Romania are exceptions to the economic growth structure of the countries further north. What little growth the two Balkan countries managed to eke out last year — 0.8 percent for Bulgaria and 0.2 percent in Romania — came mostly from rising domestic demand, while exports slowed. However, the prospects for a strong recovery in the two countries also look doubtful for this year.

The key for the region — and especially for the northern tier of Poland, the Czech Republic, Slovakia and Hungary — is a strong revival in Germany. Many German industries have outsourced large parts of their production to Central Europe, and a recovery will lift the rest of the CEE. The latest data out of Germany is fairly lacklustre, but there are signs that the economy could improve by the end of 2013.

The current slump may also position CEE companies to take advantage of any recovery, as they have now fixed their balance sheets and made themselves more competitive. The same phenomenon occurred at the turn of the century and positioned the region for a boom. “The crisis should be an opportunity for us. It cleanses companies of unneeded costs and the market of unneeded companies,” says Andrzej Blikle, majority shareholder of a Polish chain of bakery shops that is one of the country’s oldest continuously functioning businesses.

If that happens, Central Europe could restore its tattered reputation as the EU’s fastest-growing region.

By Jan Cienski

Reprinted with permission from the May 1, 2013 issue of the Central Europe Digest.
Center for European Policy Analysis
1225 19th Street NW, Suite 450, Washington, DC 20036.
Central Europe Digest is a publication of the Center for European Policy Analysis (CEPA), a Washington, DC-based research institute devoted to the study of Central and Eastern Europe. Material published in the Digest is original, exclusive to CEPA and not reproduced from outside sources.