beyondbrics

By Lars Christensen, Danske Bank

Prior to the collapse of Lehman Brothers, we were quite bearish about the outlook for the Central and Eastern European (CEE) markets due to the massive build-up of external imbalances and clear signs of bubbles in the local property markets. We were right to be concerned, as the CEE economies and markets were hit very hard by the global credit crisis. However, we are now more optimistic about the outlook for the CEE markets – or put another way, Central and Eastern Europe looks to be in much better shape now than was the case going into the crisis.

Prudence rules

A key reason for this is that the crisis was in some respects a blessing in disguise in the sense that the markets – in a somewhat brutal way – told CEE policymakers that it was high time to tighten belts and get rid of external imbalances. So, while Western European policymakers were rushing to loosen fiscal policy, CEE governments were forced by the markets to tighten – or at least not loosen – fiscal policy.

This has been very painful, but has resulted in stronger public finances in most Central and Eastern European countries than their Western European peers. Furthermore, the sharp drop in domestic demand and the massive sell-off in a number of the region’s currencies have led to a substantial improvement in the current account situation across the region.

Here Hungary is a remarkable example. Even prior to the outbreak of the crisis, the Hungarian government in 2006 (finally) implemented serious austerity measures. These measures, combined with the sharp weakening of the forint, have led to a very strong turnaround in Hungary’s external position and we now expect Hungary to run sizeable current account surpluses in the coming one to three years (unless the new Hungarian government loosens fiscal policy).

A Swtizerland of CEE

Furthermore, policymakers in the region seem to have understood the message from the markets and ‘austerity’ now seems to be in fashion. A good example is the Czech Republic where the centre-right parties recently won the parliamentary elections on a ‘promise’ to implement austerity measures and economic reforms. If the newly elected Czech coalition government goes ahead with the promised reform agenda, we think the outlook for the Czech markets could be quite rosy. Or put another way, the Czech markets could become a regional safe haven – a Switzerland of CEE.

Hence, today the biggest risks to the CEE markets do not come from external imbalances or property bubbles, but rather from possible negative spill-over from the euro area. This danger of course is most prominent in the south east European markets with large exposure to Greece. Given these risks, we still recommend a high degree of caution towards the CEE markets, but we also think there is a good chance that the economically more attractive countries in the region such as the Czech Republic and Poland could outperform the weaker-looking euro area markets over the coming year.