Europe

THE European Bank for Reconstruction and Development (EBRD) in its latest economic forecasts for the region warned that Emerging Europe runs a “high” risk of falling back into recession over the coming year especially if the euro crisis took a further turn for the worse triggering a fresh global financial crisis and economic downturn. The Bank has upgraded GDP predictions for a number of countries in the region. It nudged up its 2012 growth forecast for the 29-country emerging Europe and central Asia region to 3.2per cent from 3.1per cent in its January outlook. The confidence comes despite political instability in Greece and open discussions by politicians of an exit that caused fresh volatility on the continent’s financial markets. However, overall emerging Europe continued to be buffeted by the crisis in the eurozone despite improved economic fundamentals.

The risk that emerging Europe as a whole will re-enter recession within the next 12 months is viewed as high. The eurozone crisis poses further downside risks to the outlook, as any worsening of the situation beyond the baseline assumptions could have serious negative consequences for growth across the entire transition region. A further worsening of the eurozone crisis or an oil supply shock is both possible and pose significant downside risks for the region as a whole. In addition, domestic risks have risen in some countries. The new data show the bank increased GDP forecasts for some countries. It now sees Poland growing 2.7per cent this year although the overall rate of growth for the region will be down on 2011 levels.

Growth in the wider area of EBRD operations which now includes the four new Middle East and North African countries reach 3.1per cent this year compared to 4.6per cent last year before ticking back up next year to 3.7per cent. The EBRD predictions for Hungary moved to -1% from -1.5% in January while Romania was moved up to 1.2per cent from 0.8per cent. Predictions for Russia were unchanged at 4.2percent.The report pointed to some signs of improvement in recent months. Capital outflows in the third quarter of last year were dramatic but have leveled off this year and foreign direct investment has been holding up, he notes. Portfolio flows may also be gradually returning to the region.

Dire first quarter GDP results have left private sector economists scrambling to revisit forecasts for the region. Official government figures showed a one per cent fall in GDP for the Czech Republic and a 1.3 per cent drop for Hungary while Romania slid back into negative territory at -0.1% after just one quarter of positive growth. Economists pointed the finger at anemic domestic consumption and the backdrop of a worsening crisis in the eurozone. The only bright spots have been Germany within the eurozone and a resilient Poland within the CEE region. From Beijing to Bucharest, emerging market policymakers are as worried as those in Brussels that the rapid contraction in western European banks’ balance sheets will compound the debt crisis and further delay economic recovery. According to the International Monetary Fund, developments in the euro area pose a greater risk to the Asia-Pacific region than either a hard landing in China or a rise in commodity prices.

Meanwhile, fresh fears emerged lately that emerging Europe faces a protracted credit drought as foreign banks retrench to their home markets. Deleveraging is crimping credit throughout CEE as foreign owned banks that make up the bulk of domestic financial sector retrench to their home markets. A home bias has already materialized in some countries. Parent bank repairs, however much needed, should not hurt the economies of the host countries. More and more foreign banks are pulling out of Ukraine and confidence in the country is falling all the time. If problems arising in the relationship ‘home-host’ countries are not solved in a cooperative spirit, they will pose a serious risk to financial integration in the EU.

Asian ‘Tigers’

According to the National Australia Bank — Group Economics, growth slowed considerably in the Asian Tiger economies late last year and remains relatively sluggish in 2012. However, some partial indicators suggest that conditions have improved modestly more recently, bolstered by improvements in the US economy, and an apparent v-shape recovery in Thailand from last year’s floods. However, demand for exports from advanced economies is likely to remain soft, at least in the near term, and will continue to be a headwind for domestic activity. Indonesia has been a big exception to the slowdown — its economy is much less export driven and it has maintained very solid growth. Overall, however, the bank’s 2012 and 2013 Asian growth forecasts are largely unchanged at four percent and 4.2 percent.

Inflationary pressures have eased since mid-2011 with headline CPI growth dropping to almost three percent by February, well below both the pre and post-GFC peaks of around eight percent and four percent respectively. Most of the easing in inflationary pressures stemmed from lower soft commodity prices. Core inflation has eased to around 2.75 percent from a peak of slightly over three percent in July 2011. Despite an easing CPI inflation across most of the Asian Tiger economies, the degree of easing varies significantly between countries. Central banks in the region remain cautious of ongoing elevated inflation expectations.

One significant concern to the inflation outlook is the effect of very high energy costs. While higher oil prices may benefit net exporters such as Malaysia, consumers are likely to continue feeling the pinch with oil prices remaining at very elevated levels since the start of the year. Persistent inflationary risks present a difficult situation for policy makers, facing the potential for stagflation in an uncertain global environment. Nevertheless, the central banks are confident that CPI inflation will remain within the target band of 4.5percent and plus/minus one percent — looking through potential distortions from fuel subsidies – suggesting interest rates are likely to remain on hold.

However, European bank participation is still large enough in most countries to cause significant disruption to Asian credit markets. More broadly, Asian economies remain vulnerable to capital fluctuations, albeit less so post Asian Financial Crisis thanks to improved capital management policies. Emerging Asian economies have generally experienced credit growth in recent years that has outpaced their economic performance. Although a continuation of this trend could create difficulties down the line, it also means that a disruption to funding availability could constrain economic growth in the near term.

Excluding China, foreign bank participation in Asian Tiger economies has remained relatively unchanged at around 50 per cent of outstanding domestic credit. Of this, euro-zone bank participation is currently at 7.5per cent, down from over 10 per cent in 2008. This is broadly on par with the relative exposures in Australia and the United States, and well below that of the UK and Germany. Emerging Asia is also relatively less exposed to euro-zone banks than other emerging economies. Hong Kong and Singapore, the region’s largest financial centres outside of Tokyo, have the largest exposure to European banks, although the majority of liabilities lie with countries outside the euro-zone.

All of the Asian Tiger economies have a very high proportion of short-term foreign bank credit; Thailand is the only economy with long-term liabilities of more than 50percent. There are signs that bank deleveraging, combined with the weaker growth outlook and investor uncertainty, are weighing on credit conditions in Asia. An emerging markets lending conditions survey indicates that many banks in emerging Asia have experienced a deterioration of funding conditions over 2011. Most of this deterioration stems from international markets. Overall, Asian Tiger economies should experience less financial disruption from European bank deleveraging than other emerging economies, particularly emerging Europe.

However, European bank participation is still large enough in most countries to cause significant disruption to Asian credit markets. In the event that contagion leads to an acceleration of capital withdrawal more broadly, swings in capital flows will have significant impacts on Asian financial markets, increasing volatility and causing fluctuations in exchange rates that could be detrimental to trade. But the Asian banks are generally well positioned to inject funding if necessary; capital adequacy ratios are high, returns are healthy and non-performing loans have declined. Similarly, large foreign reserves will provide some buffer, while any quantitative easing by developed economies would likely renew capital inflows to Asia.

Arab Spring countries

Industrialised nations have stepped up plans to help countries swept up in the Arab Spring countries rebuild their economies through more access to international credit markets, investment and trade. A G8 leaders’ summit meeting held recently underscored efforts needed to stabilize the transition economies of Egypt, Libya, Jordan, Morocco and Tunisia and agreed to create a capital markets access initiative to help the five countries tap international capital markets to meet their financing needs and allow government enterprises to invest in projects that create jobs. The European Bank for Reconstruction and Development was also trying to change its charter to create a special fund worth $4 billion to invest in the region over the next three years.

The Arab Spring has led to significant turbulence in the region, which has had negative effects on the economic performance of countries in the short term. This is likely to persist in the medium term as well, depending on the success and direction of political reform. However, the political changes under way and the recognition of the key role of the private sector in generating jobs and growth may drive the needed political momentum to enhance competitiveness over the medium to longer term. The oil and gas sector is leading an investment explosion in the region, particularly in Saudi Arabia and Qatar.

The Tunisia’s central bank governor has warned that Arab Spring countries must not be fed the same economic medicine as Eastern Europe when the iron curtain collapsed. Liberalization and privatization are the wrong medicine for the new countries to be covered by the EBRD. Any attempt to directly recycle experiences from Central and Eastern Europe (CEE) might be counter-productive. The experiences of CEE in the 1990s are an imperfect match for the needs of the Middle East and North Africa today.

Economic reform must accompany political transition if the root causes of the Arab Spring protests are to be addressed and jobs created for the 2.8 million young people who enter the labor market every year. Despite a decade-long surge of foreign direct investment to the region, high and persistent unemployment is endemic, especially among the young, whose jobless rate exceeds 40percent in some countries. Foreign direct investment flows have fallen recently as a result of the ongoing global economic crisis and the impact of the Arab Spring on investors’ confidence.

The Gulf has the necessary stability and capital resources to bring stability and integration among all Arab countries that are undergoing significant political changes and become a central actor within the international arena. Incentives to the private sector are also essential to generate labor force that can contribute to the diversification of the economy much more than employments in governmental institutions. The whole MENA region faces substantial risks, including the chance of continued political upheaval and a deepening crisis in the Eurozone, which could affect global growth and demand for oil, and lead to higher financing costs for certain Middle East countries.

The IMF has forecast a slowdown in growth for the oil exporters of the region, from a cumulative 4.9percent in 2011 to 3.9percent this year, as oil revenues decrease from softer prices. Slowing growth in the largest oil-consuming nations is expected to decrease demand for the commodity, leading to lower prices. GDP growth in the net oil importers of the region will almost double to 2.6percent, from 1.3percent in 2011, as they recover gradually from the political ravages of the Arab Spring. Undoubtedly, 2012 will be challenging for many countries here, with continued political uncertainty, a deteriorating global economic outlook, and higher financing costs impeding a quick economic recovery.