Convergence or Dichotomy –
Outlook on the European Economy and Currency

Date: 11.10.2010

The recession has clearly revealed the differences in the economies of the European countries. Within the euro zone, a group of countries has emerged known under the acronym PIIGS (Portugal, Ireland, Italy, Greece, Spain) whose government bonds  have come under pressure from lacking productivity growth (Italy, Portugal, Greece), high government debt (Greece, Italy), the bursting of real estate bubbles (Ireland, Spain) and/or low participation rates (Greece, Spain).  At the same time, in 2Q 2010, Germany posted its most robust growth rate since German re-unification and state financing costs dropped to record lows.

There is a similar disparity among the countries of Central and Southeastern Europe. While Central Europe, in particular, the Czech Republic, Slovakia and Poland, have almost completely synchronized their pace of growth with that of leading euro states, and even Hungary is slowly but steadily pulling itself out of the trough it was pushed into by exports, some parts of Southeast Europe are still in recession. What has happened here – similar to Ireland – is a sort of “thrust reverse” from an environment of robust growth and practically automatically rising government revenues to declining or at best sluggishly growing economic activity.  Steep credit growth driven by the inflows of capital from abroad continued in some cases far into the year 2008. Croatia, which had already taken measures to slow credit growth by imposing stringent minimum reserve rules and other (monetary) policy measures in the preceding years, was not affected as harshly by the abrupt cutoff of liquidity inflows like, for example, Romania or Serbia. In all countries of the SEE Region, future growth will depend, among other things, on the extent to which it will be possible to finance investments from domestic savings.

Since CEE countries are not affected as much by transition problems as the SEE countries, many of the currencies have already compensated the losses incurred, above all, during the recession, while SEE currencies were under pressure for most of the current year. The Hungarian forint remained more or less unchanged.  A feature Hungary shares with the SEE region is the relatively high number of borrowers with poor crediting ratings (due to income and/or currency losses). Hungary also has the greatest similarities with the above mentioned PIIGS countries with respect to foreign and government debt. However, Hungary has made great progress in improving its state finances after a long period of cooperation (albeit with some rough patches) with the IMF. In 2009, Hungary was the only EU country with a positive primary balance, i.e., government receipts were higher than spending exclusive of interest.  While industrial production in Greece, Spain and most SEE countries is at best at the level of the previous year, in Hungary it grew steeply and exports are approximately 35% higher than in the previous year. This comparably solid industrial development is also true with some restrictions for Serbia, which is becoming increasingly established as an industrial center in the Balkans and is profiting from Croatia’s and its own EU prospects with a chance of recuperating the trend of rising direct investments. These two currencies have the potential to bring us some pleasant surprises even though the downside risks are still considerable.

Author:
Uta Pock, Head of Research,
Österreichische Volksbanken AG
11 October 2010