Public debt still determining factor on capital markets -
CEE greatly improved

Date: 29.06.2011

Many states of Central and Eastern Europe (CEE) have unjustly come under enormous pressure due to false assessments after the global financial crisis since 2009. A closer look shows that the level of public debt in most CEE countries is below the Maastricht limit of 60 percent of GDP and therefore, far below the current euro area average of more than 80 percent. Investors in the CEE region are gradually starting to recognize a healthy fundamental economic situation – but not the rating agencies. 

In 2009, the US economist and Nobel laureate Paul Krugman stated in a New York Times blog that Austria was nearly bankrupt, as it played a key role as hub for the CEE states and other countries. This assessment was based on a superficial comparison between the outstanding total credit debt (incl.CEE) of Austrian banks with Austria’s gross domestic product. But one should not compare credit volume with GDP but rather with savings deposits (and not only Austrian). The fact that the loans extended by Austrian banks were covered by local deposits of subsidiaries was not taken into account. These false assumptions were proven unfounded afterwards.  The IMF promptly apologized at the time.

In fact, this erroneous assessment created massive pressure on the states in Central and Eastern Europe. The rating agencies downgraded their ratings and the higher capital costs that these countries had to pay for financing did in fact force them to make enormous efforts. Ukraine, Hungary, Romania, Poland, and Croatia are trading in CDS spreads (Credit Default Swaps) above those of Ireland. The Czech Republic and Austria (at the time +200bp) were close to Greece and higher than Spain and Portugal.

Better than its reputation. The real economy in the CEE countries was never as bad as its reputation and the assessments of the rating agencies. Ever since, many things have improved significantly. Government debt of the principal CEE countries is below 60 percent of GDP, but only the debt level of Hungary corresponds more or less to the euro area average. The government debt of Hungary, Czech Rep., Slovakia, Romania and Croatia (CEE5 ¹) totals to around EUR 240 billion, and therefore, some EUR 80 billion lower than government debt in Greece (EUR 300bn).  If one takes Poland into account (CEE6 ²), the debt level is EUR 454 billion and in total much lower than the national debt of Spain (EUR 773bn) and Italy (EUR 1.911bn).

In an an adverse environment of persistently of high government debt levels it has become clear that CEE simply has less debt. The CEE5 ¹ countries with a population of 52 million have the equivalent of only around two thirds of the debt Greece which has a population of 11 million. The CEE6 ² region with some 90 million inhabitants only has less than two thirds of the debt of Spain (population: 47 million) and less than one fourth of Italy’s debt (population 60 million). See chart .

CEE5 countries ¹: Croatia, Romania, Czech Rep., Slovakia, Hungary,
CEE6 countries ²: Croatia, Poland, Romania, Czech Rep., Slovakia, Hungary.

Source: AMECO, Erste Group Research

The price of being industrious. Relatively healthy economic growth and careful budgeting in the CEE countries are now normalizing the premiums on their government bonds. Investors are starting to look at the real fundamental data of these countries for guidance and are pricing these into their estimates again. Ukraine, for example, is trading clearly below the spreads of Greece, Ireland and Portugal (around half and less). Croatia, Hungary and Romania are trading below Spain (+320bp/Spain, +300bp/Hungary and Croatia, +280bp/Romania). Poland currently has a spread below that of Italy (+210 BP/Italy, +165 BP/Poland), Slovakia, Czech Rep. and Austria are far below (by 100bp and far below 100bp).

The rating agencies have not responded to this market development to date and are apparently much slower in upgrading than in downgrading. However, they will not be able to avoid the independent assessment of financial market participants over the long term. And by the way, no one has heard anything from Paul Krugman up to now.


Author:
Friedrich Mostböck, CEFA,
Head of Group Research/Erste Group Bank AG
Member of the Board of EFFAS (European Federation of Financial Analysts Societies, www.effas.net) the umbrella association of European financial analysts with 6,000 members in Europe