Market Overview

Emerging Europe: Regional Economic Review – Q2 2014


Overall Economic Recovery Intact Despite Country-Specific Problems

During the second quarter of the year, the Emerging Europe region appeared to be displaying divergent trends. The fallout of the Ukraine crisis was not as damaging to the Russian economy as feared, with the economy even expanding during the review period. However, as the IMF pointed out, the sanctions imposed by the West appear to have dented investor confidence.

Though Turkey’s fiscal situation has improved, the conflict in Iraq has the potential to hurt the country’s oil-import budget, not to mention the loss of its second-biggest export market. Poland, the biggest economy in central and east Europe, seems to have been affected by the slowdown in Germany, not so much by the conflict in Ukraine. A low unemployment rate and low inflation as well as the political stability of the Donald Tusk administration, which survived a recent phone-tapping scandal, are big positives for the economy. Hungary’s economic expansion is being driven by increased industrial production and construction activity, as well as an increase in domestic demand and investments. Besides healthy exports, mainly to Germany, Hungarian consumers seem to be spending, encouraged by low interest rates. The small, export-oriented Czech Republic has benefited from the central bank’s monetary policy, which reduced interest rates and weakened the currency. Household consumption also picked up as the new government rescinded some fiscal restrictions imposed by its predecessor. Conditions in Greece appear to be turning for the better. The pace of recession has slowed drastically, while the Samaras administration has embarked on a reform spree to attract investment into some sectors of the economy. From a debt-driven consumption model, the government wants to move the economy to an export-based one to boost growth and create hundreds of new jobs.

At a Glance

Russia: Though Russia’s economy expanded by 1.2% annually in the second quarter, the Ukraine crisis and the resultant sanctions by the U.S. and the EU seem to have affected investor sentiment.

Turkey: Though the economy lost some momentum in the second quarter, Turkey’s fiscal situation has improved compared to last year. However, the conflict in Iraq may hit the economy in more ways than one.

Poland:  After expanding in the first quarter, growth seems to be slowing in Poland, possibly due to a slowdown in Germany and the side-effects of the Ukraine crisis. Still, the economy looks healthy based on parameters such as the unemployment rate and inflation.

Czech Republic:Helped by the central bank’s supportive monetary policy and increase in demand from Germany, the Czech economy has been expanding gradually after coming out of a recession last year.

Hungary:Hungary’s economic expansion is being driven by increased industrial production, construction activity, as well as an increase in domestic demand and investments. Another encouraging factor for the economy is the low level of inflation.

Greece:As Greece’s pace of contraction slows, the government has announced reforms aimed at boosting exports to create more jobs and to attract investments into some sectors of the economy such as energy, pharmaceuticals, tourism, and food processing.



After falling to a five-year low in May, business activity in Russia stabilized in June. Still, the Ukraine crisis has reduced growth and stalled new investments due to the effect of sanctions imposed on the economy by the United States and European Union. More than anything else, the energy-driven economy seems to be reeling under a crisis of confidence. Nevertheless, the fall in investment has not been as sharp as before, indicated by the reading in May. The outflow of capital also seems to have slowed after the mayhem witnessed in the first three months of the year. Russia’s economy expanded by 1.2% annually in the second quarter, compared to a meager 0.9% in the first quarter. The Russian economy ministry appears to be upbeat about a gradual improvement in economic growth for the year, saying the fall in business investment has slowed. However, the International Monetary Fund expects growth to decline further in the year. The Washington-based lender is feels that even if there is no escalation on the Ukrainian front, the uncertainty and loss of confidence could result in reduced consumption, more capital outflows, and weaker investment.

It appears that the crisis could not have at a more inopportune time for the Russian economy, which had been slowing down even before the Ukraine crisis broke out. The old energy-based model is waning, but for the Russian economy to diversify, new business investments and modern technology are in order. Against this backdrop, there is all the more reason for Russia to become more integrated with the global economy. Events such as the Ukraine crisis only help isolate the economy from the rest of the world. Globally, the fallout of the geopolitical situation in Ukraine has been limited so far, especially with regard to energy prices.

Domestically however, manufacturing activity shrunk for the eighth month in a row in June due to the Ukraine crisis, though the June reading was better than the previous month. Inflation levels moderated in the month of June even as the Russian central bank said inflation could touch 6.5% by the end of the year. Despite slowing growth, the central bank has been unwilling to reduce interest rates as inflation has generally remained high in recent months. Moreover, consumer spending has not picked up despite the drop in unemployment levels.


The political climate in Turkey took a turn for the better in the second quarter after the volatile situation that prevailed in the beginning of the year. Economic growth, which was clocked above expectations in the first quarter, reflected the easing of political tensions. Increased consumer spending, growth in exports, and government spending all drove the expansion. However, the economy seems to have lost some of that momentum going into the second quarter. Manufacturing, for instance, which had showed some improvement in May, contracted in June, raising doubts about the sustainability of economic growth.

Still, the government and the central bank appeared confident about the strength of the economic recovery going by some of their recent policy actions. After raising interest rates in January, the central bank cut interest rates twice, the latest round towards the end of June, citing easing inflation. According to a Reuters report, the Erdogan administration might have prevailed upon the bank to keep rates low to stimulate growth ahead of the August presidential polls, despite inflation remaining considerably above the central bank’s forecast. Prime Minister Erdogan has thrown his hat into the ring hoping to become the first elected president in the nation’s history. Meanwhile, Turkey continues to be singled out amongst emerging economies as one of the most vulnerable to volatile capital flows, especially in the wake of the U.S. Federal Reserve winding down its bond purchases. The recent tensions in Iraq highlighted yet again the vulnerability of the country’s currency. Iraq, Turkey’s second-biggest export market after Germany, is strategically important as the economy tries to rebalance. Turkey purchases most of its crude oil from foreign countries and Iraq is its principal supplier of oil. While the higher price of oil is likely to push up inflation in a net oil importing economy like Turkey, the loss of a lucrative market to sell its wares will hamper the country’s efforts to bring down its current account deficit, which stood at $65 billion in 2013. Encouragingly though, the Turkish Finance Minister has said a broader recovery in Europe and a weak currency should help the economy narrow the deficit.


After clocking an annual growth rate of 3.4% in the first quarter, Poland’s economy appears to be heading towards slower expansion in the second quarter. The manufacturing index showed a fall in activity in June compared to the previous month though the reading was still above the mark that separates expansion from contraction. On a less impressive note, industrial output and retail sales fell in June. There appear to be several factors in play contributing to the declines. Besides the possible contagion effect from the Ukraine crisis, the recent slowdown in Germany, Poland’s main export market, was more likely responsible for the fall in factory activity. Russia’s banning of certain imports from Poland has hit the economy, but not significantly. The economic sentiment in the 18-member Euro-zone, a major export market for Poland, fell in June on concerns that the Iraq crisis may push up prices of oil and affect growth in the currency union. Nevertheless, the economy looks healthy based on parameters such as the unemployment rate, and inflation, which stands at 0.2% on an annual basis. The low level of inflation in Poland’s trade partner Euro-zone appears to have had a trickle-down effect on the central European economy.

The Polish economy has also benefited from the European Central Bank’s reduction of interest rates to near zero. The central bank has maintained interest rate at 2.5%, which boosts domestic demand. For the Polish central bank, it seems to be a case of once bitten, twice shy as the memory of years of high inflation still remains fresh. There also is the increasing fear that strong growth may push up consumer prices. Recently, the bank said consumer price inflation in Poland will remain below its target of 2.5% through 2016. The stability of the Donald Tusk administration, which recently won a vote of confidence after a political scandal over some leaked telephone talks between some senior government officials, also bodes well for the economy.

Poland, the only European Union economy to avoid a recession in 2009, has been able to clock consistent growth rates over the last few years. Still, stable economic growth in the Euro-zone, especially Germany, is likely to be crucial for the Polish economy going forward.


The small, central European economy, which exited a prolonged recession last year, has made good economic strides, going by the revised quarterly data. The mainly export-oriented economy registered 0.8% quarterly growth, the fastest pace since 2011. Expansion has been driven by increased trade with the economy’s partners in the Euro-zone and good domestic demand.

Still, it must be noted that the economic bounce back has been made possible also by the intervention of the central bank, which reduced the interest rates to zero and also weakened the Czech currency, boosting the country’s exports. The dip in factory activity in recent months was nothing but a reflection of the slowing industrial production in Germany, the economy’s chief trading partner. Despite this, the Czech purchasing managers’ index has consistently registered growth for the past fourteen months in a row.

The new-found optimism appears to have spread to the country’s companies as well. As consumers regain confidence, firms are preparing to ramp up production and hire more workers. While manufacturers and exporters are clearly driven by the increase in demand to Germany, consumers are breathing easy as the new government has rescinded some fiscal restrictions imposed by the earlier government. Notably, household consumption has picked up, with retail sales rising for the sixth month in succession in April. The overall growth momentum in the economy prompted the central bank to forecast economic expansion of 2.5% this year after a 0.9% contraction in 2013. Unlike its predecessor, the newly-elected government has been liberal with public spending, pumping money into big construction projects and railway schemes, which help generate new jobs. In a report published in April 2014, the International Monetary Fund (IMF) concurred with the Czech government’s move to hike spending. The IMF also echoed the central bank’s growth forecast for the economy this year. The Washington-based lender further noted that it is desirable that the central bank’s monetary policy should remain supportive of the economic recovery. After the pace of investment slowed down drastically during the recession, the new government has been focused on attracting foreign direct investment, signing a few deals recently. The move to boost FDI is in line with the government’s policy to spur output and economic growth by all means possible.


Hungarian Prime Minister Viktor Orban won another four-year term in the elections held in April, assuring political stability at a time when the country’s economy is picking up pace. The electorate gave their vote of approval for continuity of the incumbent government, apparently overlooking some measures implemented in the banking and energy sectors perceived to be unfriendly to investors. The new government is likely to continue to enforce fiscal discipline and increase domestic participation in some strategic sectors of the economy, punctuated by the recent announcement of plans to increase stakes in natural gas and power generation companies. During the first quarter of 2014, the economy expanded by 3.5% annually, the fastest growth rate clocked since 2006. The economic expansion was driven by increased industrial production, construction activity, as well as an increase in domestic demand and investments. As usual, Germany was instrumental in driving Hungary’s exports, especially in the automobile manufacturing sector. Besides healthy exports, Hungarian consumers too eased their purse strings, reflected in the increased retail sales during April and May. Manufacturing activity though seems to be slowing down across central and eastern Europe, going by the latest data from the region. Hungary’s Purchasing Managers’ Index showed a reading of 51.5 in June compared to 53.5 in May. Another encouraging factor for the Hungarian economy is the low level of inflation, which even dipped into the negative in April 2014. Besides low inflation, monetary policy actions of the European Central Bank seem to have spurred the Hungarian central bank to reduce interest rates to 2.3% in June. It appears that low inflationary pressures and the uptick in growth have emboldened the central bank, which sees inflation coming down to zero this year. To put things in perspective, Hungary’s interest rate had touched a whopping 7% in August 2012. The bank forecasts economic growth above 2.5% in 2014 based on the assumption that the Ukraine-Russia conflict won’t escalate further. Ratings agency Fitch affirmed Hungary’s sovereign ratings, encouraged by the decent growth and fall in unemployment in 2013 and early this year. The banking sector, which remains adequately capitalized, is also a major driver.


Optimism, they say, is a state of mind. For Greece, the Euro-zone economy that has been in recession for the last six years, Q1 2014 numbers showing a less-than-expected economic contraction appear to have come at the right moment. Greece’s GDP shrunk 0.9% on a year-on-year basis during the quarter. To decipher the big picture, the pace of contraction has shrunk for the fourth quarter in a row, continuing the return-to-growth process that started in 2013. Greece’s return to markets with a successful bond sale and improved market sentiment has fanned hopes that economy may possibly emerge out of the recession this year. Notably, consumption and net exports increased during the quarter.

Greece had a consumption-driven economy funded by debt in the run-up to the crisis, which led to the bailout of the economy. Prime Minister Antonis Samaras outlined a course of action to put Greece’s economy back on track. Besides sticking to reforms, the premier unleashed a plan to boost exports to revive growth and create hundreds of jobs. Though Greece’s unemployment rate saw a dip in March, the jobless rate, at 26.8%, is still the highest in the 28-member European Union.

Samaras’ program involves introducing reforms in energy, pharmaceuticals, food processing, tourism, logistics, and the fish-farming sectors. Towards this end, Greece’s energy minister announced a tax cut for companies operating in the oil and gas sector, enticing them to explore the country’s offshore oil resources. According to a Reuters report, the reforms are expected to generate more than 700,000 jobs in the next seven years and add €54 billion to GDP. Samaras said the fast growth resulting from implementing these reforms will help reduce taxes gradually.

Rating agency Fitch upgraded Greece’s rating, taking into account the progress made on several fronts. Greece achieved a primary surplus in its budget in 2013 and has been able to reduce its deficit over the last four years. The agency’s projection is for the economy to grow 0.5% in 2014. Fitch said the government has been able to recapitalize banks to a large extent, also helped in part by private sources. However, the International Monetary Fund had a word of caution for the Greek government. It warned that the public sector should be made more efficient to achieve fiscal targets, adding that the coalition government seems to have been hit by a reform fatigue.


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