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26 Jul 2013

CEEMEA stuck in slow lane

Murat Ulgen

by Murat Ulgen

HSBC Chief Economist, Central and Eastern Europe and sub-Saharan Africa

Turkish currency note

Turmoil in Turkey has largely subsided but recent unrest has caused the political-risk premium to rise

CEEMEA countries – Central and Eastern Europe and sub-Saharan Africa – were already struggling with meagre economic growth or further slowdowns in early 2013. Now they will probably be stuck in the slow lane even longer, thanks to changing expectations for US monetary policy and the US Federal Reserve’s plans to taper quantitative easing. Moreover, global economic activity is slowing again, led this time by the emerging markets.

The risk to the CEEMEA region from the Fed is that tapering reduces hitherto abundant global liquidity. The initial reaction to higher developed-market interest rates was higher CEEMEA rates and weaker currencies.

The latter could boost competitiveness in a world of weak external demand, but with potentially higher inflation squeezing real wages and raising the cost of capital for investments, it may eventually mean even lower growth. CEEMEA also has low domestic savings, generally speaking, hence a reduction in global liquidity means less or scarce financing for growth.

Turkey and South Africa are most vulnerable to a global liquidity shock, in our view, with Ukraine and Serbia most at risk among the region’s smaller economies.

Turkey and South Africa are most vulnerable to a global liquidity shock, in our view, with Ukraine and Serbia most at risk among the region’s smaller economies

Turmoil in Turkey has largely subsided but widespread demonstrations and clashes have caused the political-risk premium – long dormant – to rise as the country prepares to enter a busy election cycle starting from 2014.

The macro and market outlook has deteriorated sharply since Moody’s became the second agency to upgrade Turkey’s credit rating to investment grade in May. But we do not think the Goldilocks period is over. Political stability continues, the government’s strong approval rating is undented by the social unrest, and structural reforms should boost savings and competitiveness.

There are also strong supply side reasons for robust medium-term growth, thanks to heavy capital investment and a rise in the number of women working. And with Turkey having avoided a potential clash with the European Union over the domestic unrest, we expect new accession talks to resume in 2013.

Nonetheless, markets are now re-assessing past expectations of a buoyant economic recovery after 2012’s sharp slowdown with a benign inflation outlook. Turkey’s large external financing requirements leave it vulnerable to a global liquidity shock with downside risks to growth and upside risks to inflation.

South Africa’s currency was under severe depreciation pressure even before expectations changed on US monetary policy. The fundamental story looks bleak, with persistently low growth, elevated inflation and chronically high unemployment.

Bad macroeconomic performance reflects a rigidly unionised labour market, worker unrest that can disrupt production, high costs for businesses, and an economy increasingly dominated by the public sector. The rand – the main adjustment mechanism when wages and input costs are rigid – has been hit hard by global liquidity worries because of South Africa’s large external funding needs.

But not all CEEMEA countries feel the impending change to external liquidity to the same extent. Central and Eastern European markets have held up relatively well, anchored more to the eurozone financial system and European Central Bank monetary policy. Cheap liquidity did not lead to a credit boom there after the global crisis: if anything, eurozone woes led to severe deleveraging and collapsing credit growth in Hungary and other countries.

Non-resident portfolio positioning is at a record high in Poland and Hungary, risking higher rates and tighter monetary conditions if investors continue offloading emerging-market assets. Sharp market volatility could prove a drag on consumer and investor confidence too.

China’s slowdown will hit global trade with core economies, particularly Germany, and this will translate into weaker growth in Central and Eastern Europe. Russia, now China’s largest trading partner, could also suffer. China’s drag on oil prices could weigh on Russian macro balances too – though renewed unrest in the Middle East that boosts oil prices indirectly supports Russia’s outlook.

We originally expected a subdued and gradual recovery for the CEEMEA region during 2013 but the timeline has moved further out. Based on expectations of some improvement in global growth and the trade outlook for 2014, the region may see better days later in that year but the near-term picture remains fairly bleak.

We have thus cut our 2013 growth forecasts for South Africa and lowered them for the Czech Republic, Poland and Turkey for 2014 too. However, we have raised our 2014 growth forecast for Hungary from 0.9 per cent to 1.3 per cent, as we now expect even more monetary stimulus.

This research was first published on 17 July 2013.

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