Eastern Europe Continues to Suffer Economic Chill

States which only two decades ago escaped their forced Soviet embrace grew mightily from their increased contact with the rest of Europe.  But they remain vulnerable to chills emanating from the Eurozone.

Output is up in Russia, but it remains an important exception in the east.  Even Poland, one of Eastern Europe’s most important success stories, trails Russia in consumer confidence, sales growth, and GDP.  Second quarter figures indicated that the Czech Republic continued in recession for its third quarter.

Elsewhere in the region, reported a recent survey by the Center for European Economic Research and the Erste Group Bank, economic confidence is down, falling 1.7 points in August.  Growth slowed in the second quarter and, warned William Jackson of Capital Economics Ltd. in London:  “Weak domestic demand was the main drag on growth coming on the back of fiscal austerity and falling confidence.  With external headwinds mounting, we think growth is set to slow further over the coming quarters.”

Earlier this year analysts warned that banks from Western Europe would look east if they had to deleverage.  Bad loans already are a problem and are rising.  The CEO of Erste Group Bank, Andreas Treichl, recently said that he hoped the worst was over, “but it is bad enough for the moment.”  Should Greece be forced to leave the Euro, the shock could grow.  For instance, Mihai Tanasescu, vice president of the European Investment Bank, warned:  “The main threat of a Greek exit lies in the tentacular expansion of its banks in the region.”  Bulgaria and Romania face the greatest exposure, but other countries also would be affected.

Ironically, governments in the region have been able to borrow at lower rates due to investors looking for alternatives to the Eurozone.  “Being outside the euro zone is now a strength,” observed Marek Kaczor from PKO BP in Warsaw.  Yields on both Czech and Polish bonds are down.

Nevertheless, with economic uncertainties abounding, countries in the region should place a premium on maintaining fiscal probity and reducing barriers to foreign investment.  Economic reform often is politically painful.  But the chaos in Greece demonstrates that failure to reform can lead to even greater hardship.

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