Escalation of eurozone crisis would pose serious risk to emerging Europe - EBRD

By Anthony Williams

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The EBRD has revised up slightly its growth forecasts for emerging Europe for 2011, but the Bank’s latest economic outlook warns of mounting risks from the eurozone that could jeopardise economic prospects for the region.

Against the backdrop of a continuing recovery from the global economic crisis, the EBRD’s economists are predicting growth of 4.8 per cent across the 29-country region in 2011, up from 4.6 per cent seen in May. The 2012 forecast is unchanged at 4.4 per cent.

But the EBRD’s latest Regional Economic Prospects report says risks to the outlook are continuing to mount. “An escalation of the eurozone crisis would pose serious risks to growth and recovery across the region, especially in south-eastern Europe and the new EU members,” says Erik Berglof, the EBRD’s Chief Economist.

Individual areas within the EBRD region would be impacted by any worsening of the eurozone crisis according to their varying circumstances, the report said.

The recovery in south-eastern Europe was still weak and this region was most directly threatened by the financial instability related to the eurozone turmoil, as significant parts of the region’s banks are owned by Greek banks.

The report said that, in the event of an escalation of the crisis, some of these banks could require financial support and might struggle to keep up their lending to the local economies. “This could contribute to a notable downturn in economic growth in that region.”

The deep integration with western European markets of central Europe and the Baltic states would mean that this region would be exposed to disruptions in financial markets, increases in bank funding costs and a slow-down in eurozone growth.

CIS countries were likely to be less affected by eurozone debt market instability. Energy exporters in the CIS would be hurt by eurozone stagnation that could stem from the turmoil through its impact on commodity markets. This could result in lower demand for commodities including oil and gas, reducing their currently high prices. 

Potential slow-downs in the United States – where market confidence could falter due to protracted debt ceiling negotiations – or in China posed further risks to the transition region, the report said.

Looking at the performance of the economies themselves, the report showed that some of the countries that experienced particularly deep drops in real income during the crisis, including Estonia, the Kyrgyz Republic, Lithuania and Ukraine, were among the strongest first quarter performers.

However, it noted that south-eastern Europe continued to under-perform, with Croatia the one country in the EBRD region yet to show convincing signs of recovery. Other transition regions have either reached or are approaching their pre-crisis levels of real GDP, but the Baltic countries remain over 10 per cent below their early 2008 output levels.

Credit to the private sector remained generally weak relative to other emerging market regions and continued to provide only limited support to economic expansion. An exception is Turkey where high credit growth adds to concerns about overheating.

Capital inflows into the region were stronger in the first quarter of 2011 than in most of 2010. While foreign direct investment remained the main form of capital inflows, portfolio investment also picked up. More recent data point to some reversals in these trends, with bond fund net inflows into the region remaining around zero in April and May and equity funds showing a sharp outflow in May.

The report said: “This may be partially due to investors perceiving the region as particularly exposed to the developing debt problems in Europe, as flows into other emerging market regions did not fall as significantly.”

Rising inflation remains an issue, particularly in eastern Europe, the Caucasus, and central Asia, fuelled by external factors such as higher food and commodity prices, but also as a result of strengthening domestic demand.

Belarus witnessed the most dramatic increase in inflation, to 44 per cent in June year-on-year, a reflection of its balance-of-payments crisis and a large exchange rate devaluation. However, inflation in May 2011 was higher in almost all transition countries relative to a year earlier.

Unemployment rates remained high compared with pre-crisis levels in some of the countries that experienced sharp economic downturns during the crisis. In March, unemployment rates were still about 10 percentage points above those seen in late 2007 in Latvia and Lithuania, despite slight recent decreases. In both countries, the large increase in unemployment also resulted in a sharp rise in the share of long-term unemployment. In most other new EU member states long-term unemployment shares were already high before the crisis.

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