EMERGING EUROPE: ECONOMIC REVIEW AUGUST 2011

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Russia: Shrugging off the curse of August

Twenty years after the country came into being as an independent nation following a revolt against the Gorbachev regime, Russia has had its ups and downs in its transition to a market-based economy. Historically, the month of August has bestowed its share of ills upon Russia, from the country’s entry into World War I during the same month in 1914 to last year’s severe drought that led to huge crop losses and a forest fire that clouded the capital Moscow in smoke. Though data available for the month of July from a Purchasing Managers’ Index showed contraction, Russians currently seem to be enjoying a relatively uneventful August. Not so for Russia’s currency market, where the rouble shed all of its gains for 2011 during the first few weeks of the month, only to recover quickly within a couple of days. A report from FT says the volatility actually points to the “positive evolution” of the central bank’s monetary policy.

As he has done in the past, Russian Prime Minister Vladimir Putin came up with some eyebrow raising thoughts. The latest salvo, according to an FT news report, is his proposal to create a “Eurasian economic union” by 2013 combining the former Soviet states. An FT report says the premier had famously termed Russia’s sovereign debt grade assigned by foreign rating agencies an “outrage.” Last year, Putin had created a customs union between the states of Belarus, Russia, and Kazakhstan, exempting the goods traded along their borders from tariffs and customs levies.

Once bitten, twice shy. After last year’s devastating drought which affected much of its farm produce, Russia seems to be treading cautiously as far as its food security is concerned. Russia’s Agriculture Ministry has made a proposal to buy grains from farmers to create a food stockpile. The government has also allowed the farmers to buy the grains back at the same price, provided they take care of storage facilities, according to a news report from Bloomberg. Currently, Russia has grain reserves of 6.7 million tons.

Still, the curse of August seems to have cast its shadow on the Russian corporate world. The TNK-BP joint venture, which was formed in August 2003, has been plagued through the years by the litigation between the British company and its Russian oligarch partners. While the Russian owners had demanded compensation from BP for damages related to its attempted tie-up with oil producer Rosneft, BP has now retaliated, according to an FT report, accusing its partner Renova of violating the shareholder agreement by running independent gas and fuel companies in Russia and the Ukraine. The ongoing mud-slinging between the two partners continues to raise serious questions about corporate governance standards in Russia.

Turkey: Rates cut in surprise move

On the face of it, Turkey has every reason to cheer. The economy expanded a stupendous 11% during the first quarter, outpacing even China. However, there are already signs that the economy may not be able to sustain the same momentum going forward this year. With half of Turkey’s exports shipped to the European Union, which is under strain, Turkey’s trade deficit almost doubled to $10.2 billion in June compared to the year-ago period, according to a WSJ report.

The Turkish central bank has been following an unorthodox monetary policy of keeping the interest rates low for several months now. In the bank’s view, raising interest rates to tackle inflation would attract hot money and lead to currency appreciation, a scenario that would undermine the country’s export competitiveness. Hence, so far the bank has decided against hiking interest rates. However, recently, the central bank surprised the markets with a sharp reduction in the already low interest rates to 5.75% from 6.25% earlier. Still, investors do not seem convinced by the argument. Inflation continues to rage on at 6.3% a year, above the central bank’s target rate of 5.5%. Besides, the current pace of GDP growth is expected to lose steam and slow down to 6% by the end of the year. Many market participants view the rate cut to be a signal that Turkish policy makers are wary of the global economic scenario. Some say the move could be an attempt to insulate the Turkish economy in the event of another financial crisis, as a WSJ report points out. The ripples were felt in the markets almost immediately, with the lira falling 2% against the U.S. dollar, and the Istanbul bourse losing over 1% of its value.

Meanwhile, Turkey’s long-pending accession to the European Union ran into another road block as a group of U.K. parliamentarians objected to the move. The findings of the group’s research, published by the Financial Times, pointed out that Turkey’s acceptance into the EU would compromise the “security of the EU external border” and “make EU member states more vulnerable to organized crime.” The report also mentioned the sticky point that Turkey could be used as an entry point for illegal transit of immigrants into the European Union. The latest development comes as a surprise as Britain was considered a staunch backer of Turkey’s ambition to become a member of the European Union.

Poland: Rate cut in the cards

Initial estimates showed that Poland’s second-quarter GDP expanded 4.2% compared to 4.4% growth recorded in the first quarter. With the falling rate of inflation and slowing economic growth, policy makers may be prompted to lower interest rates. The central bank had left borrowing costs untouched in July after raising interest rates between January and June this year. Inflation in Poland will hover around 4% year-on-year over the next few months and will slow down to 3.5% by the end of 2011, according to a news report from Reuters that quoted a foreign ministry official.

With this, trouble seems to be brewing for Poles who had taken out mortgage loans denominated in Swiss francs at the height of the country’s real estate boom. Though the Swiss franc has lost value against both the U.S. dollar and the euro after peaking during the second week of August, it has put these borrowers under strain. FT quoted a study by a financial advisory firm, which said that about half of such loans issued during 2006-2008 are in trouble. The situation is dire for both borrowers and lending banks, with borrowers finding themselves in a situation where they owe the banks more than what their property is worth.

Meanwhile, the U.S. debt rating downgrade did not prompt sharp reactions in Poland. In fact, economists seem to think that Poland stands to gain from the move, since the country has not been a party to the debt crisis, and because its comparatively low deficit and reasonable economic growth make the country an attractive investment destination for investors. Poland is determined to contain its budget deficit, introducing cuts in spending and private pension funds, and levying higher taxes. Poland has a self-imposed public debt threshold of 55% of its GDP.

And, amid the uncertain economic environment, Poland had something to cheer about on the foreign direct investment front. U.K. retailer Tesco seems to have big plans for the Polish market as it plans to invest about $360 million in the country in 2011 and open at least 80 new outlets.

Hungary: GDP growth slows down

The Euro-zone’s woes had a direct impact on Hungary’s growth, as second-quarter numbers indicated that Hungary’s GDP growth was annual 1.5%, down from the 2.5% clocked in the previous quarter. The slowing growth reflected poor export demand and weak factory activity, while its main trading partner Germany recorded anemic activity during the second quarter. According to an FT report, Citibank cut its forecast for Hungary to 2.3% in 2011 from its earlier view of 2.8%.

Acknowledging the slowdown, Prime Minister Viktor Orban said the government will announce some tough decisions to tide over the crisis. The premier also commented that the country is likely to miss the target rate of 3% growth this year. According to an analyst quoted in a WSJ news report, as growth lags in Hungary, the government could revisit the “crisis taxes” imposed over the next three years on select sectors of the economy. Orban added that Hungary would be able to meet its budget deficit target of under 3% of output this year, the report said.

Encouragingly, big manufacturers seem to think that there is an upside to every downturn. German car maker Audi recently said it plans to expand its factory in Hungary to create some 2,100 jobs.

Czech Republic: Inflation falls on lower food prices

The economy expanded at an annual rate of 2.4% in the second quarter, compared to 2.8% in the previous quarter. The slowdown in Germany especially weighed heavily on the Czech economy, which is dependent on foreign export demand for 70% of its gross domestic product. What’s more, the fiscal austerity measures imposed by the government have affected the economy’s growth as consumer spending has cooled. According to an FT report, GDP could slowdown more in the second half of the year.

Still, falling food costs in Eastern Europe in general have helped to ease price pressures in the Czech Republic as well. The rate of inflation declined for the second month in July to 1.7% compared to 1.8% in June. Understandably, the Czech central bank governor said the bank does not intend to raise interest rates anytime soon.

Meanwhile, Czech government-owned power producer CEZ seems to have a knack for grabbing news headlines these days. Looks like central Europe’s largest listed company may be in for a windfall from the sale of carbon emissions credits. Emissions trading, a market-based system which has evolved in recent years, aims to control pollution by offering economic incentives to companies who achieve stipulated pollution emission targets. Carbon credits, as the permits are widely known, can also be traded at a profit. According to a study by an environmental group, CEZ has a surplus of some 4.7 million credits, valued at €80 million, according to an FT news report.