The key economies of eastern Europe are looking to an upturn in growth in their western trading partners to put them back on an expansionary path. Russia’s problems are more deep-seated
Eastern and central European markets have found themselves squeezed from two sides during 1999, but strictures on at least one front look like easing.
The sluggishness of the Euroland economies, and political instability and economic uncertainty in Russia, have conspired to make for an uneven year. The coming and going of prime ministers did little to slow the performance of the Moscow exchange during the first six months of the year. This was not due to improving fundamentals, but rather a more confident mood among investors, and rising oil prices. There was also the prospect of foreign investors returning to the Russian market, which encourages local investment with the hope of strong sell-on profits. Since the peak in June, however, there have been growing worries.
The IMF has done its best to offset these, by predicting a shallower recession than anticipated in Russia, and praising the government's attentiveness to the economic conditions set down by the organisation when it provided a $4.8bn loan to shore up the rouble in the summer of 1998. Speaking at September’s IMF meeting in New York, Michel Camdessus, managing director of the IMF, said Russia was a “programme which works”.
But investor confidence remains shaken by the conflict between the Kremlin and the government, and in particular the prospect of war in the Caucasus. With elections looming, the market remains stagnant, and foreign investors are still cool towards the country.
“We are negative on Russia at the moment for the obvious reasons,” says Chanat Patel, Eastern European analyst at CAIB. “Obviously political problems are to the fore, but these also have their impact on the economy. For example unrest in the Caucasus could lead to conflict and an increase in defence expenditure out of all proportion to the 2000 budget.”
These issues added to the investigations into money laundering mean that Russia is viewed “in a poor perspective”, says Patel. “There is also a worry about Y2K, as Russia is the least prepared of the region’s countries for the end of the millennium. On the plus side, Russia is also the least computerised economy, and so the impact will be less than it could be.” The only real positive factor he sees is oil prices.
The major central and eastern European markets of Poland, the Czech Republic and Hungary should be able to disentangle themselves from the problems of Russia if western growth improves, most analysts believe. With recent predictions of 2% growth in the euro area for 1999 and 2.8% in 2000 the outlook should be promising.
“After a poor first quarter, mainly due to worries about the Euroland economies, Poland and the Czech Republic have shown good performances,” says David Aserkoff at Credit Suisse First Boston. “Hungary has failed to keep up, mainly due again to political worries. In this case the divergence from the 1999 budget figures has been the problem, and with difficulties within the coalition and worries about the 2000 budget, Budapest has stagnated rather.”
Aserkoff believes, however, that prospects for 2000 are good, provided the growth predicted for Euroland translates into reality. Certainly the three economies at the core of eastern Europe will be hoping that German demand will recover, given the importance of that export area.
His view is echoed by Robin Geffen, portfolio manager at Orbitex Russia and Eastern Europe Fund. “The focus on Russia as the leader of this region is outdated,” he says. “The EU convergence countries are far more interesting, and their results will be dictated by the recovery in demand in western Europe. At the moment we could not really justify a major presence in Russia.”
Consequently Geffen is overweight in Hungary, and retains interest in developments in Poland and the Czech Republic despite their recent difficulties. He confirms, however, that ground has been lost in eastern Europe, principally because of the political problems in Russia. These range from the threat of war to allegations of corruption and the Duma's rejection of the 2000 budget. Despite rising oil and gold prices the index is now less than half of its July high.
Geffen believes that in Hungary the good corporate results expected in some sectors, together with healthy predictions for growth, will outweigh the anxieties expressed by some analysts. Equally Poland's predicted GDP growth figures of 3.5% for 1999 and 5% for 2000 will help offset the recent hikes in interest rates, which have hurt the banking sector, and in turn affected trading volumes on the exchange. He is also positive about the Czech Republic but fears that neighbouring Slovakia will have difficulty escaping from its current recession, being hampered by an over-valued currency.
Patel is equally optimistic about the European Union fast-trackers, but points out an interesting anomaly. “It is true that all three countries, Poland, Hungary and the Czech Republic, will be dependent on growth in Euroland next year, but Poland is distinct from the other two. Polish exporters are aimed mainly at western European, particular German, consumers. Hungary and the Czech Republic, on the other hand, are geared towards industrial importers. A commodities breakdown clearly shows this. Consequently I expect Poland to lag a little behind the other two, but to pick up strongly next year with a predicted growth in GDP of 5.1%,” he says.
With sound fiscal reforms in place and progressive pension reform well under way, not even concern about the current account deficit is dampening enthusiasm for Poland. “I think it could be the strongest growing economy in the region next year as the current account deficit comes down as a result of German recovery,” says Patel.
He is neutral, however, about the Czech Republic. “Recovery there has been driven by the domestic market, and next year they will have to look to exports to take up the slack as that market shrinks. The problem is that most of the major equity players are aimed at local consumers. Also the strong currency means that the central bank will have to step in to help exporters.”
As for Hungary, Patel considers it the most reliant on western growth in the region, and believes it will bounce back despite budgetary worries, adding that nominal revenue predictions are more realistic for 2000.
If he has a worry about this block it is the prospect of more paper coming to the market. “There is a limit to how many more issues the exchanges can absorb. This is a problem as all three governments are keen to follow through their privatisation programmes. There is only so much liquidity there.”
Whilst warning against the institutional and fiscal management problems in Romania and Bulgaria, Geffen also points out the problems in Croatia. This is the tale of a victim of the problems haunting eastern Europe at the moment. “Croatia has suffered from the over-valuation of its currency, and although there have been some corrections, it is still a cause of concern. It is not one of the EU fast-track countries, and its geographical proximity to Kosovo has hit tourism, a major earner. There is also the possibility of UN sanctions following the accusation from The Hague that Croatia has failed to co-operate with the International War Crimes Tribunal.” With elections due in January we may see a change of government for the first time since the war of separation – only a positive for Croatia.
Other less travelled areas could also prove profitable in the new year. The recent flotation of a major bank boosted activity on the Slovenian exchange, similar to the effect Eesti Telekom had in Estonia. That sluggish market, however, needs a similar boost from the results of the same company due soon.
Many analysts agree with this view of the smaller markets where only one or two significant stocks can provoke a disproportionate response from the market. In these countries investors should perhaps concentrate on company results, rather than the macro economic conditions of the host country.
Peter Szopo, managing director of East Fund Management in Vienna, is content to concentrate on Poland and Hungary and to a certain extent the Czech Republic over the next six months, “although we have exposure in companies rather than countries elsewhere in the region”.
Szopo is optimistic about next year but expects worries about the US and Y2K to mean a slow end to the year.
Eastern Europe then, continues to look to the west in the hope that growth there will lead to improving prospects, and cushion any fall-out from Russia. However, analysts tend to favour countries with hard, rather than soft, commodity exposure. This inevitably works against most markets in the region, but other factors such as regional growth and industrial outlook, valuations and exposure to cyclicals make for better reading.
The markets most geared to the EU's industrial cycle, Hungary and Poland being the prime example, remain the most attractive. On the downside, the narrow Hungarian currency band continues to worry investors, but political worries should not be overstated. Poland's gearing to European cyclical stocks also offers prospects for good earnings.
The question remains, however, what will spark a sustainable recovery in the region. Local problems are plentiful, and one worry is that a strengthening of the EU economy could mean investment staying within the union rather than heading eastwards. Although in the long term, analysts agree EU growth will benefit the emerging markets, as the year-end approaches faster growth in the west and the rising yen are driving financial flows away from net users of global savings, like emerging markets, including EMEA.
There seems genuine hope for optimism in the long term however, and after a disappointing few years the region could be set for a strong performance in 2000.
Kevin Hall