Central Europe: the very good, the not so bad and the not so ugly anymore
The European Commission just published its spring forecasts: the EU and the Eurozone are expected to grow in 2014 and 2015 after two years of GDP declines in 2012 and 2013. The forecast growth will not be spectacular however; it lags US expectations for the same period.
Meanwhile, most of the European periphery, i.e. Greece, Italy, Portugal and Spain (Ireland is an exception), will still lag the average growth rate of both the Eurozone and the EU at least in 2014. The EU, with 1.6% GDP growth expected for 2014 and 2.0% for 2015, will outrun the Eurozone, where the GDP growth forecasts are 1.2% and 1.7% respectively. This means that EU countries not using the euro are doing better than those that are. This subset of nations, foreseen to grow at 2.6% and 2.8% in 2014 and 2015, almost match rates expected for the US.
One could surmise that the UK and Sweden contribute largely to this result, but the numbers show the three Central European countries, which haven’t adopted the euro yet, i.e. Poland, the Czech Republic and Hungary, having vim and vigor. This trio exhibits similarities and significant differences in their recent economic histories.
The main similarity stems from their common location in Germany’s backyard and their function as its industrial input providers.
No disrespect intended; this only highlights the reality that these nations’ economies are more intertwined with that of Germany than any on the European periphery. Exports to Germany account for almost 33% of overall exports for the Czech Republic, and 25% each for Poland and Hungary. While the second-largest trading partner for each of these three countries accounts for less than 10%. Thus the economic fate of these Central European countries depends heavily on Germany’s well-being; in this respect they resemble Switzerland, which exports massively to Germany.
Hence, with Germany outrunning the Eurozone, it makes sense that those countries will do so too. That said, Poland, the Czech Republic and Hungary are less similar when considered on their recent economic history and present economic management.
Poland is a major success story in Europe over the last decade. Since 2001 it has grown on average 3.7% annually, and grew even during the global recession of 2008–09. The Czech Republic grew more slowly at 2.7% annually on average, while Hungary lagged at 1.8% yearly, but also incurred rather deep recessions and a prolonged stagnation from 2005–2013. This stagnation was caused by a severe housing and mortgage crisis, prompting Hungary in 2008 to request a USD 26bn rescue package from the IMF and the EU. Two years later the Hungarian government declined another IMF credit line and instead nationalized its private pension funds. After another deep recession in 2012, the country has recuperated and is now expected to grow at rates on par with its neighbors to the North.
Because these three countries do not use the euro, they can pursue independent monetary policies. Their policies are currently rather accommodative given the lack of inflation pressure. However, in terms of institutional framework and forward guidance, the Polish monetary policy is the most credible, followed by the Czech monetary policy, which has adopted a Swiss-like floor for the Czech koruna against the euro. Hungary’s policy is least readable; one can sense that policymakers underestimate the value of policy continuity and clear communication.
So from a general economic perspective, Central Europe looks attractive for investors… if not for one Damocles sword to the East, where the Ukraine and Russia are grappling. We therefore remain neutral on Poland, the Czech Republic and Hungary from an investment perspective.