From The Economist
IT HAS gone on splendidly for years, and the party isn’t quite finished yet. For a decade or more eastern Europe has benefited from exceptional (and mostly unforeseen) good fortune. Economic and political stability, including for ten countries membership of the European Union, has boosted investors’ confidence and cut borrowing costs. A big pool of cheap and diligent workers, along with the unleashing of entrepreneurial talents, has produced thriving new private businesses. In most countries, growth rates have been stellar (see chart).
Inevitably, it could not last. Wage costs are creeping up. Labour shortages are biting. Out-of-date infrastructure, such as Poland’s notorious roads, is clogging trade. In several countries inflation is rising. And world markets, both for raising capital and for exporting, are looking tougher. In the face of all this, growth this year has been surprisingly strong. That is partly because the euro-area slowdown has only just started; partly because domestic demand has been rising; and partly because intra-east European trade has started to make up for softer exports westwards.
The big exceptions are the Baltic countries of Estonia and Latvia, home to colossal current-account deficits and breakneck growth in recent years. Now their bubbles have popped. In Latvia, for example, retail sales fell in June by 8.3% on a year earlier; industrial production is down by 6.4%. The construction industry has imploded. Inflation remains high at a whopping 17%. For a country with a pegged currency, that is scary. Yet the gloomiest predictions have so far proved unfounded. For example, Latvia has not been forced to devalue. The foreign banks, mainly Swedish, that own most of the financial system seem largely untouched by the credit crunch elsewhere in the world. And there is no sign of the contagion spreading from the troubled (but tiny) economies of the Baltic to the rest of the region.
In the biggest economy, Poland, things look better. Growth in the first quarter of 2008 was a sprightly 6.1% on a year earlier. Many Poles who left to work in Britain and Ireland are coming home, tempted by higher wages. Unemployment, which was 20% in 2003, has all but vanished in most parts of the country. But growth is now likely to slow, particularly if interest rates keep rising: they were 4% in 2007 and are 6% now, with another rise likely. That will strengthen the zloty further; it has risen against the euro. That may be a reason why Poles are returning from Britain, but it hurts Polish exporters.
Critics say the government should now do more to reform public finances, especially pensions, and get big infrastructure projects going, before a contraction in the labour force kicks in during the next decade. That would also improve the country’s chances of joining the euro, which it now seems unlikely to do before 2013. So far, Slovenia has adopted the single currency and Slovakia will do so next year. No other country looks close.
The biggest worry is Hungary, which is the country most dependent on the continuing confidence of the capital markets. A shaky government has done surprisingly well in restoring macroeconomic stability after the near-disastrous spending and borrowing splurge in the early years of this decade. The budget deficit reached a yawning 9.4% of GDP in 2006; Neil Shearing of Capital Economics, a consultancy, reckons it may be down to as little as 3.5% by the end of 2008.
This has come at a heavy price, both in the government’s rising unpopularity and in a near economic standstill last year. The economy has picked up a bit since then, but inflation remains troubling at over 6%. The question is whether the government has the stomach for another round of fiscal tightening. Public spending is still over 50% of GDP, the highest in the region. A further worry is the looming slowdown in the richer half of the continent. The Hungarian economy depends heavily on exports to western Europe, which account for nearly 40% of GDP.
Despite the EU’s worries about corruption and organised crime in its newest (and poorest) members, Romania and Bulgaria, their economies have been growing fast at around 7-8% a year. They are now leading candidates for a hard landing. A property bubble in Bulgaria seems to be on the verge of bursting, though this has still to filter through to the rest of the economy. Yet for now, few seem worried. Having dodged sanctions from Brussels (not fully in the case of Bulgaria), politicians in the Balkans seem to think that defying the laws of economic gravity is a cinch.
