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The Recession in Central Europe, Part 2: Country by Country

August 6, 2009

This week I'd like to address the topic of currency. Flip through any business journal and speculation runs deep, though the ups and downs are far from predictable. A year ago everyone who thought they had half a brain and a pile of money comparable to Uncle Scrooge was threatening to transform all of their wealth into the seemingly unstoppable Yuan. Travel agents were pushing dirt-cheap excursions taking advantage of the near-worthless Icelandic krona to suburbanites with inquiries about sunny beaches and palm trees. And this year, if you're looking for a destination that won't hurt your pocket book, one might suggest Central Europe for that romantic second honeymoon.

In the long run though, currency speculation is a serious business that takes patience and an overall understanding of a nation, country or union. IMF reports and debt calculators are a good indicator, but they can be flawed and don't take into account the grand scheme of things. I've said it before and I'll say it again, the bigger picture is the one you want, and nothing prepares you for this kind of commitment than the intelligence you get from my friend George Friedman at STRATFOR. I'm sending you a piece that considers the recession in Central Europe, country by country. I encourage you to read and consider it in your portfolios. Click here to check out STRATFOR as well, as my readers get a special offer.

John Mauldin, Editor
Outside the Box

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The Recession in Central Europe, Part 2: Country by Country

August 5, 2009 | 1146 GMT


No region has been affected by the global financial crisis quite like Central Europe, where a heavy burden of foreign debt, accumulated during the boom years of the 2000s, must be repaid in 2009. Not all Central European states are burdened by the same external debt load, but most face cutting social welfare expenditures as they sign on for relief from the International Monetary Fund and the European Union. Administrations old and new will have a tough time protecting their currencies and stimulating growth at the same time.

Editor's Note: This is part of an ongoing series on the global recession and signs indicating how and when the economic recovery will begin.


Related Special Topic Pages

Special Series: The Recession Revisited

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The Recession in Europe

The Recession in Central Europe, Part 1: Armageddon Averted?

Central Europe is at the epicenter of the global financial crisis. The region became the top destination for foreign capital in 2002, overtaking East Asia; but since September 2008, it has experienced a massive outflow of foreign capital that threatens to crash the region's currencies. The region founded its growth largely on the influx of foreign loans that are now in danger of appreciating in real value as domestic currencies depreciate.

Part 1 of this two-part analysis looked at the problems and policy options faced by Central Europe as a whole; Part 2 examines the economic and political situations unique to each country. For the purposes of this analysis, Central Europe is defined as Bosnia, Bulgaria, Croatia, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania and Serbia. We exclude Austria, Slovakia and Greece because those countries are in the eurozone.


Bosnia's gross domestic product (GDP) is expected to contract by 3 percent in 2009, after nearly 6 percent growth in 2008, with the unemployment rate above 40 percent. A 1.2 billion euro ($1.7 billion) loan from the International Monetary Fund (IMF) will help stabilize the budget, but the austerity measures required by the IMF are sure to increase social tensions. The IMF requires 10 percent cuts in social welfare programs and governmental salaries, and considering that government expenditures in Bosnia total 44 percent of GDP, the IMF cuts will be substantial and have significant social impact. Indeed, the financial crisis already has threatened to reignite old ethnic and political tensions in the country, which has never truly recovered from its brutal 1992-1995 civil war.

Economic Crisis in Central Europe


Bulgarian GDP is set to contract by around 6 percent in 2009. This, combined with an expected budget deficit of 2.5 percent of GDP, contributes to some worrisome numbers, although not as dramatic as figures elsewhere in the region.

However, Bulgaria does not have sufficient foreign currency reserves to cover its extremely high external debt coming to maturity in 2009. The problem for Bulgaria is not necessarily foreign currency-denominated lending (household-sector foreign currency-denominated lending is actually quite low), but rather years of high current-account deficits that required trade financing and corporate lending. According to Fitch Ratings, Bulgaria has $26.2 billion of debt coming due in 2009, equal to 64 percent of GDP. Therefore, despite recent assertions by newly elected Prime Minister Boyko Borisov that no IMF loan will be necessary, Sofia may be forced to consider outside funding as the second half of 2009 gets under way. This will put political pressure on the new administration very early on.


Croatian GDP is set to plunge by about 5 percent of GDP in 2009, with unemployment expected to reach double digits (10.5 percent) following a rate of 8.4 percent in 2008. This will present new Prime Minister Jadranka Kosor with the unenviable task of picking up the pieces left by her predecessor, Ivo Sanader, who resigned unexpectedly in July.

Most pressing is the need to cut social welfare expenditures, which actually increased more than 10 percent year-on-year in the first quarter of 2009 due to an absolute increase in unemployment benefits. Croatia is also facing considerable private foreign-debt pressures, with the total external debt coming due in 2009 almost twice that of Zagreb's available currency reserves. Also worrisome for Croatia is the high percent of foreign currency-denominated lending, which at 62 percent of total lending is one of the highest percentages in the region.

While Zagreb has not asked the IMF for a loan yet — and the government for the most part is vociferously denying that it needs one — Croatia is on STRATFOR's short list of Central European countries likely to seek one in the second half of 2009. With Sanader's resignation offering a release valve for social angst in the short term, Kosor may have some political room to maneuver in order to implement the IMF's stringent austerity measures.

Czech Republic

Throughout the 2000s, the Czech Republic has been prudent enough to contain external debt, keep inflation low and maintain low interest rates. This has meant that foreign currency lending has not been as popular in the Czech Republic as it has been in other countries in Europe. In fact, lending to Czech households in foreign currency is nonexistent, with consumers perfectly content to borrow cheap koruna instead of euros.

Nonetheless, the Czech Republic will be hit by the economic crisis just as the rest of Central Europe will be hit, with an expected 3.2 percent decline in GDP in 2009. The key issue for the Czech Republic is the return of external demand for its manufactured products, particularly automobiles, which account for 18.96 percent of total Czech industrial output. With 76 percent of its GDP dependent on exports, the Czech Republic is at the mercy of its export markets in Western Europe (particularly Germany, to which it exports more than 30 percent of its goods).

Composition of Gross External Debt  
Click image to enlarge

Meanwhile, the imbroglio that is Czech politics continues following the March 24 resignation of Prime Minister Mirek Topolanek, with elections called for October. The Czech Republic has a tendency to produce extremely weak governments that depend on minor parties for a majority in the parliament. Such an arrangement during a recession would severely impair the government from making the difficult decisions that are needed to get the economy back on its feet.

The Baltics (Estonia, Latvia, Lithuania)

Of the three Baltic states, Latvia has thus far suffered the most from the financial crisis. However, in terms of macroeconomic indicators, Estonia is not much different than Latvia. Estonia's gross external debt, most of which is privately held, is 116 percent of GDP, compared to Latvia's 124.6 percent. Furthermore, Estonia and Latvia both have a very high percentage of foreign currency-denominated loans in their loan portfolios (86 percent and 90 percent, respectively). Were Latvia to abandon its currency peg to the euro, Estonia's kroon would likely devalue as well because of investor pressures on the region as a whole.

Meanwhile, unemployment in Latvia is soaring, reaching 17.2 percent in June, compared to 7.5 percent in 2008. With one prime minister ousted in February, the current four-party coalition is looking shaky, especially as it attempts to implement the rigid austerity measures of the IMF.

Lithuania is not doing any better, with a 22.4 percent-of-GDP decline in the second quarter. Lithuania does have less of a reliance on foreign currency lending — 66 percent of total lending is in foreign currency — but it still has enough that a serious currency depreciation caused by a devaluation in Latvia would hurt many consumers and businesses.

The Baltics remain the most volatile region in Central Europe and the most likely flash point for social angst over austerity measures and the effects of the recession. One should not discount the possibility that Lithuania and Estonia could ask for an IMF loan or that further political changes are in store.


Hungary is the only country in the region, aside from Poland, with a considerable amount of external public debt (53.2 percent of GDP) — the result of years of overspending in a politically contentious atmosphere between the main right and left wing parties. This is in addition to a considerable level of private debt (39.5 percent), most of which was fueled by foreign currency lending. The IMF and EU 20 billion euro ($28.8 billion) loan has forced Budapest to start cutting into the chronically high budget deficit, but at the cost of reducing social spending that the populace grew used to in the free-spending 2000s.

The ruling Socialists are attempting to hold on to power following the resignation of Prime Minister Ferenc Gyurcsany, with the center-right party Fidesz looking to capitalize on the crisis and come to power in the 2010 parliamentary elections (or earlier if elections could be forced sooner). Much as other countries in the region, Hungary is struggling to protect its currency from depreciation (so as not to appreciate the value of foreign currency loans) and stimulate growth at the same time.


Despite its high public and private indebtedness, Poland has thus far been remarkably resilient during the crisis. In 2009, Poland has actually experienced positive GDP growth (0.8 percent year-on-year), surpassed only by Cyprus in the European Union, and is expected to have grown (albeit at a slower pace) in the second quarter. The reason for Poland's resilience is the fact that, unlike the other Central European economies, it has a robust internal market with exports accounting for just 40 percent of its GDP (compared to 76 percent of GDP in the neighboring Czech Republic, 80 percent in Hungary, 55 percent in Lithuania and 86 percent in Slovakia). Poland can therefore depend on consumption to spur growth and is not so much at the mercy of demand from neighboring Western Europe for its recovery.

Foreign Currency Exposure  
Click image to enlarge

With consumption holding steady, Poland has been able to weather the recession on the back of its $400 billion economy. While high levels of foreign debt are definitely a cause of concern, Poland serves as an instructive example of a Central European country that has not had to depend on Western Europe for both capital and export markets. Two quarters of minimal growth in 2009 at a time when most countries in the region are far worse will also provide Poland relative political stability.


Romania is another Central European economy that is far too indebted abroad, has relied on foreign currency lending for too much of its domestic credit and is looking at a serious budget deficit. It secured a 20 billion euro ($28.8 billion) IMF standby loan in March, part of which was used to keep the leu stable so as not to allow the real value of foreign loans to appreciate.

Unlike Poland, which is an example of a Central European economy with a robust local market, Romania is the exact opposite. Its trade deficit in 2008 stood at 14 percent of GDP, indicating that not only did it borrow foreign money but also that it used the money mainly to buy foreign products.


The Serbian economy is forecast to contract by nearly 5 percent in 2009, with unemployment crossing 20 percent (from around 18 percent in both 2007 and 2008). Because of the crisis, Serbia has been forced to take a 3 billion euro ($4.3 billion) IMF loan and sell a vital part of its infrastructure — state-owned energy company NIS — to Russian energy giant Gazprom at below market value.

The fundamental problem with Serbia is that, because of political instability and tenuous governments that have plagued the post-Slobodan Milosevic era, the country has never been able to cut its expenditures, particularly in public-sector employment. Numerous multiparty coalitions have had to cater to parties looking to advance their interests, while the government essentially raises money through the privatization of state-owned enterprises. Furthermore, the fundamental Central European problem of borrowing abroad to finance expensive Western imports is true of Serbia as well. Foreign currency-denominated loans have made up 68 percent of total loans in 2009, mainly due to the traditional instability (and high inflation) of the dinar.

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