Foto: Roman Chlupatý

And some analysts claim the potential of the region has yet to be exhausted.

Provided that the rest of the word does not tumble, CEE countries should yet again deliver some interesting opportunities in the course of the next 11 months. Among the recommended picks are not only stocks but also the Czech crown and the Polish złoty, says Raffaella Tenconi, chief economist of Wood & Company. She adds that the potential party spoilers, besides the bump in the road of the global economy, are bad calls during the upcoming elections.        

Q: To what extent do you expect the ongoing problems that Greece has—and that Spain, Portugal and Italy are expected to have—to become contagious for CEE markets?

A: Well, there is a direct influence through risk appetite. The problems in Greece increased the risk aversion, and that is affecting the markets a little bit in Central and Eastern Europe—the currencies and the bond market. But, in general, I think that the contagion should be relatively limited because the problem in Greece and in other peripheral European countries is acute on fiscal sustainability. And although these problems exist in CEE, especially in troublesome countries, they were already tackled because of the crisis last year. In Hungary’s and Romania’s case, the IMF (International Monetary Fund) programs put a lot of emphasis on fiscal sustainability. And because the action has already been, taken, the contagion should be limited.

Q: Does it mean that you do not expect anyone from the CEE region to experience significant problems this year, or are there countries where you cannot rule out such a possibility?

A: I think all the borrowing needs of CEE are manageable in a reasonably benign global environment. Or, rather, as long as the global environment doesn’t become as troublesome as it was in 2008 and early 2009, which is by no means our central scenario. There are some countries that are slightly more stretched than others—the Czech Republic’s borrowing requirements are quite high for instance. But, as I said, nowhere do I expect serious problems.

Q: Where can we expect some problems—who are the potential troublemakers at the moment?

A: Well, fiscal sustainability is essentially a problem of political will. If the politicians want to keep the budget tight, then no problem occurs. And so the biggest issue is which countries have the biggest uncertainty on the political front. In Hungary there is a general election and the opposition may come to power. And it warned that the deficit might come out higher than the current target several times.

So, there is a risk there, although we fundamentally think that it is not really in the interest of even [center-right opposition party] Fidesz to diverge from the consolidation path way too much. In Romania, the government actually doesn’t have an official strong majority. So should the current coalition be weakened, then yes, that would be a problem. And in the Czech Republic if the left were to win the general election [to beheld in May] and decide to do nothing about the fiscal deficit, then problems would occur. But as I mentioned before, none of these political risks are actually significantly high this year.

Q: Let’s try to be more concrete. First of all, the current Hungarian government recently increased this year’s gross domestic product (GDP) growth forecast from minus 0.6 percent to plus 0.3 percent. Should the opposition win, to what extent might this projection be compromised?

A: Actually, I find those projections already very conservative. Our current forecast is plus 0.9 [percent], and we made it intentionally quite conservative. And we think that there are upside risks to Hungary’s profile, even assuming a global environment that is on the recovery path but that is not in a boom state. So, I think that when Fidesz comes to power the recovery of the economy will actually play in their favor and, therefore, they will keep the support for the fiscal consolidation path. But, as I said, maintaining the target requires a lot of political will. And probably they won’t be as committed as the previous government.

Q: What are your possible scenarios for the Czech Republic after the elections?

A: Well, given the current polls it is possible, or slightly more likely, that a center-left coalition [led by the Social Democrats (ČSSD)] will come to power. This will most likely bring some changes in the taxation environment—but not in any major way to really undermine the medium-term outlook of the economy. What I mean is that should the left decide to become really aggressive on taxation and increase income tax significantly, then that could have a negative spillover effect on the FDI (foreign direct investment) process.

But I don’t think they will go as far. The main issue, if a left government comes to power, is that they are very likely going to be slow in reacting to the sustainability of fiscal policy, and that’s where the problem lies. Because of the high deficits of 2009 and probably 2010 the debt stock is rising toward 44 or 45 percent of GDP. And the projection is deteriorating. Therefore, the sovereign rating outlook may be downgraded toward the end of the year—if there is no action in the very near term.

Q: From the economist’s point of view, who is the darling among the parties or potential finance ministers that are running for office this time around in the Czech Republic?

A: From the economist’s point of view, fiscal prudence is welcomed and so the center-right government [led by the Civic Democrats (ODS)] would be more welcomed.

Q: Let’s say that it is not going to be a center-right government but that the Social Democrats will win the elections and manage to assemble the next government. To what extent would you expect this to influence markets—the Czech crown and potentially the Prague Stock Exchange?

A: It could have a negative temporary impact on the currency and the stock market. But, fundamentally, the Czech economy is very robust and especially the balance of payments—the funding of the current account deficit—is abundant. So we are actually quite bullish on the crown. We think that it can easily strengthen to 24.5 [crowns] against euro by the end of the year, despite the fact that we are aware of the potential political change. So the fundamentals of the economy dominate over the political risk as long as any policy change is not draconian.

Q: You said that you are bullish on the Czech crown. Which other assets are you bullish on—or which ones do you at least consider worth following?

A: We are also bullish on Polish złoty. We expect it at 3.7 against the euro by the end of the year. We are bullish on Hungarian and Romanian debt because there is still significant monetary easing in the pipeline, and some of it is not priced in the market yet. And we’re bullish on equity markets. At least in the near term, or in the coming quarters, because we think that there is a global recovery taking place.

Generally, monetary policies and fiscal policies remain stimulative, and this is positive for asset prices. The issue will come through more strongly in 2011 when there’s going to be tighter monetary policy and tighter fiscal policy and also tighter financial regulation or tighter regulation of the financial sector.

Q: How about Estonia—to what extent might the anticipated accession to the eurozone that might materialize as early as next year influence its currency and the stock market?

A: Estonia is quite a success story because despite a very severe financial crisis they’re most likely to have met the Maastricht criteria for the deficit last year, which means that they should be able to enter the eurozone in 2011. I don’t think it is going to have a major impact on the region. But it will give a positive signal that despite difficult circumstances the euro adoption process is actually accelerating. And particularly for the neighboring countries like Latvia and Lithuania it should be a very positive signal and it could increase confidence toward these two countries; confidence that the recovery is finally taking place.

Q: Another success story is Poland. It is the only EU country that did not fall into a recession last year. Will the Polish economy keep delivering or are there some fundamentals that can compromise the potential for growth this year or more generally in the years to come?

A: In the near term, the Polish economy will strengthen further. We are expecting a growth in the region of 3 percent this year and even a slightly above that in 2011. The reason why the Polish economy is so strong is that they had massive fiscal and monetary stimulus on top of robust fundamentals—especially the private sector has very strong balance sheets. And these factors are not going to change.

The potential problems in the medium term are again in terms of fiscal sustainability. There is a lot of stimulus in the pipeline, and it will have to be reigned in probably in late 2011, 2012. And, in general, Poland risks being in the same position Hungary is in at the moment: when borrowing in foreign currencies is significantly cheaper than borrowing in local currency eventually the private sector, and especially the households, is pushed into euro-denominated or other-currencies-denominated borrowing, which creates a financial stability problem in the medium term. So, the primary risk to avoid in Poland is to let the amount of leverage and the type of leverage to go out of hand during these robust growth years.

Q: All these things we are talking about are conditioned by the continuous recovery of the global economy. Now, let’s say that there will be a pause or even a pullback as some experts claim. How much of a game changer would it be for the CEE region?

A: Well, clearly, if the recovery were to stall significantly, then the sentiment would change and it would be a harder year [with] weaker growth and less positive for asset prices. In general, you are looking at a recovery that is quite job-light. We expect there’s going to be some job creation in most countries but not very robust. Wages are still fairly low in nominal terms.

On the other hand, you are benefiting in some countries from lower inflation, so there are real wage gains. And there is a big push from inventories, which is a transitory effect. And that’s why the stance on monetary and fiscal policy is so important—when the recovery is fragile you need more stimuli. Generally, I tend to be more positive because policy makers all around the world made it clear that they don’t want to withdraw stimuli too early.

So, if we were in a position where the recovery flags in the first half of the year, you probably wouldn’t see the monetary tightening that the market expects materializing in the second half. Thus, you would have stronger stimulus that would nourish the recovery. The problem might be once the recovery is on a stronger footing and the stimulus is withdrawn—how fast it is withdrawn will essentially dictate what happens to growth next year.

Q: You’ve mentioned the job market, which is a big problem at the moment with unemployment being high essentially everywhere. How quickly do you expect it to recover in the CEE region?

A: We’re already seeing employment intentions improving across countries or rather across most of the countries. We expect the unemployment rate to peak at some point in the first half of this year. And in some countries there is a potential for some improvement in the second half.

Q: Which countries might experience such an improvement, and where will the job market lag?

A: At the moment, the Czech Republic appears somehow soft. So perhaps we are talking only about stabilization of the unemployment rate. In Poland, there is a significant improvement in employment intentions, so they should see the unemployment rate down by as much as 1 percentage point in the second half of the year. And countries like Romania and Hungary are going through a restructuring phase that probably won’t be completed until the end of this year, and so at best we are looking at stabilization. But the important thing to notice is that even in the eurozone, the most important partner for the CEE, even there we can see a turnaround in employment intentions. And that’s why—in my view—the recovery is there. It is not going to be very strong, but it’s there.