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Good growth prospects in emerging Europe, overshadowed by downside risks

The economic recovery that began in most parts of emerging Europe last
year is continuing in 2011 but facing increased downside risks.

In its latest quarterly economic report on the
region, the European Bank for Reconstruction and Development (EBRD) said growth in 2011 is likely to remain reasonably
strong, showing average expansion of a little over 4% despite
continued regional divergences.

The report continues to forecast average growth for the EBRD countries
of operations of 4.2% for 2010, unchanged from projections made
in October last year.

The stronger than expected recovery in core Europe, strengthening
remittance flows from Russia, and a measured recovery in credit growth
have supported growth across the region during 2010 although in several
countries a high level of non-performing loans is continuing to be a
drag on balance sheets. In a few countries, summer droughts slowed growth.

The EBRD also sees growth of 4.2% for 2011, broadly in line with
previous forecasts. However, the report adds “Downside risks have
increased”.

On the positive side, the report notes that stronger-than-anticipated
growth in the core eurozone, fiscal and monetary stimuli in the United States as well as rising commodity prices are likely to boost growth across the region in
an increasingly private sector-led recovery. Fiscal consolidation will
likely restrain growth in Southeastern Europe.

However, the report adds that risks could emerge if loose monetary
policies fuel persistently higher inflation in advanced countries,
leading in turn to an earlier than anticipated monetary tightening by
major central banks.

Financial sector turmoil surrounding eurozone sovereign and related bank
debt markets may cause a stronger increase in a global risk aversion than
has been witnessed so far, it says.

In Eastern Europe itself, domestic policies, such as moves to cut back
on private pension funds or the introduction of significant bank taxes,
could worsen investor sentiment and create potential for a quick
reversal of recent net capital inflows. The report also notes that
private sector borrowers remain vulnerable to any sharp currency
depreciations.

“An even worse scenario could materialize if currency wars turn into
trade wars in the form of import restrictions. Rising food prices and
extreme-weather-related food security concerns can also lead to trade
restrictions in the absence of global policy coordination,” the report says.

Looking at emerging Europe by region, the new EBRD report sees an
increasingly divided growth path in Central Europe and the Baltics.
Estonia, Poland and the Slovak Republic are expected to show growth of
above 3% in 2011, based on the prospect of only slightly
slower growth in Germany this year.

But moves to unwind the pre-crisis credit boom and fiscal retrenchment
will continue to hold back growth in Latvia and Lithuania. Modest growth
in Hungary last year is expected to accelerate only marginally in 2011.

The report says that the recovery in Southeastern Europe continues to
lag behind other transition economies with the exception of Turkey. In
Eastern Europe the Ukrainian economy has continued to
recover from the 15% contraction seen in 2009. However, the
regional drought in 2010 adversely affected agricultural production.

In the EBRD's largest economy, Russia, growth momentum is expected to
pick up again after slowing in the third quarter of 2010 when output was
adversely affected by a heat wave, drought and forest fires, the EBRD
report says.