CEE Economics/Romania-Bulgaria

Eastern Europe’s woes

Stopping the rot
Nov 27th 2008
From The Economist print edition


East European economies crack, with Romania and Bulgaria the worst off

JUST another week’s news in eastern Europe: Latvia, after vehement denials, starts talks with the IMF; Bulgaria loses €220m ($286m) in promised payments from the European Union because of its failure to tackle corruption; and the European Bank for Reconstruction and Development cuts its growth forecast for the region by half. But the good news is that worries of a huge meltdown, from the Baltic to the Black Sea, now look overblown.

The most likely outcome is several years of low or no growth, with bigger hiccups in countries that have the shakiest financial systems and biggest imbalances. The outside world (ie, the IMF, the EU and the European Central Bank) is ready to help when necessary and—more usefully—even before problems hit markets. The ECB has opened a €10 billion credit line to Poland, which saw its currency, the zloty, fall sharply earlier this month. Hungary’s central bank was even able to cut its interest rates by half a point from the 11.5% rate that it set last month, as part of a $25 billion international bail-out. And foreign banks have stood by their subsidiaries in the ex-communist countries. It was their risky lending that inflated the property bubbles, now popped, and also financed huge current-account deficits in such places as Latvia and Bulgaria.

The biggest worries are now focused on Bulgaria and Romania, the poorest and worst-governed new members of the EU.

The Bulgarians have their hands tied by a currency board that pegs the lev rigidly to the euro. That rules out devaluation to restore competitiveness, which is a concern as exports sag. It also removes a potential buffer, because the central bank cannot adjust interest rates. A current-account deficit worth a quarter of GDP looks alarming.

At least Bulgaria’s fiscal position is strong. The state has little foreign debt and runs a budget surplus. That should allow it to increase public spending as the economy slows. It can also borrow abroad (though the authorities say they have no plans to approach the IMF). The loss of some EU money is embarrassing, but Bulgaria is still in line to get €11 billion in the years up to 2013. Oriens, a Hungarian-based merchant bank that specialises in the Balkan region, reckons that growth next year will be 2.3%: low but not awful.

Romania has a current-account deficit of only 14% of GDP; a floating currency that gives it more flexibility; and is less dependent on exports to the slowing euro area than Bulgaria. But it may have a harder landing. Oriens forecasts GDP growth of just 0.9% next year. Its banking system is less profitable than Bulgaria’s. Although it is mostly foreign-owned, it looks wobblier; inter-bank rates have nearly doubled this year to 15%. Foreign reserves are scantier and the IMF reckons that the currency, the leu, may be overvalued by 19%.

Thanks to populist spending in the run-up to this week’s parliamentary election, the budget deficit may reach 3.9% of GDP by the year-end. That is not a lot by some standards, but it may still cloud outsiders’ willingness to provide more cash. Whatever coalition the election produces, serious reform is a long way off. Bulgaria’s politics are also troubling. Politicians’ ties to organised crime remain scandalous; the main populist party seems to blame the country’s Turkish minority as the economy slumps. Meltdown may have been averted, but the eastern Balkans still face bleak times ahead.