Emerging Europe 2013 Retrospective

In December last year we outlined nine trends that we expected to play out across Emerging Europe in 2013 ( see 'Key Themes For 2013: Emerging Europe', December 13 2012), and although not quite year-end, it looks like we were clearly correct on five, had a mixed performance on one, unclear on another, and outright wrong on two.

Central and South-East

Of the three trends we anticipated for 2013, we had a relatively mixed performance.

Vulnerabilities Exposed
Turkey - Current Account, US$mn (6 month rolling average)

In December last year we outlined nine trends that we expected to play out across Emerging Europe in 2013 ( see 'Key Themes For 2013: Emerging Europe', December 13 2012), and although not quite year-end, it looks like we were clearly correct on five, had a mixed performance on one, unclear on another, and outright wrong on two.

PERFORMANCE OF 2013 VIEWS FOR EMERGING EUROPE
Sub-Region View Played Out?
Central and South East Baltics to grow faster than Central Europe, South East to lag Mixed
Fiscal consolidation to continue Yes
Growing vocal opposition to deeper EU integration Unclear
Russia and CIS Bullish CIS Agribusiness No
Ukraine and Belarus to shift political and economic focus towards Russia Yes
Commodity Exporters to look further east Yes
Event Risks in Caucasus No
Turkey Increased political debate over Turkey's future Yes
Economic rebalancing vulnerable to headwinds Yes
Source: BMI

Central and South-East

Of the three trends we anticipated for 2013, we had a relatively mixed performance.

1. 'Growth In The Baltics To Outperform' - HIT, 'South East To Underperform' - MISS

The first part of this view, that the Baltic economies would grow faster than their CEE peers was a clear 'hit' for us, with the weighted average real GDP growth rate for the Baltic economies over two percentage points (pp) faster than for Central Europe. However, the South Eastern region did better than we had initially expected, mainly thanks to a strong recovery in Romania, which mitigated the very poor economic performance for other Balkan economies.

2. 'Fiscal Consolidation To Continue Apace' - HIT

If we measure fiscal consolidation by narrower fiscal deficits this year then last, then we were broadly correct, with most set to record narrower nominal fiscal shortfalls in 2013 than 2012 (accounting for around two-thirds of the region's GDP). In Czech Republic and Estonia deficits will remain around last year's level (in percentage of GDP terms), although in both cases this partly due to a cyclical slowdown in growth which is likely to reverse in 2014. Bulgaria, Slovenia and Croatia have also clearly failed to continue with fiscal consolidation. Nevertheless, with Latvia, Lithuania, Hungary and Romania all managing to exit the EU's excessive deficit procedure (EDP) this year, we believe we also got this one right.

3. 'Opposition to deeper EU integration' - UNCLEAR

The success of this view was much less clear cut, in part because it is also much harder to quantify. If we go by the most up-to-date Eurobarometer surveys, over 60% of Emerging European population surveyed (excluding Turkey) lost trust in the EU between the Autumn of 2012 and Spring of this year. This phenomenon was most obvious in Poland, where trust in the EU fell 20%, and similar sentiment being echoed by the country's government, best highlighted by Finance Minister Mateusz Szczurek's recent labelling of benefits of euro adoption as 'fiction'. However, broad-based antipathy towards the EU has not been as widespread as we had expected, and therefore cannot say whether this has really played out.

Russia and CIS

Our views on Russia and the CIS were less impressive, but we still identified two key trends.

1. ' Bullish CIS agribusiness' - MISS

Not only did this view not play out in 2013, but our bullish CIS agribusiness equity view was actually our worst performing asset class strategy this year (we closed out with implied losses of 12.5% over an eight month time horizon). So why did we get it so wrong? This was partly down to timing, as we still believe the sector offers attractive long-term prospects for some, but the main reason was that we vastly underestimated the impact of regulatory/political factors on the stock prices of key players in the sector. Russian potash producer Uralkali lost over 30% within two weeks following its dispute with its Belorussian counterpart Belaruskali, prompting us to cut our losses on the view. This is a timely reminder of the risks of doing business in the Russia/CIS region, even in those sectors which offer a lot of long-term growth potential.

2. 'Ukraine and Belarus to shift political and economic orientation to Russia' - HIT

This view was severely tested over the course of 2013, but in the end both Belarus and Ukraine have made definitive moves back into Russia's sphere of influence. Ukraine's last minute rejection of an EU Association Agreement was the starkest example of the grip that Russia has on some of its former satellite states, and the decision is likely to prompt a major backlash from a large proportion of the Ukrainian population that favours EU accession.

3. ' Commodity exporters to look further East' - HIT

There has been a major push from Russia and Central Asian states to establish closer trade and investment ties with East Asia over the past 12 months. Oil and gas majors Rosneft and Novatek have firmed up investment plans for expansion of liquefied natural gas (LNG) capacity aimed predominantly at serving the Asian market, while the Russian government announced several major infrastructure projects (at least partly funded by pension contributions) to develop the country's Far East and boost trade capacity with APAC economies.

Equally significant was the announcement of massive funding from Chinese firms into Central Asia, including US$30bn to Kazakhstan, US$15bn to Uzbekistan, and around US$3bn each for Kyrgyzstan, Tajikistan and Turkmenistan, all with the aim improving Chinese access to the region's commodity wealth. This represents a clear recognition of the importance for trade and investment diversification away from tradition Western markets.

4. 'Security risks in Caucasus' - MISS

We overestimated the potential for a flare up in tensions in the Caucasus region, and while tensions between Russia and some of its southern neighbours may be set to rise, as Georgia and Azerbaijan agree on closer relations with the EU, there has been no major military threat from either side. Nor has Russia seemed to experience any notable domestic security issues ahead of next year's Sochi Winter Olympics, which we also highlighted as a potential source of regional instability.

Turkey

Despite a lot of investor hype towards Turkey at the start of the year, we flagged some major question marks over the country's political stability and attractive investment story.

1. 'Increased political debate over long-term trajectory' - HIT

Although we did not anticipate the level of violent protest in Turkey this year, it was a clear sign that Turkish society is becoming more divided over the country's economic and political future. Istanbul's Gezi Park protests, which started in late May and precipitated the Turkey's fiercest demonstrations in over a decade, were a direct response to the government's decision to push ahead with plans to redevelop the park. However, they took place in the context of growing discontent with what many see as Prime Minister Recep Tayyip Erdogan's increasingly authoritarian form of governance and Islamist policy agenda. While Erdogan's Justice and Development Party (AKP) still maintains support from the majority of the country's electorate, we see this year's unrest as an indication growing division within Turkish society over the country's secular/Islamist identity.

2. 'Economic rebalancing vulnerable to headwinds' - HIT

In our 2013 outlook we stated that " at least one of the major credit ratings agencies will follow Fitch's lead in upgrading Turkey to investment grade in 2013...This could result in a dilemma for the central bank as a stronger currency would hurt exports, and threaten Turkey's economic rebalancing." In May this year Turkey received official promotion to investment grade status when Moody's ratings agency upgrading its rating to Baa3.

Vulnerabilities Exposed
Turkey - Current Account, US$mn (6 month rolling average)

However, the subsequent rise in US bond yields on the back of better US economic data highlighted the vulnerabilities of Turkey's rebalancing process and its reliance on short-term capital to plug the massive current account shortfall. Indeed, from early 2013 we increasingly highlighted how excessively dovish monetary policy was exacerbating Turkey's external account imbalances, eroding central bank credibility in the process.

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Sector: Country Risk
Geography: Europe
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