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EASTERN EUROPE Troubling times Eastern Europe is one of the most affected regions in the emerging markets universe of the global economic and financial crisis. One key reason for this is the aggressive expansion of Western banks in recent years. However, we think that this legacy will be manageable when the global economy recovers and foresee continued real and financial convergence with the West. Eastern Europe burdened by credit overhang Eastern Europe appears to be in considerably worse shape than Asia or Latin America. Hungry for new business, Western banks have aggressively expanded into the Eastern Europe, offering services to companies and households that were previously without access to modern finance. In principle, there is nothing wrong with that. Moreover, the expansion into Eastern Europe was more stable than the accumulation of “toxic assets” in America. Nonetheless, it all happened too fast. Growth was pushed out of line with the economy’s productive capacity, resulting in overheating, or a positive output gap. Several countries, with the Baltics being the most extreme case, must now try to roll back the excesses through a detour in which output is substantially below capacity. This is a painful process, most obviously for the unemployed, but also for the banks that now have to deal with credit losses. Real GDP (percentage changes) 2007 2008 2009f 2010f 2011f Estonia 6.3 -3.6 -8.0 -1.0 2.2 Latvia 10.0 -4.6 -13.5 -0.5 2.7 Lithuania 8.9 3.1 -9.0 -1.5 2.9 Czech Republic 6.0 3.1 -2.3 0.1 3.5 Hungary 1.1 0.2 -4.5 -0.2 2.5 Poland 6.7 4.8 -0.5 0.6 3.7 Slovak Republic 10.4 6.4 0.2 1.1 3.9 Russia 8.1 5.6 -3.2 2.1 3.3 Kazakhstan 8.7 3.2 -1.0 2.8 4.2 Ukraine 7.6 2.1 -9.5 0.5 3.5 Turkey 4.6 1.0 -3.5 0.8 3.3 Source: Official statistics and <strong>Handelsbanken</strong> forecasts The Baltic countries are now in a deep recession Generally speaking, the more leveraged a country became during the period with high growth, the more difficulties it is facing today. The Baltic countries, with their currencies pegged to the euro, offer a vivid illustration of this point. With ultra-hard exchange rate pegs in Estonia and Lithuania, under the auspices of currency board systems, and strong economic policy credentials in other areas, some Swedish banks found the temptation to scale up activities in the East simply too hard to resist. In Latvia, which has no currency board, but where the independent Central Bank behaved like one, things got especially out of hand. All three countries are now deeply in recession with huge falls in real activity as a result. Not surprisingly, Latvia is in the worst shape and was eventually forced to go to the International Monetary Fund (IMF) for financial support. There are two options now. The first is to stick to the currency pegs, sweat it out and face a long period with weak growth, high unemployment and mounting credit losses. The second would be to abandon the pegs, and devalue, in an effort to speed things up. The verdict is still out and the distribution of probabilities is rather even, but seems to be in favour of the first route. 30 April 28, 2009
Russia may bounce back as the global recovery gets under way To some extent, Russia is also a case of excessive leverage. However, most of this leverage can be found in the corporate sector rather than the economy as a whole. During the boom in commodities, many large Russian corporations took up large loans abroad to finance their expansions. As commodities eventually ran out of steam and fell sharply, cash flows were squeezed. There may be some defaults, or at least some restructuring of these loans, and perhaps some debt equity swaps. As troubling as this may be for some creditors, we still think that this process will be manageable, especially if the current positive tone in commodity markets continues. The authorities deserve credit for the way they have handled the situation so far. One might conclude that Russia has proved to be better with macro management than structural policy. Against this background, we think that the economy may bounce back as the global recovery gets under way. Russia also looks like an attractive inflation hedge when there is more concern about the aftermath of rate cuts and quantitative easing in the developed world. Barring a renewed reform drive, we expect Russia to fall short of long-term full convergence with the West. Central Europe: Exports Source: Reuters Ecowin Central Europe struggles due to close links with the EMU As we have argued before, the more advanced countries in Central Europe are generally in better shape. Poland, the Czech Republic and the Slovak Republic were fortunate to escape the worst credit excesses, thanks in part to their ability to pursue an independent monetary policy. In these countries, domestic demand may not have to be as severely restrained as in the Baltics. However, they are still suffering from their close integration with the EMU core, and above all, Germany. Activity and trade collapsed in the final months of last year and have continued to fall in the first few months of 2009. In Czech Republic, Hungary and Poland, exports were down almost a third in February compared to a year ago. While this decline may be attributed to particular circumstances, falls in real GDP for the year will not be avoided. Further rate cuts are likely, mirroring developments in the EMU. Regarding currency markets, we think that the PLN has been affected particularly unfairly. A recovery is possible when risk aversion abates further. As we have noted in the past, Hungary is the odd man out, struggling with past policy errors and authorities are now struggling to keep the budget under control despite a drastic cut in real GDP. The scope for near-term rate cuts is also limited. We do think that short-term pain will be rewarded further down the road and that Hungary will eventually recover. Gunnar Tersman, +46 8 701 20 53, gute03@handelsbanken.se April 28, 2009 31
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Page 4 and 5: INTRODUCTION Who will pull the worl
Page 6 and 7: Emerging economies have been badly
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Page 10 and 11: tion is due to the fall in oil pric
Page 12 and 13: The pattern evident in fourth quart
Page 14 and 15: Inflation forecast GDP forecast Sou
Page 16 and 17: Heavy falls in Investment and expor
Page 18 and 19: three quarters, the most rapid incr
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Page 22 and 23: this outlook, we also sketch an alt
Page 24 and 25: Finnish households have reduced the
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Page 28 and 29: JAPAN Three more years of slump The
Page 32 and 33: CHINA Here’s one on the right tra
Page 34 and 35: Highly restrictive lending quotas w
Page 36 and 37: Slowdown to 5 percent growth in 200
Page 38 and 39: Aggressive cutting to catch-up with
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Page 42 and 43: MONEY AND INFLATION Money matters W
Page 44 and 45: Money & price level in pooled data:
Page 46 and 47: spiral taking hold. In the late 199
Page 48 and 49: Global currency and interest rate f

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