By Kim Catechis
Central and Eastern European economies have made much progress since the turn of the millennium, with many reaping the benefits of European Union integration, but the region resists neat categorisation.
A high-level view of Central and Eastern European economies shows some shared themes, sluggish growth and a surge in populist politics being two prominent ones. But when we zoom in the political and economic landscapes are, unsurprisingly, more variegated.
Russia remains a complicated beast for foreign investors, having been hit hard by the fall in oil & gas prices and is, to the dismay of foreign investors, still suffering from endemic governance problems. Tensions with the Ukraine have subsided, but sanctions remain, and ironically this appears to have stoked the nationalist fervour that caused the problem in the first place. In our view, Moscow is unlikely to enact the reforms needed to diversify the economy and combat corruption, for fear of antagonising key constituencies. And with little room to boost government revenue or make painful cuts to social spending and the military during the 2016– 2018 election cycle Russia will in all probability draw from its sovereign wealth funds or modestly increase borrowing.
Meanwhile, Greece has stepped away from the precipice, helped by the recent debt-restructuring, but the economy is very fragile, with unemployment stubbornly high and capital still flowing out of the country. The country’s large debt stock will weigh negatively on investment and economic recovery, ensuring PM Alexis Tsipras’s government remains vulnerable to popular backlash and calls for an early election. In short, the risk of a Greek exit from the Eurozone will linger over the next two years, and although the odds have diminished significantly, this will keep a lid on foreign investor appetite for local stocks.
Poland has not been spared the populist winds sweeping across Europe. We see two key politically driven, long-term risks for the economy. First, there is a serious risk of fiscal slippage. The ruling Law and Justice party (PiS), which came to power last year, has made generous promises – lower retirement age, higher income tax threshold, and child allowance hikes – that it can’t easily back away from. Second, some sectors are likely to suffer under the PiS government. Plans include a possibly progressive turnover tax on retail. Also, banks face a newly introduced tax and might suffer losses as a result of a PiS-backed program for the conversion of Swiss-franc denominated mortgages in which most of the cost is covered by the banks themselves.
Despite the prevailing macroeconomic stability, the investment climate and the long-term growth prospects for Hungary’s economy will likely continue to deteriorate. The governing Fidesz party appears determined to extend the role of the state in strategic sectors, while selectively and punitively taxing and regulating service sectors dominated by foreign companies. And although there has been a recently lowered tax burden on some foreign-owned service sectors (banks and telecoms), the government’s enduring commitment to economic nationalism and statism will continue to present regulatory and tax risks to foreign-owned service sectors, especially in retail, media, and energy. The EU will remain only a weak constraint on the government’s discriminatory policies against these sectors. However, domestic and foreign manufacturers are likely to continue enjoying preferential treatment as a result of the government’s re-industrialisation push.
Elsewhere, the investment backdrop in the Czech Republic is comparatively benign. There is a general political agreement on maintaining macroeconomic stability and pro-market policies. The authorities are likely to maintain macroeconomic stability and the country’s generally pro-market orientation. The cabinet will prioritise joining the EU’s budget stability pact and bringing the Czech Republic closer to eurozone entry, as well as increasing EU subsidy absorption to fund infrastructure investments, supporting Czech exports, and reintroducing incentives for foreign investors. That said, a fragmented political system, recent high government turnover, and the ideologically diverse governing coalition currently in power will influence how effectively such policies can be pushed through.
Finally, the recent failed coup in Turkey has underscored the country’s political fault lines. President Recep Tayyip Erdoğan is likely to continue to concentrate powers in his office, although the calculus surrounding much-talked-about early elections appears to have changed. With the economy decelerating there will be further pressures on the central bank not to tighten rates too much, or other policies targeting near-term growth. Positives such as the lower oil price are likely to be eclipsed by strengthening headwinds, and while there are well-run local firms, we remain concerned about the broader backdrop.
As bottom-up stock pickers one might think that we look exclusively at the micro level, and while this is where most of our conviction is built we believe it is important to overlay our insights here with the broader picture.
Kim Catechis is head of global emerging markets at Martin Currie Investment Management
