CEE and coronavirus: Strong fundamentals outweigh trade risks


Lucy Fitzgeorge-Parker
Published on:

Emerging Europe’s economies are vulnerable to trade disruption from Covid-19, but strong macro fundamentals and robust banks will limit the impact.

Events in the Czech Republic and CEE are being closed to the public, due to the outbreak


Coronavirus has been slow to arrive in emerging Europe. With recorded cases starting to rise in countries such as the Czech Republic, Poland and Romania, however, market participants are taking stock of the possible impact of the disease on the region’s economies and banking sectors.

For the moment, the consensus is that the main risks stem from the very high integration of the region’s open economies into European and global trade flows and supply chains.

This is particularly true for the manufacturing hubs of Central Europe. In Hungary, the Czech Republic and Slovakia, total exports account for more than 80% of GDP, according to economist Liam Peach at Capital Economics.

“Poland is less export-orientated, but it is still a highly open economy, and exports of final consumer goods account for a larger share of exports,” he adds. “As a result, the economy would be affected by weaker consumer demand from virus-hit economies, particularly in the eurozone.”

For Central Europe, the biggest concern is trade links with Germany.

“These countries have a total trade turnover with Germany of 25% to almost 50% of their respective GDP,” analysts at Raiffeisen Bank International (RBI) noted. “Any interruption there will substantially impact them.”

Concerns about the potential loss of revenue through weaker economic activity are unlikely to prevent governments from providing policy support 
 - Liam Peach, Capital Economics

The coronavirus outbreak has also focused attention on ties between Italy and southeastern Europe. Here Slovenia and Albania are most exposed. Both countries have a trade turnover with Italy equating to around 20% of GDP, half of which is made up of exports.

Other countries affected include Croatia, Serbia and Bosnia, where trade with Italy accounts for around 10% of GDP.

RBI analysts have also run the numbers on the potential impact on emerging Europe of supply-chain disruption. Based on OECD data, they rate Slovakia as the most exposed country in the region, with a share of 45% of foreign value-added in exports.

“Unsurprisingly, the role of Germany is most important for CEE supply chains, but China plays a significant role (source of 2% to 3.5% of value-added) for many countries,” they added. “Italy is most relevant for Slovenia, while Slovakia uses value-added from South Korea in its (vehicle) exports.”

A precipitous decline in tourism also poses a risk to countries in the region, particularly those that are further south. The sector accounts for 20% and 15% of GDP in Croatia and Albania, while Hungary, Slovenia, Bulgaria and Bosnia also have relatively high exposure.

Strong fundamentals

These risks are balanced, however, by emerging Europe’s generally strong macroeconomic fundamentals.

Government debt-to-GDP levels across the region have declined substantially over the last decade on the back of strong economic growth, falling borrowing costs and prudent budget management. Labour market conditions also remain extremely tight, reducing the risk of downward pressure on wages.

This means most countries have room for fiscal stimulus to mitigate the impact of coronavirus.

“Concerns about the potential loss of revenue through weaker economic activity are unlikely to prevent governments from providing policy support,” says Peach.

“Budget positions would generally allow greater government spending in Hungary, Poland and the Czech Republic.”

RBI analysts agree.

“Most of the larger Central Europe and SEE countries should have enough fiscal policy leeway,” they said in the first week of March.

The exception is Romania, where the deficit reached 4.6% of GDP last year.

There is less consensus on the potential for monetary easing.


Tim Umberger,
East Capital

Tim Umberger, partner at East Capital, takes a positive perspective.

“Countries have both the fiscal and monetary firepower to deploy if stress becomes more severe,” he says.

Peach notes, however, that above-target inflation may limit the options for some central banks, particularly in Central Europe.

Nevertheless, he adds, the combination of the Federal Reserve’s emergency rate cut on March 3 and expected easing by the European Central Bank could prompt near-term rate cuts in Poland and the Czech Republic.

That in turn would put pressure on bank margins and profitability. Overall, however, Umberger notes that banking sectors in emerging Europe are well-positioned for a potential downturn.

“Regulators in central and eastern Europe were for years pursuing both very high minimum capital requirements as well as the highest counter cyclical buffers in Europe,” he says. “Hence, capital ratios are at very high levels and can withstand a more severe crisis.”

Asset quality is also good, with sector-wide non-performing loan ratios in low single digits in Central Europe. Even in SEE, where banks were particularly hard hit by the 2008 financial crisis, NPLs now account for less than 10% of total loans across the region.

“We are much better prepared than we were in 2008,” says a senior bank executive in SEE. “The banking system is much better capitalized and much more liquid.”

Banks’ corporate clients are also in much better shape than they were 12 years ago, he adds.

“They have significantly deleveraged,” he says. “They have learned the lessons of the previous crisis and are very careful. If anything, they have been under-borrowing over the past few years.”

Peach notes that, unlike in 2008, CEE banks today have very limited exposure to wholesale markets.

“They now rely much more on relatively stable deposits as a source of funding,” he says.

GDP growth

Overall, the consensus is that emerging Europe is well-placed to weather the coronavirus storm. In a research note issued on March 6, ahead of the oil price collapse, RBI’s base case remained for GDP growth to reach 2.8% in Central Europe this year and 2.7% in SEE.

Even in the worst-case scenario of a trans-European pandemic, the Austrian bank’s analysts expect to see positive growth across most of the region, reaching as high as 2.5% in Poland and Romania. In that scenario, the Hungarian and Czech economies are tipped to expand by 1.5%, with Slovakia the only notable laggard in Central Europe and SEE.

Peach at Capital Economics strikes a similarly buoyant note.

“Our underlying assumption is that the impact of the virus on CEE will be relatively mild and partly offset by stimulus measures,” he says.