Quite an interesting report with what sound like logical arguments and conclusions:

Verdict on the Credit Crunch: Eastern Europe
Tuesday, October 07, 2008 2:01 PM

(Source: Datamonitor)Predictions of an economic separation of Eastern Europe from the wider world have turned to be out unfounded. While some countries in Central Eastern Europe should weather the storm better than others - notably Poland, Slovakia and Slovenia - the Baltics are already reporting negative GDP growth. That said, EU membership will shelter the region from volatility, as seen in other emerging markets.
Inflation, combined with the macroeconomic effects (and aftershocks) of the credit crunch and the tightening of liquidity, has created the perfect economic storm. The implosion of banks in the US and Europe has only exacerbated this situation. As predicted by Verdict Research, the impact of the credit crunch is now beginning to be felt in Eastern Europe, and growth will slow down considerably from its recent peak performances.

Due to the fact that the investment in US junk bonds in Central Eastern Europe (CEE) has been limited as funds were used mainly for investment purposes in the region, Eastern European banks are yet to take significant direct hits from the sub-prime crisis. However, indirect consequences will arise. These banks' refinancing operations also rely on funding from outside the region, and this will be much harder to come by in times of low liquidity.

At the same time, the amount of credit available to property developers and retailers will be reduced significantly. A related concern is that foreign investors are coming under pressure domestically. The worst case scenario involves a significant amount of foreign direct investment - which has contributed up to half of the growth of some CEE countries in certain years - being pulled out of the region. There are already examples of this outcome, with Austria's Immoeast canceling half of its property projects in the region (with a book value of E2.0 billion) and the collapse of Spain's Martinsa Fadessa putting paid to shopping center developments in Eastern Europe. Verdict expects future foreign investment levels into the former Eastern Bloc to reduce significantly, before eventually recovering in the post credit crunch era.

A ripple effect from the credit crunch will be witnessed across the region. Most sectors will be impacted, with property and construction the first in line, as has already been seen in the Baltic economies. As a result, Verdict expects various established long-term trends in CEE, such as steadily declining unemployment rates, rising income and purchasing power levels, to reverse temporarily.

In addition, the credit crunch will have an impact on consumer behavior, with tighter lending criteria limiting consumer spending going forward. As much of the region's fast growing consumer expenditure has been financed by credit, reduced consumer credit levels will be a bitter pill to swallow for many retailers in the region. This also means that incumbent international retailers will find it more difficult to rely on sales from the region to boost their overall sales growth.

Tighter credit lines will also affect retailers, making cash flow management much harder and adversely impacting store expansion programs as finance becomes more difficult to secure. Smaller retailers will feel the squeeze the most, creating takeover opportunities for the multinational heavyweights (if they can raise the capital to make an acquisition or merger against the backdrop of the credit crunch).

The situation has been exacerbated by high inflationary pressures, which have left purchasing power in CEE under acute threat. Rapid inflation in CEE is partly a corollary of explosive growth, but also reflects the worsening global macroeconomic situation, with accelerating food and raw material price rises, high energy costs and oil prices. As purchasing power levels have remained low compared to the West, half of retail expenditure in the region is still taken up by the food and grocery channel (around and below 40.0% is the norm in the more mature markets in the West). Rapid inflation is instantly and keenly felt by non-food specialists, as spend on non-essential purchases is the first to evaporate.

That said, while demand for CEE products from the EU15, its biggest export partner, will slow significantly, EU membership and the benefits that this brings, such as a stable financial and legal framework, EU transfer payments, the fight against corruption, integration into the West and international security, should ensure that convergence will eventually gather speed once again. The region should emerge from the global crisis in better shape than Russia or Brazil, for example, which both appear to be under threat from extreme volatility going forward.

Source: Verdict Research

Good article. It is definitely time to question those two drivers of CEE growth - FDI and access to credit.

There is one potential landmine for the CEE consumer that the article doesn't mention, mortgage funding in Swiss Franc. A wide uptake of this cheap funding source has led to many consumers taking extremely large currency bets (no doubt with limited understanding of the risk). If CEE central banks see fit to cut interest rates and stimlate the economy, any response if FX markets (a likely weakening of the CEE currency) will increase both the mortgage payments and the amount of the outstanding loan, further squeezing the consumer and further slowing those related parts of the economy.

Such 'carry trade' currency moves / repricing can be quite violent (see graph of Aussie Dollar v. Japanese Yen) and need not be in response to rate cuts (less FDI in local currency and wider market perceptions of risk are potential suspects)

Fingers crossed that such moves don't happen, but maybe PS have some information on takeup of mortgages in foreign vs local currencies for the various CEE countries?

the attachment mentioned above.

(If it doesn't appear, the AUD has depreciated by approx. 30% against the Japanese Yen over the last 2 months)

Hi Huw - thanks for that - yes, we are looking at poorer performance in CEE compared to what we were expecting even a few days ago - but significantly better relative performance than other markets.

Latest from here in Munich is that the Baltics are down about 30% in property prices and in full recession.

With Iceland caving in to its current account deficit, the Baltics have to be next in the firing line.

The economies are reform led and politically stable - but their survival depends more on how quickly confidence returns to lending than to anything else.

Cheers
Neil

The Polish Zloty has fallen by some 18% relative to the Swiss Franc since the start of August. How much further? The Polish currency has been strong relative to other currencies, but I believe the risk has to be on the downside.

So Neil, what are Ps's revised CEE predictions?

How much is the Verdict report? Thanks

I have no idea - I picked this up on the web.
Huw

Another interesting perspective on CEE from Monsters & Critics .com:

Vienna - After years of roaring growth, eastern Europe's economies look increasingly fragile as the global financial crisis spreads.

European Central Bank action Thursday to ease a credit crunch in Hungary was a warning that the area from the Baltics to Bulgaria is ripe for spillover. Now analysts are speculating which country might be next to come under attack.

High on the list are EU members Romania and Bulgaria and non-EU Ukraine. Across the region, there are signs that investors are more wary of an area where double-digit economic growth often seemed the norm just months ago.

'Everybody is looking at how to avoid risk, rather than looking at how to make a buck,' said Lars Christensen, Danske Bank's top emerging markets analyst.

Eastern Europe has long been exposed to a possible credit crunch: the ex-communist nations relied heavily on foreign money for investment, property booms and consumer spending in the race to reach Western living standards.

The private credit boom in eastern Europe - and the banks who made the loans - stoked concern after financial markets seized up and fears of a global recession soared.

'Central and Eastern Europe is the most indebted and most leveraged region in the world,' Christensen said.

If a full-blown financial crisis strikes, the economic slowdown expected to persist in the region through 2009 would likely worsen.

Hungary, an early post-communist success now mired in economic stagnation, caught the first blow over the past week as the country's financial system came under pressure.

Government bond yields soared, stocks plunged and the Hungarian currency, the forint, slumped. Many banks halted loans in foreign currencies like the euro and Swiss franc, which have been hugely popular devices in eastern Europe's debt spree.

The International Monetary Fund held urgent talks with Hungarian officials. On Thursday, the ECB stepped in with a 5-billion-euro (6.8-billion-dollar) credit line for Hungary's central bank.

Much depends on how much foreign banks will curb their eastern exposure. One bellwether will be the three Baltic nations, now in, or on the cusp, of recession after a decade of meteoric economic growth.

'The Scandinavian banks are the crucial players in this. Provided they keep the finance taps open, the Baltics should avoid a financial crisis, but there will be a long and painful recession that will entail negative growth both this year and in 2009,' said Neil Shearing, an economist at London-based Capital Economics.

Investors have been reassessing risks in eastern Europe. Austria's blue-chip ATX stock index, which includes banks and industrial companies heavily involved in the region, has fallen 57 per cent since its July 2007 peak.

Balkan countries like Serbia - poor, economically struggling, politically messy and stuck with hard-to-sell state companies - stand to be among the biggest losers as investors blink and borrowing costs soar.

'Much bigger efforts will be required to attract foreign investors,' Serbian central bank head Radovan Jelasic told the Vienna daily Der Standard. 'Credit costs are much higher. The rosy times of privatization are over.'

Croatia, seeking to be the next eastern European nation to join the EU, saw the share of equities held by foreign investors drop from 39 per cent to 32 per cent in the year through June, Austrian bank RZB Group said.

Slovakia's currency, the koruna, has weakened even though the nation is set to join the top-flight club of euro-using countries on January 1.

Highly leveraged Romania, although still an inviting low-wage place to build a factory, is exposed because its currency, the lei, trades freely and government spending is set to rise.

For now, Poland - eastern Europe's largest economy - and the Czech Republic look financially and economically strongest in the region, analysts say. Still, consumer lending is tighter, crucial exports to western Europe are set to weaken and companies are starting to idle workers.

Some analysts say fears of a perfect financial storm hitting eastern Europe are overblown. They point to big infrastructure projects, such as those for Poland's co-hosting of the Euro 2012 football championship. There is also the outlook of easing wage pressure as the region's economies slow.

Next year's slump will be 'only a moderate bump in the overall path of economic convergence' with the old EU countries, RZB Group analysts forecast.