With capital inflows to the CEE economies slowing to a trickle in Eastern Europe, a sharp correction is now underway in most countries’ external imbalances and in particular in their current-account deficits. For the CEE-6 (Poland, Czech Republic, Hungary, Romania, Bulgaria, Turkey), net private capital flows are forecast to slow to $59.5 billion in 2009, down from an estimated $161.9 billion in 2008, according to estimates from the Institute For International Finance. The basic concern is that those countries with significant external deficits are extremely vulnerable to foreign capital reversals, especially in the current environment of global credit tightening.

FDI flows (which are generally considered more stable and less susceptible to rapid outflows than other capital flows) have been the main form of financing for current-account deficits in recent years, but such inflows are set to slow sharply in 2009. The Economist estimates that between 2003 and 20007 FDI inflows (on average) covered almost 100% of the current-account deficit in the ten EU member states. In 2008, this coverage fell to an estimated 55%

As FDI has fallen back, debt – particularly intra-bank lending – has become the main financing vehicle for the current-account deficits. Nevertheless, intra-bank lending – that is, lending between foreign parent banks and their subsidiaries in the region – is falling back sharply in 2009, with nett bank lending to emerging Europe, excluding Russia, being projected at around $22 bn in 2009, down from $95 bn in 2008 (according to the Institute for International Finance)

Now the central issue is that such corrections in external imbalances can take pplace in one of two ways – either domestic demand drops sharply and/or the currencies weaken significantly. In the case of those countries with an exchange rate peg the second route is not open, hence what we are likely to see is a very sharp contraction. Such contractions are already evident in the Baltics, but what about Bulgaria. How sharp will the correction in Bulgaria be? Only today capital economics have come in with a forecast of 5% contraction over the year. But how realistic is this, let’s look at some data.

Well, we could start with this little deatil: retail sales down 25.7% month-on-month in January, according to the national statistics office. For an economy which has been driven by a consumer borrowing and lending boom, that looks like dramatic evidence of some kind. It looks like dramatic evidence, but it isn’t really quite so dramatic as it appears at first sight, and the first warning I would issue to anyone who wants to study the Bulgarian economy is never to believe anything you see at first sight.

The data came from a Bulgarian press source (see extract below), but they evidently had no idea what they were talking about, since they confused the basics of year on year and month on month, and obviously non seasonally adjusted sales are down massively January over December, every year. Actually according to Eurostat, seasonally corrected sales were down only 0.15% month on month, and were even still up 4.79% year on year, although this is still a very large drop from the 20% rate of increase registered earlier in the year. So the basic point would seem to hold, that Bulgaria’s economy is now in freefall, but I have learnt something: never, ever, cite material from direct Bulgarian sources without checking.

Retail sales revenue in Bulgaria declined by 25.7% in January from the same month of last year, the National Statistical Institute (wwwo.nsi.bg) said in a statement. The slump was attributed to a sharp decrease in retail sales of larger consumer goods, although a decline is normal for the beginning of each year. A major 31.5% drop was reported in sales of vehicles and technical maintenance. Revenue generated by non-food sales went up by 3.0% year-on-year, the data showed. Revenue from food, beverages and cigarettes sales showed a minor increase of 0.5%

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According to Secretary of State at the Hungarian Finance Ministry László Keller Hungary will post a public sector deficit of HUF 332.9 billion in the month of March, up from the preliminary forecast of HUF 329.8 bn made only a month ago. At the same time the Finance Ministry has left its full-year deficit projection of HUF 730.6 bn virtually unchanged from the one made a month ago of HUF 729.9 bn. (In fact the entire Q1 deficit is expected to run to HUF 581bn or 2.2% of annual GDP. This seems like a huge chunk of the whole years deficit spent already, but we should remember that there is a strong seasonal component here, and for comparative purposes we could note that the actual deficit for Q1 was HUF 508bn or 1.9% of GDP, so while the situation is not good, it may not be as bad as it seems at first sight).

However, as the months pass the ability of the government to live up to its budget objectives seems more and more remote, despite constant reassurances from Keller that “The cabinet is in control of the situation” and that “The government wants to keep the budget deficit under 3.0% (of GDP) at all costs”. Continue reading →

Ten Year Bond Spread Between Between Greek and German Benchmarks Post 1999

The Greek government announced this week that it is introducing a public sector wage freeze together with and a one-off tax for high-income earners in an attempt to prevent the budget deficit from spiralling yet further out of control. The measures, which were announced on Wednesday, constitute a significant change of discourse from a government which until now has claimed Greece’s service-based economy could avoid falling into recession. Speads on European government bonds widened again this morning The difference in yield between German and Irish 10-year government bonds, increasing five basis points (to 281 basis points), the most since February 1993. Portuguese, Spanish and Greek (see chart above) spreads also widened versus the German benchmark.

Basically what follows is a brief examination of the evidence we now have to hand for a sudden and sharp slowdown in Greek GDP, and of how this may influence future expectations on the spreads. This follows in the path of my two previous Greece related studies:

Why We All Need To Keep A Watchful Eye On What Is Happening In Greece

and

The Long And Difficult Road To Wage Cuts As An Alternative To Devaluation Continue reading →

From Wikipedia:

Enric Duran, also known as “Robin Bank” or “Robin Hood of the Banks” is a Catalan anticapitalist activist and member of the “Temps de Re-volts collective”. On September 17, 2008, he publicly announced that he had ‘robbed’ dozens of Spanish banks of nearly a half-million euros as part of a campaign of political action to denounce what he termed the “predatory capitalist system” and finance various anti-capitalist movements. From 2006 to 2008, Duran took out 68 commercial and personal loans from 39 banks with no guarantees or properties as collateral. Duran published an article entitled “I have ‘robbed’ 492,000 euros from those who most rob us in order to denounce them and build some alternatives for society” explaining via the internet that he had taken out a series of loans from numerous Spanish banks as well as publishing his “confession” in the Catalan magazine Crisis. Duran called his action an act of ‘financial civil disobedience.’

Of course, while Timothy Geithner recieves a supportive understanding pardon for his “sin of omission” (he forget to present adequate tax returns), and AIG directors continue to haggle about their bonus payments, Duran is whiling away his time in prison awaiting trial on charges of fraud. There is a fairly credible rumour going the rounds that he will be receiving no support from the official government “bail”-out fund.

Meantime we are constantly reassured that Spain’s banks are completely sound, that every loan was judiciously and meticulously checked, and that there really is nothing at all to worry about.

My point here is not to defend Duran’s actions, but to highlight the double standards embodied in the way we go about things. I think his case can also give us some inkling of an insight into why it is that some of our young people are now becoming so disaffected. Apart from being left with the lions share of the debt to pay off over the years to come, they will also be called upon to sustain our ever more fragile pension systems.

We are told that recovery is just round the corner, maybe as soon as the end of this year. Personally I fail to see how this can be the case, not only because none of the macro economic data I am looking at are consistent with such a view, but also because it isn’t at all evident how things can ever “correct” themselves while we still have such a massive “values overhang”. Part of the problem we just got into was about greed (it always is), not just the greed of those who wanted an ever bigger cash bonus, but the petty greed of all those millions who got themselves ever deeper into debt on the basis of the flawed idea that the price of their home (or second home) would simply go up and up forever. We still have a lot of “cleaning out” to do in this department, all of us, before what is steadily getting worse can start getting better.

The much maligned Keynes went to work as a volunteer at the Bank of England during World War II, the man who was arguably the twentieth century’s greatest philosopher (Ludwig Wittgenstein) spent the war as a porter in Charing Cross hospital (he was already old, and a pacifist), while one of Russia’s greatest painters, Pavel Filonov, starved to death in 1943 since stayed behind in a beseiged Leningrad simply to take care of a sickly old woman. When we start to see people of this calibre up there and running things, then we will know we are starting to emerge from the crisis. Meantime, its “war” as usual, although hopefully not the type of “class war” that Duran and his associates would have us get ourselves into.

Of course, these scenes shot outside Barcelona’s central university yesterday afternoon are one good example of how NOT to handle the crisis.

I suppose industrial output numbers for Poland are not exactly the sort of thing that set most Afoe readers alight with blazing interest. They are, however, not without some significance, since one of the issues every right thinking European needs to be trying to assess right now is just how valid the “each Eastern Economy is different” actually is in reality.

Well, it is, and it isn’t is my view, since evidently there are differences, and some of them are important, but equally evidently there is one common underlying reality: an ongoing and extensive regional economic crisis. In this context the fact that Polish industrial production fell for the fifth straight month in February is not simply an incidental piece of news. It offers us and easy to understand indicator of the problem which exists, as well as providing the latest signal that the Europe’s economic crisis really is having an impact on domestic economic growth in Poland and other parts of central Europe. In fact annual output dropped by 14.3 percent in February, following a revised decline of 15.3 percent in January. Output was however up 2.7 percent month on month.

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I have been warning on the parlous position of Italy’s Unicredit for some time now (see this initial EU Bonds post, or the earlier history of the Unicredit problem, here, here, here, here, here). Well, today the story took another turn for the worse.

It all started yesterday, when Bloomberg came in with a report about Unicredit’s eastern exposure, outlining how a decade long expanison, which saw more than $65 billion of acquisitions in operations stretching from Poland to Kazakhstan is now alarming analysts who forecast that loan defaults in eastern Europe, where the bank focused its growth, are set to balloon. Unicredit’s stock is down 76 percent in the past 12 months, the second-biggest decline among Italian banks.

“Eastern Europe is the new bogeyman,” said Massimiliano Romano, an analyst at Concentric Italy in Milan. “UniCredit has subsidiaries in 17 different countries there. We used to see that as diversification, now we see it as a risk.”

Then came the news, again yesterday, that the bank had suffered a 57 percent decline in fourth-quarter profit. Finally, this morning, the bank informed us that they are planning to ask for as much as 4 billion euros in government aid. In fact the profit results were not as bad as some analysts had been forecasting, but then these results are for 2008, which, as the company said in its statement, was still a “very good year” in eastern Europe. 2009 looks set to be quite a lot worse, and 2010? As Unicredit CEO Alessandro Profumo said, the bank is “monitoring countries including Ukraine very closely”.

In fact the bank is going to apply for aid in both Austria and Italy, and this is not surprising since according to a statement from the Bank of Italy earlier this week, Italy’s national debt climbed to 105.8 percent of gross domestic product at the end of last year, up from 103.5 in December 2007. So the credit rating agencies’ patience is already being badly strained, even if the quality of their mercy might not be.

Oh, and just to cap it all, and a very bad day for Unicredit, HVB Group, their German banking unit, announced this morning that they had a loss of 671 million euros last year because of writedowns on investments and higher provisions for risky loans. HVB’s trading results were “severely affected by the extreme market turmoil which intensified in the fourth quarter of 2008,” according to the company statement.

Basically, this is that well known proverbial situation, where Europe’s leaders twiddle their thumbs, while Rome, almost literally, burns.

Joke – How do you know when a country is in crisis? Well, on the buses on the way to work, and in the bars and cafes during the mid morning break, everyone is reading the economy rather than the sports section in the local newspaper.

Several pieces of news out over the last week are relevant to the whole debate we are having about how to drag the Estonian economy (kicking and screaming it would seem) out of its current slump. In the first place the Estonian parliament passed a supplementary 2009 budget at the start of the week, in an attempt to address the ongoing crisis in the economy and the dramatic decline in revenues. The cuts were approved by 61 votes to 35 against in what was also an effective vote of confidence in the present government. So at least it is clear that the majority of Estonia’s politicians back the present course, and the degree of public support for the current path is greater than it would seem to be in, say, Latvia. That is, naturally a very positive point.

The supplementary budget lowers the amount of revenues in the annual budget by EUR 615.5 mln and of expenditure by EUR 419.9 mln. According to the revised budget, state revenue this year is now anticipated to be EUR 5,635 mln and expenditures EUR 5,871 mln. Both these numbers are of course conditional on the economic contraction for 2009 only being the forecast one (on which the budget is based) of 9.5%.

The second piece of news is that the Estonian Finance Mininistry have sent an official loan application today to the European Investment Bank, with a request to borrow Eur 550 million for 5 years. And this point is important, since obviously, as I will argue below, Estonia’s private sector (households and companies) is now basically very overleveraged (in too much debt) and the government is being forced to step in and assume greater responsibility for the collective debt as the correction continues.

The third relevant piece of news is that the number of unemployed registered with the Estonian Labour Board was up again last week, and reached 50,527, which means 2418 more people signed on with the board during the week, following the 3,019 who joined the list in the previous week. Meanwhile the Estonian Parliament has been having a debate about what kind of labour market reforms the country needs to handle the present crisis. Since one witty soul appropriately baptised me in my most recent post the “excel economist” I would just like to add-in my own chart-based contribution. People are leaving Estonia. How do I know that, well just take a look at the spike at the end of the time series shown in the grphic below, the volume of income transfers to Estonia (largely worker remittances) has been on the increase ever since the crisis started in 2007, and during the last quarter of 2008 they really spiked up, just (coincidentally?) as the economy spiked sharply downwards.

We don’t know too much about the murky topic of out-migration in the Baltics, since no one seems to consider it a particularly pressing issue. In fact, migrant labour flows could be considered to be a leading indicator for a modern (open) economy (in both directions), but surprisingly little attention is paid to the matter. We do have an old “estimate” that around one third of those working abroad are working in Finland, and now somewhat dated reports of young people working in Finland repairing motorway crash barriers for 150 kroon an hour, but that’s all we seem to have, anecdotal evidence. Maybe one of the reforms all those very busy parliamentarians could think about agreeing to would be the introduction of a question in the labour force survey about whether or not the interviewee currently has (or has had in the recent past) a family member working abroad. Continue reading →

Paul Krugman has a reasonably to the point Op-ed in the New York Times today. It starts off like this:

I’m concerned about Europe. Actually, I’m concerned about the whole world — there are no safe havens from the global economic storm. But the situation in Europe worries me even more than the situation in America.

and ends up like this:

For much of the past decade Spain was Europe’s Florida, its economy buoyed by a huge speculative housing boom. As in Florida, boom has now turned to bust. Now Spain needs to find new sources of income and employment to replace the lost jobs in construction. In the past, Spain would have sought improved competitiveness by devaluing its currency. But now it’s on the euro — and the only way forward seems to be a grinding process of wage cuts. This process would have been difficult in the best of times; it will be almost inconceivably painful if, as seems all too likely, the European economy as a whole is depressed and tending toward deflation for years to come.

Does all this mean that Europe was wrong to let itself become so tightly integrated? Does it mean, in particular, that the creation of the euro was a mistake? Maybe.

But Europe can still prove the skeptics wrong, if its politicians start showing more leadership. Will they?

Amen to that!

Meanwhile, Spain’s Economy Minister Pedro Solbes has been talking about EU Bonds:

The euro zone is not yet ready for a joint bond but states in the 16-member currency area could coordinate their debt issuance more closely, a German newspaper on Wednesday reported Spain’s economy minister as saying. ‘I think the currency union is not yet ready for something like that,’ Economy Minister Pedro Solbes, referring to the idea of a joint bond, told Germany’s Handelsblatt in extracts of an interview to run in the business daily’s Thursday edition.

So the argument isn’t that they are not a good idea, it is that – with Spain’s unemployment now at 3.5 million, and money starting to run out on the public works “stimulus programme” – we aren’t yet ready for them. When will we be ready, when Spanish unemployment here hits 5 million, or six, or seven, or when we have 5 million people who have run out of unemployment benefit payments, when things eventually start to fall apart at the eurozone level, or after the German elections, perhaps? Come on. Enough of all this passivity. Let’s have some action up there. The issue is we set up a currency union without the necessary political architecture to make it work, so now we need to go to work on the architecture. Do our leaders have the mettle to finish the job, or, as Krugman fears, are they simply intent on proving all the skeptics right!

You can find some explanation of what EU Bonds are, and how they might work, in this post here.

On the face of it Hungary’s situation is pretty dire. As I keep reminding readers of this blog, even Angela Merkel recently claimed that “you cannot compare the dire situation in Hungary with that of other countries” as if the worst off you could be was where Hungary is now, effectively turning Hungary into the benchmark case for economic “badness” (at least as far as the EU goes, Ukraine is obviously “another country” in this respect). I cannot agree. As I have suggested time and again on this blog, although Hungary’s situation leaves little to be envious of, it is not as bad as some are making out in the current “demonisation” process, nor are the other Eastern Economies (even those in the Eurozone as I argue here in the cases of Slovakia and Slovenia) really as sound as some have been making out. Indeed in my view the Hungarian economy is not the worst case in the EU27 (I would rather suggest that either Bulgaria or Romania will be battling it out soon enough for that dubious honour). Obviously Hungary is in the midst of a major correction, and has been for nearly three years, but during that time Hungary has made considerable progress along its appointed road, and now has an industrial export sector which no one should be sneezing at. The problem is simply that Hungary (for reasons to be explained below) is now an export dependent economy, and such economies are among the worst affected in the short-term by the present slump in European (and global) economic activity.

This simple fact was brought home only last week by January’s export figures, which show the dramatic nature of the recent decline in Hungary’s external trade, since both exports and imports were down at a rate of around 30% year-on-year. The decrease was slightly higher for exports than for imports, and consequently the trade balance was once more negative. Exports were down by 31% compared with January 2008, showing the extent to which Hungary’s export driven economy has been affected by the recession in the rest of Europe.

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“Most other countries in the region are faring much better, though….Like Slovenia, which joined two years ago, Slovakia can enjoy the full protection of rich Europe’s currency union, rather than just the indirect benefit of being due to join it some day.”
The Economist

“Saying that the situation is the same for all central and eastern European states, I don’t see that……you cannot compare the dire situation in Hungary with that of other countries.”
Angela Merkel

“Happy families are all alike; every unhappy family is unhappy in its own way”
Tolstoy

Slovenia’s economy contracted for the first time in more than 15 years in the fourth quarter of 2008, and is almost certainly heading for quite a deep recession as a construction boom came to an end while demand dropped for exports to other economies in the European Union. Gross domestic product shrank 0.8 percent year on year following a revised 3.9 percent expansion in the previous quarter. More astonishingly, quarter on quarter GDP contracted a seasonally adjusted 4.1 percent. Only Estonia and Latvia contracted at a faster rate.

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