Central/Eastern Europe: A New Golden Age?

Despite a host of challenges, Europe’s formerly communist countries are poised for strong, steady growth.

Brexit. The migrant crisis. Terror attacks. Tensions with Russia, particularly over the Baltic states. The unresolved euro crisis in Greece. And now growing worries over Italy’s banks.

This is proving to be a pretty tough year for the European Union and its members, which include the formerly communist countries of Central and Eastern Europe (CEE) and Southeastern Europe (SEE).

Bebov, Balkan Advisory Company: Romania and other Southeastern European markets are drawing huge interest.

Commentators have been quick to suggest that these economies, which are still trying to converge to the European Union average, might be among the most vulnerable to these crises, especially Brexit. The UK’s departure from the EU will significantly lower the GDP contribution of the non-eurozone members of the EU from around 40% to 16% of the total, and thus possibly weaken their political and decision-making clout within the wider EU, as well as deprive them of a valuable ally against the dominant German-French axis. It may also increase pressure on countries like Poland, Hungary and the Czech Republic to adopt the euro, something none is keen to do. Unsurprisingly, stock markets across the region have been roiled since the Brexit vote, and uncertainty persists.

But look a bit closer, and CEE and SEE are actually not doing all that badly. Even though foreign direct investment is expected to remain weak compared with that of a few years ago, commentators expect shortfalls to be made good by EU structural funds, which are virtually automatic, long-term and targeted at fixing the weakest parts of these countries’ economies and infrastructure: Disbursements from the 20142020 structural adjustment funds for each country are now ongoing and will provide an important component of future GDP growth.

“It’s quite possible that 2016 could be the start of a new golden era,” says Sandor Pataki, deputy director of OTP Bank in Budapest. “Growth will be lower than before the (2008 financial) crisis but more sustainable, not least because of all the important adjustments these countries have made. Inflation is pretty much under control, unemployment is low, exports are pretty much on track, current-account deficits are reasonable, and budget deficits are typically not much more than around two to three percent of GDP.”


Previous comparisons between SEE and CEE have focused on the fact that reforms in the latter have proceeded much further, integration with the core eurozone countries is greater (the four Visegrád economies—Czech Republic, Slovakia, Hungary and Poland—are closely integrated with Germany), and convergence with the EU average is more advanced, especially in the three Baltic countries, compared to Southeastern European countries.

Observers close to the key SEE countries of Romania, Bulgaria and Serbia (not to mention Croatia and the smaller western Balkan economies) now say the region’s relative underdevelopment is actually what is moving it forward, as investors wake up to the opportunities and wealthy consumers start to spend more, aided by lower taxes rates (Romania has a flat-rate income tax of 16%, and Serbia just 12%) and growing personal wealth.

The largest SEE economy, Romania, is leading the way. Its 22 million inhabitants constitute a sizable market. GDP there is expected to rise 3.8% this year, and 4% next, with agriculture, manufacturing and the service sector all enjoying strong growth. Meanwhile, Bulgaria is expecting 3% growth this year, and Serbia 2.5%.

“The amount of interest we are now seeing in these countries is remarkable,” says Alex Bebov, an investment banker who heads the Balkan Advisory Company, which operates across the SEE region. He points to strong domestic demand, low debt levels, a strong entrepreneurial spirit and low interest rates as underpinning the new mood of confidence, leading to strong merger and acquisition activity (some of it cross-border) and rising investor confidence.

Other pluses underpinning Romania are its relative political stability—hopes are high that the technocratic prime minister Dacian Ciolo will stay on after this year’s November parliamentary elections—and vigorous anticorruption movement.

Anticorruption measures are especially evident in Romania, where they enjoy the strong personal support of the popular president, Klaus Iohannis. Once the most corrupt country in post-communist Europe, Romania has jailed one former prime minister (Adrian Nstase) and indicted another (Victor Ponta) for corruption, while a large number of less senior lawmakers and officials have all been successfully prosecuted. In July alone, Liviu Dragnea, leader of the powerful Social Democratic Party, was indicted for abuse of power and forgery (having already received a two-year suspended sentence for voter manipulation back in 2012), while Bogdan Olteanu, deputy governor of the Central Bank, was forced to resign over allegations of corruption. The message that no one is above the law is a powerful one, particularly in a country with such a grim recent past.

All this has emboldened investors and the financial sector. The Bucharest Stock Exchange is the biggest and most dynamic in the region. Banks, meanwhile, have been performing well in terms of return on equity and assets, with nonperforming loans averaging around 12% for the sector—expected to fall by year’s end to 10%.

Cercel, Societe Generale: Nonbank entities are driving innovation and growth.

According to Claudiu Cercel, deputy CEO of BRD Groupe Société Générale, in charge of financial markets, liquidity is growing fast and loan growth this year is expected to be around 6%. Innovation proceeds apace. “The mortgage sector is very healthy, as is direct banking, with growth and innovation being pushed by nonbank operators. Mobile and Internet banking are seeing a big investment across the board,” he says.

Romania’s story is echoed elsewhere in SEE. Despite canceling the privatization of Telekom Srbija last December because of low bids, the Serbian government’s 41% stake in Komercijalna banka, the country’s second-largest bank, with more than 230 branches and some one million accounts, is to be sold by year-end. France’s Societe Generale—whose BRD Groupe Société Générale currently ranks as the second-biggest bank in Romania—is among those reported to be interested. Meanwhile, in Bulgaria the energy sector has been attracting investment, notably to Bulgargaz but also to other entities.

“Bulgarian Energy Holding’s €550 million ($612 million) eurobond offering was four times oversubscribed, attracting some €2.2 billion; we are working on another bond right now, for €150 million, and are seeing similar levels of interest,” says Bebov. “These are dynamic markets.”


If populism is the enemy of sensible decision-making, then these are anxious times for Central Europe, with populist or semi-populist governments in power in three of the four Visegrád countries, Poland, Hungary and Slovakia.

Markets have been particularly roiled by Poland’s interventionist, right-wing Law and Justice government, amid fears it might wreck Poland’s record growth spurt: GDP here has grown every year without interruption for 23 years, with per capital GDP more than doubling to almost 66% of the EU average and exports increasing 25 times since 1990. And fears persist over Viktor Orbán’s Fidesz government in Hungary, whose controversial moves include its foreign exchange loan-conversion program, which forced local banks to convert some €14 billion in euro and Swiss franc consumer debt (almost 77% of total household debt) into forints at fixed rates. The total cost to Hungary’s banks has been estimated at €3 billion.

The political noises emanating from Budapest and Warsaw have been unsettling. In June the European Commission said Law and Justice’s changes to the constitutional court violate the rule of law; the EC has threatened sanctions. But for investors so far, things have been more upbeat. There was widespread relief in early August that Warsaw had opted not to imitate Budapest’s forcible approach toward local banks regarding foreign currency conversion. Instead the central bank will oblige banks to carry out gradual conversion of customer loans and mortgages, as new regulations make it less profitable to maintain foreign exchange loans and banks are obliged to compensate customers for excessive forex charges.

Poland’s new central bank governor, Adam Glapiski, said his priority is financial stability. Bank share prices rallied on the news, amid calculations that the measures will cost banks 25 billion to 30 billion Polish zloty ($6.5 billion to $7.8 billion) in conversion losses, against the 70 billion zloty feared. Observers point out that, although continued future growth for Poland cannot be guaranteed, the immediate future looks reassuring after last year’s GDP growth of 3.6%.

“Although Poland faces some structural and cyclical headwinds, buoyant real incomes and a tightening labor market should help underpin growth, which I do not expect to dip much below 3% this year,” says senior EBRD economist Alex Lehmann in Warsaw.

Lehmann is also confident that Hungary—which endured a double-dip recession in 2007 and 2010—is seeing light at the end of the tunnel, although the recovery has further to run, with consumer spending still relatively depressed. In April the IMF lowered its growth forecast to 2.3% for the year, after figures for the first quarter showed a contraction of 0.8% against the first quarter of 2015.

However, there has also been encouraging news regarding FDI, which in recent years has been somewhat underwhelming. In July, Daimler announced it would invest €1 billion more in a new production plant near Kecskemét—its second, bringing its total investment in the country to €1.6 billion and further reinforcing the Visegrád region as one of Europe’s main car-manufacturing hubs.

In May, ratings agency Fitch upgraded Hungary to investment grade (BBB-). Budapest is confident Moody’s will follow, when it releases its new credit ratings in November.

In this environment, the outlook for banks is improving, with the government and National Bank easing the regulatory and tax burden and the sector actively looking to boost such areas as digital banking and mortgage penetration, which has been falling over the past few years.

“There is considerable scope for the expansion of mortgages right now; house prices are rising, interest rates are zero, household finances are improving, and unemployment is at a record low of around 5%,” says OTP Bank’s Sandor Pataki. “After the challenges of the last few years, the outlook for banks has much improved here.”