Key Themes For 2013: Emerging Europe
The gradual global recovery is set to affect Central and Eastern Europe in various ways . Below, we identify key trends and themes for the sub-region s over the next 12 months .
Central and South-Eastern Europe
These economies will experience differentiated economic recoveries based on the regions within Europe they are most exposed to. The Baltics will continue to outperform while South-Eastern Europe will be the regional laggard due to its high exposure to weaker eurozone countries.
Fiscal consolidation will continue apace as many of the region's countries remain under the Excessive Deficit Procedure, and the threat of suspension of EU funds looms large.
That said, we also expect opposition to deeper EU integration to remain a key theme in line with our expectation that the EU will lose political influence over CEE in the coming years.
CIS and Central Asia
We remain bullish towards CEE agribusiness as the region will benefit from growing food demand and rising incomes, mainly in the Asia-Pacific region.
We expect key eastern European states Ukraine and Belarus to increasingly shift their political and economic orientation towards Russia in 2013. At the same time we anticipate Georgia's new government to take a more moderate path between Russia and the 'West'.
Commodity exporting states in the region will increasingly shift their focus East towards higher growth markets in the APAC region. This will result in higher tensions between states as they battle for market share.
2014 poses a number of event risks that we anticipate will be preceded by rising security risks and a military/anti-terrorism build-up in 2013.
The Turkish government is in the midst of re-writing the constitution, and it is proving challenging to reach consensus between the secularists and Islamist elements in government.
We see increased political debate over Turkey 's long-term trajectory ahead of the 2014 presidential election.
Having avoided a hard landing in 2012, the Turkish economic rebalancing remains vulnerable to hefty headwinds in 2013 given a still-high reliance on short-term capital flows to finance the current account deficit.
Three Themes In Central And South-Eastern Europe
Differentiated Economic Recoveries
Broadly speaking we expect to see Central and South-Eastern European (CEE/SEE) countries post economic recoveries in 2013 following a challenging 2012, when growth slowed substantially across the region due to weaker global external demand and flagging confidence as a result of the eurozone sovereign debt crisis. However, sub-regional recoveries will vary depending in large part on which economies in the wider EU they are most interconnected with.
|Stable Parent Banking Sectors Bodes Well For Baltic States|
|Baltics - Foreign Claims By Nationality Of Reporting Bank, US$bn & % of Total Assets (RHS)|
In this respect, we view the Baltic economies as the most likely to continue posting robust growth as the region is highly integrated with Scandinavian countries, some of the most stable economies in Europe. Scandinavian banks, in particular Swedish banks, have large claims on Baltic banking sector assets. According to Bank of International Settlements (BIS) data, at end-Q212 Swedish banks' combined claims on Baltic assets (Estonia, Latvia and Lithuania) amounted to US$46.6bn, this was equivalent to 36.9% of Latvia's total assets, 54.0% of Lithuania's and 68.2% in Estonia. Not only are Scandinavian banks more stable than their eurozone counterparts, but they have also repeatedly affirmed their commitment to remaining invested in these countries. Although these banking sectors will not necessarily be a key driver of growth, the Baltic states will benefit from stability in this sector, providing a solid base for economic recoveries in 2013.
|Recovery In Germany To Be A Boon For Central Europe|
|CE-4 - Direction Of Trade, % of Exports|
The recovery in Central European countries (Poland, Czech Republic, Hungary and Slovakia) will be based largely on an improvement in the outlook for the eurozone, in particular in Germany, the bloc's economic powerhouse. Stronger domestic demand in core eurozone countries will concomitantly boost Central European economies' growth outlooks given a high degree of integration between CE countries and the eurozone - on average 60% of CE exports were destined for the common currency bloc in 2011.
|Exposed To The Weaker Eurozone|
|SEE - Foreign Claims By Nationality Of Reporting Bank, US$bn & % of Total Assets (RHS)|
We expect South-Eastern Europe to face the largest headwinds in 2013 and expect recoveries in these countries to lag the region. Unlike the Baltics and Central Europe, the Balkan region is exposed to weaker elements of the eurozone - mainly Greece, Italy and France. A striking example of this is in the banking sector, where Greek claims on Bulgarian and Romanian assets remain elevated (15.0% and 22.1% of total assets, respectively at end-Q212). While these exposures have been falling, banking ties with the struggling eurozone laggards leave Balkan economies vulnerable to parent banks withdrawing capital to shore up capital buffers in home countries. Flagging domestic demand in these weaker eurozone economies will also keep exports weak going into 2013. This will be particularly noticeable for countries like Croatia and Serbia, which are embarking on fiscal consolidation plans and for which external demand is key to preventing deep real GDP contractions.
Austerity Drives To Continue
We maintain our expectation that fiscal consolidation efforts will continue through 2013 (see November 12 2012, ' CEE Austerity Drives To Continue Through 2013'). CEE/SEE governments have come a long way in repairing fiscal gaps since the 2008/09 downturn, when deficits ballooned well above the 3% of GDP Maastricht-defined limit as governments enacted countercyclical fiscal policies to prevent deeper contractions. However, most of CEE EU member countries remain under the Excessive Deficit Procedure (EDP), with many expected to have reduced government deficits by 2012 or 2013.
|Still A Bit To Go|
|CEE - Budget Balance, % of GDP & Maastricht-Defined Limit|
In spite of high public discontent, this commitment to austerity will persist, weighing on economic growth, and thereby further stoking social tensions and domestic antipathy to ruling parties. However, we see little choice but for CEE countries to persevere with austerity. While the EDP lacks the capacity to seriously penalise most Western European countries failing to comply (the fine for noncompliance in eurozone countries is not more than 0.2% of GDP), the threat of EU funds suspension in newer EU members should keep countries on track with deficit reduction plans, given a generally high reliance on funds for bolstering economic growth.
More Opposition To EU Integration
While economically, the convergence pattern of CEE countries will continue apace, we have previously outlined our expectations that the EU would continue to lose political influence over the CEE region in the coming years as core eurozone countries struggle with political and economic crises (see 'EU Losing Influence In Emerging Europe', August 24 2012). The struggles surrounding the EU budget talks are a prime example of this. The chasm between the 'creditor' countries in Western Europe and funds drawers in Eastern Europe remains deep and is likely to hinder a workable agreement on the next seven-year budget for the bloc going into H113.
|Political And Social Risks Of Austerity To Remain Prevalent|
|Map of Central & Eastern Europe|
In 2013 we expect to see this theme play out in relation to plans to implement banking and fiscal unions. Newer EU member states such as Poland and the Czech Republic have already expressed concern that they have no voice at the eurozone level and have explicitly (in the case of the Czech Republic) or implicitly (in Poland's case) voiced disdain for such a deep degree of integration without consultation. Given that eurozone leaders appear to have little appetite for extending dialogue to include future eurozone members, we anticipate further friction over these issues in 2013.
Four Themes For The CIS And Central Asia
Bullish CEE Agribusiness Outlook
We reiterate our long-ter m bullish outlook towards agribusiness in the CEE region, a theme we anticipate will become ever more prevalent in the coming year (see ' Attractive Opportunities In Emerging Europe Agribusiness ' October 17 2012) . Growing populations and shifting diets in the Asia-Pacific region , as a result of rising incomes, will keep demand for agriculture products high over the coming decade. Eastern European countries (namely Russia, Ukraine and Kazakhstan) are ideally placed to benefit from this increasing demand. Moreover, the region benefits from vast swathes of arable land, and owing to years of neglect under and following the collapse of Soviet rule, it will take little investment to unlock the region ' s potential.
Investment into th is sector continues to pour into the region via a number of avenues . Strong government support has seen significant sums of public money invested into upgrading the agriculture complex. This strong state support also has the impact of attracting foreign investors keen to capitalise on the opportunities available. As a result, money for these initiatives come from a diverse base of funding pools ranging from the public sector to international organisations to private hedge funds. We see little scope for these positive developments in the sector to slow in 2013 and maintain a bullish outlook on a number of agribusiness companies (see 'Regional Equity Strategy', December 11 2012) .
Bridge States Shifting Focus Towards Russia
The political and economic orientation of Ukraine, Belarus and Georgia will be an important theme in 2013 as the first two face deep political and economic challenges and Georgia ushers in a new government, whose orientation is currently up for debate. We anticipate both Belarus and Ukraine to orientate their economic and political policies more towards Russia, and away from the EU. Both countries have been criticised by the EU on humanitarian grounds as Ukraine's former Prime Minister Yulia Tymoshenko remains incarcerated, on questionable charges and reportedly in poor conditions, and Belarus's President Alexander Lukashenko runs what is termed by some human rights organisations as 'Europe's last dictatorship'.
|Heavily Reliant On External Financing|
|Ukraine - Breakdown of Financial Account, US$mn|
Another motivation for Ukraine to increasingly look towards Russia is the difficulty in meeting IMF demands - chiefly removing gas subsidies - to unlock much-needed funds. However, turning to Russia cap in hand, which involves its own stringent demands - such as control over gas infrastructure and/or joining Russia's customs union in exchange for lower natural gas prices - will not be easy sailing. Nevertheless, we expect Russia to try and leverage off its increasing appeal to both these states, which could result in more acrimonious 'gas wars' and have knock-on impacts for EU economies dependent on these gas flows.
Georgia, however, is likely to take a more moderate path, opting to maintain its affiliation with the West while taking a less hard-line stance with Russia. Uncertainty regarding the orientation of Georgia between the EU and Russia was high following the surprise election of Prime Minister Bidzina Ivanishvili and his Georgian Dream party in October 2012 elections. However, rhetoric from the new government continues to revolve around deepening relations with the EU and NATO, in our view. Meanwhile, Ivanishvili's ties to Russia (where he made his fortune) will also moderate the country's hostile stance on Russian relations. That said, the 2014 Sochi Olympics pose a key risk to this relatively sanguine outlook (to be discussed below).
Looking Further East
The expectation for weaker global commodity prices on the back of mild growth, ample supply and the shift in contract pricing in Europe will increase competition for market share in high growth markets in the Asia-Pacific region amongst commodity exporters, particularly suppliers of hydrocarbon products. The investment and development drive in Russia's Far East is a theme our Shipping and Freight team have been highlighting for some time now (see 'Vanino Privatisation To Drive Growth', November 28 2012). The motivations behind this push are twofold. Firstly, political unrest since the end of 2011 has resulted in a crackdown in Russia, and a renewed desire to reassert the Duma's influence over the Far Eastern stretches of the country (see 'Putin's Firm Grip On Power Tightens', October 25 2012). Externally too, Moscow will look to increase its political influence in the Asia-Pacific at a time when the US has shifted its foreign policy fulcrum to the region.
|Falling Prices To Boost Competition For Bigger Piece Of The Pie|
|Brent Crude Oil Price, US$/bbl ave|
Economically speaking, reasserting its influence in Asia-Pacific will enable Moscow to take advantage of high demand for oil and gas in China and Japan, while diversifying the economy away from low growth markets to the West over the coming decade. As a result of this officially-driven investment push, we see vast opportunities in the rail and freight, oil and gas, and infrastructure sectors in 2013 and beyond (see 'Chayanda FID Creates Momentum For Eastern Gas Programme', October 31 2012).
Besides Russia's push for more access to these markets, Central Asian resource-rich countries are also set to become bigger players. Japan inked a deal in November at the Central Asia Plus Japan forum worth US$700mn for the exploration for oil, gas, uranium and rare earth metals. Indeed, we anticipate energy exporting states to compete for the attractive East Asian and South Asian markets, where states are energy hungry and willing to pay for expensive pipelines, which could result in increased political tension in the region.
We expect tensions in the Caspian Sea region to remain prevalent as these states compete for market share. Indeed, getting Turkmen gas to the European market poses a particular challenge as it must largely go through Russian pipelines, and Russia has an interest in suppressing Turkmen exports for its own gain. Turkmenistan is keen to have the Trans-Caspian pipeline built in order to facilitate exports, however, owing to unresolved delimitation issues and Russian and Iranian interests in keeping pipeline plans on ice, this is unlikely to be realised anytime soon (see Relations With Azerbaijan To Remain Tense, August 16 2012 ).
|Near The Danger Zone|
|Map Of North Caucasus & Location Of 2014 Winter Olympics|
2014 poses a number of event risks that we anticipate will be preceded by a military/anti-terrorism build-up in a number of countries in 2013. Russia will be holding the 2014 Winter Olympics in Sochi, over the border from the disputed Abkhazia region of Georgia and near the volatile North Caucasus region. Russia has carried out military drills as a show of force and there is a very real possibility for tensions between Russia and Georgia to mount over the course of 2013 as Russia's military presence in the region increases.
|Caucasian Anxieties Apparent|
|Military Spending, % of GDP|
Russia will continue to face domestic security risks from areas such as Tatarstan. There have been a number of attacks on moderate Muslim leaders and we see scope for Moscow to react with an iron fist. This would likely result in the radicalisation of elements in the region, which would prove disastrous given its economic and socio-political importance (see Radicalisation Risks In Tatarstan: Key Implications, August 23).
Related to this point, 2014 marks the drawdown of US military presence in Afghanistan, which presents a key strategic threat to the wider region. Major powers Russia and China, along with Central Asian stalwarts Kazakhstan, Uzbekistan and Turkmenistan are concerned that the resultant power vacuum in the war-torn country will increase the militant Islamist threat to weaker states such as Tajikistan and Kyrgyzstan and potentially destabilise the regimes in these countries, ushering in more militant leaderships or protracted conflicts. Porous borders and weak governance also present the opportunity for the illicit drug trade to thrive. These are threats we have been highlighting for a number of years now and which we expect to increase in importance in 2013.
Turkey: In A League Of Its Own
2013 will be an important year for Turkey for a number of reasons. Politically speaking, the country is in the midst of re-writing the constitution, pitting staunch secularists against more Islamist elements in the government (represented by Prime Minister Recep Tayyip Erdo?an ' s AKP party) . W e foresee increased political debate over Turkey ' s long-term trajectory ahead of the 2014 presidential election , where Prime Minister Erdo ? an is likely to go head-to-head with President Abdullah Gül .
|AKP Support Near Record Highs|
|Turkey - Support For Major Political Parties, %|
We also believe that Turkey is at a decisive turning point in its economic and foreign policy orientation between the East or the West. Export diversification towards faster growing markets in the East has been crucial to putting Turkey's economic future onto a more sustainable track given the continued economic malaise in the EU. Turkey has avoided a hard landing in 2012 on the back of a number of unorthodox monetary policy measures and a gas-for-gold plan with Iran (owing to an exemption from US sanctions on Iran).
That said, the country remains highly reliant on short-term capital flows to finance a hefty current account deficit, most of which originate in the EU. Despite this, we expect Turkey to increasingly shift its focus to high growth markets in the East in order to support its longer-term economic potential ( see 'Turkey Outperforming Russia Over Next Decade', September 20 2012) .
|Exemption From US Iran Sanctions Bolstering C/A Adjustment|
|Turkey - Select Merchandise Goods Data, % chg y-o-y|
Although our core scenario is for the rebalancing to continue, there remain a number of risks to this outlook. While it appears the US has extended Turkey's exemption from sanctions on Iran, it is still possible that this could be repealed at some point in 2013. This would prove troubling for Turkey's external position given the impact of the 'gas-for-gold' scheme on flattering the current account deficit (see November 29, 'Risks To The Rebalancing'). We also anticipate that at least one of the major credit ratings agencies will follow Fitch's lead in upgrading Turkey to investment grade in 2013, which will lead to increased capital inflows into the economy and capital markets. This could result in a dilemma for the central bank as a stronger currency would hurt exports, and threaten Turkey's economic rebalancing.