Eastern Europe Financial House Stronger than Debt-Ridden Neighbors
December 14, 2011
For some Eastern European investors, the geographic proximity to the eurozone has been too close for comfort, with the Russian MICEX Index declining about 20 percent year-to-date. However, stronger fiscal and monetary stances in Eastern Europe compared with its western neighbors warrant a second look.
Eastern European countries generally have experienced higher GDP growth along with less debt, so financing costs have less of a negative effect on GDP than in Western Europe. According to research firm UniCredit Research, in most of Eastern Europe, every one percent increase in the cost of funding only detracts about 0.5 percentage points from GDP. Hungary is the only exception. This compares favorably to developed European nations, as additional interest rate expenditures shaves three times more from Greece’s GDP and twice as much from the GDPs of Italy, Ireland and Portugal than in the East.
The Central and Eastern Europe region is also “in a more comfortable fiscal position” when it comes to making adjustments to the primary balance, says UniCredit. These countries’ public debt compared to their GDP is about half that of developed Europe, requiring there to be a lower adjustment to what they borrow or lend, not including interest payments. Countries such as Russia, Estonia and Turkey are running at a slight deficit and have little public debt to GDP, so there is less of a need to make adjustments to their primary balance. UniCredit says, “Poland has outperformed its own targets in 2011 and is well on track for a continued narrowing of its deficit next year,” and Turkey can “use fiscal policy to support economic activity next year if needs be.”
Turkey has increased its fixed capital spending in machinery and equipment, says BCA Research. Whereas other developing nations including Brazil, Mexico and South Africa are not investing in their own countries, capital spending is booming in Turkey, with fixed capital investment as a percent of GDP above 16 percent, a 15-year high. And while BCA believes there are a few difficulties facing Turkey, including financing its current account deficit, its “structural outlook remains bright.”
We believe the fiscal and monetary soundness are important factors that will help Eastern Europe weather the financial crisis better than its western peers. Historically, following major corrections, emerging Europe stocks have rebounded much more strongly compared to the overall MSCI World Index. With company valuations currently depressed, this area is worthy of a closer look today.
We also discussed the Russian Elections in last week’s Investor Alert.
All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.
The MICEX Index is the real-time cap-weighted Russian composite index. It comprises 30 most liquid stocks of Russian largest and most developed companies from 10 main economy sectors. The MICEX Index was launched on September 22, 1997, base value 100. The MICEX Index is calculated and disseminated by the MICEX Stock Exchange, the main Russian stock exchange. MSCI World Index is a capitalization weighted index that monitors the performance of stocks from around the world.