Eastern Europe economy: Immune to the currency crisis?
Amid all the fuss about the Irish bailout it would be quite easy to miss an apparently minor spat brewing between Hungary and the European Central Bank (ECB).
he centre-right Fidesz government wants parliament to appoint members of the interest-rate setting Monetary Policy Council (MPC) directly, bypassing Hungary’s own central bank and placing monetary policy squarely in the hands of the politicians.
Central Europe’s remarkable resilience to the problems hitting the euro zone.
Ireland’s problems have been shrugged off with no more than a minor wobble in the region’s currencies, which have generally been flourishing on the back of healthy global appetite for emerging-market risk.
Fidesz, which has a two-thirds majority in parliament, plans to change the country’s Central Bank Act so that Parliament’s economic committee would control appointments to the MPC.
So if this change goes through, Fidesz supporters can take control when the four floating members’ mandate expires in March 2011.
This is a rather blatant attempt by the government to seize control over monetary policy, after a long-running dispute with the central bank. Fidesz has long complained that the country’s high interest rates and tight money policy are strangling the life out of the economy
. So far, Hungary, like the other Central European states, has weathered the currency storm well. But its spending deficit is stubborn and debts are relatively high. If it lowers rates too aggressively, investors could still flee its currency.
Looking at the performance of the Polish zloty, Czech koruna, Hungarian forint, and Romanian leu, the four large floating Central European currencies largely tracked the euro/dollar rate throughout the year: starting from the weakest point (early June for all of the Central Europeans bar the leu, which bottomed out later because of domestic political concerns), they all appreciated against the dollar until they hit a peak on November 4th: the zloty, koruna and forint all rose by about the same amount as the euro (20%), with Romania slightly lower on 17%. In contrast, between November 4th and November 25th the euro weakened by 5.6% and the Central European currencies suffered rather more, with the zloty falling 8.4% against the dollar, the forint 8.2%, the koruna 7.6% and the leu 6.6%.
There were genuine fears that the region could suffer from a domino effect, with the problems that hit Greece and Ireland flowing into currency crises in Central Europe. But it hasn’t happened, even though the region remains less popular than other emerging markets, for example Asia, with international investors. In fact, investors seem to have recognised Central Europe’s underlying strengths, certainly in comparison to countries like Greece and Ireland. For the moment, they are not abandoning their currencies, although Hungary in particular has complained of limited appetite for some of its recent bond issues.
Central European states do not share the debt and spending problems that caused such problems in Greece and Ireland, and threaten to cause problems in other countries such as Portugal and Spain.
Severe recessions have made public spending look out of control in countries such as Latvia, which will run a budget deficit of well over 8% of GDP this year. Its economy shrank by 18% last year. In fact, Latvia (which runs a currency board) is the only country in the region with spending problems as severe as those in the troubled euro zone countries: its deficit is slightly higher than Portugal’s but well below those in Spain, Greece and Ireland (bank bailouts will push the Irish deficit to 30% of GDP this year).
The other side to the equation is the size of the national debt, and again the Central Europeans compare well to the troubled euro zone members. The problem case here is Hungary, where public debt nudging 80% of GDP is higher than in Spain and similar to that in Portugal. The rest of the region has debt comfortably below 60% of GDP, and well below the levels seen in the euro zone casualties.
That should reassure against any short-term crises, but in the longer term there is little room for complacency. In particular, keeping debt levels under control will rely upon tightening spending drastically, even brutally. The big question mark here is perhaps over Poland. It has promised to reduce its deficit to below 3% of GDP by 2013, and faces big EU fines if it fails to do so. But with elections looming next year it has done little so far, and has consistently ducked the big questions over reforming everything from inefficient welfare systems to the backward farms that still employ a big chunk of its workers.
The other big question is over Hungary. It has taken brutal action to cut its deficit by more than half in recent years, with realistic ambitions to bring it below 3% of GDP next year. Nevertheless, it has been in deficit since 2004 and its debt levels are high enough to worry the currency market. It needs relatively high interest rates to attract outside investors. Fidesz might not like that but it is something the government needs to remember as it seizes control of monetary policy.