Economy will bottom out in H1

Transcription

1 Central & Eastern European Strategy 2 nd quarter 213 Economy will bottom out in H1 Fiscal consolidation is proceeding Corporate Eurobonds: strong issuance from Russia High liquidity available for equity investments Equal stock and bond weightings

2 Content Central & Eastern European Strategy Topical issue: CEE under the sway of weak net exports and fiscal consolidation 3 s CEE incl. Austria 4 Asset allocation CEE incl. Austria 6 Focus on: Fiscal consolidation is the right answer 1 Austria 12 CE: Poland 14 Hungary 16 Czech Republic 18 Slovakia 2 Slovenia 21 SEE: Croatia 22 Romania 24 Bulgaria 26 Serbia 27 Bosnia and Herzegovina 28 Albania 29 Kosovo 3 CIS: Belarus 31 Russia 32 Ukraine 34 Turkey 36 Sovereign Eurobonds 38 Corporate Eurobonds 4 Equity markets 42 Sectors 48 Equities - top picks 54 Equities - region overview 59 Sector weightings in comparison 63 Technical analysis 64 Quantitative analysis 66 Acknowledgements 67 Explanation: e... estimate f... forecast p... preliminary figures n.v.... no value Abbreviations Currencies and Countries ALL Albanian lek BAM Bosnian marka BGN Bulgarian lev BYR Belarusian roubel CZK Czech koruna EKK Estonian kroon HUF Hungarian forint HRK Croatian kuna LTL Lithuanian litas LVL Latvian lats PLN Polish zloty RON Romanian leu RSD Serbian dinar RUB Russian rouble SIT Slovenian tolar SKK Slovak koruna TRY Turkish lira UAH Ukrainian hryvnia Economic abbreviations %-chg Percentage change (not in percentage points) avg average bp basis points C/A Current Account CPI Consumer Price Index FCY Foreign Currency FDI Foreign Direct Investments FX Foreign Exchange FY Full year GDP Gross Domestic Product LCY Local Currency mmav month moving average mom month on month O/N overnight rate pp percentage points PPI Producer Price Index qoq quarter on quarter T/B Trade Balance ULC Unit Labour Costs yoy year on year ytd year-to-date Stock Exchange Indices BELEX15 Serbian stock index BET Romanian stock index BUX Hungarian stock index CROBEX1 Croatian stock index PX Czech stock index MICEX Russian stock index SASX-1 Bosnian stock index WIG 2 Polish stock index Equity related DY Dividend yield EG Earnings growth LTG Long term (earnings) growth P/B Price book ratio P/E Price earnings ratio RS UR Eurozone CE SEE CIS CEE Recommendation suspended Under Revision Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovenia, Slovakia, Spain Central European countries - Poland, Hungary, Czech Republic, Slovakia, Slovenia South East European countries - Albania, Bosnia and Herzegovina, Bulgaria, Croatia, Romania, Serbia European CIS (Commonwealth of Independent States) countries - Russia, Ukraine, Belarus Central and Eastern Europe (CE + SEE + CIS) 2 2 nd quarter 213

3 Topical issue CEE under the sway of weak net exports and fiscal consolidation Recent declines in GDP will only gradually be replaced by growth during H2 213 in CEE Greater-than-expected leeway for interest rate cuts keeps a lid on exchange rates Equity market performance will remain heterogeneous in the spring During recent months, little has changed in terms of the fundamental economic situation. While most of the countries in Central Europe (CE) and Southeastern Europe (SEE) are now suffering from the contraction in production as anticipated, the CIS countries are still posting positive growth rates. Nevertheless, growth in these countries has also slowed to levels well below the long-term potential rates. As in the previous quarter, the recession in large parts of the Eurozone is dragging net exports deep into negative territory. Since Q4 212, GDP growth rates in CEE have also slipped into the red, aside from a few exceptions, as the widespread budget consolidation efforts and the modest increases in real income have hampered domestic demand for quite some time. The available indicators suggest that economic performance will bottom out in the first half of 213. Consequently, a more significant pick-up in growth throughout Eastern Europe will probably only start during the second half of the year. Growth in Russia and Ukraine was also much less dynamic early this year, compared to 12 months ago. In Austria, a mild improvement in growth will also probably only emerge after the spring quarter. Fiscal consolidation in Central and Southeastern Europe is proceeding at different speeds. Generally speaking, however, it is true that appetite for CEE government bonds both for LCY paper and Eurobonds has increased substantially, due to the extremely low yields in the Eurozone. This will also help ease the financing requirements of these countries as 213 progresses. The declines in inflation seen throughout the region early in the year should continue until the third quarter. This, in turn, will support some improvement in real incomes in the second half of 213. For Austria, we also estimate that consumer price inflation will drop below 2 % rom the second quarter, leading to headline inflation of 1.9 % for the year as a whole, which is considerably lower than last year s rate (2.6%). Impact on monetary policy and exchange rates The economic slowdown and the favourable course of inflation have significantly boosted the scope for easing monetary policy. For instance, interest rates in Poland have been lowered more than expected, and the new governor of the central bank in Hungary will also push forward with rate cuts. A modest downward trend in interest rates is even taking shape in Russia. The more pronounced declines in interest rates are partly reflected in somewhat weaker exchange rates. Political tensions in Hungary have also resulted in weakening of the HUF exchange rate to levels over 3 versus the euro. Impact on the bond and equity markets Strong foreign demand for CEE government bonds has helped to lower yield levels. We believe that most of the more expansive monetary policy has been discounted in prices. Consequently, we project that yields on government bonds throughout the region will remain broadly unchanged until mid-year. By contrast, we see more potential for the CEE equity markets, where we expect to see indices to rise by between 4% and 9% by the end of Q2. In terms of performance Istanbul should take the lead, followed by Bucharest and Vienna. Peter Brezinschek GDP development (% yoy) e 214f Eurozone CE SEE CIS CEE Recommendations 1 - stock markets Indices Buy Recommendations 1 debt markets Corporate bonds ATX, WIG 2, BUX, PX, BET, CROBEX1, ISE National 1 Sectors Overweight Industrials, Energy, Materials Underweight Telecommunications, Utilities Equities Buy CA Immobilien EUR Target price: EUR 12.7 MOL HUF 16, Target price: HUF 2,5 Azoty Tarnow PLN Target price: PLN 67. PKO BP PLN Target price: PLN 39.8 LUKoil RUB 1,941 2 Target price: RUB 2,555 Sell Halyk Bank 7.25% due 217 Evraz 6.75% due 218 Buy Promsvyazbank 6.2% due horizon: end 2nd quarter the indicated price is the last price as available at 6.3 a.m. (CET) on 21 March 213 Source: Raiffeisen RESEARCH 2 nd quarter 213 3

4 s Real GDP (% yoy) Countries e Consensus 214f Consensus Poland Hungary Czech Rep Slovakia Slovenia CE Croatia Bulgaria Romania Serbia Bosnia a. H Albania SEE Russia Ukraine Belarus CIS CEE Turkey Austria Germany Eurozone USA Source: wiiw, Raiffeisen RESEARCH Current account balance (% of GDP) Countries e 214f Poland Hungary Czech Rep Slovakia Slovenia CE Croatia Bulgaria Romania Serbia Bosnia a. H Albania SEE Russia Ukraine Belarus CIS CEE Turkey Austria Germany Eurozone USA Gross foreign debt (% of GDP) Countries e 214f Poland Hungary Czech Rep Slovakia Slovenia CE Croatia Bulgaria Romania Serbia Bosnia a. H Albania SEE Russia Ukraine Belarus CIS CEE Turkey Austria n.v. n.v. n.v. n.v. Germany n.v. n.v. n.v. n.v. Eurozone n.v. n.v. n.v. n.v. USA n.v. n.v. n.v. n.v. General budget balance (% of GDP) Countries e 214f Poland Hungary Czech Rep Slovakia Slovenia CE Croatia Bulgaria Romania Serbia Bosnia a. H Albania SEE Russia Ukraine Belarus CIS CEE Turkey Austria Germany Eurozone USA Exchange rate EUR/LCY (avg) Countries e 214f Poland Hungary Czech Rep Slovakia euro euro euro euro Slovenia euro euro euro euro Croatia Bulgaria Romania Serbia Bosnia a. H Albania Russia Ukraine Belarus 6,9 1,7 12,3 13,7 Turkey Austria euro euro euro euro Germany euro euro euro euro Eurozone euro euro euro euro USA Consumer prices (avg, % yoy) Countries e 214f Poland Hungary Czech Rep Slovakia Slovenia CE Croatia Bulgaria Romania Serbia Bosnia a. H Albania SEE Russia Ukraine Belarus CIS CEE Turkey Austria Germany Eurozone USA Public debt (% of GDP) Countries e 214f Poland Hungary Czech Rep Slovakia Slovenia CE Croatia Bulgaria Romania Serbia Bosnia a. H Albania SEE Russia Ukraine Belarus CIS CEE Turkey Austria Germany Eurozone USA Ratings 1 Countries S&P Moody's Fitch Poland A- A2 A- Hungary BB Ba1 BB+ Czech Rep. AA- A1 A+ Slovakia A A2 A+ Slovenia A- Baa2 A- Croatia BB+ Ba1 BBB- Bulgaria BBB Baa2 BBB- Romania BB+ Baa3 BBB- Serbia BB- not rated BB- Bosnia a. H. B B3 not rated Albania B+ B1 not rated Russia BBB Baa1 BBB Ukraine B B3 B Belarus B- B3 not rated Turkey BB Ba1 BBB- Austria AA+ Aaa AAA Germany AAA Aaa AAA USA AA+ Aaa AAA 1 for FCY, long-term debt 4 2 nd quarter 213

5 s Exchange rate forecast Countries 21-Mar 1 Jun-13 Sep-13 Mar-14 vs EUR Poland Hungary Czech R Croatia Romania Serbia Albania vs USD Russia Ukraine Belarus 8,64 8,8 9,3 1, Turkey EUR/USD : p.m. (CET) 2y LCY yield forecast Countries 21-Mar 1 Jun-13 Sep-13 Mar-14 Poland Hungary Czech R Croatia Romania Russia Turkey Austria Germany USA : p.m. (CET) Expected yield change Poland Hungary Czech Rep. Romania Bp-change of gov. bond yield in next 3 months Stock market indicators Germany USA Earnings growth Price/earnings ratio 13e 14f 13e 14f ATX 29.8% 11.9% WIG % 5.4% BUX 8.7% 11.1% PX 1 1.4% 5.9% MICEX 5.% 3.6% BET 31.4% 1.% CROBEX1 5.6% 5.5% ISE Nat.1 1.2% 8.7% Czech Rep. (PX): excl. Orco Property Source: Thomson Reuters, IBES, Bloomberg, Raiffeisen RESEARCH Key interest rate forecast Countries 21-Mar 1 Jun-13 Sep-13 Mar-14 Poland Hungary Czech R Romania Russia Turkey Eurozone USA : p.m. (CET) 5y LCY yield forecast Countries 21-Mar 1 Jun-13 Sep-13 Mar-14 Poland Hungary Czech R Croatia Romania Russia Turkey Austria Germany USA : p.m. (CET) Yield structure Poland Hungary Czech Rep. Romania Bp-spread between 1y and 3m maturity Stock market forecasts Germany USA Index estimates 21-Mar 1 Jun-13 Sep-13 Mar-14 ATX 2,452 2,56 2,5 2,63 WIG 2 2,396 2,5 2,45 2,65 BUX 18,25 19, 18,8 19,9 PX 983 1,2 1, 1,8 MICEX 1,459 1,5 1,48 1,62 BET 5,687 6, 5,9 6,2 CROBEX1 1,18 1,15 1,14 1,2 ISE Nat. 1 82,374 9, 87, 95, 1 11:59 p.m. (CET) In local currency 3m money market rate forecast Countries 21-Mar 1 Jun-13 Sep-13 Mar-14 Poland Hungary Czech R Croatia Romania Russia Turkey Eurozone USA : p.m. (CET) 1y LCY yield forecast Countries 21-Mar 1 Jun-13 Sep-13 Mar-14 Poland Hungary Czech R Croatia Romania Russia Turkey Austria Germany USA : p.m. (CET) LCY changes vs. EUR (% qoq) 1 HUF PLN CZK RUB RON TRY USD Mar 213 in comparison to 31-Dec 212 Source: Bloomberg Expected index performance 1% 8% 6% 4% 2% % ATX WIG 2 BUX PX Jun-13 Source: Raiffeisen RESEARCH MICEX BET Sep-13 CROBEX1 ISE Nat. 1 2 nd quarter 213 5

6 Asset allocation - performance CEE markets prove their potential to catch up Outperformance thanks to offensive overweighting of equities versus bonds Croatian equity market closes the gap Successful overweighting of Russian bonds in all periods Sum of last quarter 1 RBI portfolio (in EUR) -2.18% Benchmark (in EUR) -2.11% RBI outperformance (in EUR) -.7% by weighting of equities vs. bonds.6% regional equity weightings -.14% weighting of EB vs. LCY bonds -.1% country weightings of LCY bonds.4% country weightings of EB EUR.% country weightings of EB USD.% joint effects / duration -.2% EB...Eurobonds Period 1: 31-Dec Jan 213 RBI portfolio (in EUR) -.77% Benchmark (in EUR) -.75% RBI outperformance (in EUR) -.2% by weighting of equities vs. bonds.15% regional equity weightings -.17% weighting of EB vs. LCY bonds -.1% country weightings of LCY bonds.2% country weightings of EB EUR.% country weightings of EB USD.% joint effects / duration -.2% EB...Eurobonds Period 2: 3-Jan 26-Feb 213 RBI portfolio (in EUR) -.58% Benchmark (in EUR) -.51% RBI outperformance (in EUR) -.7% by weighting of equities vs. bonds -.9% regional equity weightings.1% weighting of EB vs. LCY bonds -.1% country weightings of LCY bonds.1% country weightings of EB EUR.% country weightings of EB USD.% joint effects / duration.% EB...Eurobonds Period 3: 26-Feb 21-Mar 213 RBI portfolio (in EUR) -.85% Benchmark (in EUR) -.87% RBI outperformance (in EUR).2% by weighting of equities vs. bonds.% regional equity weightings.2% weighting of EB vs. LCY bonds.% country weightings of LCY bonds.% country weightings of EB EUR.% country weightings of EB USD.% joint effects / duration.% EB...Eurobonds Due to the very challenging market conditions the CEE portfolio ended up with mild underperformance of 7 basis points (bp). The more offensive overweighting of equities versus bonds by 5 percentage points in the first period resulted in outperformance of 15bp, and much of these gains were taken following a somewhat more defensive weighting in the ensuing period. In the most recent period, this weighting was shifted to neutral. In the equities segment, Poland and Russia were overweighted in the first period based on their economic strengths, with these positions financed from Hungary and Croatia. Comparatively speaking, the bet on Russia developed the best, and the gains were taken in the next period as this weighting was maintained. Along with Hungary, the better-than-average performance in Croatia during the first period came earlier than expected, and in reaction to this an overweight position was successfully adopted in the following periods (+3bp). The financing from Czech equities during this period was also broadly advantageous. In the bonds segment, all in all a significant outperformance of around 5bp was achieved on the individual positions. During the first period, USD- and EURdenominated Eurobonds were underweighted versus LCY bonds, leading to a neutral result. During the first period, the overweight on Russia and Turkey was financed with an underweight on the Czech Republic and Hungary, which resulted in outperformance of more than 3bp, mainly due to the positive performance in Russia which was expected. During the following periods, the positions on Russia and Turkey remained overweight, this time financed exclusively from lower yielding Czech bonds. This ultimately resulted in outperformance of over 1bp. Performance Jan-13 Feb-13 Mar-13 RBI-Portfolio Outperformance (r.h.s.) Stefan Theußl in percentage points 6 2 nd quarter 213

7 Asset allocation - total portfolio CEE stock markets still in a waiting position CEE hardly able to profit from the rebound in the established markets so far Prospects for modest increases in core countries Neutral weighting of equities versus bonds Since the beginning of the year, very few of the CEE markets have been able to keep up with the performance seen on the established markets. For the CEE portfolio, we expect the risk-return profile for equities to be complicated over the medium term. Amongst other things, the reason for this is the differentiated situation for the two largest positions in our portfolio. On the one hand, there is Poland, which has robust, albeit weakening economic growth prospects and a financial market which is attractive for investors. On the other hand, there is Russia, where valuations are still looking very cheap in historical terms, but which is strongly driven by developments in commodities. In terms of currencies and yields, we do not expect any major moves throughout the CEE region in Q2. Yields on 1Y Czech government bonds should rise slightly, whereas a mild downward trend should be seen in Russia. Assuming there is a modest economic recovery, we see the yield potential for equities at around 4% for this region on the whole. For bonds, we expect a development of around 2%. In view of the relatively elevated uncertainty in the CEE markets, we would expect a higher premium on risky assets and consequently we weight these asset classes neutral versus each other. Within the bond portfolio, the current conditions do not leave much leeway for overweighting LCY bonds versus Eurobonds. The first group is profiting from strong capital inflows and for the second group there is a trend towards tighter spreads. Consequently, we also shift both these positions to neutral. Stefan Theußl Risk-return (in %) Historic ytd performance in % Historic 1y volatility in % In local currency CEE portfolio weightings Q1 213 LCY-bonds: 4% [ pp] DJ Eurostoxx CEE CTX EB USD: 5% [ pp] RTS- Index WIG 2 EB EUR: 5% [ pp] BET 1 HTX Equities: 5% [ pp] LCY local currency [-], [+] = Over-/underweight versus benchmark Source: Raiffeisen RESEARCH Historical volatility & performance (in %) Equities 1 Bonds Volatility Performance Volatility Performance Countries EUR LCY EUR LCY EUR LCY EUR LCY Czech Republic Hungary Poland Romania Russia Turkey Croatia CEE MSCI indices Volatility in EUR; 3 months volatility annualised; ytd performance in EUR LCY local currency 2 nd quarter 213 7

8 Asset allocation - bonds Demand remains robust for LCY bonds Sustained inflows of capital into Eastern European LCY bonds More rate cuts ahead amidst slack economic conditions Currencies mostly expected to move sideways Portfolio weightings: bonds* Portfolio Benchmark Difference EB USD 1.% 1.%.% EB EUR 1.% 1.%.% LCY 8.% 8.%.% Czech Republic 17.% 2.% -3.% Hungary 2.% 2.%.% Poland 45.% 45.%.% Romania 5.% 5.%.% Russia 6.5% 5.% 1.5% Turkey 6.5% 5.% 1.5% Croatia.%.%.% * share in percentage points Source: Raiffeisen RESEARCH In the quarter ahead we expect to see quite uniform development on the LCY bond markets in the CEE portfolio. No major shifts are anticipated in exchange rates or yields. The only country where there is significantly elevated event risk is Hungary. Nevertheless, the currency has already shown a strong negative reaction, and consequently we do not expect to see any large-scale moves in the forint this quarter. Against the background of this sideways trend, we make two carry bets in the bond portfolio. We overweight high-yielding Turkish government bonds and Russian government bonds by 1.5% each and finance this with an underweight on Czech government bonds, which have the lowest yields in the portfolio. Historical relative performance* 4.% 3.% 2.% 1.%.% -1.% As we expect both the Russian and Turkish central banks to lower interest rates, additional price gains may improve the results, along with the interest rate benefits. Investors intense investment needs and the hunt for somewhat higher yields may lead to further inflows of capital into the high-yielding bond markets and result in some overshooting, although this is not reflected in our forecasts due to the fact that the Eastern European bond markets have already reached quite high valuation levels. Another negative factor may be a sharp appreciation of the euro, as both the Russian rouble and Turkish lira are partially oriented to USD. -2.% Czech Rep. Hungary Poland EUR Romania LCY Russia Turkey Croatia Veronika Lammer *in percentage points, year to date, local currency bonds versus portfolio bond benchmark Expected bond market performance (in %) 3m 6m 9m 12m Countries EUR LCY EUR LCY EUR LCY EUR LCY Czech Republic Hungary Poland Romania Russia Turkey Croatia Not annualised; 1y treasury bond, LCY local currency Source: Raiffeisen RESEARCH 8 2 nd quarter 213

9 Asset allocation - equities Positive conditions on the equity markets, but no rally Eastern European equity markets moving in line with the established markets Romania and Poland as modest outperformers Russia and Czech Republic offer less potential Following divergent performance in the first quarter, we mainly expect to see more strong price gains in Turkey during the second quarter. This market, however, is not represented in the CEE portfolio. Romania should follow close behind, after seeing a very dynamic beginning to the year following a longer period of underperformance; we see the valuation of the BET as very attractive, with a 213e P/E ratio of 6.1. The state-regulated, high dividend ratio increases the attractiveness of the Romanian market, which we consequently overweight by 1.5 percentage points. Portfolio weightings: stocks Portfolio Benchmark Difference Czech Republic 13.5% 15.% -1.5% Hungary 12.% 12.%.% Poland 26.5% 25.% 1.5% Russia 38.5% 4.% -1.5% Croatia 3.% 3.%.% Romania 6.5% 5.% 1.5% Source: Raiffeisen RESEARCH Due to its size and liquidity, the Polish equity market also remains interesting. The decline in earnings anticipated for this year has probably already been priced in and hopes for improvement during the year should entice investors back to this market. Poland is also overweighted by 1.5 percentage points. Historical relative performance* 2% 15% 1% The Russian MICEX looks less attractive, as this market should suffer from the gloomier economic outlook and weak projected growth in aggregate earnings for 213. Nor will oil prices provide much support in the second quarter. The performance expectations for the Czech PX are also lower than for the other CEE countries. We consequently underweight both of the equity markets 1.5 percentage points. Veronika Lammer 5% % -5% -1% -15% Romania Croatia EUR Russia Hungary Local currency Poland Czech Republic *in percentage points, year to date, to MSCI CEE, since 18 December 212 Expected stock market performance (in %) 3m 6m 9m 12m Countries EUR LCY EUR LCY EUR LCY EUR LCY Poland Hungary Czech Republic Russia Romania Croatia Not annualised, LCY local currency Source: Raiffeisen RESEARCH 2 nd quarter 213 9

10 Focus on Fiscal consolidation is the right answer 1 Today, many CEE governments would be less flexible in raising their spending and rolling out new fiscal stimulus Elevated public debt for many CEE governments requires fiscal tightening We believe that revenue-boosting measures alone will not fully compensate for the lack of spending cuts Thus we believe CEE governments will be better served by preserving fiscal discipline Fiscal stimulus vs. output gap 29 (25) (2) (15) (1) Fiscal stimulus = public balance % GDP 29 minus 24-8 average, GDP gap = actual GDP growth rate % minus mid-term potential GDP, inverted scale /RBI Fiscal consolidation vs. output gap (6) (5) (4) (3) (2) (1) (5) - - RS HU HR GDP gap BY SI CZ BG HU UA SK PL Fiscal consolidation = public balance % GDP 212 minus balance 29, GDP gap = actual GDP growth rate % minus mid-term potential GDP inverted scale /RBI Public finances, % GDP Fiscal balance UA RU HR BG SK SI RO CZ BY RS PL Fiscal stimulus RO RU GDP gap 212 Deficit reduction (7) Under RS (6) pressure UA (5) CZ SK HR (4) SI PL (3) (2) RO HU Sustainable BG (1) BY - RU 5 1 Public debt Unsustainable Data as of 212, Maastricht defined levels for fiscal deficit and public debt are minus 3% and 6% respectively, fiscal balance inverted scale /RBI CEE governments have demonstrated good resolve in tackling loose fiscal policies from the past. A fair amount of fiscal consolidation took place between 21 and 212. Nevertheless, the consolidation path was not straightforward since a large bulk of the fiscal consolidation occurred when the eurozone crisis escalated. So far, the recession scare brings the old question back as to what fiscal policy CEE governments should pursue in such a situation. Perhaps incidentally, we find no clear evidence suggesting that fiscal consolidation automatically results in excessive output loss. Consequently, we see no evidence in favour of excessive fiscal packages in CEE, as proven by the fairly uneven and often modest response of regional economies to the stimulus. Also, the success of the fiscal measures remains highly dependent on the package design and implementation quality, as well as the overall strength of the economy to absorb such stimulus. This perhaps explains the phenomenon of Russia and Ukraine, both of whom suffered tremendous economic losses despite the major stimulus applied by their governments during the crisis. Another exemplary issue is the impact of fiscal loosening on public debt. It is no secret that the majority of CEE governments had modest and sometimes very little public debt as measured relative to GDP, and compared very favourably with many developed markets. However, fiscal loosening and difficult economic conditions led to the rapid accumulation of new debt and the sharp deterioration of their public finances. IMF recommends emerging markets should attain a level of public debt that does not exceed 4% of GDP. If we applied a conservative approach using the IMF recommendation for public debt in emerging markets, we would find the majority of CEE countries in breach of the limit. We also apply the IMF approach, which measures financing sustainability by using the difference between the real interest rate on public debt and the real GDP growth rate (r-g ratio). Consequently, a positive difference underlines the higher risk of a debt stock increase. Despite the IMF sample not including all CEE countries, we find that except for Russia and Estonia, who have small public debt, the r-g ratio points towards a higher risk of debt growth for the rest of CEE and requires an urgent response, including belt tightening. Since governments also borrow in foreign currencies and sell debt to non-resident investors we cannot ignore currency risk and ownership concentration. As we can see, nearly all CEE countries depend on foreign capital and have foreign liabilities that substantially exceed their foreign assets. The only exception is Russia, which receives hefty trade surpluses from energy commodity trading. Although a negative NIIP (Net international investment position) is fairly common for many fast-growing developing countries, it is alarming that the debt-to-export ratio stands at over 15% for the majority of countries, higher than normal, while for Romania it exceeds 2%. All in all, this emphasises the higher external risk, since CEE countries might find it difficult to sustain a higher debt leverage in times of market volatility and global financial crises. 1 This section is only a summary of our Special CEE public finances, 28 Mar 213, feel free to request your electronic copy of the report or please visit Raiffeisen RESEARCH site nd quarter 213

11 Special One more aspect we find important in this context is the share of public debt in foreign currency and the share of non-resident investors in total government debt. The higher reliance of the public sector on foreign borrowing and foreign investors increases governmental vulnerability to sudden market shocks and credit crunches like we saw during the 29 crisis. In fact, CEE governments remain the largest issuers of sovereign eurobond debt, with a share of new placements accounting for a good 71% of overall EM placements in 212 and nearly 81% since the start of 213. Although there is no particular issue of concern at the moment in terms of public debt currency composition and foreign participation, we must re-emphasise the importance of market confidence in conjunction with a country s overall external vulnerability and fiscal position. Consequently, CEE governments must pursue economic policies which are consistent with the economic situation and market risk perception. Another common consequence of fiscal consolidation is the negative impact on government output. Interestingly, the share of government output for CEE is not overly different from that in developed EU states. Although hiking taxes is the normal response for governments in stress situations, the governments also need to strike a delicate balance so as not to overdo the taxation, which otherwise can be damaging for economic confidence. After conducting a review of literature, we agree with the following statements. First of all, there is a growing consensus among experts that taxes on corporate and personal income are particularly harmful to economic growth, with consumption and property taxes less so. This is because economic growth ultimately comes from production, innovation, and risk-taking. Secondly, raising consumption taxes, whilst at the same time lowering taxes on labour and capital, can stimulate an economy s growth forces. 2 We assume that the lower the tax burden is on the economy, the more flexible the government can be in raising taxes. So far, for many CEE economies except Hungary, the tax burden does not look overly high. A bunch of CEE countries have a tax burden below 3% of GDP, while even for higher-income CEE states this is less than 4% of GDP, with Hungary bearing the highest ratio. Still, we cannot advocate any straightforward conclusion because many poorer CEE countries also suffer from lower tax collection rates, and many have fairly large shadow economies, which can complicate the task. Incidentally, the size of the shadow economy is fairly large in the majority of CEE states. This in turn can impact on government tax collection efforts, especially in crises. So far it is not only tax increases that will be necessary for CEE but a strengthening of fiscal administration too. We also recall the Laffer Curve explaining why overly high taxation decreases revenue collection after a certain point ( In the end we found no clear evidence to suggest that a large fiscal stimulus will automatically deliver a proportionately large boost to the domestic economy. Moreover, for the majority of CEE governments the main task will be to stabilise public debt at an affordable level. We have identified no government in CEE which could safely opt for fiscal loosening just now. We also find financing and external vulnerabilities high for most CEE countries, which advocates against fiscal complacency and does not favour lax policies. As a result there is no space for the majority of CEE countries to loosen the fiscal strings, unless they can achieve sustainable deficit levels allowing them to stabilise public debt ratios in GDP terms. Selective EM countries r-g, % BG HU TR ZA LV MX IN CN Real effective interest rate (r) Real GDP growth (g) Interest rate growth differential (r g) r-g is the difference between the real interest rate on public debt and the real GDP growth rate (r g) is an important driver of debt dynamics, positive difference underscores higher risk of debt stock increase Sources: IMF staff estimates and projections, IMF Fiscal Monitor 1/12 Fiscal Indicators Index by Region Latin America Emerging Asia Emerging Europe (Scale, 1); 29 GDP weights at purchasing power parity used to calculate weighted averages. Larger values of the index suggest higher levels of fiscal vulnerability Sources: Baldacci and others (211); IMF Fiscal Monitor 1/12 Private debt trends, % GDP Private debt stock unsustainable, high risk PT ES HU EEGRSI IT LV BG stabilization needed SK CZ PL RO LT acceptable Private debt increase Selective EU and CEE economies, private debt includes obligations of private sector entities and households in all currencies, private debt stock as of 211 eop, private debt increase from 21 to 211 eop, all in % GDP Sources: Eurostat, Raiffeisen RESEARCH Gintaras Shlizhyus 2 What Is the Evidence on Taxes and Growth? by William McBride Chief Economist at the Tax Foundation December 212, The impact of tax systems on economic growth in Europe by Deutsche Bank (DB) Research October nd quarter

12 Austria Austria Is the economy past the trough? Mild (qoq) decline in Q4 212, GDP should mark the cyclical bottom Leading indicators point to economic revival as the year progresses Employment at a high level, but only lacklustre consumption development Inflation (yoy) to fall in the months ahead Industrial sector: Outlook brightened Industrial production (% yoy) Industrial confidence Capacity utilisation (%, r.h.s.) Perceived inflation now lower Inflation (HICP, % yoy) 4 2 Prices of weekly bulk -2 purchase (% yoy) In the fourth quarter of 212 Austrian economic output declined for the first time since Q1 21, but the contraction of.1% qoq in real GDP was relatively small (Eurozone: -.6% qoq). Furthermore, weaker economic performance had already been anticipated for the final quarter of 212. In Q4, it was private consumption that made the largest negative contribution to economic growth. Net exports also had a negative impact on the quarterly GDP growth rate, due to a significant deterioration in export growth (from +.9% qoq in Q3 to -.3% qoq in Q4), stemming from the development of goods exports. By contrast, construction investment was relatively robust, but the performance was slightly less dynamic than in the previous quarter. All in all, the Austrian economy expanded at a rate of.8% in real terms in 212. Even though the next few months are not expected to be a boom period for the Austrian economy and more significant acceleration is only expected for the second half of the year, it is quite likely that the decline in real GDP in the last quarter of 212 was the low point. While it is true that purchasing managers indices for manufacturing as well as business confidence have not returned to expansionary territory, strong gains have been seen in both of these leading indicators in the previous months. At the same time, consumer confidence has improved even more since bottoming out in September 212, but one must also keep in mind that this indicator previously declined stronger than industrial confidence. Furthermore, readings for consumer confidence continue to be lower than the long-term average. Another factor is that retail sales which fell.3% in 212 are still not yet suggesting any rebound in actual consumer demand. Private consumption is only expected to pick up more strongly during the second half of 213. While the develop- Key economic figures and forecasts e 214f Real GDP (% yoy) Private consumption (% yoy) Gross fixed capital formation (% yoy) Nominal exports (% yoy) Nominal imports (% yoy) Trade balance (EUR bn) Current account balance (EUR bn) General budget balance (EUR bn)* General budget balance (% of GDP)* Unemployment rate (avg, %, EU definition) Consumer prices (avg, % yoy) Real wages (% yoy) Unit labour costs (% yoy) * state, provinces, municipalities and social security authorities Source: Statistics Austria, Thomson Reuters, Raiffeisen RESEARCH 12 2 nd quarter 213

13 Austria ment of employment continues to be surprisingly stable, the number of registered unemployed is rising sharply in year-on-year terms. Due to the lagging nature of the labour market, a recovery in economy activity will probably be felt relatively late there. At any rate, the sharp decline in the number of vacancies means that a turnaround on the labour market looks unlikely in the near future. In the industrial sector, sentiment has clearly improved in recent months, but here again confidence has still not yet returned to the long-term average level. In contrast to private consumption, however, some initial signs of a rebound are being seen here. For instance, industrial production rose by 3.5% mom in December (seasonally adjusted). As a result, the base effect for Q1 213 amounts to 1.9% qoq. Furthermore, capacity utilisation is judged to be slightly higher again, and with demand picking up this may prompt companies to undertake more investment in capacity expansion. Following subdued developments at the beginning of this year, we expect investment activity to pick up in the second half of the year, which also applies to exports. For example, the Raiffeisen Export Index, which weights the leading indicators of Austria s most important export countries based on their significance for Austrian goods exports, has improved continuously in recent months. For 213 as a whole, we expect GDP growth of.5% in real terms, followed by 1.5% next year. Inflation (HICP) is currently at an elevated level (February: 2.6% yoy), but has already come down somewhat from the peak registered at the end of 212 (December: 2.9% yoy). In the months ahead, further declines are expected which should bring down the inflation rate to 1.9% in 213, from 2.6% in the previous year, followed by a slight increase to 2.% in 214. Price inflation for essential goods (mini basket of goods and services weekly bulk purchase) has fallen tangibly and is for the first time since end-29 lower than the overall rate of inflation (HICP). Matthias Reith GDP: value added by sector Change (% yoy, in real terms) e 214f Agriculture & forestry Prod. of goods/mining Energy/water supply Construction Wholesale and retail trade Transportation Accom. & restaurant trade Information and communication Credit and insurance Property & business services Other economic services Public sector Healthcare, social services Other services Gross domestic product Source: Statistics Austria, Raiffeisen RESEARCH GDP: expenditure composition Change (% yoy, in real terms) e 214f Private consumption Public consumption Gross fixed capital formation Equipment Construction Exports (broad definition) Imports (broad definition) Gross domestic product Source: Statistics Austria, Raiffeisen RESEARCH Contributions 1 to real GDP growth (qoq),6,5,4,3,2,1, -,1 -,2 -,3 -,4 -,5 Q2 11 Q3 11 Q4 11 Q1 12 Q2 12 Q3 12 Q4 12 Q1 13 Q2 13 Q3 13 Q4 13 Private Consumption Public Consumption Investment Stocks External Trade Real GDP 1 in percentage points 2 nd quarter

14 Poland Slowdown bottoming out 213 unlikely to be strong bond year Commitment to tight fiscal stance not growth supportive, but supports leave from EU Excess Deficit Procedure Tangible slowdown of economy resulting in inflation well below target, which creates upside for real wage growth No more rate cuts expected, flows into and out of the bond market could influence EUR/PLN in the months ahead Bond yields still well anchored at current low levels, while there might be some gradual upshift going forward Real GDP (% yoy) Real GDP (% yoy) 213e Industrial output (% yoy) Budget balance and public debt e 214f 214f General budget balance (% of GDP) Public debt (% of GDP, r.h.s.) Economic outlook In Q4 212 GDP growth slowed down to 1.1% yoy, decelerating from average growth of 2.4% in the first three quarters of the year. Once again, growth was fully generated by net exports while internal demand declined by.7% yoy. The Polish economy remains on a slowing trend which is mostly reflected in private consumption and investments. In Q4 212 private consumption declined by 1% yoy, marking the first negative rate in the history of this data series. Households low willingness to buy will probably persist into H1 213, due to the high unemployment (currently exceeding 14%) and nominal wage growth ranging near its historical lows in 212, due to high inflation (resulting in negative real wage growth) and unsupportive consumer confidence. As the beginning of 213 featured a surprisingly steep decline in inflation, the negative impact of this factor on private consumption will fade. We consequently expect limited declines in consumption in H1 213, and project modest growth returning in Q3 and Q4. Apart from unusually weak consumption, the Polish economy is suffering from tight fiscal policy and falling public investments, which are linked to EU funds. As new flows of funds from the fiscal period are expected to appear in the economy in 215 at the earliest, this factor will generate no momentum for the economy for the next two years at least. Slack public investment is accompanied by negative developments in private gross fixed capital formation and an almost neutral contribution from inventories. As a small open economy the main positive driver for growth may come from the external environment. This means that in line with the slowly improving German economy (as the main trading partner) and low base effects the Polish economy should show some initial signs of improvement in H2 213 when we expect GDP growth to average 1.4%-1.6% yoy. Key economic figures and forecasts e 214f Nominal GDP (EUR bn) Real GDP (% yoy) Industrial output (% yoy) Unemployment rate (avg, %) Nominal industrial wages (% yoy) Producer prices (avg, % yoy) Consumer prices (avg, % yoy) Consumer prices (eop, % yoy) General budget balance (% of GDP) Public debt (% of GDP) Current account balance (% of GDP) Official FX reserves (EUR bn) Gross foreign debt (% of GDP) EUR/PLN (avg) USD/PLN (avg) nd quarter 213

15 Poland Weak internal demand and sub-potential GDP growth are generating deflationary pressures. The latest inflation report projects that the negative output gap will remain until end-214. Unsupportive GDP growth projections and inflation forecasts point to a risk of the CPI staying at the bottom of target range (1.5%-3.5%) in 215 as well, and this has encouraged the Polish MPC to move ahead with further cuts in interest rates to 3.25%. In our view, the 5bp cut in March most probably marks the end of the MPC s rate-cutting cycle and central bankers will now move into wait-and-see mode. This scenario, which is also suggested by the MPC members themselves, is coherent with our view of the Polish economy bottoming out in mid-213 and inflation peaking to its 2.5% target in 214. Financial markets outlook Early 213 saw some weakening of the Polish currency as EUR/PLN reached a 4-month high at over The main source of this was local factors which gained importance once the slowdown began to pose a threat of the Polish economy slipping into recession. Although recent data provide a much more optimistic view, the drop in inflation which prompted the MPC to cut interest rates by 1bp during the last 3 months also kept PLN under pressure. On the other hand, as we expect that the MPC concluded the easing cycle with the last 5bp cut, monetary policy in Poland should no longer provide reasons for any significant weakening of the currency, even though to some extent the market still seems to believe in the possibility of more cuts (as indicated by FRA quotations). From the perspective of external factors, there are still several risks which should limit the appreciation potential of the zloty in Q2 or even cause temporary weakening. In the short term, Eurozone uncertainties may still cause increased risk aversion while in the medium term the main condition for the expected EUR/ PLN decrease towards 4. in H2 213 is the assumption of a recovery in the Eurozone economy. This improvement should support market sentiment as well as provide an impulse for higher GDP dynamics in Poland. Apart from the external situation the risk for PLN still stems from the record high share of foreign investors on the Polish sovereign bond market (now above 35%). A sudden outflow of foreign capital could weaken the currency as well as lead to further increases in yields. However, even though we see it as highly probable that some of the (speculative) inflow from 212 will be reversed later in the year, it should not be a sudden retreat as some investors will still find it attractive to allocate or keep funds on the Polish market. Positive investor sentiment on Poland was enhanced lately by the revision of the Polish rating outlook to positive by Fitch. Furthermore, even though fiscal consolidation may slow down the Excess Deficit Procedure is still likely to be lifted in 213, confirming the sound fiscal position. Marta Petka-Zagajewska, Dorota Strauch Interest rate forecasts 21-Mar 1 Jun-13 Sep-13 Dec-13 Mar-14 Key rate Consensus Exchange rate development Mar-11Sep-11Mar-12Sep-12Mar-13Sep EUR/PLN (eop) PLN yield curve (%) Yields as of Mar-13 Yield curve Mar-13 Yield curve Dec-12 Jun-13 Exchange rate forecasts 21-Mar 1 Jun-13 Sep-13 Dec-13Mar-14 EUR/ PLN Cons USD/ PLN Cons : p.m. (CET) Yield forecasts 21-Mar 1 Jun-13 Sep-13 Dec-13 Mar-14 2y T-bond Cons month month month month : p.m. (CET) 2 Bid rate 5y T-bond y T-bond Cons : p.m. (CET) 2 Ask yield 2 nd quarter