December 17, 2011

Eastern Europe: The Much Stronger Fiscal Half of Europe


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.

Cost of a One Percent Increase in Interest Costs

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.”

Eastern Europe Requires Less Adjustment to Stabalize Public Debt

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.  

Capital Spending Booming in Turkey


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.  Go there now.

About The Author - Frank Holmes is CEO, Chief Investment Officer of U.S. Global Investors, an investment management firm specializing in commodities and emerging markets based in San Antonio, Texas.  Frank is also the co-author of The Goldwatcher(EconMatters author archive here.)


The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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