Central Europe’s “Good “ countries lose ground while the “Bad” catch up

Until recently Poland, the Czech Republic and Slovakia were seen as the countries with the best governing standards, the most solid banking systems, the most open to foreign investors and with generally predictable politics. There used to be a pretty easy split between the good and bad halves of central Europe but today it is becoming increasingly difficult to tell them apart.

The bad guys were further south: Hungary, controlled by Viktor Orban’s nationalists espousing unorthodox and populist economic policies, and Romania and Bulgaria, burdened by deep corruption and unstable politics brought up the rear. The well-governed Baltic countries made it onto the worse side of the ledger thanks to their plummeting economies and very weak banking systems.

But now that growth is returning to most of the countries of central Europe, those divisions are increasingly difficult to find.

Poland, the region’s largest economy, is only slowly emerging from an unexpectedly sharp economic slowdown that came within a hair of pushing the country into its first recession in two decades. Polish politics have also become much more unpredictable, as Donald Tusk’s Civic Platform party loses ground to Law and Justice in opinion polls.

“For the first time in many years we’re seeing political risk rising in Poland,” says Nicholas Spiro of Spiro Sovereign Strategy, an economic analysis firm.

Poland has also tarnished its international reputation with a controversial government plan to revamp the pension system by shifting assets from privately run OFE pension funds to the government system. Although the IMF and ratings agencies seem to be fairly calm about the changes, confiscating over 50 per cent of OFE assets held in the form of government bonds has resulted in a spate of bad publicity.

“The reform starts with confiscation and ends by revoking the promise that assets that workers accumulate over time (and which were taken from their wages) will be theirs to spend in retirement,” said a recent column in the Wall Street Journal, which called the changes a “swindle”, while the Economist called the plan “Smoke and mirrors”.

The changes could also have an adverse impact on the Warsaw Stock Exchange, the region’s largest capital market one one of the reason’s that Warsaw has become the CEE’s financial hub.

The Czech Republic and Slovakia are both battling very deep corruption problems, caused by unhealthily close ties between politics and business. Both the Czech Republic and Slovakia figure near the bottom end of a recent Ernst & Young corruption perception survey, with 84 per cent of Slovak business leaders saying that bribery and corrupt practices are widespread and 73 per cent of Czechs agreeing.

Slovakia’s politics were overturned when the centre-right government coalition collapsed over the eurozone crisis, and was destroyed in the ensuing election campaign where embarrassing secret police tapes showed senior politicians engaged in corrupt deals with powerful businessmen.

The government of Robert Fico has since rolled back many of the deep economic reforms that had made Slovakia one of central Europe’s star performers and a darling of foreign investors.

In Prague, the government of Petr Necas, dubbed the “Mr Clean” of Czech politics, collapsed earlier this year in a tawdry sex and influence peddling scheme. The left, which looks poised to win snap parliamentary elections, is promising to undo some of the tight fiscal policies of former finance minister Miroslav Kalousek.

“On the left, the current opposition party the CSSD is staging a very populist campaign of reversing structural and welfare policy reforms ” says Peter Attard Montalto of Nomura, the investment bank.

While the core of central Europe experiences a turn in fortunes, the periphery is doing better than expected.

Despite populist policies and a disregard for many democratic norms that raises hackles in Brussels, Mr Orban has actually managed to get Hungary out of a recession.

Although ideas aimed at helping the millions of Hungarians with foreign currency mortgages may imply a big hit to banks’ bottom lines, Hungary remains attractive to foreign investors. The country hosts a new €900m Audi car plant, output data is doing better than expected, and Hungary recently exited the EU’s excessive deficit procedure.

Romania has also exited its excessive deficit procedure after the country brought in a series of tough measures including cutting public sector wages and changing its pension system to rebalance public finances. Romania is now expected to grow by 1.7 per cent this year and by 2.2 per cent in 2014, among the best in the region.

A destructive battle between Romania’s president and prime minister has abated, restoring political stability.

Bulgaria has among the tightest public finances in central Europe, running a deficit of only 0.5 per cent last year, although that may grow to 2 per cent this year – still better than almost anywhere in the EU. But the Balkan country has been rocked by months of political protests. Premier Boiko Borisov was forced out earlier this year over outrage following anti-austerity demonstrations, but protesters are still in the streets despite May’s snap elections.

The Baltic three have also returned to growth, although they have still not not returned to 2007 output levels. Estonia is now in the euro, Latvia is poised to join next year, and Lithuania is in line to adopt the euro as well.

Latvia undertook some of the most draconian economic reforms in the world after the economy collapsed into a depression in 2009, a policy that saw premier Valdis Dombrovskis returned to office.

“If you are in a situation where you have lost the confidence of financial markets, it is best to act quickly to restore that confidence,” said Mr Dombrovskis.

The erosion of the old gap between the “good” and the “bas” in the CEE makes for a much more level laying field across the region. That means that Poland, the Czech Republic and Slovakia are going to have to work harder to continue attracting investors and will not be able to coast on their reputations. It also evens the chances of CEE countries in the Balkans and the Baltics.

By Jan Cienski, Warsaw correspondent for the Financial Times


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