Eastern Europe: island of calm in a sea of Emerging Market uncertainty?
Stéphane Matile
Country Sales Head Switzerland Partnerships, Executive Director, Vontobel Asset Management
Eastern European Bonds offers a valid investment alternative in this increasing negative yielding territory environment.
In recent years, Eastern Europe has not been one of the favourite regions for international investors. Conflicts with Russia and the crises in Greece caused this entire market to be less popular than the major emerging markets in Asia and Latin America. But thanks to the interest rate hikes by the Fed, Eastern Europe may come more into focus again for investors.
Because many of the countries in Central and Eastern Europe boast solid economic fundamentals with reasonable current account deficits and consequently they may be better able to digest the rate-hike cycle in the USA compared to other emerging markets which are currently more favoured by investors. One exception in this regard is still Turkey, as this country’s higher dependence on foreign capital means that outflows and negative impacts can be anticipated.
The fact is that economic conditions in many of the region’s markets are better in an EU comparison. While the economies in Western Europe are growing modestly but growing nevertheless, many of the countries in Central and Eastern Europe are producing attractive growth rates. This performance is supported by the improved economic outlook for the Eurozone, along with the revival in domestic demand and the more expansive monetary policies of the central banks. While inflation rates are now back on the rise again, they remain at levels which provide the central banks with more leeway.
The performance of CEE assets during the first quarter was very strong. In particular, the bond markets and currencies did exceptionally well, even beating our expectations. This positive market trend can be traced back to the supportive influence of the monetary policy decisions in Europe and USA, as well as the return of EM investors’ risk appetite amidst otherwise unsettled conditions around the world. [1]
The economy in Central Europe now moves into the third strong year of recovery
In 2016, the CE region is headed for real GDP growth of just over 3% on average again. In South-eastern Europe, the convergence process is also under way, and GDP growth rates averaging 3% in 2016 are possible there as well. As in the euro area, this performance is propelled by private consumption. Retail sales figures for the start of year point to a continuation of this trend. Private consumption is being driven by the improvement in purchasing power and favorable developments on the labor market.
By contrast, we have lowered our 2016 GDP projection for Russia and Belarus to -2% for both. However, if the bottoming out for commodities and oil prices seen since January proves to be durable and prices begin to increase in the second half of the year, the recession in Russia should also come to an end. First, however, the budget deficits will have to be remedied.
All countries except Russia are net energy importer
Thus the oil price decline has brought a positive growth impulse. The decline in net energy imports due to changes in oil prices in % of GDP allows such countries to reallocate resources to other part of the economy such as infrastructure projects for example. Take Hungary for instance; in 2015 they have spent only 3% of their GDP for energy needs which is half of what they spent in 2014.
Nearly no export dependency with China
The growth problems in the other EM countries are hardly having any impact on Eastern Europe, as the growth driver has shifted from external trade to domestic demand. The monetary policy room for maneuver opened up by the ECB through to 2017 should also be a beneficial factor. If you consider the export rate, these countries have less dependency to China than other EM regions. Out of their total exports, most of the Eastern European countries have less than 5% of their exports going to China and the most important trading partner is the EU.
EU structural funds transfers
One important factor to the positive development of Eastern Europe is that it benefits since years from EU structural funds transfers (measured in % of their GDP p.a.). Effective utilisation of EU support has fostered the success of their economic performance in the last years. No other Emerging countries benefits from such structural steady regular transfers! For more information you can read the KPMG report.[2]
All in all, Raiffeisen Capital Management [3] views Central and Eastern Europe as an interesting region for investment, which may offer attractive risk-adjusted returns despite certain political risks. Poland’s government is being viewed very critically by the EU Commission, political conditions in Slovakia were reshuffled by the elections in March, already announced is the head of government in Ukraine that will change in the next two weeks, and in Croatia a government was finally formed, which may push ahead with reforms. There are also stability risks in relation to Russia’s tensions with Turkey, as well as its involvement in the Middle East and in Ukraine.
For the second quarter, however, we expect that events on the financial markets will be determined once again by economic news and monetary (external) factors.
Pioneers in Emerging Europe since 1994.
Raiffeisen Capital Management launched his first open-end Bond Emerging Europe in 1996. Exciting 20 years of real track record [4] gives you an overview how interesting this region is and what potential lies in.
[1] CEE Strategy 2nd Quarter 2016 by Raiffeisen RESEARCH
[3] Raiffeisen Capital Management stands for Raiffeisen Kapitalanlage-Gesellschaft m.b.H.
[4] Source: Raiffeisen KAG, own calculations, 17 June 1996 – 30 September 2015, Performance from 17th June 1996 to 22nd of July 2009 refers to the Raiffeisen-OsteuropaPlus-Rent which was hen merged in the Raiffeisen-Osteuropa-Rent. The performance is calculated by Raiffeisen KAG in accordance with the method developed by the OeKB (Österreichische Kontrollbank AG) on the basis of data provided by the custodian bank (in the event that the payment of the redemption price is suspended, using an indicative price). Past performance results do not permit any reliable inferences as to the future performance of an investment fund.
The following analysis and positioning refer to the current market situation and can change at any time without notice. They are not a forecast for the future development of the financial markets and/or funds of Raiffeisen Capital Management.