Central and Eastern Europe: Covid-19 Shock Triggers Deep Recession

Scope Ratings says that, with the euro area economy set to contract by about -6.5% in 2020 under a baseline scenario (and -11.5% in a severe scenario), EU-member CEE countries will also slide into deep recession this year. In the rest of the emerging Europe region, Russia faces the additional impact from lower-for-longer oil prices.

Turkey is vulnerable to the present global financial market turmoil. This relates to high volatility in FX and bond markets, which is likely to remain so over the duration of Covid-19 lockdowns, reflecting crisis impacts on global risk aversion. CDS and bond yield spreads in CEE widened markedly in mid-March before narrowing again in some cases more recently.

Varying magnitudes of economic contraction and sovereign ratings implications

The magnitude of this year’s contraction will vary from country to country, but the economic impact of the pandemic alongside higher spending needs will sharply widen budget deficits and push levels of public debt back towards 2014 levels for most CEE governments.

How severe the impact turns out to depend on how quickly and durably lockdowns in CEE economies as well as in western Europe can be relaxed, how effective the monetary and fiscal response to the crisis proves, and how fast an economic recovery takes hold later on in Q2 and through the second half of the year.

“The current situation is exceptional for CEE countries on four fronts,” says Giacomo Barisone, head of sovereign ratings at Scope. “The countries face: i) an unprecedented supply and demand shock to services sectors; ii) the adverse impact of global supply-chain disruptions and temporary suspensions of critical regional car industries; iii) renewed volatility in capital and currency markets; and iv) a collapse in oil prices, meaningful especially for Russia,” Barisone says.

Cyclical implications of the crisis relate to risks linked to rising unemployment, corporate defaults, borrowing rates, and FX and banking sector risks. Structural implications correspond to monetary and fiscal policy responses being deployed – which raise debt ratios longer-term and weaken the private sector and government balance sheets.

Sharp economic contractions in EU member states of CEE

In Scope’s baseline scenario, output in Poland and Hungary will contract by around 4% in 2020. In Poland, an important factor is the high share of temporary employment and self-employed, each around 17% of total employment, with these agents usually having limited cash buffers and are thus more exposed in times of economic distress. In contrast, Hungary has one of the highest exposures to global value chains among CEE countries, which constitutes a key risk in times of global economic turmoil.

Under the baseline scenario, Scope forecasts that output will contract by around 5.5% in the Czech Republic and Slovakia, given reliance on car industries, which account for 10% and 13% of their GDP, respectively, and by almost 7% in Slovenia, which has high goods trade with a severely weakened Italian economy. Romania’s economy will contract by around 4.3%, with limited room for fiscal stimulus, given the country’s already elevated budget deficits.

Bulgaria’s output will shrink by 4.6% this year. Croatia’s economy will be heavily hit – with a projected contraction of almost 7.5% in 2020 – given its dependence on travel and tourism, which contribute around a quarter of GDP (indirect activities linked to the sectors included). The small, open economies of the Baltic states will shrink by over 6% each.

Deep contractions in the rest of emerging Europe

For Russia, Scope has revised a baseline growth projection to around -5% in 2020, accounting for the recent oil price collapse, with Brent crude oil prices now trading around USD 20 a barrel at time of writing even after OPEC+’s 10m barrels a day output cut decision.

Scope anticipates a GDP contraction of 5% in 2020 in Turkey, revised down from an earlier estimate of about -1% in 2020. Turkey’s external sector weakness, including significant FX debt exposure and high external debt outstanding, increases its sensitivity to any extended period of global economic weakness and/or “risk-off” market conditions. Lastly, Georgia’s externally-exposed economy may contract over 3% in 2020.

Risks to baseline assumptions remain skewed to the downside as growth in CEE could be weaker if the economic shock from the Covid-19 crisis endures longer.

Read more in the rating agency’s Q2 2020 CEE Sovereign Update.

Giacomo Barisone is Managing Director in Public Finance at Scope Ratings GmbH.

Russia – Not the Rating it Needs but the Rating it Deserves

But let us not focus on the glorious admirers of Karl Marx. The very question of Russia’s rating is quite amusing.

Three large agencies, in particular, S&P, Fitch and Moody’s, currently provide an investment rating for Russia. Interestingly, the first two did not even lower Russia’s rating (despite the sanctions). Moody’s, in its turn, lowered it and then returned it to the previous level.

The main intrigue is whether this will have any effect. At this stage, the effect will most likely be a purely speculative one. The truth is that a rating is not valid unless it is awarded by two of three agencies. This means that the decision of Moody’s will not affect the situation with Russian assets. Let us see what will happen next. The picture may change if Russia’s rating continues to grow and at least two of three agencies ‘grant’ Russia one more level.

Does Russia actually deserve its current rating? Russia’s current rating implies that it is in the same line with such ‘locomotives of the global economy’ as Hungary, Morocco and Portugal. The ratings of Poland and Mexico, for example, are only one level higher. Only a little higher are the ratings of China and Ireland.

Does Russia deserve this indicator? The numbers, alas, give a negative answer.

Sovereign Dept as percantage of GDP

Let us analyze the ratio of Russia’s sovereign debt to GDP. In Russia, this ratio is one of the lowest in the world and the lowest among the countries presented in the tables below.

We can also review the ratio of gold reserves to GDP and budget replenishment.

The figures obviously speak of Russia’s underestimation. International reserves as percentage of GDP Credit Rating EM

Now let me summarize. According to real macro-economic indicators, Russia should have at least a BBB+ or A- rating. We can assume that geopolitics and sanctions have directly affected the decisions of the world’s leading credit agencies.

I prefer to keep away from excessive optimism. There are too many problems in the economy. Commodity dependence is still there. The ruble is very volatile. Let alone small and medium businesses that suffocate under the burden of bureaucracy and barely make ends meet instead of pushing the economy forward. Not all of them, of course, but the majority. The Russian economy is in dire need of reforms and the reduction of the state’s role. Anyway, this is a completely different story and I’ll certainly get back to it.

The article was written by Evgeny Kogan, Ph.D., investment banker, the author of the telegram-channel Bitkogan.