Euro dips as EU deal rally fades

Unravelling high public debt and fiscal shortfalls will slow recovery for the European Union's eastern economies and present laggard Hungary is poised to shine in 2011 after being the first to tackle painful reforms.

Policymakers said this week that the worst was probably over for a region hit by the collapse in western consumer demand and investor flight that has crushed growth and caused Hungary and other countries to turn to international bailouts.

Fuelled by ballooning public spending that has filled the vacuum left by the drop in consumption, growth has resumed in the strongest countries, Poland and the Czech Republic, and is expected to follow in many other states by late next year.

But even with the region's lifeblood -- foreign financing -- returning, central banks and governments are still cautious in signalling the all clear and are looking ahead at how the need to unwind huge fiscal expansions will effect growth mid-term. Hungarian deputy central bank Governor Ferenc Karvalits told Reuters Central Europe Investment Summit that while there were encouraging signs from the euro zone, policymakers had to be aware the recovery was still fuelled by fiscal stimulus.

"The hard question is what happens when the fiscal and monetary impulses are taken away," he told the summit, held in the Reuters office in Vienna.

"On the global level, there is a chance there will be a shortage of capital which would cause further deleveraging processes, which would also influence growth outlook."

On Monday, European Central bank Governing Council Member Ewald Nowotny said the economic contraction in the euro zone had hit bottom but growth would remain sluggish next year. [ID:nnLS314689]


Hungary was the first EU state to grab an International Monetary Fund-led lifeline last year, and was forced by its minders to cut back government spending and enact reforms including upping consumption tax and raising the retirement age.

Those were painful moves, also including cuts in pension payments and social spending at a time when unemployment is rising and the economy expected to shrink 6.7 percent this year and 0.9 percent next year -- much more than in its neighbours.

But the emergency measures have also quickly helped reverse imbalances and may give it a chance to rebound earlier to higher growth, and Karvalits said in 2011 it would take off.

"We project negative growth in 2010, but in 2011 we project 3.5 percent growth," he said.

That growth would beat the forecast performance of countries that did not pass as close to the brink as Hungary.

Czech central bank vice Governor Mojmir Hampl told the summit on Monday the recovery there would resemble an asymmetric "W", with a second low point, less deep than the first one, around mid-2010.

Hampl, like Karvalits, said the biggest risk to growth would be if the recovery in the region's biggest export destination -- the euro zone and particularly Germany -- would not gain speed.

But he also said he did not expect growth to quickly return to levels of 5 percent and more seen before the crisis.

"My suspicion is that if the economies do return to growth, the potential will be lower than prior to the crisis," he said.

The Czech government approved a deal last week to reduce the planned 2010 fiscal deficit from 7.5 percent of GDP to 5.2 percent. Ministers expect that to knock 0.6 percentage points off next year's growth, producing a contraction of -0.3 percent.

The Czech central bank sees 2011 growth at 2.2 percent, an estimate does not include any potential fiscal tightening steps.


In Poland, the only country in the EU to show positive growth in every quarter this year, the government expects GDP to grow by 1.2 percent next year and 2.8 percent in 2011.

But there are clouds gathering, with unemployment rising and credit conditions persistently tight -- factors present across the EU -- making life tough for firms.

Miroslaw Pietrewicz -- viewed as a hardline supporter of lower rates on the Polish central bank's policy council -- warned on Friday the outlook was not yet completely clear and advocated more interest rate cuts.

"There is a chance that the economic situation will be worse next year than it is this year," he said.

Poland's government expects its fiscal gap to top 7 percent of gross domestic product in 2010, more than double the limit required to join the euro.

And on Tuesday, the Polish central bank said it expected public debt to exceed 55 percent of GDP, the first of two thresholds which under current rules would likely trigger sharp cutbacks in later budgets, hitting consumption and wiping up to several percentage points off growth.

Financial Mirror, September 29, 2009 - Reuters|||East EU faces tough 2010, Hungary hopeful on 2011
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