CEE sinks deeper into recession, outlook poor

PRAGUE Thu Nov 15, 2012 8:12am EST

PRAGUE (Reuters) - Much of central and eastern Europe fell deeper into recession in the third quarter, hit by austerity programmes and by slowing demand for exports, with a broad economic upturn still a distant prospect.

A widespread drought, bouts of political instability and a slowdown in main western trading partner Germany also weighed on Thursday's gross domestic product data from the region.

A slump in Hungary extended to nine months as GDP dipped 0.2 percent quarter-on-quarter, while the Czech Republic showed a worse-than-expected 0.3 percent decline, extending the economy's slide to a full year.

"It's pretty grim reading really... The main headwind is the problems in the euro zone which have weighed on trade, the banking systems and generally dragged on confidence, but there are local problems too," said Neil Shearing, EMEA economist at Capital Economics.

Central Europe depends heavily on exports to the euro zone and a slowdown there bodes ill for manufacturing, especially when paired with barriers to domestic growth.

"If we don't have a really messy escalation of the euro zone crisis, the region will avoid the kind of epic (GDP) falls that we saw in 2008-2009, but by the same token some countries will remain in recession and growth (elsewhere) will be pretty tepid," Shearing said.

Tax hikes and spending cuts have sapped domestic demand in much of the CEE region, with infrastructure investments falling along with welfare payments.

One exception is Slovakia, whose booming car sector kept the country on a solid growth path.

The region's poorest and least developed country Bulgaria eked out growth of 0.1 percent, and its biggest economy Poland is expected to report a slowdown in year-on-year growth to 1.8 percent on November 30.

DROUGHTS ADD TO WOES

Hungary and Romania - which reported a 0.5 percent quarterly GDP decline instead of the 0.3 percent drop predicted by analysts - both suffered droughts, damaging their farm sectors after good harvests in 2011.

Hungary has suffered from uncertainty surrounding Prime Minister Viktor Orban's plans for an aid deal with international lenders that would stabilize the central Europe's most indebted country.

Facing a sharp fall in popularity, Orban has campaigned against any IMF-imposed austerity and insisted on keeping a whip hand on policymaking that has included the highest tax on banks in Europe and legal reforms critics say have threatened the central bank's independence.

"We see the possibility of another five or six mini-budgets through next year which would tend to undermine policy credibility," said Peter Attard Montalto, strategist at Nomura.

Romania fell into a double-dip recession at the end of last year and has been struggling to weather the impact of austerity measures taken under an aid deal with the IMF.

"The government was forced to cut back on capital spending, with a negative implication for engineering works and the construction sector," said Mihai Patrulescu, senior economist at UniCredit in Bucharest.

The Czech Republic has seen its manufacturing shrink year-to date and export growth vanish, while the government has hiked taxes to rein in the budget.

"The (Czech GDP) numbers are worse than expected and it is even more surprising when you look at data from Germany and France that came in slightly better than expected," said David Marek, chief economist at Patria Finance.

"Domestic demand is still in a slump, and net exports could not offset all the negative impact of...domestic expenditures."

The Czech central bank has cut interest rates to 0.05 percent this month and went on a communication offensive to convince the public to spend more.

The government, squarely focused on fighting debt in the past two years, made a U-turn last week. Centre-right Prime Minister Petr Necas said that cutting debt further below 3 percent of GDP was no longer a priority.

Slovakia showed a slowdown but remained one of Europe's brightest spots with 0.6 percent quarterly growth rate.

One of the newer euro zone states, it has benefited from a boom in the car industry, and new capacity there added to an over 60 percent year-on-year jump in output in the sector.

(Reporting by Reuters bureaux; Editing by John Stonestreet)

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