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East Europe’s Growth Likely Faltered as Debt Crisis Intensified

Eastern European economic growth probably slowed in the third quarter as Europe’s debt crisis damped demand for exports, the region’s main driver for expansion, and stunted lending by banks.

The Czech and Hungarian economies probably grew at the slowest pace in 1 1/2 years, while Bulgaria’s recovery may have stalled after returning to growth a year ago and Slovakia’s output may decelerate for a second consecutive quarter in the July-September period, Bloomberg surveys of economists show.

Eastern Europe’s export-led recovery is in peril as the deepening crisis in the euro area infects the region through trade and banking links. Recession risks in the euro region and weak domestic demand, which is still recovering from the worst slump in two decades, have intensified the risks of economic stagnation.

“We expect a slowdown of gross domestic product growth across the board as a result of weaker exports and tightening lending conditions,” said Raffaella Tenconi, an economist at Bank of America Merrill Lynch in London, by phone yesterday. “The latter affects primarily Hungary at this stage.”

Lenders that bankrolled eastern Europe’s boom before the 2008 credit crunch are being squeezed by deteriorating loan quality and slowing economic growth. The region was the world’s worst-hit in the aftermath of the collapse of Lehman Brothers Holdings Inc. three years ago and may face the threat of another sharp slowdown as the euro area’s troubles spread.

Financial Stability

The region’s financial stability is at risk as western European banks trim their balance sheets by as much as 2.5 trillion euros ($3.4 trillion) to meet capital requirements, analysts at Morgan Stanley said in a note yesterday.

UniCredit SpA, Erste Group Bank AG, Raiffeisen Bank International AG and Societe Generale SA are the four biggest lenders in the former communist part of Europe. All four fell short of a minimum threshold of 9 percent of risk-weighted assets as defined by the European Banking Authority. At the same time, many of their units in eastern Europe require wholesale funding because they have less deposits than loans.

Czech economic growth was 1.6 percent in the third quarter from a year ago, slowing from 2.2 percent in the previous three months, while Hungary’s economic output decelerated to 0.8 percent from 1.5 percent, according to Bloomberg surveys.

Bulgaria’s GDP grew 0.2 percent, compared with 2 percent in the previous three months. Slovakia’s growth eased to 3 percent in the third quarter from 3.3 percent, while Romania likely bucked the trend, accelerating to 1.9 percent growth from 1.4 percent, separate Bloomberg surveys showed.

‘Magnitude’ of Hit

“The exact magnitude of the hit depends on the slowdown in the euro area,” said Annika Lindblad, an economist at Nordea Markets in Helsinki.

The European Commission on Nov. 10 cut its euro-region growth forecast for next year by more than half to 0.5 percent and said it sees the risk of a contraction as leaders struggle to keep the fiscal crisis from spreading. The euro region is heading toward “a mild recession,” European Central Bank President Mario Draghi said on Nov. 3.

“The turnaround in sentiment from the first half of this year has been remarkable,” said Neil Shearing, an economist with Capital Economics in London. “Six months ago if you’d asked anybody whether there was a recession risk in eastern Europe, the answer would have been unambiguously ‘no.’”

Export Driven

Eastern economies most dependent on exports to drive growth and countries with closer financial ties with the euro area are most at risk of a recession, the economists said. Countries such as the Czech Republic, Slovakia and Bulgaria sell as much as 80 percent of all goods they ship abroad to other EU members.

Central banks in the European Union’s eastern members are weighing faltering growth prospects against weaker currencies after tightening policy earlier this year. Monetary authorities in the Czech Republic left the benchmark two-week repurchase rate at a record-low 0.75 percent on Nov. 3, while Hungary kept its benchmark rate steady at 6 percent for a ninth month on Oct. 25.

In the last month, the Polish zloty, Hungarian forint and Czech koruna are the three worst performing of 31 major currencies monitored by Bloomberg. The forint has weakened 7.34 percent against the euro in the period, while the koruna fell 3.76 percent and the zloty 2.12 percent.

“The common thread is that there’s less scope for policy response now than there was in 2008 in most countries,” Shearing said.

Central and southeast European countries, which are “particularly vulnerable” to euro-region contagion, will see the deepest slowdown, the European Bank of Reconstruction and Development said on Oct. 18.

The bank revised its 2012 forecast in the central Europe and Baltic region to 1.7 percent, from the 3.4 percent seen in July. Growth in southeastern Europe will be 1.6 percent next year, more than 2 percentage points lower than the July prediction.

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