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After two decades of strong economic growth, emerging Europe has lost momentum. Robeco Emerging Markets Equities is currently not invested in Central and Eastern Europe because of the unstable economic policy in the region. “Poland, Hungary and the Czech Republic have to be careful that their economies do not end up in structural slowdown mode. Brexit is a longer-term risk.”
“We are currently avoiding emerging Europe. The economies of Poland, Hungary and the Czech Republic are still growing more quickly than those of developed Europe, but this growth is below average pre-financial crisis levels and is also low compared to some emerging countries in Asia. These countries have to be careful that their economies do not end up in structural slowdown mode”, states Wim-Hein Pals, portfolio manager of Robeco Emerging Markets Equities (see table with GDP growth figures). Together with co-portfolio manager Dimitri Chatzoudis, who focuses on Central and Eastern Europe, he explains why – for the time being – he has no holdings in emerging Europe in portfolio.
During the 2008-2009 crisis, Poland was the only country in the European Union that managed to avoid recession. At that time, this lone economic star shone proudly. But today it's a shadow of its former self. The economy is struggling and economic policy is unstable. “There are two parts to Poland’s story. The country has attractive companies with growth potential, but current government policy means that things are too uncertain to invest in them”, explains Chatzoudis. “This also applies to Hungary to a lesser extent.”
Index compiler MSCI counts Greece, Turkey and Russia as emerging Europe, in addition to Poland, Hungary and the Czech Republic. However, in this article we just look at these last three which are EU member states.
When Poland, Hungary and the Czech Republic became members of the European Union in 2004 and, by doing so, committed themselves to observing European legislation and regulation, it created a steady investment climate for companies from Western Europe and elsewhere. “There was political stability and money was available from Brussels to improve infrastructure. With more than 38 million inhabitants, Poland was an appealing market", says Chatzoudis.
Pals: “While on the other hand, Western Europe, and Germany in particular, provided an important market for goods and services from these new EU members. And after 2004 their economies grew faster than the EU average.”
However, the crisis hit companies in Western Europe hard and this was followed by only marginal economic growth. Investments in Central and Eastern Europe dried up and the exports from East to West dwindled. Buoyed up by high income from raw materials, Russia looked like an ideal potential new market for emerging Europe. But this too came to an end in the summer of 2014, when the oil price collapsed.
The most recent event to weigh heavily on emerging Europe is the Brexit. “The United Kingdom is a major supplier of funding to the EU. Given the current degree of EU skepticism, it seems unlikely that other European countries will be prepared to pay more once the UK contribution stops. This means that the subsidy that goes to emerging Europe will shrink. This is a long-term risk for Poland, Hungary and the Czech Republic”, predicts Chatzoudis.
Meanwhile in Poland and Hungary the political wind has changed direction. In Poland, Jaroslaw Kaczynski's national-conservative Law and Justice party (PiS) is making euroskeptic and populist noises. In Hungary, at the comparable Fidesz - Hungarian Civic Alliance, headed by Viktor Orbán sentiment is similar. Poland and Hungary are particularly recalcitrant – with legislation that undermines the democratic constitution, restrictions on central bank independence and a rebellious stance on receiving refugees. They are no longer progressive and stable countries and their investment climate has worsened.
“Kaczynski and Orbán are well aware of where the money actually comes from and, as a result, they keep in line with European budget guidelines and adjust their more controversial legislation", says Chatzoudis, qualifying the politicians’ behavior. He understands what causes the dissatisfaction in these countries. “The strong economic growth in Poland has not resulted in a higher income for the man in the street. People feel this is unfair. PiS wants the ‘hardworking Pole’ to benefit more, and the business community to pay up for this.”
‘Emerging Europe is no longer progressive and stable’
As a shareholder in many banks and insurers, the Polish government has a strong influence on the country's financial sector. The government wants to strengthen the sector through consolidation and make it less dependent on foreign banks. About 60% of the Polish banking sector is in foreign hands.
State-owned insurer PZU has its eye on Pekao and wants to take a significant stake in the bank. “It is difficult to assess whether this investment is voluntary, or whether the Polish government is exerting pressure”, says Chatzoudis. “The same tendency is evident at Polish utilities companies that are being forced to invest in Polish coal mining entities. The Polish government's majority stakes in such companies do not always result in favorable decisions for other shareholders.”
Chatzoudis and Pals feel that Poland, in particular, needs far-reaching economic and political change. A revival of the West European economy is in itself not enough to ensure recovery. Chatzoudis: “Poland scores poorly on some major points when compared to other countries in emerging Europe. The demographic situation is not that favorable. The working population is shrinking as a result of a more rapidly aging population and net emigration. Investment is limited and private-sector savings are also at low levels. Labor productivity is low and research and development spending is negligible. Hungary and the Czech Republic are doing slightly better.” He feels that the risk of significant economic contraction is greatest in Poland, followed by Hungary and then the Czech Republic.