Economic Vulnerability of Central European Economies By Les Nemethy, CEO, Euro-Phoenix Financial Advisors Ltd., Former World Banker

The recent global economic scene today may be characterized by two related phenomena: first, an “everything boom” , where virtually all asset prices have rapidly exploded in value, and second, steeply rising indebtedness. Both have been underpinned by extremely low interest rates, which have simultaneously fueled high asset prices and a huge debt binge, whereby Governments, corporates and individuals worldwide take advantage of Central Bank suppressed interest rates.

In finance, the concepts of debt and risk are inextricably intertwined. The more debt– the more chance of bankruptcy and default. It is almost a certainty that the current situation will finish badly, the big question: when?

Central Europe is not alone in its high debt levels. In 2020, global average national debt surpassed 100% of GDP (with some countries like Japan and Greece having spectacularly high national debts—at 230% and 168% respectively—although Japan has an incredibly strong economic engine).

Total global debt in 2020 increased from 300% to 360% of global GDP, an eye popping increase. The numerator of this ratio increased due to massive pandemic spending; GDP, the denominator, decreased in many countries, also due to the pandemic.

If we see the storm clouds approaching, we should batten down the hatches. In this article, we look at how vulnerable Central Europe might be to a potential economic downturn. We do this by providing the highlights of an analysis by Rabobank on Poland, Czech Republic and Hungary: Exhibit  1: Vulnerability of  Central European Economies 
  Czech Rep Hungary Poland
Economic Indicators 0,6 -5,7 1,5
Current Acct Deficit (as a % of GDP) 3,8 0,4 4,1
Inflation (% yoy) 2,8 3 2,9
Economic growth (%) 4 -3,6 -2
Budget balance (as % of GDP) -5 -7,5 -4,9
Competitiveness (value) 4,8 4,3 4,6
Political risk (scale 0-100) 67,9 71,5 56
Security risk (scale 0-100) 93,6 87,3 88,6
FX reserves (import cover months) 10,3 3,3 5,6
Debt vulnerability indicators 2,4 -4,4 1,3
Total external debt (as a % of GDP) 77,5 148,6 53,8
Government debt (as a % of GDP) 43,4 85,7 60,6
Household debt (as a % of GDP) 34,4 21,1 34,9
NFC debt (as a % of GDP) 56,2 70,4 44,6
NFC debt in foreign currency (as a % of GDP) 26,6 31,5 14,5
Government debt in foreign currency (% GDP) 3,3 17,7 15,9
Financial markets index -1,1 -1,5 0,4
Volatility 9,1 10,1 9,8
Market Beta -0,4 -0,3 -0,3
Liquidity 0,4 0,4 0,6
Hot money indicator 0,1 -0,2 -1,4
Source:  Rabobank, World  Bank, IIF, OECD, national sources

When the scores are aggregated, they provide the following scores:
Country Overall score
Czech Republic 1,93
Hungary -11,73
Poland 3,23
While Poland and Czechia receive marginally passing scores, according to Rabobank, Hungary scores the weakest not only among the major Central European economies, but also scores the second worst performance among the twenty plus global emerging economies ranked, after Argentina. The poor Hungarian score is driven by high levels of total external debt, primarily Government debt and debt of Non-Financial Corporations (NFC’s). A high percentage of debt is owed to external creditors.

As American financier Howard Marks said: “Financial [stability] doesn’t come from making or having a lot of money…You know what it comes from? Spending less than you make. Living within your means. It’s important to know that your antifragility comes from the extent to which you are not at the limit.” This may be applicable not just for individuals, but also for companies and nations. Most of the world seems close to the limit, some closer than others.

The world economy is integrated as never before– the contagion risk is enormous. This is why antifragility measures—e.g. reducing indebtedness, denominating debt in local currency as much as possible, lengthening the tenor of debt—would be so important.

Over the past few years, in most countries we have had the lowest interest rates in the history of the world. This is the only reason high debt levels have not led to default and crisis. Interest rates are so low—they are lower than inflation rates in most countries.

If interest rates were to suddenly rise (e.g. a reversion to the historical mean of real interest rates), it would simultaneously
  • knock the wind out of asset prices (e.g. possible collapse of financial markets), and
  • create failures in debt service—defaults and bankruptcies of individuals, corporations and government.
Governments, corporations and indiviuals need to consider antifragility measures. Omicron may or may not be the next shock that hits the financial system—but mutations will not stop with Omicron. Sooner or later there is likely to be a mutation that does not respond to vaccines. And there are numerous other non-pandemic “black swans” swimming out there.

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