Business Monitor’s recent downward revision of its 2009 Hungarian economic growth forecast to -6.4% well reflects my view that the systemic crisis risks I have been highlighting since Q308 have morphed into the region’s core scenario. While small economies like the Baltics and frontier markets such as Ukraine have long been forecast to contract in excess of 9%, the shift in the outlook for Hungary, a major central European economy, clearly underpins my view that it is not just the niche economies which are set for a severe economic adjustment.

With the latest downgrade to Hungary’s outlook, BMI’s aggregate real GDP growth forecast for the emerging Europe region has fallen to -3.4%, with 26 of 30 countries expected to experience full-year recession. By a wide margin, Central and Eastern Europe (CEE) is expected to be the worst performing emerging markets region in the world, well ahead of the second worst, Latin America, which is forecast to contract by just 1.0%.

Searching For A Point Of Reference…

Almost by definition, a systemic economic crisis is a fairly uncommon occurrence, and much effort has been expended in the media to historically contextualise the present situation. While on a global scale, the most common comparison for 2008/2009 has been with the 1930’s great depression, with CEE specifically being a developing region with high external exposures, Asia 1997/1998 has justifiably been the favoured point of reference.

As I see it, the comparison certainly has its uses. Both Asia in 1997 and CEE in 2008 had built up massive external asymmetries indicated by gargantuan current account deficits and in both cases it was a sudden outflow of capital, which in turn required a sharp increase in the savings rate (and reduction in consumption), that translated into very large economic contractions. That said, beyond the similarities in the balance of payments deficits, there are also sharp differences in these crises’ which suggest that the outlooks will prove different. Indeed, when I’m asked whether CEE going forward will be like Asia in 1998, my response is: “Not at all, CEE will be worse”. The key difference is the external climate. Asia’s crisis occurred amid a healthy global economy and strong demand conditions in key developed markets in Europe, the US, Australia and Canada. This enabled for a relatively quick and V-shaped recovery via a relatively orthodox model of export-led growth.

The External Environment Makes All The Difference

The similarities stop short here though. Amid the worst credit constriction in almost 80 years and the deepest recessions in decades expected in core European demand drivers such as Germany, the UK, Spain, France and Scandinavia, the ability of the CEE economies to trade their way out of this crisis is practically non-existent.

Moreover, the Asian financial crisis did not occur within the context of a structural crisis of the global capital system as is the case today. Indeed, in 2008/2009, asset writedowns in key developed world banks have translated into fundamental concerns of solvency and issues of confidence in the world’s underlying financial system. This in turn has resulted in widescale nationalisation of the US, UK and eurozone capital market and a systemic process of deleveraging. Under these systemic international conditions, the potential escalation of capital outflows from emerging markets this time round, goes well beyond that caused by the idiosyncratic debt problems of the Asian economies in 1997. So, what this boils down to is that CEE in 2009 will not only lack the export avenue as a means of output recovery but it is also facing a combined capital problem of both domestic debt deleveraging and a liquidity crisis globally.

Don’t Expect A Quick Recovery

To be sure, there are metrics by which CEE in 2009 will look better than Asia in 1998. South-east Asia (as an aggregate region) for instance, contracted by 6.4% in 1998, and this level of economic decline is unlikely for emerging Europe with Russia and Turkey forecast to fall by 4.0% and 3.3%, respectively. It is also worth noting that the key central European economies beyond Hungary (Czech Republic, Poland and Slovakia) are relatively better positioned to exploit a recovery, with only limited external debt levels and manageable current account deficits.

But, while the downturn in CEE in 2009 might not be as sharp as in Asia 1998, the longer-run outlook looks far worse. Under similar global conditions as Asia in the late 1990’s, we would likely expect a similar form of recovery for CEE in 2010. As things stand however, the likelihood of an L-shaped recovery and a protracted period of below trend growth can be expected. Simply put, with credit and external demand unlikely to return to pre-2008 levels within at least the coming 10 years (if even within my lifetime), emerging Europe is set to experience a much longer period of low growth (by developing market standards) in addition to the immediate risks of a sharp contraction in 2009.

The EU Has The Means But Not The Will For A Rescue

Much has been made of the potential for multi-lateral support for the region, including by me! I once wrote that if there is anything that makes CEE exceptional from other emerging markets, it is the clearly defined institutional support it can expect from the EU, which in turn improves the prospects for additional IMF funding. While I still recognise the potential for the EU to offer concerted financial aid to prevent a series of balance of payments crises (at least for the EU members within CEE), I have grown increasingly sceptical of its willingness to do so. Indeed, the magnitude of the package required to fundamentally shift market momentum by alleviating any concerns about refinancing risks in CEE would have to be in excess of EUR200bn (the Hungarian Prime Minister proposed a comprehensive package worth EUR180bn). But with the core eurozone economies all facing sharp recessions of their own resulting in spiralling unemployment and public dissatisfaction with respective governments, the political will for a bail-out of eastern Europe has been at best lacklustre. Germany, the one country with the means to spearhead such a bail-out, has been reticent to utilise fiscal means to stimulate its own economy, let alone CEE. Moreover, I can personally attest as a UK taxpayer my own displeasure should Gordon Brown choose to spend even more of my cash to prop up countries who, fairly or not, were clearly borrowing more than was justified.