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A N A L Y S I S B Y T H E U N I C R E D I T G R O U P N E W E U R O P E R E S E A R C H N E T W O R K

CEE Quarterly

No 1/2008

CEE Quarterly 01/2008

For authors see last page

Imprint Published by UniCredit Group/Bank Austria Creditanstalt Aktiengesellschafthttp://www.unicreditgroup.euhttp://www.ba-ca.com

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Management Board: Erich Hampel, Chairman of the Management Board; Federico Ghizzoni, member of the Management Board, Central andEastern Europe (CEE); Thomas Groß, member of the Management Board, Chief Risk Officer (CRO), Risk Management; Wilhelm Hemetsberger,member of the Management Board, Markets & Investment Banking Division; Werner Kretschmer, member of the Management Board, PrivateBanking and Asset Management; Ralph Müller, member of the Management Board, Retail Banking; Regina Prehofer, member of the Manage-ment Board, Corporate Banking; Carlo Vivaldi, member of the Management Board, Chief Financial Officer (CFO); Robert Zadrazil, member of theManagement Board, Chief Operating Officer (COO), Global Banking Services.

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ContentsRegional Scenario 2

EU MembersBulgaria 6

Czech Republic 10

Estonia 14

Hungary 16

Latvia 20

Lithuania 22

Poland 24

Romania 28

Slovakia 32

Slovenia 36

EU Candidates and Other CountriesCroatia 38

Turkey 42

Bosnia and Herzegovina 46

Kazakhstan 48

Russia 50

Serbia 54

Ukraine 56

AnnexCountry ratings – foreign currency long term debt 58

Country ceiling ratings scale 58

Credit Defaults Swaps 59

Money market interest rates 59

Exchange rates – ECB methodology 59

Banking networkUniCredit Group CEE banking network – Headquarters 60

2 CEE Quarterly 01/2008

Regional Scenario

CEE region copes with the new globalenvironmentLower growth in the US and the eurozone, great uncertainty and volatility anda general repricing of risk are the mainfeatures characterising the new globalenvironment. Our scenario is now assum-ing growth at 1.5 % in the US and 1.4 %in the euro zone in 2008, with proactivemonetary policies leading to fast declinesin interest rates to 2.5 % in the US and3.5 % in the euro zone. The risk of a po-tential deeper recession in the US re-mains, however, and the view of interna-tional financial markets is on the pes-simistic side. Uncertainty about the truesize of international banks’ write-off re-lated to the US sub-prime crisis is stillgreat and likely to remain so until the endof the final 2007 results disclosing period.Equity markets have proved to be ex-tremely nervous and volatile, as the mid-January sell-off week testifies (–7 % onaverage in one week). Repricing of risk atinternational level is also clear – CDSspreads have doubled or tripled allaround the world since July 2007. More-over, international investors are startingto be quite selective, penalising mostcountries which show greater imbalances.

We recognise two possible contagionchannels for the CEE – namely a tighten-ing of credit conditions and low eurozone demand. Still, we believe the regionremains in a position to cope with thenew environment. We continue to fore-cast relatively strong economic perfor-mance, with growth at 5.7 % in 2008, ver-sus 6.8 % in 2007, and our previous esti-mate for 2008 of 6.0 %.

Usual growth drivers remain supportive …Consumption is fuelled by rising house-hold income and declining unemploy-ment, though high inflationary pressuresand tighter monetary conditions areleading to some moderation. Despitecredit tightening, prospects for invest-ment activities remain positive thanks toa relatively lively corporate sector and anumber of infrastructure projects fi-nanced by structural funds (in EU mem-ber countries) or investment and growthfunds (former CIS). Lower growth in theeuro zone and rising production costswill be reflected in some pressure on ex-port performance. Still, the region re-mains competitive in absolute terms andselected industries might even benefit

from international companies’ decisionto maximise the return on their past de-localisation strategy. Oil and raw materi-al prices remain supportive for formerCIS countries.

... but vulnerabilities arising from financing domestic growth with international savings will now be afeatureIn recent years most countries in the re-gion have been relying on external sav-ings to finance their growth. Rising cur-rent account deficits were financed byforeign direct investment, but also by ex-ternal debt. The banking sector has alsoplayed a role, with strong lending growth– one of the main drivers of the retail andinvestment boom – being largely financedfrom abroad. In 2007 the region has at-tracted roughly 100 bn euro of interna-tional debt, while the banking sector hasalmost doubled net access to externalfunding, with the net position betweenexternal liabilities and external assets in-creasing to 143 bn euro, i.e. 8.2 % of totalbanking assets in the region.

The repricing of risk at international lev-el has led to a hike in the cost of such ex-

Regional outlook 2008–2009Real GDP Inflation Interest rate Exchange rate Current account/ Fiscal Balance/

eop. eop. eop. GDP GDP2008 2009 2008 2009 2007 2008 2009 2007 2008 2009 2008 2009 2008 2009

Central EuropeCzech Rep. 4.0 4.5 5.0 2.7 3.50 3.75 4.00 26.6 26.5 26.0 –3.3 –3.2 –2.9 –2.9Hungary 2.8 3.4 4.4 3.5 7.50 7.00 5.75 253.4 254.0 252.0 –4.4 –4.1 –4.0 –3.2Poland 5.2 4.4 3.8 2.2 5.00 5.50 4.75 3.58 3.65 3.63 –4.3 –4.7 –2.7 –2.5Slovakia 6.9 6.0 3.6 3.6 4.25 3.50 3.00 33.6 32.3 EUR –3.0 –1.7 –2.3 –1.8Slovenia 4.4 4.7 3.5 2.3 4.00 3.50 3.00 EUR EUR EUR –3.8 –4.2 –1.0 –1.2

Baltics & SEEEstonia 5.3 5.9 7.1 5.0 7.2 5.1 5.1 15.65 15.65 15.65 –14.5 –14.0 1.5 1.0Latvia 6.8 6.0 9.5 6.5 6.0 5.5 5.0 0.70 0.70 0.70 –20.2 –17.0 1.0 1.1Lithuania 6.8 5.4 6.8 5.2 7.2 4.2 3.5 3.45 3.45 3.45 –11.9 –11.2 –0.5 –0.3Bosnia-H. 6.5 6.0 4.3 2.8 – – – 1.96 1.96 1.96 –12.5 –11.8 1.9 1.3Bulgaria 5.9 5.7 7.2 5.3 4.56 4.12 3.47 1.96 1.96 1.96 –19.2 –17.0 3.2 2.0Croatia 4.3 4.5 5.0 2.7 6.70 6.50 6.00 7.33 7.28 7.28 –6.8 –6.5 –2.6 –2.8Romania 5.4 5.0 5.8 4.0 7.50 9.50 8.75 3.61 3.58 3.66 –14.8 –14.5 –3.0 –2.9Serbia 6.0 6.2 8.4 6.7 10.0 12.0 10.0 79.24 82.00 82.50 –14.8 –13.9 –0.6 –0.9

Other CountriesKazakhstan 5.0 8.0 9.5 7.0 11.0 11.0 9.0 175.4 173.6 166.1 –4.0 –5.0 2.0 2.0Russia 6.7 6.2 10.0 8.0 6.0 6.2 5.7 33.6 32.9 32.4 4.9 3.9 7.5 7.2Turkey 4.9 5.5 6.1 4.8 15.8 14.3 12.5 1.71 1.75 1.75 –7.6 –7.8 –2.5 –2.0Ukraine 5.6 5.1 12.1 9.0 8.0 7.8 6.3 7.42 7.07 6.82 –5.0 –4.9 –3.0 –3.5Source: UniCredit Group New Europe Research Network.

3CEE Quarterly 01/2008

ternal financing, enhancing the risk ofsome general tightening of credit condi-tions. Countries with bigger external im-balances and greater dependency on for-eign funding are also those facing thebigger increase in the cost of risk, thusbeing more likely to suffer from somecredit tightening.

Central European countries largelyunaffected, with some cyclical tight-ening on the cardsWe forecast growth at 4.7 % in CentralEurope, down from 6.0 % in 2007 andcompared to our previous 5.0 % forecastfor 2008. Countries in the region are lesssensitive to a possible credit squeeze, asexternal imbalances are under controland the cost of risk, despite increasingsharply, remains relatively low (the 5YCDS stood on average at around 48 bp atthe end of January 2008, up from 35 bp atthe end of 2006). We expect some cyclicaltightening in the wake of rising inflation-ary pressures and growing production ca-pacity constraints, particularly in Polandand the Czech Republic. In the latter, thenew tax system is likely to have a negativeeffect on consumption growth, whichmade us revise our growth forecasts from4.8 to 4.0 %. It should be noted that thestrong pace of growth, combined with inflationary pressures, suggests somecounter-cyclical tendencies where the eu-ro zone is concerned – this might becomean issue for Slovakia, which is planning toenter the euro zone at the beginning of2009 and should then adopt an easiermonetary policy stance, and for Slovenia,which entered the euro zone in 2007.Hungary remains the tricky country inCentral Europe, still reaping the conse-quences, in terms of growth, of the fiscalcorrection plan. Results in terms of stabil-isation in 2007 are better than expected,but recovery in terms of growth is veryslow, while inflationary pressures allowonly moderate cuts in rates. We are nowrevising our growth forecasts from 3.1 to2.8 % in 2008, assuming 50 bp cuts inrates in 2008, unlikely to be achieved be-fore end Q1 2008. The country is the mostsensitive in Central Europe to deteriora-tion in the global environment, as provedby the strong increase in the 5Y CDSspread, which stood at 79 bp at the end ofJanuary, versus 21 at the end of 2006.

The new international environmentreveals long-term vulnerabilities inSouth Eastern Europe and in theBaltics We forecast some slowing in rates ofgrowth in SEE and Baltic countries, from6.7 % in 2007 to 5.7 % in 2008, comparedwith our previous forecast of 7.4 % for2008. All these countries have small andvery open economies, which have largelyfinanced their growth in recent years fromexternal savings. Such funding has comein the form of foreign direct investment,but also in the form of external debt, withthe – largely foreign owned -banking sec-tor playing a role. Global repricing of riskhas particularly hit these countries in viewof their structural imbalances, e.g. CDSspreads jumped from 16 bp at the end of2006 to 115bp in January 2008. Such an in-crease in the cost of risk is likely to lead tosome restriction in capital inflows. Whilewe expect credit growth to moderate asbanks find it more expensive to financethemselves and companies´ direct accessto international markets will come at ahigher cost, we do not see any major dete-rioration in the local operating environ-ment, something which could affect theappetite for foreign direct investments. Ifthis is the case more pronounced deceler-ation would be on the cards.

Some slowing in growth is welcome inthe Baltics, where overheating concernswere repeatedly addressed in recentyears. The increase in the cost of risk isleading to some credit tightening (bothwhere direct foreign funding and bank-mediated funding are concerned). Localcurrency markets are pricing in some de-valuation risks, but very minor (the mar-ket is, however, possibly too shallow forspeculative attacks).

We forecast growth close to 6 % in Bul-garia. Markets are starting to price ahigher cost of risk for the country, amidstits high current account deficit and risinginflationary pressures, which raise ques-tions about the long-term sustainability ofthe currency board. We claim, however,that macroeconomic policies are very co-ordinated, focused towards some moder-ate cooling, in order to prevent overlystrong real appreciation, and towards in-creasing flexibility in order to enhance

the economy’s efficiency and competi-tiveness. International repricing of riskmight even be supportive, by supportingsome tightening of monetary conditions.

In Croatia, the Central Bank’s strategy ofcooling domestic credit growth, whilelimiting local banks’ external indebted-ness and forcing their recapitalisation,has proved successful. Domestic lendingis being squeezed, constrained by fixedtargets, while the economic impact ofsuch tightening is smoothed by the in-creasing relevance of cross-border lend-ing. The current account deficit remainsstrong, at an estimated 7.4 % of GDP in2007, with no financing problems, as con-tinuing pressures towards an apprecia-tion of the kuna suggest.

The markets’ mood towards Romania haschanged substantially in the last year.While growth prospects remain positive,the country is paying the cost of its long-term vulnerabilities and of a rather inco-herent political environment. The CDSspread has increased from 20 bp at theend of 2006 to more than 170 bp in Febru-ary 2008, while the exchange rate, de-spite a rather tight monetary policy, haslost roughly 20 % in half a year, and re-mains quite volatile. We forecast growthat around 5.4 % and some moderation inlending growth and we continue to high-light the fact that structural risks exist.Even more than in the case of othercountries, we believe sustainability ofcurrent imbalances in Romania can onlybe achieved if the country remains attrac-tive to international capital. In the shortterm, the Central Bank is opting for highinterest rates as a strategy. In the longterm, we believe the challenge is to pre-serve overall competitiveness, remainingattractive for productive FDI.

In Serbia, even though incumbent BorisTadic won February’s presidential elec-tion, the political environment will re-main uncertain with a continued highrisk of early parliamentary elections. Theconsequences of Kosovo’s unilateral dec-laration of independence are still notclear. Meanwhile, economic growth isforecast to be moderate, from last year’speak, on the back of tighter global creditconditions and more hawkish NBS

Regional Scenario

4

rhetoric. Though gradually easing, con-tinued high external imbalances mightpose an additional threat in the context ofa new deteriorated global environment.

In Bosnia-Herzegovina the domestic po-litical environment is also focal and rais-es questions about whether agreement onthe form of a new constitution will bereached and signing of the SAA (Stabiliza-tion and Association Agreement) with the EU will take place. On the economicfront, robust credit growth and strongmanufacturing activity point to stronggrowth in 2007 and this year too.

Countries in the rest of Europe moresensitive to international repricing of risk, but continuing to show veryhigh growthThe repricing of risk at international lev-el since July has hit Russia, as both banksand medium and large Russian compa-nies relied heavily on external funding inrecent years. Limited access to interna-tional markets and the increase in thecost of funding has led to a moderatecredit squeeze. The main evidence so farrelates to a deceleration in corporate de-posit growth and hikes in corporate lend-ing growth, which are both a sign of re-duced access by the corporate sector todirect external funding. So far a realslowdown in domestic lending has notmaterialized. While some small banksare running into short-term liquidityproblems, the bulk of the banking sectorhas been able to withdraw its foreign-held assets, thus continuing to finance itsexpansion plans. Overall we do not ex-pect any major impact on the Russianeconomy, as the banking sector in gener-al remains liquid and banks like Sber-bank, VTB or the smaller foreign-ownedbanks continue to have wide access to in-ternational financial markets and cheapfunding. Big companies could have ac-

cess to international markets as well –they will probably refrain, in order to notshow that they are paying higher mar-gins. We forecast lending growth at35,3 % in 2008, fuelling consumption andinvestment growth. Overall we forecastgrowth at 6.7 % in Russia, little changedfrom our previous bet of 6.6 % for 2008,with high oil prices remaining a key dri-ver for the economy.

We forecast growth of 5.6 % in 2008 forUkraine, down from 7.3 % in 2007. Thecountry continues to experience a con-sumption and investment boom, largely financed by strong capital inflows and by arapidly expanding banking sector. Imbal-ances are present, with the current accountdeficit standing at –4.1 % of GDP and infla-tion peaking at 16.6 % in December. Wekeep a positive short-term view of the coun-try and we expect strong inflows of capitalto continue, as FDIs are searching for a low-cost production base in Europe and banks,which are increasingly under foreign con-trol, continue to target the market. We be-lieve, however, that the long-term potentialof the economy can be realised only if in-vestments are effectively channelled to-wards enhancing local production capacityand competitiveness is preserved. It shouldbe noted that the economy remains quitesensitive to potential external shocks, suchas a sudden drop in steel prices or anothergas crisis with Russia.

The Turkish economy slowed down sig-nificantly during 2007, which was a veryeventful year, dominated by both localelections and global uncertainties. De-spite the fragile global environment,prospects for the Turkish economy arenot gloomy. Firstly, policy rates are now225 bp lower than five months ago (nowat 15.25 %) and this trend will providesupport for investment activity andgrowth prospects. Secondly, the political

uncertainties were dispelled, and the gov-ernment, backed by the president and bya stable parliamentary majority, is pro-moting important reforms (reform of thecontroversial article 301 of the penalcode, a new constitution, the Kurdish is-sue and the “turban problem”). The infla-tion target has been missed again in 2007,and the Central Bank will probably sus-pend interest rate cuts until the secondhalf of the year, depending on the disin-flation process and on the global scenariotoo. The latter is a source of concern asTurkey – as an emerging and “high beta”country – is very exposed to financial con-tagion stemming from abroad. However,the banking sector is sound and relativelyprotected by relatively limited dependen-cy on international borrowing (theloans/deposit ratio is still below one).

More serious concerns for Kazakhstanin the short term, with medium- tolong-term potential preservedA liquidity crisis is visible and alreadytranslating into a clear credit squeeze inKazakhstan. The consumption and invest-ment boom which has been behind theimpressive growth of recent years is se-verely constrained. Companies have re-duced access to international debt mar-kets, while the banking sector, which wasfuelling a credit boom through externalborrowing, now has to severely limit lend-ing expansion to its deposits’ attraction ca-pacity. The construction industry, whichwas one of the most dynamic sectors of re-cent years, is now overheating and coolingis likely to further impact on banking sec-tor performance. We now forecast growthas low as 5 % in 2008, after rates close toor above 10 % in the last few years. Westill expect the country’s long-term poten-tial to be maintained, as with high energyand raw material prices the country hasmoney and commitment enough to pre-vent any major crisis.


Euro adoptionSlovenia Slovakia Estonia

LithuaniaHungary Poland Czech RepublicLatvia

Bulgaria

2007 2008 2009 2011/20122010 2013/2014

Romania

EURO


Country Latest Political Event/Main Achievements Main issues to be facedBOSNIA- • The government initialed the Stabilization and Association Agreement • Plans by Brussels to sign the SAA in March 2008 look like they will be HERZEGOVINA with the EU after agreeing to an “Action Plan” for police reform, put on hold after backtracking commitments given on police reforms.

while the contested voting-system reform in the multi-ethnic state- • Agreement on a new constitution looks unlikely this year.level cabinet was decreed by the High Representative.

BULGARIA • The government revealed its stability, despite difficult cooperation • The interim report presented by the European Commission in Januarybetween the ruling parties. 2008 concluded that the country has made progress in 3 out of 6 bench-

• Local elections were held in November 2007. marks only. It lags behind in two benchmarks in particular: high-level • On January 18, 2008 Bulgaria decided to join the South Stream Gas corruption and organized crime.

Pipeline project, which will rival the EU-backed Nabucco project. • Strong popular disaffection and discontent over the Country’s political life.CROATIA • On January 12, after more than a month of negotiations following • To speed up the reforms necessary to meet EU accession criteria, Croatia

the general elections (November 2007), Parliament gave its approval has opened negotiations on 14 chapters only. The most difficult chapters to Prime Minister Ivo Sanader’s new coalition government (con- (competition policy, justice and legal affairs, agriculture and environ-sisting of HDZ, Peasant-Social Liberal Parties with 83 seats out of 153). mental protection) are yet to be opened.

CZECH REPUBLIC • Despite the fragility of the coalition government, having the barest • The weak coalition government has to face strong left-wing opposition,majority in parliament, the package of economic reforms (consisting especially to get approval for the necessary reforms (pension system, of tax changes, welfare spending cuts and healthcare system) aimed further healthcare reform) and succeed in the vote on stationing of a at lowering the budget deficit has been introduced. US missile defense radar system.

• President Vaclav Klaus has been reelected in a third parliamentaryround vote for a further five-year term.

ESTONIA • Act amending the Commercial Code on cross-border mergers cameinto force in December 2007.

HUNGARY • In January 2008 Hungary became the first EU country to ratify the EU • PM Ferenc Gyurcsany lacks the backing of both the public and his ownReform Treaty. party to continue his reform agenda. Strengthening opposition.

• National referendum over three reform measures (doctor appointment fee,daily hospitalization fee and education fee) is to bee held on March 9, 2008.

LATVIA • A new centre-right government led by PM Godmaris was confirmed • To fight widespread corruption.by Parliament in mid-December 2007 after the Kalvitis governmentstepped down due to plummeting consensus

LITHUANIA • On November 8 parliament enacted a law on fiscal discipline. • Parliamentary elections are scheduled for October 2008.POLAND • Parliament approved a new government (a coalition between PO • The Government decided to withdraw Poland’s 900 troops from Iraq by

and and PLS), led by PM Donald Tusk, on November 24. the end of 2008.• The government is improving the country’s relations with the EU • To push ahead with privatization, tax cuts and deregulation.

and in particular with Germany and Russia.ROMANIA • Heavy defeat of the ruling Tariceanu government at the European • To face government fragility until the next parliamentary elections

parliamentary elections (held in November), while the opposition (to be held in November 2008)Democratic Party, which supports President Basescu, emerged • According to the latest EC interim report, Romania lags behind in all fourthe winner. of its benchmarks (particularly in the fight against high-level corruption).

RUSSIA • President Putin’s party, United Russia, won 64.1 % of votes in • Presidential elections to be held on March 2, 2008.parliamentary elections held in December 2007.

• To signal his policy continuity, President Putin backed (Dec. ‘07) the first Deputy PM Dmitry Medvedev as his preferred candidate to.

SERBIA • In December 2007 Parliament adopted the laws on the President • To manage Kosovo crisis.and Presidential elections and on Jan 3 the West’s favorite, • To conclude the Stabilization and Association Agreement with the EUincumbent President Tadic, was confirmed as Serbian President. (currently opposed by the Netherlands and Belgium because of non-

• Kosovo’s unilateral declaration of independence on Feb 17 may compliance with The Hague Tribunal).lead to a serious escalation of tensious.

SLOVAKIA • The coalition survived a no-confidence vote in December, despite • To ratify the EU Reform Treaty (the centre-right opposition forced delays a scandal over corruption. to the ratification vote to protest against the government’s refusal to

withdraw the media reform).SLOVENIA • Danilo Turk, supported by the leftist opposition, won the presidential • Slovenia holds the EU Presidency from January 1 to June 30, 2008.

elections – held in November 2007 – highlighting the increasingunpopularity of Jansa’s centre-right government.

• The EU Reform Treaty has been ratified.TURKEY • Improvements in bilateral relations with Greece (Greek PM paid • Parliamentary approval of a constitutional amendment easing the ban

the first official visit in the last 50 years). on women wearing the headscarf at universities is raising opposition.• AKP is working on some amendments to handle the Kurdish issue.• To approve the social security reform.

UKRAINE • Almost 3 months after the elections, a new government has been • To stabilize Ukraine-Russia relations.formed (consisting of the Yulia Tymoshenko Bloc, BYuT and Our • To face strong opposition to the country’s decision to join NATO Ukraine/Self Defense Party). Y. Tymoshenko is appointed as PM. (Ukraine’s accession to NATO will be decided by referendum).

• On February 5, 2008 Ukraine was approved as member of • To sign a new Partnership and Cooperation Agreement with the EU, the WTO. The Ukrainian parliament has six months to ratify. including the creation of a deeper free trade area.

• EU-Ukraine agreement reducing country’s export duties.• The country has filed a formal application to join NATO.

Source: Political Studies, Institutional & International Affairs, UniCredit Group


Bulgaria

• Despite a one-off drop in Q3 2007,full-year real GDP growth is estimat-ed to have reached 6.1 % yoy backedby continued strong accumulation ofphysical capital in the private sector.Prospects for growth remain good in2008, although worsening externalconditions are likely to have a nega-tive impact on investment dynamics,bringing slight deceleration of GDPgrowth to 5.9 % yoy.

• CPI inflation reached a new historicalhigh, ending last year at 12.5 %. Weanticipate pressure on prices to gradu-ally decrease in 2008, although thedisinflationary process is likely to bebumpy and take a long time overall.Wage dynamics in the public sectorwill be the key development to watch.

• So far the global financial crisis hashad a limited impact on the realeconomy. The real estate market also

demonstrated strong resilience, whileavailability and cost of external fi-nancing in the banking sector wereaffected negatively. The biggest im-pact was reported on the local stockexchange market. Prices wentthrough a sizeable downward correc-tion after reaching levels clearly mis-aligned with underlying companies’fundamentals a couple of monthsago.

MAIN TOPICS

OUTLOOK

MOODY’S LT FC RATINGBaa3/Positive

S&P’S LT FC RATING BBB+/Stable

FITCH LT FC RATINGBBB/Negative

SPREAD AVG (JAN) 113EMBI+ Spread on Euro Curve

Macedonia

Poland

Czech Republic

Slovakia

Hungary

Slovenia

Croatia

Bosnia Herzegovina Serbia

Monte- negro

Austria

Germany

Italia

Estonia

Latvia

Lithuania

Romania

Bulgaria

Disappointing agricultural output led to asizeable decrease in real GDP growth inQ3 2007. However, growth momentumelsewhere in the economy remainedstrong and we expect a resurgence inthe pace of economic expansion in thelast quarter, with continued goodprospects in 2008. Surpluses in the con-solidated fiscal programme reached anall-time record, while the current ac-count deficit and inflation continued to

follow a negative trend. Global reassess-ment of risk negatively affected the costof funding for the local economy, whichremains heavily reliant on externalsources of financing. Thus, FDI (especial-ly in the real estate and vertically inte-grated sectors), investments and creditgrowth (in line with monetary authori-ties’ aspirations) are likely to lose mo-mentum, also bringing some marginaldeceleration in GDP growth.

Macroeconomic data and forecasts

2006 2007e 2008f 2009f 2010fNominal GDP (EUR bn) 25.1 28.7 32.6 36.5 40.4Per capita GDP (EUR) 3,270 3,760 4,290 4,830 5,370Real GDP, yoy (%) 6.1 6.1 5.9 5.7 5.6Inflation (CPI), yoy, eop. (%) 6.5 12.5 7.2 5.3 4.2Inflation (CPI), yoy, avg. (%) 7.3 8.4 7.7 6.2 5.0Unemployment rate, eop. (%) 9.1 6.9 6.7 6.5 6.4Exchange rate BGN/EUR, eop./avg. 1.96 1.96 1.96 1.96 1.96LEONIA, avg. of Dec 3.55 4.56 4.12 3.47 3.45LEONIA, avg. of the year 2.79 4.03 4.53 3.69 3.53Current account balance/GDP (%) –15.7 –20.4 –19.2 –17.0 –14.0FDI/GDP (%) 17.4 19.8 15.4 13.5 11.2Budget balance/GDP (%) 3.6 3.8 3.2 2.0 1.6General government debt/GDP (%) 24.7 19.8 18.6 18.4 18.1Total external debt/GDP (%) 80.1 94.0 101.0 108.0 115.0Sources: Central Bank, Central Statistical Office, Bulbank Research Unit, UniCredit Group New Europe Research Network.


A one-off drop in GDP growth in Q32007, with full-year GDP forecast at 6.1 % Real GDP grew at a disappointing 4.5 %yoy in Q3 2007, posting its weakestquarterly reading in the last three con-secutive years. Slowdown was entirelyattributable to the agricultural sector,where unfavourable climatic conditionsbrought a 43 % drop in real Gross ValueAdded (GVA). At the same time GVAgrowth in the manufacturing and ser-vice sectors increased by a real 12.8 %and 11.1 % respectively, highlightingthe broadly based and far-reaching posi-tive implications of EU membership.Given each sector’s share of total GVA,simple calculations indicate that realeconomic growth would have reachedalmost 10 % – flat growth in the agri-cultural sector.

On the demand side, growth continued tobe propelled by booming investments,which reached a striking 38 % of GDP forthe first nine months of the year whenadding changes in the unfinished produc-tion reserves. Growth remains over-re-liant on externally funded investments,which in turn drives net exports into neg-ative territory. Rapid accumulation ofphysical capital still fails to bring the de-sired payoffs in terms of export capacityexpansion, as a large share of invest-ments are channelled into the non-trad-able goods sectors. In the household sec-tor, consumption of durables and foodhas been on a downward trend since July,

which seems mostly attributable to theimpact of high inflation. Also consumerconfidence has suffered on the back ofthe same causes. Still, personal consump-tion increased by 6.2 % in the first ninemonths.

Partial economic data releases for theclosing months of 2007 were generallyfavourable. Industrial output and salesgrowth remained among the strongest ofall EU member countries. There waslikewise little evidence of a slowdown ineconomic activities in the constructionindustry, although clearly the focus isgradually shifting from residential to-wards the greater relevance of infra-structural and commercial real estateprojects. GVA in the financial intermedi-ation sector is anticipated to have drawnsupport from recent acceleration bybank credit growth to 64 % yoy at theend of the year. Furthermore, the prob-lematic agricultural sector has tradition-ally made a very limited contribution toGVA growth in the winter months and itsimpact on economic performance in thelast quarter is thus anticipated to havebeen marginal. On the demand side, re-tail sales and net exports continued tofollow a downward trend, which we be-lieve is counterbalanced by the strongincrease in investments and the still am-ple inflow of foreign capital. All thesefactors point to a resurgence in econom-ic activity in Q4 (we forecast 7.2 % yoygrowth), bringing the full year GDP datato 6.1 % yoy.

Good economic prospects despiteheightened risks Economic growth reached its peak in2007 and we expect some gradual slow-down in 2008. We anticipate some weak-ening of personal consumption in thecourse of the year, but rather marginal inscale, as both labour market conditionsand real income growth are likely tomaintain their positive dynamics. Weak-ening of final consumption in the house-hold sector will ease upside pressure onimports and foreign trade imbalances.Bulgaria has so far been very successfulin attracting FDI. However, FDIs arecyclical in nature and hardly sustainablein the proportions seen in the last fewyears, particularly taking into accountthat a large share was directed towardsthe real estate sector, which might turnout to be more sensitive to the new globalconditions. Reassessment of risks alreadyadversely affected both availability andcost of foreign financing. We expect somedeceleration of FDI (also in the form ofintra-company loans) to have an impacton investment demand. As the bankingsector is also financing its lending growththrough external funding, we might alsosee a bank-related credit squeeze, whichruns in line with the Central Bank’s aspi-rations. We expect an increase in centralgovernment and municipality investmentspending, on the other hand, as access toEU structural and cohesion funds gradu-ally improves. Overall, we reckon GDPgrowth will slow to 5.9 % in 2008 and5.7 % in 2009.

Facing the challenges of a new global environment

Short-term indicators

Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07Real GDP, yoy (%) 5.7 – – 6.2 – – 6.6 – – 4.5 – – –Industrial production, yoy (%) 1.2 3.2 8.9 9.0 11.7 7.0 7.7 14.3 8.4 8.9 11.3 7.1 –Inflation (CPI), yoy (%) 6.5 7.1 4.5 4.1 4.2 4.3 5.6 8.4 12.0 13.1 12.4 12.6 12.5Unemployment (%) 9.12 9.67 9.48 8.92 8.38 7.82 7.42 7.25 7.00 6.78 6.73 6.62 6.91Exchange rate, EUR, eop. 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96 1.96LEONIA, avg. 3.43 3.53 3.52 3.68 3.81 3.84 4.01 4.10 4.09 4.24 4.26 4.58 4.68Export, (EUR) yoy (%) 13.5 6.1 2.6 10.9 3.2 11.5 9.8 14.7 6.4 14.2 23.1 20.7 –Import, (EUR) yoy (%) 32.4 24.1 17.8 16.6 15.6 17.6 20.7 20.0 8.2 23.1 21.6 26.9 –Trade balance, EUR mn –772.9 –585.2 –472.0 –559.0 –523.3 –606.1 –540.1 –607.0 –584.4 –604.0 –702.6 –788.5 –Current account, EUR mn –807.5 –631.7 –475.8 –499.9 –549.2 –465 –278.6 –222.5 –244.2 –506.6 –671.1 –746.4 –Sources: Central Bank, Statistical Office, Bulbank Research Unit


Bulgaria

Looking at the banking sector, there are no signs so far ofa tightening in credit standards and lending volumes, whilesome 30 % and 15 % of banks in the US and Europe respec-tively have reportedly tightened eligibility requirements ap-plied to prospective borrowers. No increases in defaults ormajor changes in the currency structure of loans and de-posits are reported either. The fundamental difference be-tween retail lending in Europe, and in the emerging marketsin particular, is that it is much more conservative comparedwith the US market. In Bulgaria, retail lending remains con-centrated in the wealthiest 25 %–30 % of the population andcredit penetration in the sub-prime segment (customerswith controversial credit histories) is still very limited. At thesame time, it is clear that the crisis will affect the availabilityof liquidity in the economy and particularly the cost of exter-nal borrowing, which might affect banking activities, asbanks are also using external funding to finance theirgrowth. Looking at the price and volumes of overnight de-posits traded on the local money market, it becomes evidentthat this scenario is already underway. Since the start of thecrisis, daily volumes of overnight money market deposits aredown from an average of roughly BGN 200 mn to BGN 100mn, which is a substantial contraction, especially given thatliquidity conditions in Bulgaria are very favourable at the endof the year, as the monthly scale of public-sector spendingalmost doubles. Likewise, the margin between LEONIA andEONIA money market rates increased from close to zero priorto the start of the crisis, to around 80–90 bp at the moment.We think another hike in the Minimum Reserve Require-ments (MRR) rate should not be ruled out given the combi-nation of unabated inflation and concerns that rapid creditgrowth might have been accompanied by easing of somebanks’ credit standards, focused on building market share asan overriding priority. Looking ahead, competition for de-posits from the domestic market will intensify even further.Thus a small increase in lending rates is clearly on the cards,whilst keeping the loans-to-deposits interest rate spreadmore or less unchanged.

Corporate sectorCapacity utilization and new order volumes in the manufac-turing sector are at their highest-ever levels, while businessmanagers’ concerns relating to labour shortages and weak-ening of households’ demand in the trade sector increasedmarginally. There are no indications of revision of compa-nies’ investment plans. The corporate sector is already feel-ing the effect of the crisis, however, as the cost of interna-tional borrowing has increased and international lendershave become more selective. In response, the corporatesector is increasingly turning its attention to domesticsources of financing. Interest in launching new IPOs on thelocal stock exchange is huge, and demand for loans extend-ed by domestic commercial banks is rising, though the

banks themselves are facing higher costs of external bor-rowing. It is reasonable to think that the investment cycle inBulgaria reached its peak in 2007. We may also anticipatesome distress in firms’ business confidence and their exportsales, but only in the event of the crisis’s impact on the EUturning out to be more severe than initially thought. Somepressure on credit ratings should not be ruled out either, asalready signalled by the negative revision of Bulgaria’scredit rating outlook from Fitch IBCA.

Real estate market demonstrates resilience so far. Re-cently released data for Q4 2007 provides no indication of aslowdown in residential property prices. The holiday homessegment, on the other hand, remains vulnerable, as a largepart of external demand originates from the UK – a countrywhere the sub-prime mortgage crisis may potentially have abig detrimental impact. Still, there are some signs of themarket softening. The number of newly issued constructionpermits for Sofia, Plovdiv and Ruse decreased in the firstnine months of 2007, but the overall picture remains mixed,as growth is still pretty buoyant on the coast and in the mid-sized regional centres.

The biggest impact so far was reported on the local stockexchange market. In the first nine months of the year, stockmarket prices were inflated to levels unconnected to under-lying company fundamentals. In September, the P/E ratio formost of the companies included in the leading stock marketindices in Sofia exceeded those at the height of the dot-combubble in the USA. The market price correction that naturallyfollowed wiped out some 25 % of total market capitaliza-tion, bringing the traded companies’ P/E ratio into the 20 %and 30 % range at the end of January 2008. We think theongoing market price correction cycle is approaching its end,but is not over yet. Our baseline scenario envisages the peri-od of increased market turbulence continuing in February be-fore stabilization and a moderate price recovery starts inMarch, or possibly April.

Global crisis impact

11,500

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Percent DJ lost during the 10. 10. 07–23. 01. 08 correction: 15.50 %Percent SOFIX lost during the 27. 11. 07–24. 01. 08correction: 32.33 %

High: 14,165 – 10. 10. 2007

Low: 1,321.03 – 24. 01. 2008Low: 11,969.1 –

23. 01. 2008

High: 1,952.4 – 15. 10. 2007

DJ Industrials and SOFIX stock exchange market indices Jan. 2007–Jan. 2008

Source: Bloomberg


Disinflation process remains challenging According to the national methodology,CPI inflation topped 12.5 % yoy in Decem-ber, averaging 8.4 % for the whole of2007. Almost two-thirds of consumer priceincreases were attributable to higher foodand transport costs, which were driven byone-off factors largely beyond the controlof local policy makers. Excessive wagegrowth, combined with rapid increases inmoney supply, and lack of structural re-forms aimed at boosting competition insome specific sectors of the economy,were likewise among the causes of the in-creased price pressure in 2007.

This year inflation will slow gradually,further underpinned by the particularlywidespread fundamental effect of thefoods and beverages component. Thecauses of inflationary pressure remainbroadly based, however, and are oftenstructural in nature, which emphasisesthat what is likely to follow is a challeng-ing and long drawn out disinflationaryprocess. Wage growth in the public sectorwill be the fundamental development towatch for, particularly this year. Against abackground of food and energy prices thatare already quite high, we anticipate thatadministration-regulated prices will bethe major contributor to inflationary pres-sure in 2008. These factors are likely toprevent inflation from slowing as much asrequired by the Maastricht criteria, with12-month inflation only easing to 7.2 % by year end. We remain sceptical aboutthe chances policymakers will have to un-dertake the restructuring efforts neededto expand the role of the free market andcompetition in the energy and railwaytransportation sectors. The start of re-forms in education and also possibly inthe healthcare sector is a positive devel-

opment. However, we are clearly far fromthe moment when reforms (if implement-ed) will feed through to these sectors andwill favourably affect costs for healthcareand education service end consumers.

Increasing external financing needsremain an issue for concern The twelve-month current account (CA)deficit widened to 20.2 % of anticipatedfull-year GDP at the end of November, upby 69 % yoy. Most of the deteriorationcontinued to stem from the balance oftrade. Export growth slowed down to11.5 % year-on-year, mostly in responseto sector-specific transitory factors innonferrous metals, agriculture, and verti-cally integrated foods and beveragesmanufacturing. Decommissioning of thelast two Soviet-era reactors at the Ko-zlodyi nuclear power plant likewise had anegative effect on export volumes, al-though the harm was rather minor giventhe limited relevance of electricity to totalgoods exports. Imports grew by 19.3 %,fuelled by the rapid increase in invest-ment spending and buoyant consumptionof durable goods in the household sector.Instead, the services balance remainedlittle changed, compared with its perfor-mance a year ago and relative to the sizeof the economy. In line with prevailingexpectations the income balance deterio-rated marginally in response to the com-bination of rapidly growing private-sectorexternal indebtedness and an increase inthe corresponding debt-servicing costs.Similarly, the cumulative net transfer bal-ance and capital account balance for thefirst eleven months of the year was weakerby an amount equivalent to 0.6 % of pro-jected end-of-year GDP, when comparedwith 2006. We anticipate the CA deficitwill have topped out at 20.4 % of GDP lastyear, compared to around 16 % in 2006.

On the financing side, net FDI increasedto an all-time record of EUR 4.9 bn inJanuary-November, providing almost fullcoverage of the CA deficit (97 %). Debt-creating financing posted a sizeable in-crease in the last two reporting months,as local commercial banks borrowedheavily from abroad to replenish theirbalances with the BNB, following the in-crease in the MRR rate to 12 % in Sep-tember. BNB reserves continued to in-crease, albeit at a weaker rate when com-pared with those experienced in the firstnine months of the year.

We remain cautiously optimistic regard-ing developments in the external balancein 2008. New production capacities addedin the tradable goods sectors and the an-ticipated recovery in agriculture andfoods and beverages manufacturing willboost export volumes, while also com-pensating for some of the decline in tex-tile exports after liberalization of foreigntrade between the EU and China. Decel-eration in domestic demand and morebenign crude oil price dynamics will al-low import growth to slow down, whichshould help the CA deficit to ease mar-ginally to 19.2 % of GDP this year, incombination with improvements in theutilization of EU grants. Despite worsen-ing global financial market conditions,Bulgaria will continue to attract foreigncapital inflows. High profitability marginsand low asset values compared with peercountries will continue to make the coun-try attractive to foreign investors. Never-theless, in 2008 FDIs are estimated toslow down to around 15 % of projectedGDP, causing some deterioration in thefinancing structure of the large CA mis-match too.

Event Date ReadingConsumer Prices Q1 2008 Some flattening of inflation dynamics seems likely given moderation of primary energy

resource prices and the start of post-Christmas seasonal discounts in department stores. Balance of payments Q1 2008 The scale of CA gap deterioration remains the most closely watched macroeconomic indicator.


Czech Republic

MOODY’S LT FC RATINGA1/Positive

S&P’S LT FC RATING A/Positive

FITCH LT FC RATINGA/Stable


Macedonia

Poland

Czech Republic

Slovakia

Hungary

Slovenia

Croatia


Monte- negro

Austria

Germany

Italia

Estonia

Latvia

Lithuania

Romania

Bulgaria

We believe the Czech Republic is unlikelyto be substantially affected by the dete-rioration in the international scenario.Our forecast for deceleration in growthto 4 % yoy this year, from 6.6 % in 2007,is due to the new economic reforms,which came into force at the start of2008 and are set to hit household pur-chasing power. We believe there will bea slight improvement in net exports asimport growth, depressed by weaker do-mestic demand, is projected to slow

down more than export growth, affectedby slowing external activity. Followingthe 25 bp hike in February, it is unlikelythe CNB will tighten policy further in the remainder of this year, given theprospects of the ECB turning dovish. Nevertheless, the CNB will have to stayon alert due to a risk of current sharpprice growth filtering through to inflationexpectations and the CNB’s inflation target being cut from 3 % to 2 % as of2010.


2006 2007e 2008f 2009f 2010fNominal GDP (EUR, bn) 114 128 147 159 174Per capita GDP (EUR) 11,110 12,410 14,170 15,360 16,770Real GDP, yoy (%) 6.4 6.6 4.0 4.5 4.5Inflation (CPI), yoy, Dec. (%) 1.7 5.4 5.0 2.7 2.7Inflation (CPI), yoy, avg. (%) 2.5 2.8 6.5 3.2 2.7Unemployment rate (%) 8.1 6.6 5.7 5.5 5.5Exchange rate CZK/EUR, Dec. avg. 27.50 26.62 26.50 26.00 25.50Exchange rate CZK/EUR, avg. 28.34 27.76 26.40 26.20 25.702-week repo rate, eop. 2.50 3.50 3.75 4.00 4.002-week repo rate, avg. of the year 2.17 2.88 3.73 3.90 4.001M Pribor, Dec. avg. 2.52 3.98 3.85 4.05 4.051M Pribor, annual avg. 2.22 2.96 3.80 3.95 4.05Current account balance/GDP (%) –3.1 –3.0 –3.3 –3.2 –3.2FDI/GDP (%) 4.2 4.7 4.4 5.5 4.0Public debt/GDP (%) (ESA 95) 30.1 29.3 29.4 29.6 29.9Budget balance/GDP (%) (ESA 95) –2.9 –1.9 –2.9 –2.9 –2.7Total external debt/GDP (%) 37.7 39.0 39.2 39.4 39.5Sources: Czech National Bank, Czech Statistical Office, Labour and Social Affairs Ministry, Ministry of Finance, UniCredit New Europe Research Network.

• Q3 GDP growth slowed moderately to6.0 % yoy from an upwardly revised6.3 % in Q2, with household consump-tion remaining the main pillar of ex-pansion. Gross capital formation andnet exports also made a positive con-tribution to growth, while governmentspending dipped marginally yoy. Flashestimates for full-2007 GDP growthcame in at 6.6 % yoy.

• The CNB raised interest rates by an-other 25 bp in February. The contin-ued strengthening in the crown failedto offset concerns about rising infla-tion. In fact, yoy price growth surgedto the highest point in nine years inJanuary. Food prices, housing rentsand energy costs were reported tohave the biggest impact on the infla-tion spike.

• The Czech Republic has been affectedby the re-pricing of risk at internation-al level much less than other emerg-ing markets. The crown profited fromincreased risk aversion, gaining ahefty 12 % versus the euro since mid-2007. The impact on creditgrowth has been negligible, while on-ly the stock market appeared to be hitby the international financial crisis.

MAIN TOPICS

OUTLOOK


Household spending remains the engine of Q3 GDP growthGDP growth came in at 6.0 % yoy in Q3,losing some momentum after an upward-ly revised 6.3 % expansion in Q2 andovershooting our and consensus forecastsslightly, both at 5.8 % yoy. Growth struc-ture changed little from previous periods,with domestic demand remaining themain growth driver. Household spendingwas up a hefty 5.6 % yoy, showing thebiggest contribution to Q3 expansion asrising employment, the consumer lend-ing boom and buoyant welfare spendingkept feeding household incomes. Fixedcapital formation rose 5.7 % yoy, led bydeveloper projects, investments in trans-port infrastructure, machinery and trans-port equipment. Whereas inventories alsomaintained its robust growth, govern-ment consumption slipped to negativeterritory, dipping 0.4 % yoy. Net exportsadded 0.8 p.p. to GDP growth, slightlymore than in Q2, with the export growthrate (14.8 % yoy) outpacing that of im-ports (14.2 % yoy). Neither sector break-down pointed to bigger shifts, as manu-facturing industries, trade and businessservices continued to be the main pillarsof economic growth.

Flash Q4 GDP estimate shows unex-pected growth acceleration from Q3 The estimate for Q4 GDP growth came inat surprisingly strong 6.9 % yoy, which incombination with upward revision of pre-vious quarters put the full-2007 expan-sion at 6.6 % yoy. Without revealing the

breakdown of Q4 growth, the StatisticalOffice reported that all components hadpositive contribution to growth. An extra-ordinary impetus, adding 0.5 p.p., camefrom increased spending of health insur-ers, most likely related to higher demandfor health services ahead of the introduc-tion of medical fees from January 2008.On the contrary, personal consumptionwas said to lose some momentum due tothe inflation spike. At the same time, thesigns of higher inflation eroding house-holds’ purchasing power were brought by retail sales data, which pointed to aweakening trend towards the year-end.The deterioration was mainly related tofood sales, the category that saw thesteepest price increases in last year’s final quarter. We therefore expect per-sonal consumption growth in Q4 to haveslipped by roughly 1 p.p. from Q3.

Economic reforms to take their toll on2008 growthFiscal reform measures raising indirecttaxes and cutting social spending, plus asharp rise in inflation, will further slowpersonal spending in 2008, althoughwage negotiations suggest that nominalwage growth will most likely maintain itsgood momentum of last year. We expecthouseholds’ real income growth to slowsignificantly, bringing their consumptiondown to +3.5 % yoy in 2008 from +5.6 %yoy forecast for 2007. Gross capital for-mation is also expected to lose someground, affected solely by the drop in in-ventory formation. Finally, projected

slowdown in external demand, coupledwith the impact of real appreciation ofthe crown, is set to weigh down exportgrowth. Nonetheless, we assume that thepace of imports will slow even furtheragainst a background of weaker domesticdemand, resulting in a positive contribu-tion by net exports to growth in 2008 too.On balance, we expect GDP to increaseby 4.0 % yoy, with growth bottoming outin Q1. Overall, the economy will be littleaffected by the deterioration in the inter-national scenario.

Industrial production growth continues its slowdown December industrial production rose by a mere 2.9 % yoy, putting the averagegrowth for the last year at 8.2 % yoy,down from 11.2 % yoy in 2006. The slow-down in recent months was, however,partly influenced by a shutdown in one oftwo local refineries, which knocked oil re-fining industry output down sharply on ayoy basis. In addition to this one-off nega-tive effect, the industry seems to have thefeeling that demand has peaked. Despitethe gradual slowdown, the industrial sec-tor has maintained its reputation as anengine for economic growth, fuelled pri-marily by production of cars, machinery,and electrical and optical equipment, i.e.sectors that have managed to keep dou-ble-digit growth rates. Going forward,however, the global economic slowdown,combined with negative exchange rate ef-fects, is set to slow industrial performancedown further. Deterioration in new orders

Growth slowing, mainly due to the new economic reforms, butinflation still on the rise


Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07Real GDP, yoy (%) 6.2 – – 6.4 – – 6.3 – – 6.0 – – –Industrial production, yoy (%) 6.1 10.8 13.1 11.0 14.5 6.8 6.6 11.6 6.0 1.3 8.4 6.7 2.9Inflation (CPI), yoy (%) 1.7 1.3 1.5 1.9 2.5 2.4 2.5 2.3 2.4 2.8 4.0 5.0 5.4Unemployment rate (%) 7.7 7.9 7.7 7.3 6.8 6.4 6.3 6.4 6.4 6.2 5.8 5.6 6.0Exchange rate/EUR, eop. 27.50 28.16 28.30 28.00 28.13 28.33 28.72 28.04 27.73 27.61 26.97 26.26 26.621M Pribor, avg. 2.52 2.53 2.54 2.54 2.54 2.61 2.81 2.90 3.07 3.33 3.35 3.43 3.98Export, (EUR) yoy (%) 17.5 18.6 22.0 19.7 24.0 13.1 14.3 22.9 16.1 15.6 17.6 16.4 11.1Import, (EUR) yoy (%) 17.0 21.3 17.5 15.2 20.0 11.7 14.5 21.3 16.3 12.4 15.4 13.4 9.4Trade Balance, EUR mn –133 320 468 596 141 188 287 –51 –56 505 315 424 –41Current account, EUR mn –476 –66 169 485 –586 –678 –250 –507 –1,113 –87 –500 43 –765Sources: Czech National Bank, Czech Statistical Office, Labour and Social Affairs Ministry, UniCredit Bank Economic Research.


Czech Republicstatistics and a lacklustre rise in exportsales in December might be the firstwarning signs. New orders dropped by2.2 % yoy at current prices, while thegrowth in export sales was the weakestfor the whole of 2007. We project that in-dustrial production growth will furtherslow to 5.5 % yoy this year.

CNB keeps narrowing outlook, withinflation picking up substantiallyThe last four months of 2007 saw infla-tion rising steeply to the highest rate inmore than six years. yoy price growthamounted to 5.4 % in December, gainingthree full percentage points from 2.4 % in August. The unprecedented inflationspike can be attributed primarily to asurge in food prices, which added 1.8 p.p.to the headline inflation rate in Decem-ber. Heavily weighted housing priceswere also on the rise in recent months,pulled by increasing rents. In the trans-port sector, an increase in fuel costs wasaccompanied by a hike in train fares. In-flation soared further to 7.5 % yoy inJanuary, as the whole range of goods andservices from energy to televisions feesrose. In addition, newly implementedfees in healthcare added as much as0.5 p.p. to headline mom CPI. Althoughprice growth will moderate during theyear, this year’s average inflation willlikely more than double last year’s 2.8 %.

After tightening monetary policy in No-vember, the CNB took a break at the yearend, with only two out of seven boardmembers voting for a 25 bps interest ratehike. It seems that it was mainly thecrown’s strength and the assumption ofinflation subsiding by early 2009 thatmade the remaining five central bankersleave the two-week repo rate at 3.50 %.Even though the CNB realizes fully thatthe inflation spike has been caused pri-marily by one-off regulatory price in-creases and supply shocks, the extent ofrecent price growth has increased thebank’s concerns over its impact on infla-tion expectations. Moreover, the CNB’sinflation forecast in October was overshotby a hefty 1.5 p.p. in December, as well asbreaching the upper limit of its 2–4 % tol-erance range. These worries were thenreflected in the CNB’s decision to raiseinterest rates once more by 25 bps in ear-

ly February. Global developments, im-pacting growth prospects worldwide, andCNB’s somewhat dovish statementsforced us, however, to forecast no addi-tional policy tightening for the rest of thisyear. We still project a small rate rise in2009, though, which should ensure infla-tion is consistent with the new CNB targetof 2 %, valid from January 2010.

The crown continued to firm up in the fi-nal months of 2007 and in early 2008, set-ting new all-time highs both against theeuro and dollar. The speed of the curren-cy’s appreciation was extraordinary,amounting to almost 10 % against the eu-ro and 17.5 % against the dollar betweenmid-2007 and the end of January. Where-as the crown’s strengthening was at firstdriven by unwinding carry trades, recentmonths saw global investors opening newpositions in CZK, serving as a safe-haventool against a background of increasedrisk aversion on financial markets. Look-ing ahead, the persistent uncertainty onthe international financial markets mightkeep EUR/CZK exchange rate volatility atan unusually high level for most of thisyear. On top of that, we believe that onceinvestor confidence in riskier assets is re-stored, the overvalued crown might startlosing some ground. Unlike our previousforecast, however, we now think that thecorrection will be slighter, as the gap be-tween Czech and euro zone interest ratesis set to close sooner than originallythought. Furthermore, the CNB is goingto be less concerned about (more tolerant

to) the crown’s strength than in the past,as it will help tighten monetary condi-tions at a time of higher inflation. Despitethis assumption of moderate weakeningof the CZK versus the euro towards theyear end, we project that the 2008 ex-change rate average will reach 26.40,which would be almost 5 % down fromthe average of 2007. In addition, thisyear’s real appreciation of CZK will notbe brought about solely by nominal CZKappreciation, as was the case in previousyears, but by the price channel too.

Major negative impact of interna-tional liquidity crisis observed on thestock marketAs we have mentioned above, global financial turmoil contributed to thestrong hardening of the crown in H22007, whilst causing us to predict less ag-gressive monetary policy tightening forthis year. At the same time, we have no-ticed no negative impact on bank creditgrowth so far. What was severely hit,however, was the local equity market,which failed to resist the global sell-off,with the main Prague stock exchange in-dex losing more than 17 % of its valueduring the first month of this year.

Foreign trade remains resilient to CZKappreciationForeign trade continued to show excellentresults, with its balance posting yoy im-provement in each of the last four monthsof 2007. The group of machinery andtransport equipment contributed most to

01-07 03-0702-07 04-07 05-07 07-0706-07 08-07 09-07 10-07 11-07 12-07 01-08

yoy growth (%) mom growth (%)

–1

0

1

2

3

4

5

6

7

8

CPIin %

Source: Statistical Office

the yoy improvement in the Sep.–Dec. pe-riod, suggesting that external demand hasnot yet abated significantly. Within thisgroup, exports of road vehicles, telecom-munications and computer equipmentshowed the highest yoy growth rates. The cumulative surplus for the whole of2007 more than doubled on a yoy basis,amounting to CZK 86.1 bn. Exportsjumped 15.0 % yoy, outpacing a 13.1 %yoy rise in imports. Strong performanceby the manufacturing industry proved amajor driver of last year’s improvement inthe balance of trade, having a decisiveshare of the yoy increase in exports.Favourable development in terms oftrade, as well as solid economic growth inthe EU states, also contributed markedlyto a surge in trade surplus in 2007. We ex-pect the increasing surplus trend to ex-tend to this year despite weaker foreigndemand projections. We assume that thenegative impact from abroad will be out-balanced by fading domestic householdconsumption, which will take an evenheavier toll on import growth.

The current account posted a surprisinglyhigh deficit of CZK 20.1 bn in December,breaking a trend of substantial yoy im-provement seen in the previous months.The cumulative deficit for the last threemonths of 2007, however, shrank by CZK13.2 bn yoy, almost offsetting the deterio-ration from early 2007: the full-year deficitreached CZK 106.6 bn last year, versus aCZK 100.3 bn gap in 2006. The improve-ment in recent months came primarilyfrom a widening foreign trade surplus,while the outflow of funds on balance ofincomes was little changed on the yoy ba-sis. Moreover, the balance of currenttransfers seems to have been supported bythe inflow of money from EU structuralfunds. In GDP terms, the current accountgap dipped to 3.0 % of estimated GDP for2007 from 3.1 % in 2006, signalling thatthe domestic economy’s external positionhas remained well stabilized. We expectcurrent account per GDP ratio to stayslightly above 3 % in 2008 and beyond,with the trends of a rising foreign tradesurplus and growing balance of incomesdeficit persisting. Gross FDI inflows to-

talled CZK 18.4 bn in December, lifting thecumulative 2007 inflows to CZK 168.2 bn,sharply above CZK 134.7 bn seen in 2006.Most of this increase can be attributed toreinvested profits in the wake of increas-ing corporate profitability. Relative toGDP, inward FDI reached 4.7 % in 2007,but for this year, we expect the ratio todrop to 4.4 %. However, the proceeds fromprivatization of Prague’s Airport mightboost the figure in 2009.

2007 government budget deficit well undershot The central government budget posted amuch lower than expected deficit of CZK66.4 bn last year, due mainly to robusteconomic growth helping boost tax rev-enues. The gap was below the CZK91.3 bn target approved by Parliamentand the Ministry of Finance’s latest fore-cast of around CZK 81 bn. Tax revenuesexceeded plan by CZK 16.6 bn (or 3.2 %).According to ESA 95, the 2007 centralbudget deficit was just CZK 40.4 bn, withthe difference versus the gap reported un-der GFS standards stemming from a one-off transfer of funds to a budget reserve,which does not come into ESA 95 calcula-tions. In fact, this reserve is formed bybudgeted spending which the governmentwas unable to realize, due mainly to a de-lay in implementing EU programmes.Naturally, the unspent funds, havingamounted to a sizable CZK 96.6 bn at the

end of 2007, entail a risk of undesirablefiscal expansion and a deficit surge (un-der ESA 95) in the years to come. Basedon preliminary Ministry of Finance calcu-lations, the overall public finance deficitamounted to only 1.9 % of GDP last year.This came far below the Ministry’s earlierforecast of a deficit of 3.4 % and 1 p.p. be-low the 2006 shortfall. In addition to cen-tral government, municipalities were alsoreported as making extra savings, helpingthe wider fiscal balance. Finance MinisterKalousek said he believes that 2008 fiscaldeficit targets will also be undershot. Weare not so optimistic given the prospect offaster economic slowdown.

Euro entry before 2013 increasinglyunlikely The CNB and Ministry of Finance’s annu-al joint assessment of the Czech Repub-lic’s convergence towards the EMU hasrecently confirmed a previous opinionthat the country has not progressedenough to set a firm target date for euroadoption. The assessment pointed chieflyto little improvement in labour marketflexibility and slow reform progress,which does not ensure a sustainable re-duction in public budget deficits. Eventhough the Ministry of Finance has reiter-ated that adoption of the euro is still pos-sible in 2012, Prime Minister Topolanekand some members of the CNB’s boardhave advocated later EMU entry.


Event Date ReadingRetail sales March/April 2008 They will indicate the impact of the new economic reforms on personal consumption dynamics

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

200720062005

0

10

20

30

40

50

60

70

80

90

Foreign trade (cumulative)CZK bn

Source: Statistical Office


• Growth slowed further in Q4 2007.Real GDP increased by 4.5 % yoy,down from 6.4 % yoy in Q3. Declininggrowth in industrial production and inretail sales in late 2007 (–2.2 % yoyand 4.7 % yoy respectively in Decem-ber) also point to a slowing of eco-nomic expansion.

• Inflation has increased significantly.Consumer prices were 11.0 % higherin January 2008 than a year earlier.

Prices of food and non-alcoholic bev-erages rose by 16.1 % yoy, prices ofservices by 12.6 %, prices of manu-factured goods by 6.9 % “only”.

• The current account deficit widenedto 16.0 % of GDP from 15.5 % of GDPin 2006.

• Inflows of loans and deposits fromabroad amounted to EUR 3.6 bn in2007, up from EUR 2.8 bn in 2006. Of these, EUR 3.3 went to credit insti-

tutions, no visible signs as yet ofscarce refinancing from abroad.

• Despite sufficient financing fromabroad, interest rates rose substan-tially as domestic deposits grew significantly less than lending. The 3-month interbank offer rate in-creased from 3.8 % at the end of2006 to 7.2 % in December 2007 and rose further to 7.3 % by earlyFebruary.

MAIN TOPICS

EstoniaOUTLOOK

MOODY’S LT FC RATINGA1/Stable

S&P’S LT FC RATINGA/Negative

FITCH LT FC RATINGA/Negative

SPREAD AVG (JAN) N.A.EMBI+ Spread on Euro Curve

Macedonia

Poland

Czech Republic

Slovakia

Hungary

Slovenia

Croatia


Monte- negro

Austria

Germany

Italia

Estonia

Latvia

Lithuania

Romania

Bulgaria

Slowing income and credit growth willcombine with lower investment and amore difficult external environment tocool Estonia’s rapid economic growth.This will help to even out imbalances, reduce the current account deficit andlower inflation. Risks that the adjust-ment will be a bumpy road have in-creased. We do, however, still believethat the process will be fairly smooth.Real GDP growth should fall to 5.7 % in

2008 and recover slightly to 5.9 % in2009. Inflation is not likely to decreasesignificantly until late 2008, because ofinternationally high food and energyprices and because of hikes in excise duties. We expect double digit inflationrates in early 2008, but a fall to some7 % by December. The current accountdeficit should shrink in 2008 and in2009. Estonia’s kroon-euro peg shouldthus be sustainable.


2006 2007e 2008f 2009f 2010fNominal GDP (EUR bn) 13.2 15.4 17.4 19.5 22.0Per capita GDP (EUR) 9,841 11,470 12,976 14,577 16,466Real GDP yoy (%) 11.2 7.3 5.3 5.9 7.2Inflation (CPI), yoy, Dec. (%) 5.1 9.6 7.1 5.0 4.7Inflation (CPI), yoy, avg. (%) 4.4 6.6 9.0 5.3 4.8Unemployment rate LFS (%) 5.9 5.3 4.7 4.0 3.8Exchange rate EEK/EUR, avg./eop. 15.65 15.65 15.65 15.65 15.65Interest rate eop. (3m Talibor) 3.85 7.20 5.08 5.05 4.70Interest rate avg. (3m Talibor) 3.16 4.84 6.14 5.07 4.88Current account balance/GDP (%) –15.5 –16.0 –14.5 –14.0 –13.6FDI/GDP (%) 9.6 11.5 9.3 8.7 7.8Budget balance/GDP (%) 3.8 3.4 1.5 1.0 1.5Public debt/GDP (%) 3.9 2.8 2.5 2.1 2.0Total external debt/GDP (%)1 94.7 103.8 110.4 114.9 115.91) More than one–half is trade credits.Sources: Ministry of Finance of Estonia, Bank of Estonia, Statistics Estonia, UniCredit New Europe Research Network.


Real GDP: “Only” 4.5 % in Q4Real GDP growth slowed to 4.5 % yoy inQ4 2007, bringing GDP growth in 2007 asa whole to an estimated 7.3 % yoy.

Slump in investmentGross fixed capital formation likely con-tinued to decrease in Q4, extending the5.7 % yoy loss of Q3. The reason for theslump is a combination of more pes-simistic expectations that the economywill continue to expand as fast as in thepast, overinvestment in 2006 (when fixedinvestment surged by 22.4 % yoy), andscarcer internal sources because of slow-ing profit growth and tighter credit condi-tions. It is likely that investment growthwill remain subdued in 2008 too, and onlyrecover in 2009. Growth in corporate prof-its has trended downwards since its peakin late 2005 (see chart). In Q3 2007, thelatest quarter for which data are available,it fell to just 8 % yoy in nominal terms.

Lower income gains and more enterprise restructuring to comeWhile nominal wages grew by morethan 20 % yoy in the first three quartersof 2007, output per personnel cost in in-dustry extended its fall from 0.2 % in Q12007 to 2.8 % in Q3. The pace of wagegrowth appears to be unsustainable, ifcompetitiveness is to be preserved. A deceleration in wage growth in particu-lar and in income growth more general-ly is to be expected in nominal terms,and in real terms in particular due tohigh inflation. Enterprises will need toadopt measures to shore up productivityand some market exits cannot be ex-cluded either.

Loan growth to decline faster, inter-est rates to remain relatively highThe increase in the volume of loans ex-tended to companies fell from 60.4 % yoyin (December) 2006 to 31.0 % in 2007.The analogous figures for personal loansare 63.0 % and 34.0 %. However, loans

to non-monetary financial institutions in-creased by 78.1 % yoy in 2007 afterfalling by 52.9 % in 2006, making theoverall loans growth picture less clearcut. Overall loan growth decelerated to33.3 % yoy in December 2007, from41.6 % in December 2006, not withoutsome volatility, however. At the sametime deposit growth slowed to 13.8 % yoyfrom 28.0 %. Both companies and house-holds are not increasing their deposits asfast as before. This will combine withtighter global credit conditions and high-er risk aversion to reduce loan growthfurther and keep interest rates relativelyhigh in 2008.

Some fiscal relaxation in 2008On 12 December Parliament approvedthe 2008 government budget. Expendi-ture was set at EEK 93.7 bn (33.8 % ofGDP, compared with a probable 32.6 % ofGDP in 2007), revenues are projected toamount to EEK 96.4 bn (34.8 % of GDPcompared with 33.1 % in 2007). The in-come tax rate will be cut from 22 % to21 % in January, but hikes in excise du-ties on tobacco and alcohol are expected

to more than offset income tax losses.The government budget surplus is target-ed at EEK 2.7 bn (1 % of GDP comparedwith a probable 0.5 % of GDP in 2007),the general government surplus at EEK3.6 bn or 1.3 % of projected GDP. We be-lieve that the budgeted general govern-ment surplus is slightly lower than thelikely 2007 outcome. Fiscal policy is thusrelaxing somewhat. Underlying budgetassumptions are 5.2 % real GDP growthand 8.5 % inflation.

Towards more balanced growth The fiscal relaxation will prevent a morepronounced fall in Estonia’s GDP growth.However lower investment growth andmore restricted household spendingshould reduce GDP growth to no morethan 5–6 %. The slower growth will helpEstonia to reduce the current accountdeficit and lower inflation. Deviationfrom past growth patterns always entailssome risk, but we are confident that Esto-nia is sufficiently stable and integratedinto European structures that majorproblems such as a break of the currencyboard can be avoided.

Investment, income growth, credit expansion all set to cool

Event Date ReadingQ1 2008 GDP release 9 June 2008 Will give important indications about the state of the economy

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q32005 2006 2007

Acquisition of buildings, structures (r.h.s.)Investments in tangible fixed assetsCorporate Profit

–10

0

10

20

30

40

50

60

–50

0

50

100

150

200

250

300

Source: Statistics Estonia, Eesti Pank, UniCredit New Europe Research Network

Profit and investment growth on the declineyoy, %

16

• GDP growth in 2007 is expected torecord a poor 1.3 % yoy growth.

• 4.0 % budget deficit target in 2008 islargely considered to be feasible –further reforms are, however, neededin order to push down budget deficitsas envisaged in the Convergence Program. The fragile domestic politi-cal scene and massive resistance tothe reform measures may slow downprogress in reforms.

• Inflation in 2007 recorded a peak of8 % on average. It will decreaseslower than previously expected in2008. As a consequence, the CentralBank will keep the base rate on holdat 7.50 %, at least until April/May,before it starts to ease it, dependingon exchange rate volatility too.

• The HUF’s high volatility amidst thepresent global financial crisis is ex-pected to calm down in the long run.

With CPI and interest rates convergingtowards euro zone standards, the HUFcan stay firm in the 250–260 HUF/EURrange.

• The international liquidity crisis’s im-pact on the Hungarian economy wasmainly seen in the stock market andin some repricing of risk at interna-tional level, with 5-year CDS increas-ing from to 30 to 79 bp from July2007 to end January 2008.

MAIN TOPICS

HungaryOUTLOOK

MOODY’S LT FC RATINGA2/Stable

S&P’S LT FC RATINGBBB+/Stable

FITCH LT FC RATINGBBB+/Stable


Macedonia

Poland

Czech Republic

Slovakia

Hungary

Slovenia

Croatia


Monte- negro

Austria

Germany

Italia

Estonia

Latvia

Lithuania

Romania

Bulgaria

The price of the fiscal restrictionlaunched in 2006 was very poor eco-nomic performance in 2007, marked es-pecially by a decline in public and pri-vate consumption, as well as public in-vestment. After bottoming out in Q32007 and amidst the uncertainties of theworld international scenario, the Hungar-ian economy will recover modestly andreach yearly growth of 2.8 % in 2008.The stabilization package helped the2007 budget deficit to lag far behind the

planned 6.8 % of GDP, as the preliminaryMinistry of Finance figure stands atabout 5.5–5.7 % (ESA 95 standard), andfurther improvement is expected in thenext few years. High inflation (driven byhigh oil and food prices) and volatile ex-change rates (mainly due to increasingrisk aversion by foreign investors) mightdelay easing of monetary policy. Thoughno target date for EMU entry has beenfixed yet, we do not expect Hungary toadopt the euro before 2012/2013.


2006 2007e 2008f 2009f 2010fNominal GDP (EUR bn) 89.9 100.8 106.5 115.1 124.6Per capita GDP (EUR) 8,920 10,020 10,610 11,470 12,430Real GDP, yoy (%) 3.9 1.3 2.8 3.4 4.2Inflation (CPI), yoy, eop. (%) 6.5 7.4 4.4 3.5 2.9Inflation (CPI), yoy, avg. (%) 3.9 8.0 5.6 3.6 3.1Unemployment rate (%) 7.5 7.3 7.3 7.2 7.0Exchange rate HUF/EUR, eop. 252.3 253.4 254.0 252.0 252.0Exchange rate HUF/EUR, avg. 264.3 251.3 258.0 255.0 253.02-week repo rate, eop. 8.0 7.5 7.0 5.75 5.251M Bubor, eop. 8.09 7.52 7.15 5.85 5.301M Bubor, avg. 6.80 7.83 7.30 6.45 5.60Current account balance/GDP (%) –6.5 –4.9 –4.4 –4.1 –3.7FDI/GDP (%) 6.3 2.6 3.1 3.7 4.0Budget balance/GDP (%) –9.2 –5.5 –4.0 –3.2 –2.9Public debt/GDP (%) 66.0 65.1 64.0 63.3 61.9Total external debt/GDP (%) 90.0 98.7 93.0 91.1 88.2Source: NBH, Statistical Office, Ministry of Finance, UniCredit Group New Europe Research Network.



Economic growth reached the bottomin 2007After years of dynamic growth accompa-nied by deep financial imbalances, theHungarian economy reached a turningpoint in 2007. As a consequence of thestabilization package launched by thegovernment in 2006, economic growthdecelerated considerably in the course oflast year. The rate of GDP growth gradu-ally descended to 0.9 % in Q3 2007, from4.9 % in Q1 2006 and, according to pre-liminary data release, it may achieve amere 1.3 % as a yearly average in thewhole of 2007.

Broken down according to GDP compo-nents, on the demand side restrictions inpublic spending implied a 10 % decreasein personal consumption in the form of so-cial transfers over the first three quartersof 2007, a 6 % contraction in public con-sumption and a sharp downturn in the vol-ume of public-sector investments, mainlyin the infrastructure-related segments. Re-cession in all these GDP components led toa fall in domestic demand that could not becompensated for by still fast-growing man-ufacturing company exports and some-what resurgent private investments. In-deed, slowly climbing unemployment andreal net wages declining under strengthen-ing inflationary pressure were the mainfactors affecting private consumption. InNovember real net wages declined by4.6 % yoy, while employment shrank by2.3 % and unemployment picked up to7.5 % (7.7 % in December). The majority

of lay-offs took place in the public sector,where a net 34,100 jobs were eliminated injust one year, which corresponds to a dropof 5.7 % yoy. Contraction in employmentand in purchasing power made retail salesfall from February 2007, to be 4.2 % lessthan the previous year in November 2007.Retail sales of non-food consumer goodsand vehicles suffered the sharpest fall inturnover, with a decrease of 6.1 % and6.3 % yoy respectively.

Decreasing domestic consumer demandand tight State fiscal spending inevitablycurtailed corporate investments, whichoperate under State management andwhose business performance mostly de-pends on internal sales. During the firstthree quarters of 2007 the real value ofcapital expenditure on public administra-tion, education, healthcare and otherState-controlled segments, which togetherrepresented 15 % of nationwide invest-ment outlay in 2006, was almost 19 % lessthan in the same period of 2006. Trading,transport & communications, financialservices and other business services alsorecorded a lower amount of fixed capitalformation. Moreover, construction-relatedinvestments were down by 8.5 % yoy. Onthe other hand, the private enterprise-dominated manufacturing sector, with25.8 % share of total capital expenditureimplemented in the country, at the sametime boosted real investment volumes by30.2 % yoy. Fixed capital formation in ma-chinery and vehicles was up by 11.2 %.The positive message from these statistics

is that a vigorous mood of investment inmanufacturing ensures the existence ofadequate surplus capacity, so that exportscan continue expanding in 2008, thoughsomewhat less fast than in 2007.

On the supply side, GDP growth was neg-atively influenced by performance in theconstruction sector, as well as other pub-lic administration-related sectors. Overthe first three quarters of 2007 construc-tion output suffered a yoy contraction of10.2 % on average, and declined by22.7 % yoy in November. The depressionmainly affected asset-intensive, large-scale projects, such as motorway building.With the order inventories down by 32.6 %yoy in November, a quick short-term re-covery seems a little unlikely. However,the volume of new orders that has built upsince the beginning of 2007, which seemsto indicate a moderate rise, is a promisingsign. Next to construction agricultureproved to be the most troublesome indus-try, with a cumulative 12.5 % fall in addedvalue in Q1–Q3 2007 due to harsh weatherconditions. Conversely, manufacturingproved to be in good shape, with a cumu-lative annual average growth rate of7.7 % in the same period of last year. Themost dynamic industries were those thathave been driving Hungarian exports formany years: electronics, vehicle manufac-turing, machinery and other heavy indus-trial goods. The food industry, once thelargest net exporting sector, continued tobe hampered by foreign competition andweak internal demand though.

Modest economic recovery against background of gradually improving fiscal performance


Dec-06 Jan-07 Feb-07 Mar-07 Apr-07 May-07 Jun-07 Jul-07 Aug-07 Sep-07 Oct-07 Nov-07 Dec-07GDP real growth, yoy (%) 3.7 – – 2.7 – – 1.2 – – 0.9 – – -Industrial production, yoy (%) 8.4 12.2 10.9 5.0 10.3 3.8 8.8 11.8 9.5 6.2 8.5 5.5 –Inflation (CPI), yoy (%) 6.5 7.8 8.8 9.0 8.8 8.5 8.6 8.4 8.3 6.4 6.7 7.1 7.4Unemployment rate (%) 7.5 7.5 7.4 7.5 7.5 7.3 7.0 7.0 7.2 7.2 7.3 7.5 7.7Exchange rate HUF/EUR, eop. 252.3 258.0 254.8 247.8 246.4 250.4 245.9 250.7 254.1 250.8 251.1 253.4 253.41M Bubor, avg. 8.09 8.07 8.10 8.06 8.01 8.00 7.96 7.74 7.78 7.70 7.50 7.50 7.52Export, (EUR) yoy (%) 15.9 19.8 24.6 14.1 18.7 12.8 18.2 23.1 18.3 11.4 17.4 8.1 –Import, (EUR) yoy (%) 15.3 20.9 17.9 6.1 15.9 8.5 14.2 16.8 13.9 7.4 13.5 5.5 –Trade balance1, EUR mn –2,379 –219 –270 –152 –289 –270 –202 –347 –547 –404 –356 –295 –Current account1, EUR mn 5,832 – – –1,099 – – –2,609 – – –3,999 – – –Source: NBH, Statistical Office, Ministry of Finance, UniCredit Group New Europe Research Network; 1) cumulative


Economic recovery foreseen in the upcoming periodWe expect a slight recovery in privateconsumption starting from 2008, partlydue to a low base effect and also to realnet wages starting an upturn phase. As aconsequence, actual household end con-sumption may grow from 0.9 % yoy in2008 to 1.5 % in 2009. These rates wouldbe followed by greater acceleration in2010, reaching a rate of 2.4 % yoygrowth. On the other hand public con-sumption will probably decline further(by 4 %) in 2008 and would only startgrowing in 2009 at a rate of 0.2 %, whileit might reach growth of 1.7 % yoy in2010, 2010 being an election year. Withslowly improving wage purchasing pow-er and the mood of consumers improvingalong with it, sluggish investment activi-ty in service sectors is expected to re-sume and provide an additional boost tothe constantly enlarging volume of fixedcapital formation in manufacturing. As aresult, the capital expenditure growthrate may accelerate to 6.8 % in 2008,7.3 % in 2009 and 8.8 % in 2010. Becauseof a faster-than-previously-expectedslowdown in the euro zone economy, ex-port development is unlikely to continueexpanding as fast as it did throughout2007. Strong investment performance inmanufacturing, however, will continueto support exports, and in a pessimisticscenario, there is a chance that externalsales will grow by around 10–12 % perannum between 2008 and 2010. In thesame period imports should inevitablyembark on a gradual rise in the wake ofstrengthening domestic consumptionand investments, and may expand by anaverage annual rate close to 10–12 % aswell. Consequently, though net exportswill remain the main engine of GDPgrowth in 2008 too, their contribution toeconomic growth will gradually declinein subsequent years. The abovemen-tioned developments are expected tolead to a slow acceleration in GDPgrowth, up to 2.8 % in 2008, 3.4 % in2009 and 4.2 % in 2010.

Public sector deficit remains well below targetWhile economic growth has been suffer-ing from cutbacks in government expen-diture, the stabilization package’s

achievements have at long last becomevisible in the shrinking budget deficit.According to ESA 95 figures, the publicsector deficit is likely to close at around5.5–5.7 % of gross domestic product in2007, considerably lower than the origi-nal target of 6.8 % (and 9.2 % in 2006).The main factors behind

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