Swiss franc carry trade props up eastern Europe
Along with other emerging markets, eastern European stocks have bounced back from this summer’s jitters – they are up 9% this year. These stocks remain vulnerable to fluctuations in global risk appetite in the short-term, says Capital Economics, but the medium-term outlook is positive.
Convergence with western Europe is far from over. GDP per head in the Czech Republic, the region’s richest country by this measure, is still less than half of the eurozone’s $34,000. Strong credit growth has boosted consumption and fixed investment: the latter is set to grow by 25% in Poland this year. Throw in the fact that wage costs remain low and the region is set to expand by 6.5% this year and 6% next, reckons Capital Economics. And valuations look reasonable – the MSCI Eastern Europe index is on a p/e of 13.
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One potential fly in the ointment, however, is currency risk. Households and companies across the region have increasingly been borrowing in low-interest currencies, notably the Swiss franc. In Latvia, 85% of household and corporate debt is in foreign currency; 80% of the mortgages taken out in Hungary over the past year have been in francs. So a sharp swing in the value of the franc as risk aversion prompts an unwinding of franc-funded carry trades could dent eastern European economies by depressing local currencies and squeezing local holders of franc-denominated loans.
More broadly, most eastern European countries have current-account deficits, making them more vulnerable to a global liquidity squeeze than their Asian or Latin American counterparts. Latvia’s current-account deficit is 20% of GDP, thanks to overheating credit growth and domestic demand. As ratings agency Fitch noted earlier this year, “cheap and plentiful capital inflows” have fuelled eastern Europe’s boom; the question is how well the region will cope amid a marked increase in risk aversion and tightening liquidity.
