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CEE
Quarterly
Macro Research
Strategy Research
Credit Research
CEE: Fighting the downturn
2Q2020April 2020 April 2020 CEE Macro & Strategy Research
CEE Quarterly
“Your Leading Banking Partner in
”
Central and Eastern Europe
UniCredit Research page 2 See last pages for disclaimer.April 2020 April 2020 CEE Macro & Strategy Research
CEE Quarterly
Contents
4 CEE: Fighting the downturn
16 CEE Strategy: More weakness before risk appetite returns
66 Acronyms and abbreviations used in the CEE Quarterly
COUNTRIES
22 Bulgaria: Economy braces for a deep but short recession
26 Croatia: Coping with the impact of lockdown
30 Czechia: Shocking times
34 Hungary: Pushing boundaries
38 Poland: Uncertainties galore
42 Romania: Testing times
46 Slovakia: COVID-19 shutting down a significant part of the economy
48 Slovenia: Growth to be hit by the impact of COVID-19
EU CANDITATES AND OTHER COUNTRIES
50 Bosnia and Herzegovina: Deep recession caused by COVID-19 outbreak
52 North Macedonia: EU accession talks temporary clouded by COVID-19
54 Russia: A perfect storm to test macroeconomic stability
58 Serbia: Economic challenges
62 Turkey: Recovery to be disrupted by the pandemic
Erik F. Nielsen, Group Chief Economist (UniCredit Bank, London)
+44 207 826-1765, erik.nielsen@unicredit.eu
Dan Bucşa, Chief CEE Economist (UniCredit Bank, London)
+44 207 826-7954, dan.bucsa@unicredit.eu
Florin Andrei, PhD, Senior Economist Romania (UniCredit Bank Romania)
+40 21 200-1377, florin.andrei@unicredit.ro
Artem Arkhipov, Head of Macroeconomic Analysis and Research Russia (UniCredit Russia)
+7 495 258-7258 ext. -7558, artem.arkhipov@unicredit.ru
Gökçe Çelik, Senior CEE Economist (UniCredit Bank, London)
+ 44 207 826-6077, gokce.celik@unicredit.eu
Published on 15 April 2020
Ariel Chernyy, Economist, Macroeconomic Analysis and Research Russia (UniCredit Russia)
+7 495 258-7258 ext. 7562; ariel.chernyy@unicredit.ru
Hrvoje Dolenec, Chief Economist (Zagrebačka banka)
Erik F. Nielsen +385 1 6006-678, hrvoje.dolenec@unicreditgroup.zaba.hr
Group Chief Economist
(UniCredit Bank, London) Dr. Ágnes Halász, Chief Economist, Head of Economics and Strategic Analysis Hungary (UniCredit Hungary)
120 London Wall +36 1 301-1907, agnes.halasz@unicreditgroup.hu
UK-London Ľubomír Koršňák, Chief Economist (UniCredit Bank Czech Republic and Slovakia)
EC2Y 5ET +42 12 4950-2427, lubomir.korsnak@unicreditgroup.sk
Elia Lattuga, Co-Head of Strategy Research (UniCredit Bank, London)
Imprint: +44 207 826-1642, elia.lattuga@unicredit.eu
UniCredit Bank AG Mauro Giorgio Marrano, Senior CEE Economist (UniCredit Bank, Vienna)
UniCredit Research +43 50505-82712, mauro.giorgiomarrano@unicredit.de
Am Eisbach 4 Kristofor Pavlov, Chief Economist (UniCredit Bulbank)
D-80538 Munich +359 2 923-2192, kristofor.pavlov@unicreditgroup.bg
Supplier identification: Pavel Sobíšek, Chief Economist (UniCredit Bank Czech Republic and Slovakia)
www.unicreditresearch.eu +420 955 960-716, pavel.sobisek@unicreditgroup.cz
UniCredit Research page 3 See last pages for disclaimer.April 2020 April 2020 CEE Macro & Strategy Research
CEE Quarterly
CEE
Fighting the downturn
Dan Bucsa, ■ CEE is expected to face the deepest recession of the century in 2020. Exports and imports
Chief CEE Economist
(UniCredit Bank, London) will contract sharply as global supply chains crumble. Domestic demand will be hit by rising
+44 207 826-7954 unemployment, corporate failures and uncertainty.
dan.bucsa@unicredit.eu
■ Support from governments and central banks is unprecedented, with both fiscal and financial
conditions expected to be loosened, in contrast to 2008-10.
■ The 2021 recovery is unlikely to recoup all losses incurred this year, with employment and
capex lagging the rebound. In addition, rebuilding supply chains could prove cumbersome.
■ In EU-CEE 1, we expect GDP to fall by 9.4% in 2020 and to grow by 8.5% in 2021.
■ Russia’s economy could contract by around 5.4% in 2020, with a 3.8% rebound next year.
■ In Turkey, GDP could fall by approximately 5.6% this year and grow by 6.6% in 2021.
■ We expect additional rate cuts in Czechia, Poland, Russia, Serbia and Turkey. Only Czechia
and Poland are likely to consider raising rates in 2021.
■ In 2020, inflation is likely to fall below target in EU-CEE and the Balkans, and to single digits
in Turkey. Base effects, supply shocks and large fiscal impulses will support reflation in 2021.
In Russia, inflation could rise above target in 2020 and fall below 4% in 2021.
■ Most CEE currencies are undervalued. Long-end local-currency bonds are attractive given
central bank purchases.
■ Positive potential outcomes of the COVID-19-induced crisis are a stronger civil society, a
reset of voter priorities, leaner bureaucracies and shorter supply chains in Europe.
■ Negative potential outcomes might be a further democratic backslide, poor EU fund
allotment for 2021-27 and social unrest.
CEE in quarantine…
“We were sure our hospitals were not able to withstand the situation. We had to react.”
Adam Vojtech, Czech Health Minister, quoted in the WSJ
A double hit from domestic The small, open economies of CEE are facing a double hit from domestic lockdowns and
lockdowns and collapsing
foreign demand collapsing foreign demand. Italy’s decision to go into a national lockdown once cases and
deaths escalated was quickly emulated in EU-CEE but not in the Balkans or Turkey. Russia
was the first country to register COVID-19 cases and one of the first to impose restrictions.
Yet among the countries covered in this report, Russia took the longest to impose localized
and national lockdowns. In contrast, EU-CEE countries moved very quickly, with Slovakia,
Slovenia and Bulgaria standing out. Summarized in the quote from Czech Health Minister
Adam Vojtech, the fear of overwhelmed health-care sectors was stronger than the fear of
economic damage. At the time of writing this CEE Quarterly, only Bosnia-Herzegovina,
Hungary, North Macedonia and Turkey do not have national lockdowns in place.
Lockdowns enforced in CEE Lockdowns in EU-CEE led to strong declines in travel and social activities (Charts 1 and 2).
With measures differing in intensity, the situation is not fully comparable across countries.
Data from Google also shows compliance with measures has been falling recently, a sign of
lockdown fatigue.
1
EU-CEE comprises Bulgaria, Croatia, Czechia, Hungary, Poland, Romania, Slovakia and Slovenia – all CEE countries that are members of the EU.
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CEE Quarterly
CHART 1: CHART 2: …BETTER THAN IN COUNTRIES PREPARING TO
SOCIAL DISTANCING MEASURES ENFORCED IN CEE… EASE RESTRICTIONS
change in visits and length of stay compared to 3 January - 6 February 2020, % change in visits and length of stay compared to 3 January - 6 February 2020, %
0 0
-10
-10
-20
Transit stations
-20
Workplaces
-30
CZ DK
-40 HU PL
HU -30
SI CZ DE DK DE
-50 BG SK
SK BH -40 RO
-60 SI
AT HR BG HR AT
PL TR BH
-70 -50
RO MK MK
-80 TR
-60
-100 -80 -60 -40 -20 0
-100 -50 0 50 100 150
Retail and recreation venues
Parks
Source: Google Mobility, UniCredit Research
Epidemic curves expected to Yet lockdowns seem to be working, with the number of deaths growing at a slower pace than
flatten in late April-early May
in western Europe when accounting for population and even for the number of tests.
However, epidemic curves are not flattening significantly in any of the CEE countries.
Adjusted for the number of tests, the number of infected and deceased suggest that the peak
in daily numbers of victims might be 2-4 weeks away, meaning in late April to mid-May.
Containing the spread is paramount because health-care systems in CEE generally score
poorly compared to their EU and OECD peers. While positions in global rankings have
improved since the global financial crisis, there is still room for improvement. The strains are
already showing, particularly in Romania, where poor management has led to a high number
of medical personnel becoming infected and several hospitals being closed or taken under
military administration. Vital ventilators and protection equipment were in short supply
throughout the region at the onset of the epidemic, but the situation is improving.
…drawing unprecedented response…
“We face a time of trial […], perhaps the most serious in decades. […] We won’t be able to avoid
this storm completely. […] We have to fight for our economy, our companies and workplaces.”
Mateusz Morawiecki, Prime Minister of Poland
Authorities have reacted The picture is not entirely bleak. In this unprecedented crisis, authorities reacted quickly and
quickly and continue to
implement measures to
showed uncharacteristic adaptability. The list of support measures from governments, central
address… banks and other public entities is growing by the day, with the IMF doing a commendable job
in tracking all these changes on its website. As has happened around the world, CEE
governments and central banks have reacted quickly to the looming crisis and have allocated
unprecedented resources. In the country sections of this publication, we discuss the most
important measures taken as of 7 April. Much more may be in the pipeline as authorities
grapple with the fallout from lockdowns. Influenced by the experience of other countries,
authorities have been quick to adopt best practice insofar as fiscal space allows. Differences
in firepower, scope and focus are inevitable.
Throughout CEE, governments have tried to address three stages of the current crisis:
…strains on health-care 1. The immediate strain on health-care systems. Funding was increased, public tenders
systems…
sped up to acquire the necessary equipment, health-care personnel received one-off
payments and promises of wage increases, especially in countries, such as Hungary,
that have been less generous in the past.
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…strains on companies and 2. The strain on companies and employees. All governments tried to avoid a large wave
employees…
of layoffs, albeit with differing success. Initially, authorities promised to cover the cost of
workers on furlough, with support ranging from 35% in Hungary to 75% in Romania. The
reaction was insufficient to prevent a large initial wave of unemployment for two main
reasons. First, access to financial support was cumbersome, requiring complicated
paperwork. By the time the Romanian government moved to ease access to funding, 155,000
people had been laid off and almost 800,000 had been put on furlough. As a result, many
governments, including that of Romania, simplified procedures and allowed companies to
apply for help online. Second, many companies believed that long restrictions would fatally
undermine their activity and closed their businesses. Again, governments moved to prevent a
wave of bankruptcies. The largest and most meaningful reaction to support employers came
from Poland, which pledged 6.7% of GDP to companies that try to avert closures and layoffs,
on top of shouldering 70% of the cost of furlough. Up to 4% of GDP may not be reimbursed
by the most resilient companies. Other measures include zero-cost funding for companies
(Hungary), funding with interest covered by the government (Romania), and funding at
subsidized cost (Russia and Turkey). Some countries included guaranteeing jobs until at least
the end of the year as a condition for their liquidity support.
In addition, governments allowed companies and households to postpone some tax
payments, including those that were overdue. Banks agreed to moratoriums on loan
repayments, especially for SMEs and mortgage borrowers. In Hungary and Romania,
authorities intervened to impose moratoriums until the end of the year. The danger is
excessive populism, with some politicians suggesting broader tax and payment holidays
that do not discriminate between those who need help and those able to weather the
crisis without public support.
… the future recovery.
3. The future recovery. The amount of state guarantees and credit available from
development banks and state agencies exceeds 5% of GDP in all countries and goes
above 10% of GDP in central Europe, with Hungary standing out. Central banks added to
their contributions by cutting interest rates. By the time they are done cutting, the cost of
central bank funding will be the lowest on record.
Immediate support is between It is too early to judge the success of all these measures. When looking at immediate support
1% and 8% of GDP (for health care, unemployment and companies in distress), packages amount to between 1%
and 8% of GDP, the rest coming in the form of guarantees and support measures that could
be used when the economy starts to recover. Poland stands out, followed by other countries
with large fiscal space, such as Czechia and Bulgaria. Despite starting with the worst fiscal
position in EU-CEE, Romania managed to put forward an immediate support package that is
larger and more comprehensive than Hungary’s. Slovenia, Slovakia and Croatia all pledged
urgent help in excess of 5% of GDP. Turkey’s package is over reliant on the CBRT, whose
toolbox continues to expand rapidly. Russia is the outlier, where a government with
unparalleled firepower has been slow to react.
Hungary has the most impressive package of guarantees and support measures once the
Large loan guarantee
packages…
worst is over and economies start to look forward to the recovery. It also has a tried and
tested system of funneling cheap funding to the private sector through its Funding for Growth
Schemes. Trillions of HUF have been allocated to investment in infrastructure, tourism and
business development and the take-up could be large, provided the economy weathers the
current downturn and foreign demand recovers.
… and cheap funding for the Elsewhere, lending to companies could increase because costs of funding are very low
recovery stage (Bulgaria, Croatia, Czechia, Poland, Slovakia and Slovenia) or are falling (Romania, Russia,
Serbia and Turkey).
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2020 budget deficits above 5% In 2020, we expect budget deficits to balloon to more than 5% of GDP in most CEE countries
of GDP in most countries…
(Chart 3), regardless of the commitments some governments are still making to fiscal
restraint. This translates into the largest fiscal impulses on record in Bulgaria, Czechia,
Croatia, Poland, Slovenia, Slovakia and Russia, even accounting for the decline in revenues.
Romania and Turkey, whose structural budget deficits exceeded 4% of GDP in 2019, have
the least fiscal space and will thus have less room to spend. Budget deficits of 7% of GDP or
more may be very difficult to finance outside the eurozone. Central banks could monetize
most of the fiscal deficit, but we expect the NBR to avoid this solution. To keep the deficit in
check, the Romanian government will have to cut other types of spending. The 40% pension
increase that spooked investors will probably be replaced with a much smaller rise. But this is
not all: at least half of planned public investment could be redirected to social spending and
the public wage bill could be cut.
…with 2021 deficits above 3% of Throughout CEE, governments are unlikely to withdraw support completely in 2021 due to high
GDP in many countries
unemployment, a possible return of the epidemic, the need to support the recovery or a combination
of these factors. Thus, budget deficits could remain above 3% of GDP in many countries.
Will all this matter for ratings? In our opinion, it should not. The countries facing the biggest
No rating action expected risk of downgrades, Romania and Turkey, will see public debt remaining below 45% of GDP
in 2020
at the peak, safely in investment-grade territory (Chart 4). Adjusted for the effect of COVID-19
(higher expenses, lower revenues), this year’s budget deficit is likely to be less than 4% of
GDP in Romania. In 2021, the budget deficit could be around 3.7% of GDP. In Turkey, the
current rating takes large budget deficits in the coming years into account.
CHART 3: LARGE BUDGET DEFICITS IN 2020… CHART 4: …LEADING TO A TEMPORARY INCREASE IN DEBT
budget balance (% of GDP) 2019E 2020F 2021F public debt (% of GDP) 2019E 2020F 2021F
2.0 100
90
0.0
80
-2.0 70
60
-4.0 50
40
-6.0
30
-8.0 20
10
-10.0
0
SK RS TR BG RO HR CZ SI PL HU RU BH
RU BG BH CZ TR RO PL RS SK HU SI HR
Source: Eurostat, national statistical offices, ministries of finance, UniCredit Research
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…with an eye to loosening restrictions…
“The virus makes the timeline.”
Dr. Anthony Fauci, director of the National Institute of Allergy and Infectious Diseases, US
Most restrictions to be All CEE countries are looking at the prospect of lifting lockdown measures, weighing the risk
eased in 3Q20
of high numbers of infected and strained health-care sectors against that of damaging the
economy irreversibly. The timeline remains uncertain, as no CEE country can affords a
re-acceleration of infections and deaths. Throughout CEE, states of emergency are likely to
extend into the summer, allowing authorities to reverse some decisions, be they to relax or
tighten restrictions, in response to conditions. We expect governments to start easing
restrictions this quarter, with most being removed in 3Q20.
A group of doctors have set forth the following four conditions for gradually reopening the
economy 2:
1. Contain the spread
2. Improve the capacity to test, identify and control the spread
3. Remove remaining restrictions when a vaccine becomes available
4. Invest in preparing for the next pandemic
Differentiating factors in
removing restrictions With a vaccine possibly more than a year away, some restrictions could remain in place for a
long time. Lifting lockdowns and easing controls in CEE will depend on four traits, which vary
across the region.
1. The strain on health-care systems. Some countries, such as Turkey, Romania and
Serbia, may have to impose longer restrictions to ease the burden on intensive care units
and reduce the number of deaths.
2. The handling of the disease. The experience of countries like South Korea, Taiwan and
Singapore shows that, in order to flatten epidemic curves, quantitative and qualitative
information about the epidemic is paramount. In CEE, the Baltics, Czechia and Slovenia
have been the most assiduous testers and may have a better picture of the spread and
intensity of the epidemic. However, in most CEE countries the number of tests is still well
below 1% of the population and there is probably insufficient information to draw solid
conclusions about geographical spread, the proportion of those infected (especially in
urban areas), shape of the epidemic curve and potential number of victims.
3. The intensity of current restrictions. Stronger restrictions now could allow for broader
easing in the near future. While most CEE countries imposed strict social distancing
measures, others opted for partial restrictions. Turkey quarantined only large cities.
Elsewhere, only the young and the elderly faced restrictions. Serbia curbed freedom of
movements only at weekends and between 5PM and 5AM. In contrast, Russia’s total
lockdown may not be needed if travel between regions is restricted further. Infections are
rising at much faster pace in Moscow and large cities than in remote republics and
territories. Some governors contested the decision to impose a month-long “holiday” on
the whole country and restrictions could be eased in regions with few cases.
4. Conformity with rules. Restrictions seem to be being enforced well. Once they are
relaxed, the population will still have to comply with social distancing rules in public
spaces, be it at work, while commuting or when shopping. Culture and lockdown fatigue
may well play a role. Countries where social norms and rules are easily ignored risk a
second rise in infections before 4Q20.
2
Gottlieb, S., C. Rivers, M. McClellan, L. Silvis, C. Watson, “National Coronavirus Response: A Road Map to Reopening”, American Enterprise Institute, 30 March 2020
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…to limit the recession and restart growth.
SMEs need lockdowns to ease Loosening restrictions is paramount to avoiding a longer slump after the inevitable recession
this quarter
in 2Q20. The EU is calling for a coordinated removal of restrictions. Most SMEs in CEE
estimate they can survive for 2-3 months before having to shut down activity. This means that
activity needs to resume, at least partially, in late May or June at the latest. Country evidence
also suggests that most companies seeking public support had no prior financial problems,
and boasted a good track record of tax payments and loan repayments. This is not a surprise.
Most companies applying for public support come from manufacturing and the hospitality
industry, two sectors that were thriving before the pandemic struck, but are now the hardest
hit by lockdowns.
In many cases, companies in manufacturing that are asking for public support are exporters whose
supply chains have broken down due to global restrictions. The globalization of manufacturing
came with a growing efficiency of supply chains. Just-in-time production methods increased
efficiency but reduced the need for inventories and storage capacity. As a result, production may
encounter repeated bottlenecks when it resumes, much more so than if this crisis had happened a
decade ago. Thus, a rebound in CEE very much depends on how the global economy, especially
that of the eurozone, copes with the crisis and how quickly it rebounds.
We expect global GDP to fall by 6% this year, with a very deep trough in 2Q20. The
Sharp fall in global and
eurozone GDP… eurozone’s economy could contract by 21.5% qoq in 2Q20 and by 13% in the entire year. Our
global scenario assumes that most restrictions in western Europe and the US will be lifted in
3Q20, leading to a V-shaped recovery of the global economy 3. However, it will take until 2022
for economic activity to return to pre-crisis levels.
Given our global outlook, we expect CEE GDP to fall by around 7% in 2020, but we see
…to drive CEE GDP down by differentiation among countries (Chart 5). We expect the smallest contraction in Russia, at
around 6.4% in 2020.
around 5.4%, due to at least five reasons. First, the credit impulse may be resilient, helped by
pent-up demand and the CBR’s decision to subsidize lending to companies. Second, imports
are likely to match the decline in exports, limiting the negative impact on GDP growth. Third,
the planned referendum to change the Constitution and allow President Vladimir Putin two
more terms could loosen the purse strings of the Russian authorities and boost household
income in the hope of a good result. Fourth, the proportion of workers employed by the state
Russia and Turkey to contract or state-owned companies is higher than in EU-CEE and, thus, unemployment might increase
by more than 5%, but less than less in Russia than in EU-CEE. Finally, Russia’s enormous landmass means that the
EU-CEE…
lockdown will never be as tight as in some other CEE countries. That said, risks are skewed
to the downside because the Russian government has failed so far to match the measures
taken elsewhere in CEE. If this inaction continues and/or the epidemic is not contained, the
contraction could be deeper and the recovery more muted.
Turkey’s economy could shrink by around 5.6% this year. When judged against potential,
however, the decline will be comparable to that in less open EU-CEE countries. Both the
government and the CBRT will try to help as much as possible an economy that is yet to recover
fully from the 2018 recession. Experience shows that attempts to boost lending significantly can
end up in financial turbulence and Turkey’s recovery from 3Q20 onwards could be choppy.
… where GDP could fall by Given our eurozone outlook, EU-CEE economies may shrink by around 9.4% in 2020, even if
around 9.4% in 2020. GDP bottoms out in 2Q20. More openness could lead to deeper troughs in Czechia, Hungary,
Slovakia and Slovenia, where GDP could contract by more than 20% qoq due the collapse in trade
and investment. The adjustment will be severe in countries dependent on tourism, with Croatia
standing out. Hungary, Serbia and Turkey would also be affected more than the rest of CEE.
3
For details, please see the UniCredit Economics Chartbook - The mother of all recessions has arrived, published on 2 April 2020.
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CEE Quarterly
2021 recovery will not offset In 2021, the recovery will be impressive, but most countries will fail to recoup the losses
2020 losses in most countries
registered in 2020. Throughout CEE, the upturn may be slowed by the delayed rebound in the
labor market and investment. Labor-market conditions loosened abruptly in March, as
signaled by PMIs. Unemployment is likely to rise in the coming months, either because some
companies do not have access to public support or do not want to access it. In addition, some
companies will delay redundancies until after government facilities expire. We expect
unemployment rates to rise more than during the global financial crisis and to start declining
already before the end of the year. We do not expect unemployment to have returned to
pre-COVID-19 levels by the end of 2021.
CHART 5: SHARP ECONOMIC CONTRACTION IN 2020… CHART 6: …FOLLOWED BY A RECOVERY IN 2021
yoy (%), Private consumption Public consumption Fixed investment yoy (%), Private consumption Public consumption Fixed investment
pp Net exports Inventories, error GDP pp Net exports Inventories, error GDP
Russia Russia
Turkey Turkey
Serbia Serbia
Bulgaria Bulgaria
Poland Poland
Slovenia Slovenia
Hungary Hungary
Romania
Romania
Croatia
Croatia
Czechia
Czechia
Slovakia
Slovakia
-15.0 -10.0 -5.0 0.0 5.0
-5.0 0.0 5.0 10.0 15.0
Source: national statistical offices, Eurostat, UniCredit Research
Labor market conditions to Labor market conditions will be altered by significant migrant flows. Poland and, to a lesser
ease…
extent, Czechia and Slovakia, saw a wave of economic immigrants leaving before full
lockdowns were implemented. The reasons being job losses, lack of health-care insurance or
just the desire to return to their families. The Polish government estimates that 100,000
Ukrainians left Poland in less than a month, although the number is probably much higher.
Besides the reasons mentioned above, some Ukrainians failed to renew their temporary work
permits, despite the Polish government easing access conditions when it realized the
problem. At the same time, Romania and the western Balkans experienced a wave of workers
returning from western Europe, especially from Italy, Spain and Portugal. The Romanian
press estimates that more than 300,000 people have returned from western Europe since the
outbreak of the pandemic.
…amid diverging migration The impact of diverging patterns of migration could be significant because immigrants that
leave affect some of the sectors that are not yet shut down, such as agriculture and
construction. Most returning emigrants are likely to leave again once restrictions ease. Their
main contribution to their home countries will be a large amount of remittances, of which cash
transfers will show up in the balance of payments. In countries like Bosnia-Herzegovina,
Romania and Serbia, as this money is spent it will alleviate some of the pressure on the
currency in the next couple of quarters and cover some of the widening C/A deficits.
Biggest slump in wage bills on Lower employment and wage losses due to workers being furloughed and falling working
record to weigh on consumption
hours will shrink economy-wide wage bills throughout CEE for the first time since the global
financial crisis. Like for GDP, the decline is likely to be sharper than in 2008-10. The impact
on private consumption will only be partly mitigated by government support. If unemployment
lags the business cycle, as it usually does, private consumption could weigh on annual GDP
growth until 2Q21.
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Investment – the hardest-hit Among domestic demand components, investment could be the hardest hit. It is very likely
component of domestic demand
that inventories have and will be sharply run down because of the deterioration in supply
chains. Most capex will be on hold until companies are certain that their businesses have
recovered. This is also true for FDI projects, especially those in the manufacturing of durable
goods, such as cars and electronics. Companies face cash shortages that will be accentuated
by the prevalence of trade credit. In the Balkans (both within and outside the EU), trade credit
exceeds bank loans. As a result, it will be very difficult to prevent liquidity issues or even
solvency risks, even if state-guaranteed loans are taken up in large amounts.
The worst affected building projects may be those for retail and office space, with residential
properties affected where prices have increased strongly. The most stretched markets are
Prague and Budapest, followed at a significant distance by the large Polish cities. This leaves
governments as the main driver of investment through infrastructure projects. The EU has
bundled the remaining structural and investment funds into the Coronavirus Response
Investment Initiative (CRII), which allows countries to spend the money with little
conditionality. However, a large part of the funds are likely to be used to cover current health-
care expenditure and employment support, rather than investment projects. With budget
deficits stretched, most countries will not have significant funds for infrastructure investment.
The exceptions are Hungary, Poland, Serbia and Russia, the latter only if the government
speeds up the implementation of national projects. While Bulgaria and Czechia have the fiscal
space for large-scale public investment, there seems to be little focus on such projects.
Insufficient spending – both private and public – remains a risk, despite central banks
stretching their mandates to an unprecedented extent to support economies. Their recent
action can be summarized as:
1. liquidity support for banks through repos, swaps and lower reserve requirements;
Five main instruments used by
central banks 2. regulatory lenience to allow for debt moratoriums and the use of capital buffers;
3. support for government issuance through secondary market purchases;
4. rate cuts to reduce the cost of funding once moratoriums are over and/or lending picks
up; and
5. indirect support for lending to the private sector through guarantee and lending schemes.
Rate cuts to continue in The latest range of measures is presented in the individual country sections of this report and
Czechia, Poland, Serbia, in the EEMEA Country Note - Central banking in CEE: All in. We expect central banks in
Russia and Turkey
Czechia, Poland, Serbia, Russia and Turkey to cut rates further (Chart 7). Except for Czechia
and Turkey, the cost of funding is likely to fall to all-time lows. The NBH and the NBR are
likely to ease liquidity conditions opportunistically when the pressure on their currencies
subsides. The mandate to ensure currency stability is now widespread, albeit surprising in
FX stability mandate for most many cases. We agree with central banks that depreciation will not ease monetary conditions
CEE central banks
at this stage due to supply disruptions affecting exports. The chosen solution is to split the
market in two, with the local cost of funding being significantly lower than the offshore one.
This can be done through FX interventions in Romania, Russia, Serbia and, potentially,
Czechia, by providing funds for lending at below-market interest rates (Hungary, Russia and
Turkey) and by imposing soft capital controls (Turkey). In Romania, Serbia and Turkey, moral
suasion will also play a role in stabilizing exchange rates.
Even when accounting for the unusual attention paid to currencies, financial conditions will
remain much looser than during the global financial crisis. This will complement loose fiscal
policy in supporting the economic recovery.
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CEE Quarterly
Falling inflation in 2020, A combination of supply and demand shocks is expected to send inflation below targets in
followed by rebound next year…
EU-CEE and in Serbia, and to single digits in Turkey (Chart 8). In Russia, these shocks will
dampen the FX pass-through, allowing inflation not to diverge significantly from target. In
2021, supply shocks and base effects will turn inflationary in EU-CEE, where inflation is
expected to return above target. Substituting cheaper migrant labor with local workers could
add a supplementary inflationary shock in Poland, Czechia and Slovakia. Even if inflation
…with opposite dynamics in rebounds slightly in Turkey, domestic demand pressure will remain limited. Weak domestic
Russia. demand pressure could send inflation back below target in Russia. As a result, we see 2020
rate cuts being partly reversed only in Czechia and Poland.
CHART 7: INTEREST RATES WILL REMAIN LOW… CHART 8: …DESPITE REFLATION IN 2021
policy rates, % 2019 2020F 2021F annual inflation (eop, %) 2019E 2020F 2021F Inflation target
15.0 12
12.0 10
8
9.0
6
6.0
4
3.0
2
0.0
0
PL CZ HU RS RO RU TR
HR BH SI RS SK HU PL CZ RO BG RU TR
Source: statistical offices, central banks, UniCredit Research
Outlook for markets: attractive valuation
While our detailed views can be found in the individual country sections, we highlight here the
main opinions on currencies, rates and credit.
Except for the RON and the RSD, CEE currencies are undervalued and could strengthen
Most CEE currencies are
once risk appetite rebounds. Not all recent depreciation may be reversed, since trade
undervalued
balances will deteriorate across CEE and FDI will fall. This leaves EU funds as the main
source of stable capital flows. In Romania and Serbia, where extended basic balances are
negative or close to zero, central banks have sufficient reserves and market influence to
defend their currencies, even in risk-off episodes.
Liquidity provisions by core central banks combined with currency undervaluation and central
Central bank bond purchases bank purchases in CEE make local-currency bonds attractive. In CEE, most central-bank
in CEE are not QE
bond purchases are sterilized and are therefore not used to inject liquidity. They serve the
purpose of providing a buyer of last resort. This is very important to support issuance and
ensure that bond investors can access cash when facing redemptions.
In EU-CEE, we like all long-end bonds. Although the CNB has not announced bond
Long-end local currency bonds
look attractive…
purchases yet, the curve may flatten due to demand from local investors and risk-averse real-
money funds from the eurozone. In the short term, we prefer ROMGBs because of the implied
FX hedge offered by the NBR. While Romania is facing three rating updates in 2Q20, rating
…with ROMGBs the top pick in agencies may stay on hold to gauge the impact of the crisis on budget execution. POLGBs
the short term… offer the right balance between risk and return, in our view, although the NBP is notably the
only independent central bank in CEE that has not announced support for its currency.
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…and OFZ in the long term. Longer term, we like OFZ for the convergence story that is likely to be only temporarily
interrupted.
Short-term rates not fully In the rates space, the NBH’s decision to give up using FX swaps suggests paying short-term
pricing in future central bank rates in Hungary, at least as long as EUR-HUF remains above 350. We would receive
actions
short-term rates in Czechia and Poland in expectation of further easing.
TURKGBs will benefit from CBRT support, but a vulnerable currency leaves the curve (and
especially its short end) prone to sudden corrections.
Credit is generally cheaper than local-currency bonds in CEE. We continue to like ROMANI
EUR bonds, which remain cheaper than ROMGBs. Even though the NBR is not purchasing
ROMANI EUR and RUSSIA USD EUR bonds, we do not expect ROMANI-ROMGB spreads to widen for long, with EUR bond
the top picks in the credit yields tightening with a delay to local-currency bond yields. RUSSIA USD bonds continue to
space
trade outside the sovereign rating and outside OFZ, without bearing the latter’s FX risk. .
Once risk appetite recovers globally, which may not happen until late 2Q20, we expect all
curves to flatten under the weight of global liquidity.
Fallout from the pandemic
Positive potential outcomes While it is too early to assess the impact of the pandemic on the economy, society and politics
of CEE, we highlight four positive and three negative potential outcomes.
What to look forward to:
1. The strengthening of civil society in countries where it played a role in supporting the
health-care system at a hard time for public administration and state institutions. This may
change the way people interact with the government and markets. In the words of Samuel
Bowles and Wendy Carlin 4, “the COVID-19 pandemic […] may overturn that anachronistic
one-dimensional menu [the government-versus-markets continuum of policy alternatives] by
including approaches drawing on social values going beyond compliance and material gain.”
2. A potential change in voter priorities if the middle class gets more involved in the electoral
process. One such priority is better health care. The main reason for the current sorry state of
health-care provision is a lack of political interest, emigration, poor management and
corruption. The first reason is the most important and all others are influenced by it. Another
priority may be better support for employees and companies in need. It is hard to believe that
governments will be able to withdraw all the measures on display at the moment, with some
politicians arguing for more support for the private sector. However, this clashes with the large
safety net provided to pensioners, the most active category of voters across the region. If
governments try to pursue both goals, they might have to increase taxation.
3. A leaner bureaucracy. It is unlikely that governments will be able to re-introduce the
paperwork that has been substituted with online access to public services. This means
that some public employees may lose their jobs. It also means that governments will have
to further develop their IT capacities to manage information, receive tax payments and
distribute public services.
4. Shorter supply chains for European manufacturers, triggering more investment in CEE.
The pandemic could further undermine globalization, with western European companies
likely to move their supply chains closer to home or, at least, to create an alternative to
Asian suppliers. CEE may benefit once more from this move back to Europe. Fresh from
their struggle to find workers in EU-CEE, western European companies could turn towards
the western Balkans and former Soviet republics. The main issues there are poor-quality
institutions and a lack of economic predictability. Both can be addressed, especially in
countries that are also candidates for EU membership.
4
“The coming battle for the COVID-19 narrative”, VOX, 10 April 2020.
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CEE Quarterly
Potential negative outcomes What to fear:
1. A further democratic backslide. Many governments implemented states of emergency
to simplify decision making. While the state of emergency implies a limitation of civil
rights, in some countries the decisions have gone further. In Hungary, Prime Minister
Viktor Orbán has received extraordinary powers from parliament, allowing him to govern
by decree. The only institution able to question his decisions is the Constitutional Court
(CC), which is packed with Orbán loyalists. Mr. Orbán has used these powers in matters
unrelated to the COVID-19 crisis, including to further curtail freedom of the press. An
attempt to reduce the powers of local administration in favor of central government was
withdrawn amid a public backlash. Parliament failed to set conditions that could revoke
Mr. Orbán’s powers. The move has been deemed a democratic backslide by European
institutions and thirteen members of the European Popular Party (EPP) demanded that
Fidesz, Mr. Orbán’s party, be excluded from its ranks.
In Poland, the parliamentary majority led by Law and Justice (PiS) has decided to hold
presidential elections on 10 May through a postal voting system that has never been
used before. Moreover, elections will go on as planned despite the campaign having
been suspended due to the lockdown. This benefits the incumbent, Andrzej Duda, who is
supported by the PiS. Mr. Duda receives much more media coverage than his
competitors because of his involvement in the official response to the crisis.
While questions about democratic backsliding will remain for as long as states of
emergencies are enforced, it seems that from the point of view of voters, the economic
outcome will be more important than defending political and personal freedoms. In the
words of Francis Fukuyama 5, “The major dividing line in effective crisis response will not
place autocracies on one side and democracies on the other. […] The crucial determinant
in performance will not be the type of regime, but the state’s capacity and, above all, trust
in government.” Mr. Orbán remains very popular in Hungary, while Mr. Duda could win
re-election in the first round of voting. Both base their popularity on the strong economic
track record of their respective parties. In Hungary and Poland, as in Russia, Serbia and
The EU has to prevent further Turkey, this crisis will offer elected leaders an opportunity to strengthen their grip on
democratic slippages in
power at the expense of personal freedoms. In Hungary and Poland’s case, the
Hungary and Poland
backsliding can only be averted by a stronger reaction from the EU and a more active
use of the European Court of Justice.
2. A worse-than-expected outcome in EU budget negotiations for 2021-27. The
decision of some EU-CEE countries, especially Hungary, to delay negotiations for the
EU-CEE will be the main loser next EU budget could come to haunt them. Costs related to the COVID-19 crisis will add
in EU budget negotiations
to criteria that favor Southern Europe over EU-CEE (alongside youth unemployment,
number of migrants and evolution of per-capita GDP). Unless the EU decides to top up
the EU budget allotment (unlikely at this stage), EU-CEE will see its share of funding
crowded out further and annual losses could exceed 1% of GDP for the Visegrad four
and the Baltics. Opposition to a deal would leave the EU on a temporary budget
framework with limited transfers. This would be even more detrimental to CEE, especially
in 2021-22, when economies would need support to rebound from the 2020 recession.
Social unrest. If lockdowns last for longer than anticipated and the economic damage rises,
CEE could be confronted with a wave of social unrest. Unfortunately, the press is fueling
discontent in many countries. Thus, it is paramount that governments come up with a plan of
re-opening the economy that is credible, well communicated and comes with appropriate
measures to avoid a new rise in infections.
5
“The Thing That Determines a Country’s Resistance to the Coronavirus”, The Atlantic, 30 March 2020
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CEE Quarterly
OUR GLOBAL FORECAST
Exchange rate
GDP growth, % CPI (Avg), % Policy rate* 10Y bond yield (EoP), % (LC vs. USD)
2019 2020F 2021F 2019 2020F 2021F 2019 2020F 2021F 2019 2020F 2021F 2019 2020F 2021F
Eurozone 1.2 -13.0 10.0 1.2 0.3 1.2 -0.50 -0.50 -0.50 1.12 1.14 1.18
Germany 0.6* -10* 10* 1.4 0.5 1.6 -0.19 -0.40 -0.10
France 1.3 -13.8 11.6 1.1 0.4 1.0
Italy 0.3 -15.0 9.0 0.6 -0.4 0.8 1.41 1.85 1.90
UK 1.4 -10.5 9.8 1.8 0.9 1.6 0.75 0.10 0.10 1.32 1.30 1.35
USA 2.3 -10.8 11.8 1.8 1.2 1.9 1.75 0.25 0.25 1.92 1.15 1.95
Oil price, USD/bb 64 41 47
(avg)l
*Non-wda figures. Adjusted for working days: 0..6% (2019), -10.4% (2020) and 10% (2021): **Deposit rate for ECB Source: Bloomberg, UniCredit Research
THE OUTLOOK AT A GLANCE
Real GDP CPI C/A balance
(% change) 2018 2019 2020F 2021F (% change) 2018 2019 2020F 2021F (% GDP) 2018 2019 2020F 2021F
CEE-EU 4.4 3.7 -9.3 8.5 CEE-EU 1.9 3.4 2.0 2.9 CEE-EU -0.9 -0.4 -2.5 -1.0
Bulgaria 3.1 3.4 -7.8 7.0 Bulgaria 2.7 3.8 3.2 3.0 Bulgaria 1.4 4.0 2.2 2.8
Czechia 2.8 2.4 -11.0 8.4 Czechia 2.0 3.2 2.2 2.0 Czechia 0.4 -0.4 -3.0 -1.6
Hungary 5.1 4.9 -9.3 9.9 Hungary 2.7 4.0 1.6 3.6 Hungary 0.0 -0.9 -2.9 -1.2
Poland 5.2 4.2 -8.1 7.5 Poland 1.1 3.4 2.1 3.1 Poland -1.0 0.5 -2.1 -0.6
Romania 4.4 4.1 -9.4 9.8 Romania 3.3 4.0 2.4 3.5 Romania -4.6 -5.0 -5.2 -3.9
Croatia 2.7 2.9 -10.5 6.9 Croatia 0.8 1.4 0.6 2.0 Croatia 1.9 2.9 -6.0 0.7
Russia 2.3 1.3 -5.4 3.8 Russia 4.3 3.0 4.3 3.5 Russia 6.8 4.2 2.1 1.2
Serbia 4.4 4.2 -7.0 8.4 Serbia 2.0 1.8 1.3 2.2 Serbia -4.9 -6.9 -6.5 -6.4
Turkey 2.8 0.9 -5.6 6.6 Turkey 20.3 11.8 7.9 9.6 Turkey -2.7 1.2 -0.3 -0.1
Extended basic External debt General gov’t
balance (% GDP) 2018 2019 2020F 2021F (% GDP) 2018 2019 2020F 2021F balance (% GDP) 2018 2019 2020F 2021F
CEE-EU 2.5 2.8 0.8 1.9 CEE-EU 68.7 65.0 69.7 63.2 CEE-EU -0.6 -1.2 -5.5 -2.9
Bulgaria 3.6 6.5 5.0 5.5 Bulgaria 59.1 56.2 59.2 54.7 Bulgaria 1.8 1.1 -6.2 -2.9
Czechia 1.6 1.2 -1.6 0.4 Czechia 82.8 77.6 85.3 80.0 Czechia 1.1 0.0 -5.5 -4.0
Hungary 4.3 2.5 2.7 2.5 Hungary 81.1 73.9 79.1 68.6 Hungary -2.1 -2.0 -4.3 -1.5
Poland 3.6 4.4 2.0 2.4 Poland 63.4 59.2 61.2 53.7 Poland -0.2 -0.7 -4.7 -2.8
Romania -1.3 -1.7 -2.8 -1.0 Romania 32.8 34.9 40.4 37.4 Romania -3.0 -4.6 -6.1 -3.7
Croatia 4.8 6.9 -1.0 5.6 Croatia 82.7 75.7 90.5 84.2 Croatia 0.2 -0.3 -6.1 -1.9
Russia 5.4 4.3 2.1 1.0 Russia 28.1 27.7 30.5 27.7 Russia 2.6 1.8 -2.3 -1.1
Serbia 2.5 0.9 -0.9 0.0 Serbia 62.6 60.2 66.5 61.6 Serbia 0.6 -0.2 -8.0 -2.0
Turkey -1.5 1.9 0.2 0.7 Turkey 56.4 58.0 65.0 57.3 Turkey -3.5 -5.4 -7.7 -5.6
Gov’t debt Policy rate
(% GDP) 2018 2019 2020F 2021F (%) 2018 2019 2020F 2021F FX vs. EU 2018 2019 2020F 2021F
CEE-EU 46.6 44.8 54.2 50.9 CEE-EU CEE-EU
Bulgaria 21.8 19.9 26.7 27.8 Bulgaria - - - - Bulgaria 1.96 1.96 1.96 1.96
Czechia 32.6 30.7 38.8 39.1 Czechia 1.75 2.00 0.25 0.50 Czechia 25.7 25.4 26.2 25.3
Hungary 68.5 64.7 73.4 65.7 Hungary 0.90 0.90 0.90 0.90 Hungary 322 331 340 345
Poland 48.5 45.6 55.2 50.7 Poland 1.50 1.50 0.05 0.75 Poland 4.30 4.26 4.40 4.35
Romania 34.7 36.9 44.5 43.1 Romania 2.50 2.50 2.00 2.00 Romania 4.66 4.78 4.85 4.95
Croatia 74.7 73.2 87.5 82.6 Croatia - - - - Croatia 7.42 7.44 7.50 7.50
Russia 12.1 12.5 14.7 15.1 Russia 7.75 6.25 5.50 5.50 Russia 79.5 69.3 80.9 82.6
Serbia 54.4 52.9 64.0 58.0 Serbia 3.00 2.25 1.00 1.00 Serbia 118.2 117.6 118.2 118.7
Turkey 30.4 33.1 38.9 37.5 Turkey 24.00 12.00 9.00 9.00 Turkey 6.1 6.7 7.4 8.1
Source: National statistical agencies, central banks, UniCredit Research
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CEE Quarterly
CEE Strategy:
More weakness before risk appetite returns
Elia Lattuga, ■ The large losses recorded in 1Q20 have been a rough awakening after the stellar returns
Co-Head of Strategy Research,
Cross Asset Strategist achieved in 2019 for EM assets. Credit spreads widened to their highest levels since the
(UniCredit Bank, London) 2008-09 financial crisis, and we expect this economic recession to be deeper.
+44 207 826-1642
elia.lattuga@unicredit.eu ■ Unprecedented support from monetary and fiscal authorities will cushion losses in financial
markets and will fuel a sharp rebound in risky assets in 2H, in our view. However, markets
remain exposed to more downside over next few months and we suggest keeping a
cautious approach.
Risks are to the downside Risk aversion has dominated the market over the past two months. The adjustment in the
before a sharp rebound in 2H
level of risky assets in February and March was extremely deep and fast. The S&P 500
drawdown of nearly 30% ranks among the top ten bearish moves since the 1950s, and even
within such a sample, the recent sell-off was particularly rapid. Hence, It is not surprising that
it caused large spillovers across several segments of the market. Credit premiums on most
ratings widened sharply, while funding markets shut down. Even USTs and gold were
disposed of in the hunt for USD liquidity, although the pressure was short lived. The spread of
COVID-19 and its economic fallout raised concerns over energy demand. The drop in oil
prices itself fueled another leg of sell-off across energy names on credit markets. At the end
of 1Q20, based on data from the United Nations Office for the Coordination of Humanitarian
Affairs (OCHA), countries comprising nearly 50% of global GDP had announced total or
partial lockdown measures. Hence, a significant drag on global growth is in the cards for
1H20. We believe that the ongoing slowdown will come with a fall in output more than twice
as deep as that witnessed in 2008-09, but the recovery is expected to be swifter. Such a
V-shaped path is still very uncertain, and we believe that risky assets might come under
pressure again before sentiment improves by the end of 2Q. Our view for 2H is more positive.
We forecast a sharp rebound in risky assets in 2H on the back of improving economic
conditions, and fueled by the bold measures taken by monetary and fiscal authorities.
Unprecedented support by Central banks have announced a wide range of easing measures in recent weeks. Actions
central banks
range from rate cuts to liquidity provision across several segments of the market, including FX
swap lines and asset purchases, and have been fine-tuned and/or stepped-up in response to
market conditions. Among other measures, the ECB has committed itself to purchasing over
EUR 1tn of public and private assets by the end of the year, while the Fed has announced
unlimited quantitative easing (QE). Other major central banks have followed suit.
CHART 1: EM BOND PERFORMANCE CHART 2: CENTRAL-BANK LIQUIDITY ON THE RISE
1Q2020 2019 2018 2017 2016
40% Fed, ECB, SNB, BoJ & World FX reserves (stock) 12M Change (rs)
25 4.0
30%
20%
20 3.0
10%
0%
15 2.0
USD tn
-10%
-20% 10 1.0
-30%
-40% 5 0.0
LatAm Asia EMEALatAm Asia EMEA A Baa Ba B Caa 1-3 7-10
Year Year
LC HC-USD HC-USD HC-USD 0 -1.0
Jun 04 Jun 06 Jun 08 Jun 10 Jun 12 Jun 14 Jun 16 Jun 18 Jun 20
Source: Bloomberg, Haver, UniCredit Research
UniCredit Research page 16 See last pages for disclaimer.April 2020 April 2020 CEE Macro & Strategy Research
CEE Quarterly
Chart 2 shows the total amount of liquidity provided by selected central banks (along with
global FX reserves), which has been rising sharply recently. This trend will continue over the
coming months as the announced asset purchases are implemented. The total amount of
liquidity supplied to the market will easily break above previous record highs. Monetary policy
is being counted on to provide a wide range of backstop measures to contain financial
tightening and cushion the impact of the COVID-19 pandemic on economic activity. These
measures have already helped equity markets recover some of their earlier losses and have
contributed to stabilizing bond and funding markets, where sellers predominated in the first
half of March. Pockets of stress remain and whether such liquidity will flow in sufficient
quantity to emerging markets also depends on developments in risk appetite.
Developments in risk appetite Risk aversion has risen sharply on the back 1Q losses. We track the level of risk aversion with
a series of indicators including both market and survey-based risk measures, which are part
of our risk dashboard 6. Chart 3 shows one of the indicators we track, our risk appetite index
(RAI), along with 3M returns for EM currencies (using MSCI weights). The RAI is built on the
Spearman’s rank correlation of returns and risks for a portfolio including a large number of
instruments across asset classes and aims to measure investors’ sensitivity towards risk
rather than the level of risk in the system. This makes it especially suitable for historical
comparison. The RAI ranges from -1 to +1, and has recently crossed below -0.6, marking its
fifth weakest point since 2000, at levels comparable with the 2008-09 financial crisis period.
The RAI, as well as alternative risk aversion measures, suggests caution when interpreting
the recent rebound in risky asset prices. Uncertainty as to the extent of the economic loss is
still significant and large bearish turns on global markets often come with wider implications
because of position shedding, margin calls and impaired access to funding, all of which might
continue to expose the underlying fundamental weaknesses markets have long been ignoring.
CHART 3: WEAK APPETITE FOR RISK CHART 4: EM HARD CURRENCY INDEX PERFORMANCE
RAI EM FX (MSCI weights) 3M return
previous 12M Last 3M
0.80 25 2000
20 1800
0.60
15 1600
0.40
10 1400
0.20 1200
5
spread bp
0.00 0 1000
-5 800
-0.20
-10 600
-0.40
-15 400
-0.60 200
-20
-0.80 -25 0
Jan 00 Sep 02 Jun 05 Mar 08 Dec 10 Sep 13 Jun 16 Mar 19 -80 -60 -40 -20 0 20 40 60
Total return (ann.)
Source: Bloomberg, UniCredit Research
Analyzing the performance of hard-currency (USD) bonds over the past three months and the
previous twelve shows that during the sell-off higher yielding bonds have generally
underperformed. Carry could do little to offset the large adjustment in the level of credit
spreads. Moreover, the dispersion in performance was larger among higher yielding bonds,
with a fat left tail in the total return distribution. Note also that over the chosen period, the
performance of UST was positive – USTs were among the few assets that managed to
remain in demand in (or for most of) 1Q. Repatriation probably supported this trend.
6
The UniCredit Risk Dashboard: Our framework for tracking developments in risk appetite, Global Themes Series No. 41, July 2018, UniCredit Research.
UniCredit Research page 17 See last pages for disclaimer.April 2020 April 2020 CEE Macro & Strategy Research
CEE Quarterly
Outflows have prevailed In fact, the weak EM bond performance shown above was also associated with large outflows
from EM portfolios. IIF data shows that over the month of March, more than USD 80bn of
outflows hit EM equity and bond portfolios, an amount comparable (but higher) than during
the 2008-09 financial crisis . Outflows across equity markets have been larger than in 2008-09 and
flows might quickly come back given the reactivity of global central banks, assuming that risk
appetite returns to the market, something we expect to happen towards end of 2Q.
Funding risks and deteriorating As portfolio flows dried up and with primary markets being shut down for most issuers,
credit profiles
refinancing risks started to become material for a larger part of the market. According to the
IIF, USD 30bn of redemptions fall due from EM sovereigns in 2020 (their coverage includes
30 emerging countries) and nearly USD 600bn when all sectors (sovereign, non-financial and
financial corporates) are accounted for. This includes redemptions relative to bonds in all
currencies (USD equivalent). Issuance from EM sovereigns has slowed down since mid-
February, after a good start to the year. In absolute terms, the amount coming to the market in
1Q20 was nearly 20% short of that seen in 2018 and 2019. Usually 1Q accounts for 35-45%
of the supply for the year as issuers tend to front-load primary market activity. In 2020, larger
budget deficits speak for higher funding needs compared to 2019. Hence, probably less than
25% of this year’s supply was completed in 1Q20. Considering the higher spread levels and
the support from central bank liquidity, issuance could accelerate quickly and the funding gap
bridged if market tensions ease. We are already seeing a significant improvement in
European and US IG markets, which could extend to lower-rated, riskier issuers. However,
the extent of investor demand across the various risk profiles and how quickly it will adjust
towards pre-crisis standards remains very uncertain. Moreover, a huge amount of unexpected
supply is coming to the market as a result of the fiscal actions to fight the economic
implications of the COVID-19 crisis. Central banks will help to absorb this increase in
sovereign issuance, likely adapting the size (e.g. unlimited QE) or the composition of their
asset purchases (e.g. ECB). However, especially for lower-rated issuers, funding costs might
remain elevated and above the level of maturing bonds which, along with rising debt levels
across regions (currency depreciation included), would add to debt-sustainability risks over
the medium term. In this environment, rating actions are a material threat as shown by
downgrades of several LatAm and African sovereign announced since mid-March, and might
contribute to keep market sentiment shaky.
MONTHLY PORTFOLIO FLOWS INTO EM SOVEREIGN ISSUANCE (USD BN EQUIVALENT)
Debt Equity CEEMEA ASIA Latam
80 200
180
60
160
40
140
20 120
0 100
80
-20
60
-40
40
-60 20
-80 0
1 2 3 4 5 6 7 9 10 11 12 1 2 3 4 5 6 7 9 10 11 12 1 2 3
-100 2018 2019 2020
Jan 05 Jan 07 Jan 09 Jan 11 Jan 13 Jan 15 Jan 17 Jan 19
Source: IIF, Bondradar, UniCredit Research
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