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23.03.2005

CEE securities – Brilliant performance but rising volatility

  • Weaker global economic growth and rising interest rates in the U.S. weigh on markets
  • Growth lead over Western Europe and decrease in inflation mitigate risk of lasting setback
  • Growing interest in South East European capital markets

Portfolio investments in Central and Eastern Europe (CEE) have been among the best performing investments globally throughout the past few years. Equities from this region had appreciated by nearly 30% annually during the past three years (in euro), Eurobonds by 11% and bonds in local currency by 7%. During the past week, however, there was a correction across all asset classes and currencies in the region. "This correction was a wake-up call, reminding investors in Central and Eastern Europe that securities and currencies are not moving in a one-way street", said Peter Szopo, Head of Markets Research at Bank Austria Creditanstalt.

Despite a favourable economic backdrop in Central and Eastern Europe, portfolio investors are facing new challenges. A number of mainly global factors, that had positively influenced the investment climate in 2004, are likely to turn out less benign this year: 

  • Global economic growth, which had reached a 30-year-high in 2004, will slow down and growth in euroland is again likely to disappoint;
  • U.S. interest rates, which still had been accommodative in the previous year, will continue to rise – probably followed by a rate hike by EZB later this year; and
  • the risk appetite of investors, reflected in their demand for risky assets such as Emerging Markets equities and fixed income, may dwindle going forward.

No change in direction – but volatility increasing
Positive developments are prevailing within the region: CEE's growth lead over Euroland will remain in the two to four percentage points range. Inflation in most countries is anticipated to fall during the course of the year. Moreover, fiscal and foreign trade imbalances will ease gradually. In addition, as a result of EU accession, CEE is now presenting itself convincingly as the area of growth and reform in Europe offering a low-cost and low-tax environment to corporate investors from Western Europe.

At the same time, intra-regional sector consolidation has speeded up during the past few months: Companies from the Czech Republic, Poland and Hungary (such as CEZ, MOL, Magyar Telekom, OTP, PKN) are expanding via acquisitions within CEE, especially in the South-East.

Downturn of equity markets likely to be only temporary
While the fundamental backdrop in CEE remains constructive, investors have to expect more volatility, triggered by politics (elections in Poland and Bulgaria, turbulences in the Czech Republic) or by economic events (interest rate policies). In the short term, pressure on local currencies may persist. Near-term there is room for Eurobonds spread tightening, but further rate hikes in the U.S. may lead to a revaluation of Emerging Markets credit risk in the course of this year.

Mid-March, for the first time this year, EMEA equity funds withdrew money from the region; however, the outflow was minor. Still, the year-to-date net inflow remains above USD 2bn. Consolidation does not fully come as a surprise, given the unforeseen surge in share prices since the beginning of the year and also considering that CEE equity valuations rapidly approached Western Europe levels during the past twelve months (in the case of Czech Republic even overtaking them).

“Given the relatively sound economic backdrop and the vigour in the corporate sector, we do not anticipate a longer-term downturn in CEE equity markets”, Szopo said. He stated that IPOs in Poland and Russia as well as emerging interest for South East Europe (Bulgaria, Romania, Ukraine, and Turkey) have broadened the range of investment opportunities of regional investment funds, which, in turn, is likely to attract additional capital inflows. 

Contact: Bank Austria Creditanstalt  International Markets
Veronika Fischer-Rief, Phone: +43-50505 ext. 82833
mailto: veronika.fischer-rief@ba-ca.com