"However, major challenges remain due to the scale of the negative shocks to hit the region; the costly legacy of the crisis, notably rising public debt ratios; and the uncertain "exit" from the crisis, recession and accommodative policy settings; while a relapse in one of the more vulnerable countries could trigger ripples across the region," says Mr Parker.
Concerns over public finances have moved to centre stage. Fitch forecasts the impact of the recession - in some cases augmented by fiscal stimulus measures, lower oil prices and bank bail-outs - to widen the average budget deficit to 5.9% of GDP in 2009 from 1.1% in 2008, before narrowing to 4.6% in 2010. It expects the average government debt/GDP ratio to rise to 36% at end-2010 from 23% at end-2007. Failure to implement credible medium-term fiscal consolidation could lead to rating downgrades. In many countries, social pressures and elections will make it harder to implement austerity measures. This is fertile territory for political shocks. For countries reliant on IMF-led programmes for fiscal and external financing and for underpinning economic confidence, failure to stick to programme conditions poses additional risks to macroeconomic stability.
Fitch has revised its forecast for 2009 EE GDP to -6.1% from -4.6% in its June forecast round, owing to an even steeper drop than anticipated in output in H109. This contrasts with just -0.1% forecast for emerging markets as a whole. It forecasts only Azerbaijan and Poland will avoid recession, while Armenia, Estonia, Latvia, Lithuania and Ukraine will suffer double-digit declines in GDP. However, it has revised up its 2010 growth forecast to 2.6% (from 1.5%), owing to the unwinding of the deeper 2009 contraction and more supportive global conditions. Indeed, it estimates EE GDP rose by about 1% q-o-q in Q209, after plummeting 7% in Q109, led by a rebound in Turkey. But weak investment, rising unemployment, moderate capital inflows and credit growth, fiscal consolidation and a rebuilding of balance sheets point to a subdued recovery.
External financing and currency risks, which were the primary vulnerability of many countries in EE in the initial phase of the crisis, have eased somewhat, though remain material. This reflects a rapid reduction in current account deficits (CADs), substantial multilateral assistance, a boom in sovereign external issuance (USD19bn year to date) and relatively resilient private-sector roll-over rates. Fitch estimates the region's gross external financing requirement (CAD plus medium- and long-term (MLT) amortisation) at USD304bn in 2009 and 2010, down from USD363bn in 2008.
In contrast to the rally in EE government bond prices, sovereign ratings dynamics remain negative, albeit at an easing pace. Following 11 notches of downgrades of foreign-currency Issuer Default Ratings in Q408, there were two downgrades in Q109, three in Q209 and only one in Q309. The balance of Outlooks and Watches has improved slightly since August 2009, but 12 countries are on Negative and only one on Positive. Fitch expects future rating actions to be driven more by country-specific developments than general trends.
