By Carolyn Cohn
LONDON, Aug 27 (Reuters) - Caught between a slowdown in the
euro zone to the west and a geopolitical crisis involving a
resurgent Russia to the east, central and eastern European
markets are starting to feel the pinch.
Currencies, bonds and stock markets in countries like
Poland, Hungary and the Czech Republic are heavily dependent on
getting investment flows from and sending exports to the euro
zone, where growth is forecast to slow.
Meanwhile, the conflict between Russia and Georgia over
Georgia's breakaway regions has extended into broader security
concerns between Russia and the Group of Seven industrialised
nations, particularly after the United States signed deals to
place its missile shield system on Polish and Czech soil.
The economic outlook has already taken the froth off eastern
European currencies, which were hitting record highs against the
euro only a few weeks ago, while worries in particular about
Poland have knocked Polish energy stocks and driven up the cost
of insuring against default of Polish debt.
"A slowdown in the euro zone will have an impact on central
Europe and eastern Europe -- the euro zone has been eastern
Europe's biggest export market," said Angus Halkett, emerging
markets analyst at Deutsche Bank.
"Geopolitics is definitely having an impact -- there could
be problems with energy supplies."
On the economic side, Lehman Brothers estimates that over 80
percent of central and eastern European exports flow into the
European Union and over 50 percent to the euro zone.
Add to that the fact that eastern Europe relies heavily on
western Europe for bank loans.
If the euro zone suffers a sharp downturn, western Europeans
will have less money to spend, and western European banks will
have less money to lend.
"The outlook is weakening through the export channel, and
through the bank lending channel," said Manik Narain, emerging
markets analyst at Lehman.
The IMF sliced its forecasts for euro zone growth in 2008
and 2009 this week, while the latest German Ifo survey, a key
indicator for the euro zone, unexpectedly fell to its lowest in
three years.
GOING DOWN
The Czech crown <EURCZK=>, Polish zloty <EURPLN=> and
Hungary's forint <EURHUF=> hit record highs against the euro
last month, but have since lost between 4 and 7 percent.
UBS forecasts the forint at 250 per euro by December, the
zloty at 3.35 and the Czech crown at 24.50, stable for the Czech
crown after a recent correction but weaker for the other two.
The strength of the dollar as investors scale back their
forecasts for the euro zone has hurt eastern Europe.
"The dollar is very important as a funding currency for
eastern European currencies," said Reinhard Cluse, emerging
markets economist at UBS.
"Whenever the dollar rallies, people take off their eastern
European trades."
Henning Eskuchen, co-head of equity research at Erste Bank
in Vienna, also sees eastern European stock markets hit by
economics to the west and politics to the east.
"These markets are affected by sentiment, even if it is not
supported by the fundamentals," he said.
Polish <> and Hungarian <> stocks fell 9 percent
this month, underperforming developed equity markets
<.MIWD00000PUS>. Polish refiners PKN Orlen <PKNA.WA> and Lotos
<LTOS.WA> fell around 3 percent on Tuesday alone due to a slump
for Russian stocks.
POLISH DEBT
"The situation in the Caucasus is a concern for us and is
being monitored," Polish central bank chief Slawomir Skrzypek
told a monthly news conference on Wednesday.
The cost of insuring Polish debt has risen around 40 percent
since the outbreak of the conflict with Georgia on Aug 8.
Investors are worried about Poland's alignment with the U.S.
and also, more broadly, about access to energy from Russia, the
world's second largest exporter of oil.
Polish 5-year credit default swaps are trading at 70 basis
points, meaning it costs $70,000 a year for five years to insure
$10 million of debt.
"The market is a little more wary when it comes to Poland,"
said Martin Blum, head of emerging markets economics and forex
strategy at Unicredit in Vienna.
"Not because of any imminent military fears but because of
some broader concerns about the longer-term diplomatic and
commercial relations with Russia following the missile shield
agreement."
However, analysts say central and eastern European markets
have been on an upward trend, in some case for years, due to
strong domestic growth and increased productivity.
A correction now is not surprising, they say.
Locally-grown growth may also act as a buffer against deeper
falls in these markets, analysts add.
"Domestic demand is pretty good, credit growth is still
relatively high, unemployment has not really picked up in any of
the countries," said Halkett. "Slower external demand has been
offset by strong domestic demand."
(Additional reporting by Jason Hovet in Prague)
