Fed QE Tapering Could Keep Eastern Europe Out Of Euro Zone

Fed QE Tapering Could Keep Eastern Europe Out Of Euro Zone
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Central and eastern European countries trying to join the euro zone could suffer a serious setback when the US Federal Reserve begins QE tapering in the near future, according to Societe General’s Cross Asset Research team.

Fed QE Tapering Could Keep Eastern Europe Out Of Euro Zone

CEE6 countries’ intention to join Eurozone

Bulgaria, Croatia, the Czech Republic, Hungary, Poland and Romania (collectively referred to as the CEE6) have all stated their intention to join the euro zone in the future, but before they can switch currencies they have to meet the so-called Maastricht criteria – economic standards meant to protect the euro from rampant inflation or excessive debt. Bringing down annual deficits and total public debt in particular have proven to be a challenge for many countries that want to use the euro.

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“Up until now fiscal consolidation prospects in Central and Eastern European countries (CEE) had been promising,” says SG’s report. “Yet, speculation about the Fed QE tapering spoiled the party. CEE government bond yields surged and spreads widened notably. Higher interest rates to be paid on new and rolled-over debt raises the 2030 debt/GDP ratio of CEE6 countries by some 3-8 percentage points of GDP.”

Speculation of QE tapering affecting CEE6 countries

If that were the whole story, it’s possible that these countries could still change course and account for the increase in interest rates, but QE tapering hasn’t even started yet. The increases they are currently facing are the result of speculation that QE tapering will start soon, pushing CEE6 countries even further away from their 2030 goals.

Even before the new challenge presented by QE tapering, only Bulgaria and Hungary were actually on track to meet the medium-term budgetary objectives established with the EU commission. The Czech Republic and Slovakia in particular are facing rising healthcare and pensions costs that appear unsustainable with significant economic growth or benefit cuts.

CEE6 countries experiencing consolidation fatigue

But attaining that increased economic growth is difficult while reining in government spending, not to mention politically unpopular. “We are witnessing reform/consolidation fatigue in several CEE countries, which can be mainly attributed to the large price tag consolidation had in the form of lower growth,” says Societe General’s report. “In the Czech Republic, the political situation and approaching elections are another important reason for the change in the fiscal outlook towards a less savings effort.”

In Poland the government has already officially changed course. Poland had one of the strictest fiscal rules regarding government spending, but it has suspended austerity measures in favor of ‘stabilizing expenditure measures.’

Of course the CEE6 doesn’t act as a unit. The Romanian government, for example, continues to strongly support strong fiscal rules. The challenge is whether it can maintain this support in the face of rising interest rates and slower growth until their financial system is in line with the demanding Maastricht criteria.

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