World Bulletin / News Desk
Romania pulled itself out of recession in 2012's second quarter but the Hungarian and Czech economies contracted further as their powerhouse industrial sectors fell victim to a euro zone crisis that has already hit the region's consumers.
The single currency area's deepening slump has cut demand for exports in the European Union's manufacturing-heavy eastern states, where governments have also embarked on austerity measures that have hit other potential drivers of growth.
Public spending cuts and tax hikes imposed largely to counter the effects of the crisis have helped push the Czechs, Romanians and Hungarians into the red this year, while the region's biggest economy and former EU growth leader Poland is also bracing for a rapid slowdown.
That has put pressure on central banks to loosen policy, but persistent inflation, political turmoil, and the need to keep investors sweet on their currencies have caused policymakers to baulk at trying to spur growth with lower interest rates.
Hungary and the Czech Republic each saw their economies shrink by 0.2 percent between April and June when compared with the previous three months, their second and third straight quarters of contraction respectively.
In both countries, evidence of shrinking domestic demand appeared in falling retail sales, construction, investment and other data at the start of the year. That was followed in May by a drop in production by industry, the engine of exports that accounts for more than 80 percent of output in both countries.
"At first sight, it seems tempting to conclude that it's the fact that Hungary and the Czech Republic are most open economies and that's why they are suffering, but if you look at the data it's also that they have austerity at home," said Neil Shearing, an economist at London-based Capital Economics.
He said the region was at risk from any downward spiral in the euro zone crisis, which could deepen once policymakers return from holiday and begin trying to tackle financing issues in Greece, Spain andItaly next month.
"If we're right about that, then no economy will be immune to the fallout. Within the region Romanialooks the most vulnerable, and so does Hungary," he said.
Data on Tuesday showing the euro zone economy as a whole shrank 0.2 percent in the second quarter did not brighten that outlook. The monthly ZEW economic sentiment index in the bloc's growth engineGermany meanwhile plunged to negative 25.5, versus market expectations that it would stay flat at negative 19.6.
Romania pulled out of recession, its economy expanding by 0.5 percent from the previous quarter and by 1.2 percent compared with the same period a year earlier. The better-than-expected number pushed the leu currency to a one-month high after it hit an historic low last week.
The country has been shaken by a political battle between leftist Prime Minister Victor Ponta and suspended President Traian Basescu that has drawn sharp criticism from Romania's allies in Washington, Brussels and other EU states and threatened a 5 billion euro aid package and economic backstop.
At a news conference in Bucharest, the International Monetary Fund cut its full year growth forecast for the poor Balkan state to 0.9 percent, from 1.5 percent.
Following a two-week-long review of Romania's aid deal, IMF mission chief Erik de Vrijer blamed political turmoil, the euro zone crisis, and a severe drought that has hit the country's prominent agriculture sector for the downwards revision.
He said Ponta's government had agreed to stick to its goal of keeping the budget deficit to below 3 percent of GDP this year, but had to meet benchmarks on raising gas prices, selling state firms and other measures by next month.
He added that the central bank - which analysts say has been prevented from cutting interest rates because it fears political turmoil could trigger investor flight and hit the leu - could actually tighten policy if the currency were to tumble further.
"The bank can be very prudent and, if there are pressures on the exchange rate ... tighten monetary policy," de Vrijer said.
Hungary is in a similar position. July inflation data released on Tuesday showed prices rose 5.8 percent on an annual basis, more than forecast and above June's 5.6 percent.
Some members of the central bank's monetary policy council still support a cut in interest rates to boost growth, but analysts say investor scepticism over Prime Minister Viktor Orban's unorthodox economic policies has stayed their hand.
He repeatedly spooked investors last year with the de facto nationalisation of private pension assets, introducing Europe's biggest bank tax, and other measures.
Analysts say he could shore up confidence if he were to seal an IMF-backed aid deal similar toRomania's, but talks between the two sides have run into repeated obstacles. Budapest and IMF/EU negotiators are expected to resume talks in September.
"Despite the economy being in recession, growth data will not be the key factor in the upcoming MPC decisions," Goldman Sachs said in a research note.
"To cut rates, the MPC will have to be comfortable with the market perceptions of the Hungarian risk premium, risks to the forint, and prospects for external financing; this can happen once the new financing agreement with the IMF and the EU is secured."
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