Worries about Eastern Europe are overblown

IN HIS office overlooking the river Danube, the new Hungarian Prime Minister Viktor Orban might well be regretting throwing the fiscal state of his country into the limelight and drawing unwanted attention from the markets.

In hindsight, comments from his spokesman outlining the gravity of Hungary’s economic situation and stating that a default on its debt was possible might seem rather ill-considered. While perhaps only designed for domestic consumption, the comments spooked the international markets, which are already pre-occupied with debt default in the Eurozone periphery.

The Hungarian stock market has dropped some 16 per cent since the start of April, and has shed over 1,000 points, or 5 per cent of its value, in the last week. Both concerns about external debt financing and the impact of austerity measures have weighed on the markets.

One of the easiest and cheapest ways for individual investors based in the UK to get
exposure to Eastern European stock markets is through exchange-traded funds (ETFs).

ETFs that have exposure to Hungary – there is no country-specific ETF – have also seen
their traded value fall as global stock markets tumbled. Some ETFs exposed to the region have experienced redemptions as investors pull out of riskier equities. Consequently, should holders of these ETFs be worried about events in Hungary taking a toll on the value of their investments?

In fact, there are three good reasons not to be worried. First, Eastern Europe ETFs tend to have relatively little exposure to the Hungarian stock market. Lyxor’s Eastern Europe ETF only has 13.63 per cent weighting towards Hungary compared to 57.36 per cent for Poland and 29.01 per cent exposure to the Czech Republic. BlackRock’s iShares MSCI Eastern Europe 10/40 ETF has only 6.98 per cent exposure to Hungarian equities compared to almost 70 per cent for Russia and 17.57 per cent for Poland.

fundamental perspective

Second, while the sovereign debt crisis will undoubtedly create headwinds for the economies in emerging Europe, there is little reason to be worried about contagion to Eastern Europe.

Countries in the region seem to be in a relatively strong position. Poland has escaped recession and, from a fundamental perspective, it remains a sound credit, says RBS’s head of emerging markets research Timothy Ash.

He also reckons that the sell-off in Bulgaria has been overdone: “The chances of
sovereign default over the next 12-24 months would appear remote; indeed its public finance profile would appear significantly better than all existing Eurozone member states, and much better than the EU average.”

Third, the outlook for the region is relatively rosy. The latest projections from the International Monetary Fund point to growth of 2.8 per cent this year and 3.4 per cent in 2011. In its outlook published today, the World Bank expects private capital inflows to firm, which is expected to result in a 1.1 percentage point of GDP decline in the region’s financing gap.

So if you have positions in Eastern Europe ETFs, you don’t need to be overly worried – at least, not in the near future – about skeletons in the countries’ fiscal cupboards having an undue effect on the stock market.