I am Article Layout

Select your investor profile:

This content is only for the selected type of investor.

March 2018

Emerging Market Monitor - Inflation in Central & Eastern Europe

Inflation across emerging markets is at multi-decade lows. But one region is bucking the overall trend: Central & Eastern Europe. What does it mean for investors?

First, some global observations about inflation. Average inflation across emerging markets has fallen to 2.9%, a level not seen since the 1970s, and this is good news for holders of hard currency debt.
FIG. 1 inflation in EMerging markets
Inflation in emerging markets since 2000

Source: Pictet Asset Management, CEIC, Datastream, February 2018. *Based on 30 EM consumer prices indices, GDP weighted.

As Fig. 2 below shows, the inflation differential between developed and emerging markets and EM hard currency yield spreads appear closely linked. Even if inflation is expected to pick up modestly in emerging markets, we believe it will rise less than in developed markets, and this supports a further narrowing in emerging hard currency debt spreads.

Fig. 2 - INflation differential 
inflation differential between emerging and developed markets closely correlates to hard currency EM debt spread

Source: Pictet Asset Management, CEIC, Datastream, January 2018

The exception to the rule...

As mentioned, one cluster of countries bucking the falling inflation trend is the Central and Eastern Europe (CEE) markets of the Czech Republic, Hungary, Poland and Romania. This is mainly because of wage growth, which has ticked up in all four countries.

Fig. 3 - Nominal wage growth in the CEE region 
Rising wage growth across all four CEE markets

Source: Pictet Asset Management, CEIC, Datastream, February 2018

The four markets in the CEE region account for over a trillion dollars of GDP and around 80 million people. Poland is the region’s powerhouse accounting for half of GDP and half of the population. The richest market in terms of GDP per capita is the Czech Republic.


Population, dependency ratios, unemployment and GDP per capita

infographic about population, GDP per capita, unemployment and dependency ratios in CEE

Source: Pictet Asset Management, CEIC, Datastream

The charts below show two key drivers of wage increases in these four economies: record-low unemployment and increasing minimum wages.
Figs. 5a & 5b  -

Left chart - Central Eastern Europe unemployment rates (%)
Right chart - Central Eastern Europe minimum nominal monthly wages (EUR)

charts on falling unemployment and rising minimum wages in CEE

Source: Pictet Asset Management, CEIC, Datastream, February 2018

You can depend on us...

Wage pressure could continue to build in the CEE region as ageing populations and rising life expectancy cause the dependency ratio of non-working to working people to rise across all markets. As Fig. 6 shows this is especially the case for the Czech Republic.
FIg. 6 - RISING Dependency ratios

Dependency ratio is the percentage of population outside of working age: 0-14 year, 65 years +

chart showing forecast rising dependency ratios in CEE until 2030

Source: Pictet Asset Management, CEIC, Datastream, January 2018

Central banks behind the curve

What does this mean for debt investors?  Although rising wage growth in the CEE is a sign of strong economic conditions, the risk of central banks falling behind the curve is a threat for the region’s local currency debt.

Overall CEE central banks have been slow to react to inflation. Poland and Hungary in particular have not started the tightening yet. The Czech National Bank was first to hike rates after the removal of the EUR/CZK floor in April 2017.


Romania's current account and fiscal balance (% GDP)

chart showing fiscal and current account deficits in Romania

Source: Pictet Asset Management, CEIC, Datastream. Current account January 2017, fiscal balance January 2018.

Although the Bank of Romania began hiking rates in February 2018, we believe the country is the most at risk. As Fig 7 shows it is the only market in the region with a ‘twin deficit’ – trade and current account - which is deteriorating. We believe this increases the pressure on CPI inflation through an expected depreciation of the currency, in addition to the rising domestic inflationary pressures. We expect a more rapid pace of rate increases in the year ahead.


By Christopher Bannon, Senior Investment Manager
street scene in budapest

Christmas decorations in Vaci Street, Budapest, Hungary

Backing the consumer boom

The CEE region is booming. In our view this is best captured through stocks exposed to  consumption and credit, such as banks and consumer companies backed up by strong fundamentals. Valuations here look reasonable, trading at a slight discount to western European markets. In addition, we believe that forward expectations do reflect strong macro growth dynamics. 

Fig 8. Upside in Consumer and financials  

Change to 2019 net income expectations

chart showing rising 2019 income expectations for EM europe financial and consumer stocks since mid 2017

Source: Bloomberg, March 2018

As Fig. 8 shows, both financial services and consumer sectors have seen their earnings forecasts upgraded quite consistently over the past year.

Despite the overall positive trend, the market has been paying greater attention to company fundamentals and rewarding those with the strongest growth prospects. In our view, the increasing dispersion of returns between the market's winners and losers is creating a fertile ground for stock pickers.


Stephane Couturier for Pictet


Fig 9 market watch data.png

Source: Datastream, Bloomberg, data as at 28.02.2018 and in USD. Equity indices are quoted on a net dividend reinvested basis; bond and commodity indices are quoted on a total return basis. The currency rates evolution is treated as a performance calculation based on FX rates.