Europe’s Frontier Fashion Fringe

Frontier Europe topped the MSCI pack in Q1 with 20-30 percent gains from surprise sources like Bulgaria and Serbia with tiny exchanges. In both state enterprise offerings are contributing momentum after numerous past delays, driven by post-crisis pushes for fiscal balance and higher foreign direct and portfolio investment. Bulgaria, which is also a marginal EMBI sovereign debt component, barely registered economic growth last year as consumption decline offset export performance. The budget deficit quadrupled as a fraction of GDP to 4 percent, although it was among the EU few to approach the Maastricht single-currency cutoff. The government had fiscal reserves on hand to maintain the currency board without IMF help, although headline inflation trended toward 5 percent. The current account deficit, which had been in double-digits as a portion of output, was less than 1 percent, but capital inflows were lackluster as the banking and property sectors cooled. Short-term external debt remained manageable as domestic credit was flat with NPL ratios at one-tenth the total, and Greek parents kept their local presence intact despite the banking crisis at home.

Serbiajust completed its emergency EUR 3 billion IMF program and has requested a precautionary extension after a long-postponed oil refinery divestiture. GDP of 1.5 percent last year was half 2009’s contraction and steel production has recently increased. The budget gap at 4.5 percent of GDP was within target despite the dilution of pension reforms which triggered worker protests as elections approach. Inflation is above 10 percent and Treasury bond yields at 12 percent on cumulative energy, food and wage pressures. The trade deficit narrowed on currency depreciation but the current account shortfall was still 7 percent of national output. External debt, split 60-40 between the private and public sector, is at 80 percent of GDP, and bank short-term borrowing has risen. Monetary policy has tightened after large interest rate cuts in the early crisis cycle, with reserve requirements hiked for foreign exchange transactions. The banking system remains overleveraged with the loan-to-deposit reading over 125 percent on double-digit annual business and household credit expansion. While EU accession is now considered a long-term goal, Serbian representatives met last month with counterparts from Kosovo as tensions abated following the latter’s internationally-recognized independence to discuss outstanding border control and commercial integration issues. UN and other observers praised the tone of the talks and expressed confidence in eventual substantive results that could mirror year-to-date exchange deliverables.