Inflation Threatens Eastern Europe, But Region Still Expected to Grow

By , Money Morning •

By Jennifer Yousfi
Managing Editor

The European Bank for Reconstruction and Development (EBRD) kicked off its annual meeting in Kiev with an inflation warning for Eastern Europe.

"Inflation, now in double digits in many countries, is the region's most pressing current problem," the EBRD said in its economic outlook report, Reuters reported. "If left unaddressed, inflation could risk price-wage spirals, exchange rate re-alignments, or could force a belated and sharp response by monetary policy."

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The EBRD, which was formed in 1991 to aid former Soviet states, announced that economic growth in Eastern Europe would slow to 6% in 2008, down from 7.3% in 2007. However, despite the slow down from the prior year, the 6% estimate represents an upgrade from the bank's January assessment of the region's growth.

Shortly after the New Year, the EBRD predicted a 5.0% to 5.5% growth rate for Eastern Europe. But the commodity-rich nations have proven more resilient to the slowing economies of the United States and European Union, which prompted the revision.

But rampant inflation, which last month reached 17.5% in Latvia, 11.4% in Estonia and a staggering 30.2% in Ukraine, according to Bloomberg data, has crippled consumer spending and harmed retail sales.

"The current rate of inflation is unsustainable" in Ukraine, the EBRD's chief economist Erik Berglof told reporters in Kiev on the first day of the annual meeting, Bloomberg reported. "There's a possibility of a hard landing" unless the government and the central bank respond with a more flexible currency policy, he said.

However, Berglof also noted the effect of the global credit crunch on the region has been "limited" so far with the noted exception of Kazakhstan, where it had "a real effect on growth," Berglof said. The oil-rich Central Asian country's economic growth will likely slow to 5.1% this year, according to the EBRD.

"Kazakhstan has been hit by the crisis because it's been very dependent on foreign lending," Berglof said.

To date, despite the soaring consumer prices, cheap labor relative to Western Europe combined with the region's rich natural commodity resources have helped Eastern European countries to fare better than some of their Western neighbors during the international credit crisis.

While Eastern Europe isn't expected to grow as fast as China or India, a 6% gross domestic product (GDP) growth rate is still quite respectable. Especially when you consider the United States will be lucky to eke out even 1% annual GDP growth in 2008.

There aren't many options for American investors looking to play the region, says Money Morning Contributing Editor Martin Hutchinson. One option is an exchange-traded fund that tracks the region. While the SPDR S&P Emerging Europe ETF (GUR) is on the small side for an ETF with a capitalization of only $85 million, it is also one of the only ways to tap into Eastern Europe's expected growth.

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