Credit Risks

The risk index has diminished in Central Europe (-5%) with Poland's rating put under positive watch list (A4) because of its dynamic growth and better payment behaviour of enterprises. The ratings of other new European members still range from A2 to A4 and are not subject to change.

Growth has remained robust in Central Europe, driven by still-dynamic domestic demand and strengthening foreign demand. Politically, admission to the European Union of eight regional countries marked the second quarter. The euphoria that preceded that admission nonetheless petered out mid-June with the results of the European elections revealing record abstentions — higher in new member countries than in the "old" Europe of the Fifteen — and a punitive vote coupled with gains by populist movements.

In Poland (positive watch listed A4 rating), uncertainties surrounding the political situation with the position of the new Prime Minister Marek Belka remaining shaky have contrasted with the robust economic recovery. After reaching 3.8% last year under the effect of a surge in exports spurred by the zloty depreciation, GDP growth could exceed 5% in 2004 amid strengthening domestic and foreign demand. A substantial imbalance in public sector finances has nonetheless continued to handicap the country. Although the current account deficit has remained relatively small, external financing needs have begun to grow again under the effect of increased debt amortisation. However, the country's moderate short-term debt and ample currency reserves will limit its vulnerability to a foreign exchange liquidity crisis.

In the Czech Republic (rated A2), the economy should strengthen slightly this year (up 3.5%) with investment and foreign demand firming up. The country's dependence on capital markets increased due to its growing public sector and current account deficits. The country's vulnerability to a foreign exchange liquidity crisis has nonetheless remained moderate with its external financing needs still limited compared to export earnings, its currency reserves remaining ample, and foreign investment likely to recover after the decline registered in 2003.

In Hungary (rated A2), after last year's slowdown (2.9% GDP growth) due to a loss of competitiveness and decline in public investment, economy growth has been accelerating, spurred by strengthening European demand and surging investment. The growth rate should be at least 3.5% this year. However, the persistence of large public sector and current account deficits has continued to hamper the economy. Nonetheless, improved economic policy management, the strengthening of exports — which should stem the deterioration of external accounts — and the expected foreign investment upturn should contribute to the bolstering of market confidence under way since February.

Farther east, in Russia (rated B), growth has remained dynamic, buoyed by very high oil prices. The country's financial situation has continued to improve thanks to persistent current account and public sector surpluses and the decline of private capital outflows — which have caused currency reserves to increase. That positive dynamic is not attributable solely to oil prices with tax reform having been a success and fiscal policy being exercised in a disciplined and more transparent manner.

Raw material sectors nonetheless continue to underpin growth whereas the manufacturing sector has remained hampered by a lack of competitiveness. To improve the business climate, painful reforms will be necessary: Extensive restructuring of the banking sector and natural monopolies is still pending and administrative and judicial reform seems essential to permit the many legislative changes adopted by Vladimir Putin's first legislature to take effect.