Key risks for EU's eastern wing

A two-speed recovery is under way in the European Union's emerging eastern economies, with Poland and the Czech Republic outpacing peers Hungary and Romania for now. Portfolio investors looking for higher yields in sluggish western economies are pouring into the region, but uncertainties remain, including battles over austerity and next year's budgets and the need for Germany's export boom to keep their recoveries alive.

Policymakers, bankers and corporate officials will discuss these and other issues at the Reuters Central European Investment Summit in exclusive interviews in Vienna, Warsaw, London and New York from Oct 11 to Oct 13.

Following are some of the main risks facing the region: Investment Flows

Since July, quantitative easing in Western economies has fueled a surge in investment into riskier emerging assets. Emerging Europe was slower to benefit from the increased risk appetite than Asia or Latin America, but it has now picked up.

Long seen as a safe haven, the Czech crown has led gainers this year, rising 7.6 percent against the euro versus 4 percent for Poland's zloty. But since last month, other currencies have outperformed. Hungary's forint has jumped 5.05 percent after a sharp fall in July.

A new global shock, however, could potentially cause a swift selloff across markets, resembling those seen after the 2008 collapse of Lehman Brothers that helped wipe 30 percent off the zloty's rate against the euro, or this year's Greek crisis, which hit currencies and drove bond yields higher.

"The main risk to the zloty and the rest of the CEE-3 currencies would come from any negative fundamental or fiscal developments in the euro zone, or a generalized retreat from "risky" assets," Goldman Sachs wrote in a note. What to Watch:

- The world's major monetary authorities. Comments supporting easy monetary policy will continue to fuel risk appetite. Reversing that trend could halt the rise in emerging assets.

- Although central Europe has shown resistance to contagion from the euro zone periphery, it has experienced selloffs when events such as the Lehman collapse, the Greece crisis or the hiatus over Hungary's IMF deal come to light. Hungary

Hungary's right-wing Fidesz government has confounded markets by rejecting a new safety net deal with the European Union and the International Monetary Fund and forging ahead with a pro-growth strategy that depends on unconventional measures rather than traditional cost cuts and tax hikes.

That poses fiscal risks. Under pressure from Brussels, Prime Minister Viktor Orban has pledged to stick to a commitment of a 2011 fiscal deficit of 3 percent of gross domestic product.

But his plan includes spending cuts and a two-year windfall tax on banks. The government has also lowered taxes on small and medium businesses and plans to introduce a flat personal income tax in stages from 2011 -- plans not in line with IMF advice.

[Source: By Michael Winfrey, Reuters, Prague, 09Oct10]

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