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The much-anticipated increase in US interest rates is finally here. With it comes the expectation that growth in emerging markets will suffer, as these economies bear the brunt of the additional cost to rising debt. But one region seems largely immune to this effect: Eastern Europe.
Countries in Eastern Europe have two characteristics that differentiate them from other emerging markets. First, their debt levels are low, on average equaling 45 percent of GDP in 2015. Second, because of increased integration with the European Union and in some cases entry into the euro area, their governments and companies have borrowed primarily in euros. In some cases, like Bulgaria, Estonia, and Slovakia, nearly 100 percent of sovereign debt is euro denominated.
This is in contrast to the main emerging markets of Brazil, Indonesia, South Africa, and Turkey, who have borrowed heavily in dollars over the past decade. Coupled with a dependence on commodity exports (Turkey excepted), these economies will likely be affected the worst by the rising cost of dollar-denominated debt.
Could Eastern Europe even benefit from a stronger dollar? It could, as the costs of its competitors rise with the dollar. Turkey, for example, is a significant exporter of agricultural and apparel products to the European Union. In these sectors it competes directly with EU members Bulgaria and Romania. Similarly, Turkey has a large car assembly and car-parts sector, which competes with Slovak companies. Slovakia would benefit from a weakened competitor. As another example, Slovenia competes with Indian companies in pharmaceuticals. Raising the costs of corporate credit in India is good news to their Slovenian competitors. The same is true for seaside tourism in Montenegro and Croatia, who compete with South African and Brazilian resorts as upscale destinations.
How large this beneficial effect becomes depends on the ability of East European producers to quickly capture larger market shares in industries where their competitors suffer from the stronger dollar. There are grounds for optimism in this regard. Two decades ago East European exporters had to quickly redirect their trade flows away from the former Soviet Union and towards the European Union. The adjustment needed now is smaller.
