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    Central Europe braces for knock-on effect of German slowdown

    Abstract:For the past year, business leaders and policymakers in central Europe have been wondering how long they can defy gravi​ty.

      For the past year, business leaders and policymakers in central Europe have been wondering how long they can defy gravity.

    Central

      The regions economies spent the last few years in the grip of a sustained boom, powered by a friendly mix of low interest rates, surging consumer spending and a recovery in the eurozone. But since last autumn Germany — the biggest trading partner for much of central Europe — has been sliding towards recession, and many fear a knock-on effect.

      “It is a popular saying that if Germany sneezes, the smaller [countries] nearby catch a cold, and it is true,” Hungarian finance minister Mihaly Varga said at a recent conference promoting investment in his country. “We are waiting for this cold period.”

      The reintegration of central Europe‘s economies with Germany’s has been one of the key factors in the region‘s rapid growth over the past three decades. Lured by a skilled but relatively cheap workforce, Germany’s carmakers, retailers, banks and manufacturers have flooded in, setting up thousands of plants and offices and helping fill the order books of local businesses.

      The result is that the Visegrad Four — Poland, Hungary, Slovakia and the Czech Republic — all send between 20 and 30 per cent of their exports to Germany. But while all notched up strong growth in 2018, business leaders say the slowdown in the EUs biggest economy is beginning to ripple through its supply chain.

      Analysts say it takes several quarters for a German slowdown to be felt in central and eastern Europe, and industry leaders are now feeling its impact.

      “Three months ago we didn‘t see [the slowdown],” said Michal Krupinski, chief executive of Bank Pekao, Poland’s third-largest bank. “But now you see it in the data, and when we talk to clients, they are also already seeing it: slower orders, stocks of unsold goods going up.”

      “We can see [the slowdown] but we dont feel it yet,” said Richard Jankovits, managing director of Jankovits Engineering, a hydraulic cylinder manufacturing business that supplies automotive groups such as Continental and Audi and employs 13,000 people at its plant in Gyor, the largest engine factory in Europe.

      The automotive industry has long been an economic bedrock for the German-Central European relationship. Over the past 30 years groups such as Volkswagen, Audi, Daimler and BMW have opened a network of plants across the region, turning it into one of the industrys most important global hubs.

      But with carmakers particularly at risk from the political squalls roiling global trade and the uncertainty surrounding Brexit, economists say the sector is likely to be one of the main conduits through which the German slowdown seeps eastward and south.

      “If we look at the industrial figures this year, [the German slowdown] is the biggest factor [in the slowdown in Slovakia],” said Katarina Muchova, an economist at Slovenska Sporitelna in Bratislava. “The car sector is the key one, but also those that supply it, such as metal-processing [have been hit].”

      The German economic slowdown comes as central Europe is faces a mix of other headwinds. Labour shortages are beginning to bite across the region, and the Visegrad economies are likely to get a smaller helping of EU funds in the blocs next multiyear budget, which is currently being negotiated.

      In previous years the region experienced a “glorious situation” owing to EU funds, global growth and wage rises that let to increased consumption, said Andras Vertes, chairman of GKI Economic Research, an independent economic consulting firm in Budapest.

      “Now, everything is changing,” he said.

      The slowdown coincides with a broader debate in central Europe about how the regions economies can move beyond the model of providing cheap labour to foreign investors that has powered the last 30 years of growth.

      “We have to focus to avoid the middle income trap,” said Mr Varga. “The cheap labour force time is over, and we have to find a programme which can help and support the value added sectors in the country.”

      In an effort to support this shift, Hungarys foreign minister Peter Szijjarto recently announced that it would begin offering cash subsidies for private sector investments even if they did not create new jobs, as long as they focused on innovation.

      But as well as moving up the value chain, economists say the region could also boost its resilience to external shocks by finding new trading partners and sources of investment to complement those from Germany.

      To some extent this is already happening. In the first half of 2019, for the first time, South Korea edged Germany out as the countrys top foreign investor, according to Mr Szijjarto.

      However, business leaders say there is still scope for companies in the region to do much more. “Going beyond the eurozone is the natural response [to the German slowdown],” said Mr Krupinski. “At the moment, our exports are too skewed to the EU.”

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