Too soon to dismiss fiscal risks (Mar 10)

Financial markets in Emerging Europe have, for the most part, brushed off sovereign debt concerns in the euro-zone’s periphery. While bond markets sold off earlier this year as the crisis in Greece reached its peak, yields on both foreign and local currency debt have since fallen back. However, although public debt in Emerging Europe is, on the whole, much lower than it is in Western Europe, there is little room for complacency. For a start, most governments in the region are now running large structural budget deficits, pointing to the need for a substantial fiscal squeeze over the next two to three years. But with the pace of recovery already set to disappoint this will be politically difficult. What’s more, the looming demographic crunch means that worries over fiscal sustainability persist. To be clear, a full-scale public debt crisis in the region looks unlikely. But while low domestic interest rates should help to keep a lid on local currency bonds yields, we expect foreign-currency bond yields to rise over the second half of this year.