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Central Europe: Euro's Rise Means Good And Bad News

Europe's single currency, the euro, is rising against the U.S. dollar. This may be good news for the U.S., as the dollar's slide makes its exports cheaper. But it could have the opposite effect in the Europe Union's euro-zone economy, which is already on the brink of recession. RFE/RL asks what impact it is likely to have on Central and Eastern Europe.

Prague, 20 May 2003 (RFE/RL) -- Michal Ptacnik works for Walter, a Czech company that makes aircraft engines. Walter does a lot of business in the U.S., where its goods are priced in dollars. So it's been hit hard by the dollar's slide against the euro -- and against the Czech currency, the koruna, which is closely linked to the euro.

"We had planned an exchange rate of around 30 koruna to the dollar this year. Then unfortunately the dollar began to fall and is continuing to fall, so for us it means a loss equivalent to several percent of turnover," Ptacnik told RFE/RL. "Partly we have these losses compensated by the fact that we don't produce the engines completely here in the Czech Republic, we buy some components and some of them are priced in dollars, so that partly offsets it. But nonetheless, in three months, it's [meant a loss of] roughly up to 1 million koruna."

The reasons for the euro's rise are complex. Part of the trend is due to investors pulling money out of the U.S. and investing in European stocks and bonds, where they perceive a greater return. It's not known how far the euro will rise.

Walter is one of the unlucky Central European firms being hit directly by the dollar's recent fall. For the most part, the exchange-rate fluctuation won't have too much direct impact on the region, since most trade is now conducted in euros.

But analysts say economies in the region will feel the impact of a weaker dollar -- mainly via its overall effect on the euro-zone economy. A stronger euro is making euro-zone exports to the U.S. more expensive. That could harm the Western European economies, and tip them into a recession already being felt in major countries like Germany.

Peter Havlik is deputy director of the Vienna Institute for International Economic Studies. He told RFE/RL: "The German economy is presently very weak and this could have an adverse impact on Central and East European countries because Germany has been their major trading partner. This is the first issue."

Havlik said the weaker dollar could bring some benefit to Central and Eastern Europe in the form of lower energy costs, since oil and gas imports are usually denominated in dollars. But it could take its toll later if a weaker German economy translates into less appetite there for goods from Central and Eastern Europe. And the harm could be worse if the dollar weakness is prolonged -- or if it falls further.

Ralph Solveen, an economist at Commerzbank in Frankfurt, said it's hurting already. "The [euro] appreciation we have seen in the last few weeks, few months is enough to have a negative impact and I think there is no threshold for a negative effect on the German economy. Each cent the euro is appreciating against the dollar or against other currencies has a negative impact. That does not mean that exports will collapse, but there will be a dampening effect of these appreciation on exports," he said.

The outlook for the German economy wasn't exactly rosy even before the rapid appreciation of the euro. German growth has been driven by exports -- and they've now lost the competitive edge they enjoyed when the euro was weaker.

The strict rules on European monetary union mean governments can't spend their way out of a slump either -- and Germany is already heading over the budget-deficit limit for the second year running.

Germany's woes and the strong euro come as countries across Central and Eastern Europe are embarking on the difficult job of getting their own public finances in shape as EU membership looms.

"If the German economy would continue to stagnate and to grow at a very low rate, this would make all these issues which you have mentioned regarding the consolidation of public budgets in the Czech Republic, Slovakia, but also Poland and Hungary and so on much more difficult," Havlik said.

Still, it's not all doom and gloom yet. The U.S., of course, is not Germany's sole trading partner. Plenty of its exports go to other euro-zone countries or countries closely linked to the euro. As long as it doesn't turn into a freefall, the weaker dollar should also eventually boost the American, and therefore the world, economy by making U.S. exports cheaper.

A strong euro has also raised hopes that the European Central Bank will further cut interest rates, especially since deflation, not inflation, now appears to be more of a risk.

Economies across Central and Eastern Europe have proven resilient before. In the last couple of years, they performed better than those in Western Europe, and they're still expected to show stronger growth this year. That's thanks largely to foreign investment in Central Europe -- and higher oil prices for the oil producers in countries further to the east.

And Ptacnik of Walter said the currency squeeze is forcing companies like his to cut costs and improve their effectiveness. "We're trying to rationalize our production as far as we can," he said. "This is a direction that's healthy for Czech industry because the effectiveness here isn't so high, so this weakening of the dollar will really force exporters to think about how to economize and force them -- including us -- to make our activity more economical."

The fall of the dollar may hold lessons for the future. Some enterprising Central Europe firms are now switching to contracts in euros wherever possible.