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Wednesday, 30 January, 2002, 17:52 GMT
East Europe rate cuts promise boost
A Polish sandwich shop
Would you like a loan with that?
By BBC News Online's James Arnold

Deafened by the big guns in the US, EU and UK, it may have escaped your notice that central banks in smaller countries have also been slashing their interest rates recently.

And nowhere more keenly than in Eastern Europe.

Poland, the region's biggest economy, cut its rates on 30 January, by a whopping point-and-a-half to 10%.

Last week, neighbouring Hungary and the Czech Republic did the same thing, taking rates in every major economy to post-communist record lows.

This is having a profound effect.

While most people see cutting rates as a way of giving the economy a temporary jolt, for Eastern Europe, it is changing their whole way of life.

Falling interest

The higher they were, the faster they have fallen.

Poland, the region's keenest cutter, has seen interest rates halve in the past 12 months, to just 10% this week.

That takes Polish rates just a point above Hungary's, but still way over those in the Czech Republic, where earlier, deeper cuts have taken them down to 3.5%.

Now, for the first time in recent memory, a major ex-communist economy has interest rates lower than the West European average.

As recently as 1997, Czech central bank interest rates were 50%.

Inflation deflated

The reasons for the long-term cutting campaign are partly economic, partly political.

On the pure economic front, the main post-communist threat, soaring inflation, has all-but disappeared.

In Poland in 1990, for example, consumer-price inflation was 686%; last year, it was a minuscule 0.2%.

They are also dipping their interest rates with one eye on Frankfurt.

These three countries, together with a couple more, are also aiming to become rapid adopters of the euro: they currently shadow the single currency, and aim to have their economies well within the Maastricht criteria before they join the EU, possibly by 2004.

Eager not to be seen as second-class euro-citizens, Eastern Europe's main economies want to prove they are capable of exceeding whatever targets the West sets them.

End of austerity

To some extent, too, the region's central bankers are making up for years of monetary stricture.

All three countries, and in particular Hungary, opted for severe austerity in the early to mid-1990s, keeping interest rates deliberately high in order to choke off the sort of indiscipline seen elsewhere in the region.

The result was three admirably sound economies, but growth and real incomes far lower than voters had been led to expect.

As a result, politicians have lobbied successfully for a little loosening in the past couple of years - and the region has enjoyed a welcome spurt of economic growth.

Life gets better

But lower interest rates mean much more than a passing shot in the arm.

While Eastern Europe's macro-economy has held up well in recent years, its micro-economy has consistently disappointed.

The main failing here has been the chronic shortage of small firms - the sort of bustling entrepreneurs that underpin economic success in Britain and elsewhere.

East European governments have launched scheme after scheme to stimulate small business, but the real obstacle is the almost complete lack of finance.

With interest rates in Poland at an average of 15 percentage points over inflation during last year, getting a bank loan - or a mortgage or credit card for that matter - has been woefully expensive.

Enterprise culture...

As the gap between interest rates and inflation has narrowed, so consumer credit has started to become part of everyday life.

Mortgages and credit cards have come within the reach of the moderately well-off, although still remain beyond the average citizen.

Shops find it easier to offer finance, stimulating demand for big-ticket items such as cars and electronic goods.

With small business loans getting cheaper, the post-communist surge in unemployment is being mollified by mushrooming cobblers and cafes, bookshops and bakeries.

... is in its infancy

And there is still a long way to go, as Polish inflation falls close to zero, and even Hungary - long the inflationary laggard in the region - predicting 3.5% this year.

Even the Hungarian National Bank could afford to cut another couple of percentage points off rates, while leaving a fat enough margin for lenders.

And Poland, which now faces the real risk of deflation, is in desperate need of far more drastic cuts.

In the West, central banks seem to have called a halt to their campaign of lowering rates.

But east of the old Iron Curtain, the only way is down.

See also:

15 Jan 02 | Business
Eastern Europe's difficult decade
05 Dec 01 | Business
World Bank: more globalisation
15 Nov 01 | Business
IMF and World Bank focus on downturn
30 Oct 01 | Business
Why Eastern Europe loves the euro
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