Eastern Europe's small business struggle could slow recovery

Lending to crisis-hit eastern European small business shows little sign of recovering and more state backing may be needed to stave off a spiral of bankruptcies and loan defaults that would undermine growth.

With industry dominated by foreign-owned exporters, their vast chains of smaller home-grown suppliers are a crucial motor of growth in countries like Hungary and the Czech Republic as they play catch up with their developed western neighbours.

But the conservatism of banks in the region since inflows of cheap foreign money ended last year, has left the small businesses that have grown up since communism even more exposed to a fall off in orders and business than those in the west.

Peter Latranyi's HTCM Ltd manufactures and repairs tools in Szentgotthard, in western Hungary. His biggest client is Opel, the troubled German car company, which makes engines nearby. When Opel scaled back recently, so did HTCM.

"We had to let 12 of our 60 people go," Mr Latranyi said. "We hope to get out of the slump once our clients get new orders, but we can't go on like this forever."

If business does not pick up in a few months, he says they will have to pack it in.

So far Poland, as big as most of the rest of region put together, has been the only country to avoid an economic contraction. Bankruptcy rates, though hard to compare, look sharply lower there than in Hungary, where the economy is set to shrink 6.7 per cent this year and only grow again in 2011.

"The most difficult period for SMEs is up next," said Ferenc Rolek, deputy chairman of Hungary's Confederation of Employers and Industrialists. "The next two quarters will be crucial for their survival."

Scores of Hungarian and Czech business owners are being forced to lay off staff and delay investments. Many of them could go bust soon, victims of weak markets, scarce credit and melting cash reserves, business groups and bankers have said.

Although banks are now adequately capitalised, patterns in lending show they see SMEs as risky, and fear loan losses.

According to a report issued in August by the National Bank of Hungary, banks expect a tight lending market ahead as SMEs drain inventories, spend cash reserves, struggle to collect receivables, and cut back on investments.

Banks have practically stopped signing up new loan clients.

"Lending to SMEs is very limited," said Peter Vidlicka, regional banking analyst with Wood & Co. in Prague. "Banks are afraid bankruptcies will spread if the downturn continues."

"Corporate lending, and especially working capital flows, have been declining in Poland, the Czech Republic and Hungary alike. Banks are re-pricing corporate lending upwards, and companies are not going to banks as much as they used to."

Hungarian, Czech and Polish small and medium enterprises (SMEs) account for 60 to 70 per cent of employment, and half or more of the output and taxes in their economies. That makes them crucial for the region's post-crisis growth prospects.

In Poland, whose 38 million people number just under the Czech, Hungarian and Romanian populations combined, small businesses will grow already in the second half of this year.

Export-driven Czech and Hungarian SMEs have less of a domestic market and will return to growth later, analysts said. "In the long run we need to realise that multinational exporters are helpful but not enough for catching up," said Zsolt Kondrat, an economist at Hungary's MKB Bank.

"There is no recovery without small business."

Mr Kondrat said Poland had a much bigger domestic market and that there was better opportunity there for SMEs while the Czechs were in the middle, with a solid tax system and interest rate regime.

"Hungarian SMEs suffer from a smaller market, a dependence on large multinationals, as well as counterproductive taxes and higher interest rates, which hinder growth," he said.

Hungary's financial watchdog PSZAF said in a report that the total outstanding stock of SME loans fell by 12 per cent, or 478 billion forints (€1.769 billion) in the second quarter alone.

In total volume terms, short-term loans outweigh longer-term ones nearly five to one this year, as opposed to two to one seen last year, as firms scale back on strategic investments.

Mr Rolek said government loan guarantees could help them secure much-needed bridge loans - something that the Hungarian Banking Association has also called for.

"Up to 80 per cent of all SME loans are vulnerable," said Tamas Erdei, the association's chairman. "Banks cannot, dare not undertake the risk alone."

But hardship or not, some firms are faring well. Lipoti Bakeries Ltd has grown from a mom-and-pop bread shop in western Hungary into a cross-border chain of 100-plus outlets in three years.