Economic Snapshot for Central & Eastern Europe

August 2, 2017

Polish political jitters pose major downside risks to CEE economy 

Growth in the Central and Eastern European (CEE) economy is expected to have remained buoyant in Q2, after starting the year on a bright note. FocusEconomics analysts expect regional GDP to have grown a robust 3.7% annually in the April to June period, which followed Q1’s strong 4.0% expansion. Behind the region’s healthy momentum is rebounding investment, chiefly thanks to European Union development funds, and solid demand for exports from the Eurozone. The Euro area’s economy has become a bright spot in global growth this year and this positive momentum is aiding the CEE economy, which is closely tied to the Eurozone.

While the economic story in the region remains solid, the political scene got off to a rocky start to the second half of 2017. The situation deteriorated dramatically in the region’s largest economy, Poland, after the country was rocked by mass protests in July over an attempt to overhaul the judiciary. Although President Andrzei Duda vetoed two of three controversial reforms that were passed by the ruling Law and Justice (Pis) party on 24 July, temporarily defusing a tense political scene, the situation is precarious as the party still intends to pursue the reforms. Moreover, the judicial overhauls are the latest warning sign concerning the state of the country’s democracy, which has been the subject of a lengthy row with the European Union. 

The latest events illustrate a possible profound shift in the regional giant’s political climate, which has for years been seen as a steady economic powerhouse in the region. While at this point it is hard to determine how the controversy will affect the economy, downside risks to the outlook have amplified and the country’s battle with the EU is intensifying. The EU has launched legal action against the country for breaking the bloc’s laws and heightened uncertainty and concern over the quality of Poland’s institutes could impact the business climate, investment and the country’s financial assets. 

Growth prospects unchanged after three consecutive upgrades

The FocusEconomics panel held the CEE region’s economic outlook unchanged this month, following three consecutive upgrades. While strong incoming economic data suggests that activity is firing on all cylinders, the strong figures are being overshadowed by political risks in the region’s largest economy. Our analysts see regional GDP growing 3.6% this year and 3.3% in 2018. 

The stable outlook is chiefly due to unchanged prospects for Poland, along with those of three other economies. Meanwhile, seven economies surveyed saw brighter forecasts for 2017 this month, including major-players Czech Republic and Hungary. None of the region’s economies saw their forecasts downgraded. 

Romania is projected to be the region’s fastest-growing economy this year, with an expected expansion of 4.6%. Poland and Slovenia are also seen achieving fast growth rates of over 3.6%. On the other end of the spectrum, the Czech Republic and Estonia are expected to be the CEE region’s laggards, with expansions of 2.9%. 

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CZECH REPUBLIC | Government coffers start to benefit from robust economy

The Czech economy is growing robustly, buoyed by a favorable external environment and strong household spending. After falling somewhat in April, exports jumped in May, with a greater trade surplus recorded for motor vehicles on the back of stronger demand from European Union countries. The jump in exports was behind the rebound in industrial production recorded in the same month and PMI readings suggest that both domestic and external demand are creating expansionary conditions in the manufacturing sector. The positive momentum is also being felt in the labor market, with unemployment falling to a fresh multi-year low in June, which, together with rising wages, is underpinning private consumption. In addition, recently-published data shows that public finances are benefiting from robust growth, as in Q1, the fiscal balance recorded a small surplus—reverting the deficit registered in Q1 2016—thanks to revenue growth, especially from income taxes, outpacing spending growth. 

The economy is set to accelerate this year, as a new cycle of EU funding begins, provoking a rebound in fixed investment, and strong employment and wage dynamics underpins household spending. Healthy fiscal metrics guarantee room for maneuver in case of unexpected shocks, while the outcome of this October’s elections is unlikely to substantially modify the government’s pro-market approach. Panelists see GDP growing 2.9% in 2017, up 0.1 percentage points from last month, and 2.7% in 2018. 

HUNGARY | Survey data hits new-highs in Q3

2017 is shaping up to be a spectacular year for the Hungarian economy as it is being supported by ambitious pro-cyclical policies and a resumption of EU investment funding. All evidence suggests that growth in Q2 remained robust. In May, both industrial production and retail sales expanded solidly and unemployment declined again. The external sector also performed robustly in the same month, hinting that the economic upturn is broad-based. Adding to the mounting good news, survey-based data reached all-time highs at the start of the third quarter, underscoring the strength of the country’s economic fundamentals. 

Hungary’s economic outlook is bright as loose monetary conditions, a minimum wage hike, tax cuts, increased inflows of EU funds and a solid labor market are expected to boost economic growth this year. Our panelists project that the economy will expand 3.6% in 2017, which is up 0.1 percentage points from last month’s forecast. For 2018, it is expected to grow 3.3%. 

POLAND | Judicial overhaul thrusts country into crossroads with EU and threatens economy’s stability

Heightened uncertainty and market volatility abound in the wake of 24 July’s two presidential vetoes that halted much of the PiS-led judicial overhauls that had prompted nationwide protests. In the days since, the EU has filed court proceedings against the country in what promises to be a drawn-out legal squabble over the direction of Polish democracy. Although investor confidence is likely to be tested in the near term, a strong economy and sound fundamentals are sure to cushion much of the blow—that is, a tightening labor market and healthy retail sales through June bode well for resilient consumer spending at the end of H1. Moreover, survey-based data showed a pronounced optimism heading into H2: the manufacturing PMI recovered solidly in June on improved output growth and business confidence was once again upbeat into July.

Although it remains to be seen how recent political turmoil will affect investor confidence, economic growth is expected to remain strong this year on the back of a rebound in fixed investment as greater EU funding is absorbed. A strong domestic economy will be supported by robust private consumption, while the external sector will get a necessary boost from favorable global tailwinds. FocusEconomics panelists see GDP expanding 3.7% this year, which is unchanged from last month’s projection. In 2018, the panel sees GDP expanding 3.4%. 

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ROMANIA | Government backtracks on VAT cut as fiscal woes mount

The Romanian economy seems on track to reach new heights, even after Q1’s impressive GDP outturn. Industrial production soared in May, pushing average industrial production growth in Q2 far above Q1’s result, thus suggesting that GDP could grow at a faster clip in Q2. The newly installed government is doing everything it can to prop up output by pushing through a series of pro-cyclical measures, such as public-sector wage hikes and tax breaks. However, the new government walked back some of its promises, such as a further VAT cut, in an effort to keep its ballooning fiscal deficit under control. Yet this might be too little: the political turmoil coupled with the populist policy bent has weighted somewhat on the Leu, signaling a gradual loss in investor confidence. 

The economy should record another year of robust growth this year, though risks of overheating are increasing. Growth is expected to be fueled by strong consumer spending, thanks to a combination of tax cuts and wage hikes. However, the lack of investment and the increasing fiscal pressure could lead to an abrupt adjustment down the line as investors turn their backs on the country. Our panelists predict an expansion of 4.6% in 2017, which is up unchanged from last month’s forecast, with growth of 3.7% penciled in for 2018. 

INFLATION | Price pressures ease in June

According to an estimate produced by FocusEconomics, inflation in the CEE region edged down in June, coming in at 1.6% following the 1.8% print in May. Price pressures remain meagre despite an ultra-loose monetary policy stance in many key economies. Hungary’s Central Bank made no change to its policy stance in July as solid economic activity is accompanied by benign inflationary pressures.

FocusEconomics panelists held their inflation projections unchanged for a fourth consecutive month and see it averaging 1.9% in 2017. In 2018, inflation is expected to rise slightly to 2.2% on the back of strong economic activity. 

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Angela Bouzanis

Senior Economist