Central & Eastern Europe: Solid domestic fundamentals support CEE economy

April 13, 2016

Solid domestic demand continues to drive the economies of Central and Eastern Europe (CEE) and shields them against external headwinds. More complete data confirm that regional GDP growth accelerated in Q4, rising from 3.4% in Q3 to 3.6% over the same period of the previous year. The improvement was driven by pick-ups in almost all of the economies in the region, with only CroatiaCzech RepublicEstonia and Latvia losing steam. Detailed data reveal that solid fundamentals at home drove the improved performance, while the external sector held back growth in many countries. Tighter labor markets, low oil prices and a lack of inflationary pressures have supported households in the region, while a number of economies received a boost to investment amid drawdowns on EU development funds.  

At the start of 2016, many of the conditions that supported the CEE economies’ robust growth in 2015 appear to remain in place. Although investment in the region will likely take a hit due to the depletion of EU development funds, heathy labor markets, supportive monetary policy and a low inflationary environment will continue to drive the economy. That said, concerns over the pace of global growth and political uncertainties persist. In Poland, the government remains locked in a conflict with the highest court that is weighing on the country’s democratic reputation. While in Slovakia, Prime Minister Robert Fico’s Smer-Social Democracy party lost its majority in the March election. Although Fico will remain PM after forming a four-party coalition, the government will be more precarious than before, which could impact productivity. For the region as a whole, the high inflow of refugees into the European Union has elevated tensions between a number of governments in the CEE region and EU authorities, and it is far from clear if the agreement with Turkey will improve the situation going forward. In addition, the United Kingdom’s upcoming vote on whether to remain in the EU will have repercussions for the CEE economies. The UK is a large contributor to the EU’s budget, and many CEE economies receive more funds than they contribute. FocusEconomics Consensus Forecast panelists project GDP growth to decelerate in Q1 2016 to 3.3%.

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CEE’s growth prospects remain stable 

The economy of Central and Eastern Europe is projected to continue growing at a solid rhythm in 2016. After GDP expanded at seven-year high of 3.4% last year, forecasters surveyed by FocusEconomics foresee a healthy 3.1% expansion in 2016, which is in line with last month’s forecast. The region will continue to benefit from solid domestic dynamics along with the ongoing recovery in the Eurozone.   

This month’s outlook reflects improved growth prospects for 5 of the 11 economies surveyed, while 3 countries’ forecasts were cut. Analysts raised the forecast for Poland, the largest economy in the region, amid solid data at the outset of the year. In addition, major players Czech Republic and Romania also saw their prospects raised. Meanwhile, the forecasts for Bulgaria, Hungary and Slovenia were left unchanged. 

CZECH REPUBLIC | Economy on solid footing at start of 2016

The Czech economy remains robust in the face of a challenging global economic environment. Forward-looking indicators point to sustained resilience in the first quarter of 2016, particularly in consumer confidence, which, although it has eased from January’s record-breaking peak, still remains at elevated levels and will likely translate into higher consumption growth. This is promising as consumers will be the driving force behind growth in 2016 as absorption of EU structural payments related to the 2014–2020 program winds down this year.

EU funding helped propel public spending which, in turn, translated into a remarkable 4.3% expansion in GDP last year. However, these funds were temporary and were mostly received in the first half of 2015. The potential breakup of the Schengen zone, weak external demand, and potential looser spending habits ahead of 2017 elections all present downside risks to growth over the forecast period. FocusEconomics Consensus Forecast panelists forecast that the economy will grow 2.6% in 2016, which is up 0.1 percentage points from last month's projection. In 2017, the panel expects the economy to expand 2.8%.

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HUNGARY | Data points to sluggishness in Q1 

More detailed data confirm that Hungary’s economy picked up in the final quarter of last year, although it did lose steam for the year as a whole. The improvement largely reflected continued gains in the labor market and final drawdowns on EU development funds. Sequential data points to weaker growth in the first quarter of 2016. Industrial production expanded at the slowest pace in over one year in January and economic sentiment deteriorated in March. On a positive note, the Central Bank stated in April that it had fully repaid a multi-billion-euro loan that it had taken out during the global financial crisis.   

A sharp deterioration in investment due to the depletion of EU development funds should limit growth this year. Forecasters see GDP expanding 2.4% in 2016, which is unchanged from last month’s forecast. For 2017, they see GDP growing 2.6%.

POLAND | Government remains at an impasse with top court

Poland’s economy picked up pace in the fourth quarter of 2015, supported by a healthy labor market and solid investment growth. Despite ongoing political uncertainties, economic data remains solid at the outset of the year: industrial production accelerated in February and the manufacturing PMI picked up in March. Meanwhile, the government remains embroiled in a conflict with the constitutional court which is undermining its democratic credibility. The conflict is centered on a piece of legislation passed by the ruling Law and Justice (PiS) party that would consolidated power and boost the government’s influence over court rulings. The overhaul was ruled unconstitutional by the country’s top court, however, the government has refused to honor the ruling. In April, the EU commission responsible for rule of law sided with the court and urged a speedy resolution to the conflict.  

Solid economic fundamentals should continue to propel strong growth despite downside risks from political uncertainty. Our panelists expect the economy to expand 3.6% in 2016, which is up 0.1 percentage points from last month’s forecast. For 2017, the panel sees economic growth stable at 3.6%.

ROMANIA | Government finances deteriorate amid wage increases and tax cuts 

More detailed data released by the Romanian Statistical Institute showed that the economy grew 3.8% annually in Q4 2015. The reading came above the previous quarter’s expansion and brought full-year growth to 3.8%, the highest reading since the start of the financial crisis in 2009. The expansion was supported primarily by solid private consumption and fixed investment. High-frequency data suggest that the economy remains on solid footing. Retail sales tallied double-digit growth for the seventh consecutive month in February. However, the fiscal easing policies, wage hikes and VAT cuts that have spurred a consumption boom are also weakening the government’s balance sheet. This was reflected in the Central Bank’s decision to leave the policy rate unchanged in March to secure sufficient room to apply monetary tools if needed amid growing macroeconomic imbalances.  

Growth this year will be fueled by strong private consumption on the back of expansionary fiscal policy, which will more than compensate for a slight slowdown in fixed investment and deteriorating exports. However, widening fiscal and current account deficits represent medium-term risks. For a fourth consecutive month, our panelists revised up Romania’s growth forecast for 2016 and they now see GDP expanding 4.0%. For next year, they expect slower but still solid growth of 3.6%. 

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INFLATION | Consumer prices fall deeper into negative territory in February

Almost all of the economies in the CEE region continued to face falling prices at the beginning of 2016. An estimate elaborated by FocusEconomics indicates that consumer prices declined 0.7% in February over the same month of the previous year, which was a more pronounced decline than January’s 0.5% fall. Low oil prices have driven nine consecutive months of falling prices and have prompted speculation that many Central Banks in the region will cut rates going forward. 

Inflation is expected to return this year, although it will be subdued overall. Economists surveyed this month by FocusEconomics expect inflation of 0.2% in 2016, which represents a downward revision from the 0.6% expected last month. The cut in this month’s projection reflected that the inflation forecasts for all of the economies in the region were reduced. Going forward, inflation is expected to rise and forecasters predict that it will average 1.9% in 2017.

Written by: Angela Bouzanis, Senior Economist

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