CEE: Growth wanes despite fiscal stimulus in the face of investment collapse
November 2, 2016
The economies of Central and Eastern Europe (CEE) are expected to have lost some momentum in the third quarter, after GDP growth accelerated to a 3.3% annual expansion in Q2 (Q1: +2.9% year-on-year). Fiscal stimulus, low inflation and easy monetary policies have led to a consumption boom in the region—which is particularly pronounced in the Polish and Romanian economies. Romania scrapped over 100 small taxes in October as the government continues to ease policies ahead of the December general election and passed a law converting Swiss franc loans into local currency at below-market rates. Poland’s government is expected to lower the retirement age in the coming weeks. Despite the positive push from consumption, contracting investment due to a lower drawdown of EU development funds is limiting growth and the region is expected to have expanded 3.1% in Q3.
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In the political arena, the region is ploughing through a jam-packed election calendar in the final months of 2016. In Croatia, a new market-friendly coalition government was formed on 19 October. Prime Minister Andrej Plenkovic stated that improving the business environment and implementing a tax reform are among the top priorities for the new government and efforts to reduce public debt will be included in the budget for 2017, which is slated to be released in November. Croatia’s public debt is nearing 90% of GDP and is the highest in the region. Meanwhile, the center-right opposition Peasants and Greens party won the Lithuanian elections on 24 October. The party still needs to complete coalition negotiations to form a government and faces the tough task of revitalizing growth, which slowed to a multi-year low in 2015, in the Baltic economy.
Looking ahead, a presidential election will be held on 6 November in Bulgaria. While the position of president is largely ceremonial, the vote serves as a barometer for sentiment ahead of the 2018 general elections and Prime Minister Boiko Borisov has stated that he will shuffle his cabinet if his party’s candidate Tsetska Tsacheva loses the first-round vote. Meanwhile, Romania will head to the polls for a general election in December. The outcome of the election is highly uncertain as an anti-corruption campaign has damaged a large number of the country’s mainstream parties.
Outside the region, risks associated with the United States’ tumultuous presidential election have diminished. Hillary Clinton has surged in the polls in recent weeks, reducing the risk of a Donald Trump presidency. Trump has expressed many views against reducing global trade and a victory for him could increase volatility in financial markets and spark a selloff of emerging market assets, which would hurt some CEE economies.
Growth outlook unchanged for third consecutive month
This month, the economic growth prospects for Central and Eastern Europe were stable as solid spending continues to support the outlook in the face of falling investment. Panelists surveyed by FocusEconomics project that GDP growth will slow from last year’s 3.5% to 3.0% in 2016, which is unchanged from last month’s forecast. Next year, our panel foresees growth plateauing at 3.0%.
This month’s outlook reflects unchanged growth forecasts for 5 of the 11 economies surveyed, including regional heavy-weight Poland. The GDP projections were revised up for Bulgaria, Croatia and Romania, while the Baltics were all downgraded amid weak economic conditions.
Romania will likely be the region’s fastest-growing economy this year, with an expected expansion of 4.8%. Poland and Slovakia are also seen achieving fast growth rates of above 3.0%. On the other side of the spectrum, Estonia and Latvia are expected to be the CEE region’s laggards, with expected expansions of 2.0% or below.
CZECH REPUBLIC | Government proactively tackles public debt
Economic activity in the Czech Republic seems to be picking up after having experienced a slight slowdown at the beginning of the third quarter. Industrial production rebounded strongly in August after July’s sharp fall. Unemployment fell again in both August and September, following July’s worsening, and economic sentiment recorded a nine-month high in October, gaining strength after months of relative weakness. In the political arena, on 19 October the Czech lower house approved a bill to introduce a public debt brake mechanism to avoid future excess borrowing. To bring the country into line with the European Union’s “fiscal compact”—which is nevertheless not binding for the Czech Republic, as the country didn’t sign the treaty—the bill provides that if public debt exceeds 55% of GDP, future governments will have to enact budget cuts.
The economy will lose steam this year, reflecting a decline in EU-funded public investment, but it will still grow at a healthy pace, as the substantial drop in unemployment is supporting solid private consumption. The uncertain effects of the Brexit vote and the weakening in the global environment represent the main downside risks to growth. Panelists see GDP growth of 2.5% in 2016, which is unchanged from last month’s forecast. For next year, they see growth ticking up to 2.6%.
HUNGARY | Economy is on solid footing
The Hungarian economy regained traction in the second quarter on the back of buoyant private consumption and a sharp improvement in the external sector. The latest economic indicators from the second half of the year suggest that economic activity remains resilient. In August, industrial production rebounded after contracting for two consecutive months and exports grew at the fastest rate in over a year. A strengthening labor market, reflected in record-low unemployment and growth in retail sales and credit in August, suggests that private consumption remains solid. Nevertheless, growing pessimism among consumers and businesses at the start of the fourth quarter gives cause for concern.
A contraction in fixed investment will cause GDP growth to slow this year, though the economy will still expand at a robust pace, on the back of healthy private consumption, fiscal stimulus and loose monetary policy. A challenging external scenario and lower EU structural funds pose downside risks to growth. Our panelists forecast that Hungary’s economy will expand 2.1% this year, which is unchanged from last month’s projection. For 2017, they see GDP growth picking up to 2.7%.
POLAND | Fiscal measures threaten government finances
Subdued data has emerged from Poland’s economy in recent weeks, suggesting that momentum waned at the end of Q3. Industrial production slowed notably in September and retail sales lost steam. Despite the moderation seen in September, government cash injections to families—which began in July—and an improving labor market are expected to fuel a slight pick-up in economic activity in H2 after GDP grew at the softest pace in nearly two years in the first half of the year. However, the government plans to pass a bill lowering the retirement age in coming weeks, which could have a negative impact on government finances and potential growth.
Growth is expected to slow to a three-year low in 2016, due in part to a reduced drawdown of EU development funds. The FocusEconomics panel sees GDP expanding 3.1% this year, which is unchanged from last month’s projection. For 2017, the panel sees economic growth inching up to 3.3%.
ROMANIA | Parliament passes Swiss franc loan conversion
In the second quarter, the Romanian economy grew by an almost eight-year high of 6.0% on the back of strong consumption, according to data confirmed by the National Statistics Institute in October. Growth in the third quarter looks to have been robust but is unlikely to reach Q2’s lofty figure: in August, retail sales extended their streak of double-digit growth, while industrial production rebounded strongly, growing at its fastest annual pace in a year. In October, Parliament passed a bill to re-denominate Swiss franc loans into Romanian leu. At a cost of EUR 532 million, the bill seeks to provide financial relief to Romanian borrowers who suddenly faced steep repayment increases following the abrupt appreciation of the Swiss franc in January 2015. However, the government is launching a constitutional court challenge to block the bill in its current form after a provision capping the relief available to individual borrowers was removed at the last minute.
The domestic demand-led boom witnessed over the first two quarters of the year is likely to abate going forward, as macroeconomic economic imbalances start to grow and external headwinds continue to linger. Panelists expect the economy to grow 4.8% this year, which is up 0.1 percentage points from last month’s forecast. In 2017, the panel foresees economic growth moderating to 3.5%.
INFLATION | Consumer prices fall at softest pace in over one year in September
In September, consumer prices posted the smallest fall in annual terms since September 2015, as the effect of low oil prices waned. According to an estimate produced by FocusEconomics, consumer prices fell 0.2% from the same month of last year, which followed August’s 0.3% drop. Just over half of the economies recorded positive price pressures, as inflation gradually returns in the region.
Price pressures will likely remain muted throughout this year before rising in 2017. The panelists polled this month by FocusEconomics expect that consumer prices will drop an annual 0.3% in 2016, which is unchanged from last month’s projection. This month’s outlook reflected stable inflation forecasts for four countries in the region, including the Czech Republic and Hungary. The inflation outlooks for six countries were cut, while only Bulgaria saw an upward revision to its forecast. Analysts expect that inflation will return to the CEE region next year, forecasting average inflation of 1.5%.
Written by: Angela Bouzanis, Senior Economist