The direct impact of the United Kingdom’s decision to leave the European Union is expected to be muted in South-Eastern Europe (SEE) as economic links with the UK in the areas of trade, investment and remittances are relatively weak. That said, the region could be negatively affected if the Euro area slows down due to its large trade exposure. The main view held by analysts is that the referendum outcome is a net negative for the region from a market sentiment and economic standpoint, but its costs will not be disastrous.
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There are no significant financial linkages between the SEE and the UK, so the UK’s departure from the Union will not have a significant impact on funds in the region. Substantial changes in immigration laws could affect the ability of foreigners to work in the UK, which might translate into a reduction in remittances to the region, though this risk will be manageable if migrants who eventually leave the UK consider relocating somewhere else in the European Union. The first direct effect of the referendum outcome was the collapse of the pound, which plummeted to a multi-year low in the days following the vote and has still not recovered. A weaker pound has increased the cost of holidays for the British to popular tourist destinations in South Eastern Europe such as Cyprus and Greece.
The effect of Brexit through trade will be contained since only 4.6% of the overall exports from the SEE region go to the UK and only 2.4% of the region’s imports come from the UK. However, if the European Union’s economy decelerates, this could pose more risks to the region’s economic outlook since SEE’s trade share with the other 27 countries of the region is much bigger than with the UK alone. Nearly half of the region’s exports go to the European Union, while imports from the EU account for approximately 48.1% of the SEE’s total imports. Much will depend on the new trade relationship that the UK agrees with the EU, though no big shift is expected in the near-term since, as of today, there is no strong evidence pointing to a substantial change in the current trade agreements.
Brexit has potential political implications for the region. If the European Union decides to put the enlargement project on hold, this would postpone the accession negotiations for some of the countries in the region. There might also be other political spillovers in the region as the Brexit vote will likely strengthen Eurosceptic sentiment and this will be noticeable particularly in countries such as Romania and Bulgaria, where presidential elections are due to be held later this year.
SEE economy decelerates notably in Q1; major players likely lost steam in Q2
The South-Eastern Europe (SEE) region lost momentum in the first quarter of this year amid domestic and external headwinds. GDP expanded 3.5% over the same quarter of the previous year, thus decelerating over the fourth quarter’s 3.9% increase, which had marked the highest reading in nearly five years. The slowdown was due to weaker economic developments in the region’s two biggest economies—Turkey and Greece. Conversely, slight improvements were recorded in Serbia and Romania, which tallied multi-year high growth rates thanks to a strong fiscal stimulus ahead of the parliamentary elections due later this year.
Taking a closer look at the region’s economies individually, last month, Greece eased the capital controls imposed last year substantially. The relaxation of restrictions was done in an effort to attract money and boost confidence in the Greek banking sector. In Turkey, political turmoil intensified in the wake of the unsuccessful military coup on 15-16 July, which left hundreds of people dead and thousands injured. The coup prompted a tsunami of reactions from the Turkish government, which could have irreversible effects on the country’s already troubled economy, politics and society. President Recep Tayyip Erdogan has undertaken waves of massive arrests and suspensions of police officers, judges, governors and civil servants who were suspected of participating in or being affiliated with the attempted takeover. The coup will likely have a negative impact on the economy, in particular on investments and tourism. However, much will depend on the government’s ability to stimulate the economy while implementing reforms primarily aimed at improving the domestic business environment and also at normalizing the country’s political relations with Israel and Russia.
In the coming months, growth dynamics in SEE will be dominated by escalating political uncertainty in Turkey. Moreover, the ongoing refugee crisis and Greece’s long-lasting recession have the potential to destabilize the region. Economic prospects in the SEE region will also depend on the pace of recovery of the Eurozone and further policy action by the European Central Bank. Our panel of analysts expects the SEE region to have decelerated and expanded 2.7% in the second quarter.
Growth prospects moderate in August
This month, the outlook for South-Eastern Europe’s economy was downgraded slightly over the previous month. FocusEconomics panelists expect growth in South-Eastern Europe to be 2.7%, which is down 0.1 percentage points from July’s forecast. Panel participants downgraded their projections for Bulgaria and Greece, while the forecasts for the other eight economies, including Turkey, were left unchanged. GDP forecasts were upgraded for Cyprus and Serbia. For 2017, our panel of economists foresees the economy expanding 2.9%.
Romania’s economy is expected to grow at the fastest rate this year, followed by Montenegro. The worst performers are expected to be Greece, Cyprus and Croatia, in that order. Among the other major economies in the region, Turkey will likely grow the fastest, with a projected expansion of 3.4%.
BULGARIA | Growth prospects moderate marginally amid lower EU funds
Bulgaria’s economy decelerated slightly in Q1 as a plunge in government spending and fixed investment offset solid growth in private consumption. Data for the second quarter painted a mixed picture: in May, industrial production contracted for the first time in over one-and-a-half years, while unemployment decreased to the lowest level since December 2009. For Bulgaria, the risks from Brexit are moderate. While the UK is a relatively small trade partner, Bulgaria is an open economy and its industrial sector forms part of numerous supply chains for Western European corporations. Consequently, diminished external demand could slow Bulgaria’s growth.
The economy is expected to decelerate this year due to diminished funds from the EU, which will drag on otherwise steady growth driven by private consumption. FocusEconomics Consensus Forecast participants expect GDP to expand 2.6% in 2016, which is down 0.1 percentage points from last month’s forecast. In 2017, they see growth of 2.8%.
CROATIA | President calls snap elections; economy remains robust
The Croatian economy accelerated in Q1, on the back of strong private consumption and fixed investment. According to the latest high-frequency data, the good economic momentum likely carried over into Q2, steadily supported by strong consumer spending, as evidenced by the increase in retail sales in both April and May. Croatian households are giving impetus to economic activity, sustained by increased disposable income and the falling unemployment rate. Moreover, the fiscal deficit more than halved in the first five months of 2016 compared to the same period last year, and both exports and imports increased. On the political side, after the government lost a vote of no-confidence in June, on 16 July, President Kolinda Grabar-Kitarovic called snap elections for 11 September. So far, the unstable political situation has not produced negative spillover effects on the economic environment.
The economy is shifting into a higher gear, supported by robust domestic demand and strong performance in the tourism sector. Nevertheless, the possibility of another weak coalition government following September’s elections could pose downside risks to growth. FocusEconomics panelists expect GDP to grow 1.8% in 2016, which is unchanged from last month’s forecast. The panel expects economic activity to expand 1.9% in 2017.
ROMANIA | Domestic demand drives growth in Q2
The Romanian economy accelerated to a multi-year high in 2015 thanks to a strong fiscal stimulus and substantial EU investment funds. In Q1, the economy expanded at a solid pace as increased government spending ahead of key parliamentary elections due later this year along with tax cuts and wage hikes for public employees spurred a consumption boom. Data from Q2 indicate that domestic demand is still the main driver of growth. In May, industrial production expanded while retail sales tallied their tenth consecutive double-digit expansion. Against this backdrop, Fitch Ratings confirmed Romania’s BBB- rating and stable outlook in July. Fitch pointed out that Romania’s macroeconomic fundamentals remain solid but downside risks are on the rise. Increased pre-electoral spending and reforms to the fiscal code have greatly undermined medium-term fiscal sustainability and are debilitating the country’s external accounts.
Domestic demand will remain the engine of growth this year. The UK’s Brexit vote is expected to have a minor impact on the economy since both countries have limited trade ties and remittances from Romanian workers in the UK are fairly low. Panelists participating in the FocusEconomics Consensus Forecast expect the economy to grow 4.2% this year, which is unchanged from last month’s forecast. In 2017, the panel foresees economic growth moderating to 3.5%.
TURKEY | Political turmoil threats the economy
Political unrest has deepened in the country in the wake of the unsuccessful 15–16 July military coup. President Recep Tayyip Erdogan arrested or suspended around 50,000 military and police officers, judges, governors and civil servants such as teachers and deans. While Erdogan has vowed that the purge is intended to crack down on conspirators, local opposition political parties and international institutions warn that the president is trying to suppress any dissent and tighten his grip on the country. In the aftermath of the crisis, the lira dropped to a new record low against the greenback, while, on 20 July, S&P Global Ratings cut Turkey’s credit rating to even deeper within junk territory.
Mounting political turmoil in Turkey will drag on business sentiment going forward. This situation, coupled with rising geopolitical risks, ongoing clashes with Kurdish militants and increased volatility in the financial markets following the Brexit vote, promises to impact growth. On the upside, decisive government support and a more accommodative monetary policy have the potential to shore up economic activity. On balance, panelists expect that the economy will expand 3.4% in 2016, which is unchanged from last month's projection. In 2017, the panel sees GDP growing 3.3%.
INFLATION | SEE inflation rises in June
In June, inflation in the South-Eastern Europe region jumped from the previous month’s 2.9% to 3.9%, which represented the highest reading in four months. The acceleration was due to higher inflation in Turkey, while 9 of the 12 countries surveyed posted a negative annual variation in consumer prices.
This month, our panelists left their 2016 inflation forecast unchanged at the previous month’s 4.2%. This reflects an unchanged estimates for four economies including Greece and Macedonia. The panel forecasts that inflation will accelerate to 4.8% in 2017.
Written by: Dirina Mançellari, Senior Economist