Central & Eastern Europe Economic Outlook February 2018

Economic Snapshot for Central & Eastern Europe

Central & Eastern Europe: Economic Snapshot for Central & Eastern Europe

February 7, 2018

CEE economy surges amid investment and consumption boom in 2017

Incoming data for last year suggests that the Central and Eastern European (CEE) economy grew robustly in 2017, enjoying the best year of growth in over a decade. FocusEconomics expects regional GDP to have grown 4.6% last year, a notch up from last month’s projection and notably above the 3.1% increase seen in 2016. The region is benefiting from strong export demand as the Eurozone economy, which had a stellar 2017, soars. Moreover, loose fiscal policies, tight labor markets and strong inflows of EU development funds are acting as tailwinds to the domestic economies.

Official data for 2017 is so far only available for Poland, the region’s largest economy. A preliminary estimate by the Central Statistical Office of Poland revealed that GDP grew at the fastest pace since 2011 in 2017. The domestic economy drove growth amid rising wages, a child benefit scheme and rebounding investment. Elsewhere in the region, growth is expected to have also picked up in major players the Czech Republic, Hungary, and Romania, along with the Baltic states. Romania fired on all cylinders last year, growing a notable 6.8% thanks to buoyant household consumption and loose fiscal policies.

Last year’s robust economic momentum spilled over into several countries’ financial markets, and CEE currencies were among the best-performing emerging-market currencies of 2017. Several countries, including Croatia, Hungary and Poland, also saw their bond yields fall last year. Buoyant investor sentiment came despite a sizable degree of political uncertainty in the region. Poland was embroiled in a conflict with the EU over its rule of law, Romania’s political scene was characterized by political infighting and corruption protests, and Brexit negotiations clouded the future relationship with the UK, a key trading partner. Although investor sentiment has up until now remained relatively unscathed, continued political uncertainty could dent confidence in the region. At the start of 2018, political risks are still high: The Czech Republic remains without a government following October’s elections, Poland continues to clash with EU officials and on 15 January, Romania’s prime minister stepped down, the third change in office in less than a year.  

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Prospects raised following stellar year

The tailwinds that propelled growth in 2017 remain largely in place and are expected to shore up activity this year. Tight labor markets and an accommodative external backdrop should drive fuel regional GDP to expand 3.7% in 2018, up a notch from last month’s projection. Nevertheless, political noise remains high, posing a risk to the outlook. On top of this, rising inflation could take a bite out of consumption, while tightening global interest rates could weigh on the appeal of CEE assets. In 2019, growth is projected to come in at 3.2%. 

This month’s upgraded 2018 outlook is due to upward revisions for eight of the economies in the region, including major players the Czech Republic, Hungary, Poland and Romania. Croatia, Lithuania and Slovakia saw no changes to their forecasts.

Romania is projected to be the region’s top performer this year, with expected economic growth of 4.4%. Latvia and Poland are also seen achieving fast growth rates of 3.8% and 3.9%, respectively. On the other end of the spectrum, Croatia is projected to be the region’s laggard, with an expansion of 2.8%. 

POLAND | Growth soars in 2017

Recently released data showed that GDP grew 4.6% in 2017, marking the strongest growth reading in six years. A rebound in fixed investment on the back of recovering inflows of EU funds and a stronger expansion in household spending were the main drivers of growth. Despite a marginal uptick in December, the unemployment rate was on a downward trend throughout 2017. This, together with accommodative financing conditions and robustly rising wages, translated into buoyant consumer spending. According to the business confidence indicator, 2018 started on a solid footing: In January business sentiment surged to an over nine-year high, as firms grew far more optimistic on current and future production levels. On 30 January, President Duda signed the 2018 budget into law. The budget includes a planned fiscal deficit of 2.7% of GDP, below the EU’s ceiling of 3.0% and less optimistic than the one forecast by FocusEconomics panel.

This year household spending will continue to increase at a healthy rate, buttressed by rising wages and a tight labor market; however, rising inflation and less favorable financing conditions will lead to a moderation in growth. On the other hand, the expansion in fixed investment is expected to strengthen, spurred by an increased absorption of EU funds. Downside risks stem primarily from troubled political relations with the EU. FocusEconomics panelists expect GDP to grow 3.9% in 2018, up 0.1 percentage points from last month’s forecast, and 3.4% in 2019.

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CZECH REPUBLIC | Talks to form a government drag on

The economy had a strong showing in 2017: Growth picked up pace in three consecutive quarters, and indicators suggest the momentum carried over into the final quarter. Industrial production and retail trade turned in positive results again in November, albeit moderating from the prior month. Furthermore, the manufacturing PMI continued climbing throughout the quarter, clocking a multi-year high in January. However, while consumer confidence improved in January, business confidence slipped. Politically, the sailing is less smooth. President Milos Zeman, an ally of Russian president Vladimir Putin, won a second term on 27 January; he is one of the few allies of Andrej Babis, who has been prime minister since December. Babis, who lost a no-confidence vote on 10 January, has been unable to garner majority backing to form a government. However, the Communist Party agreed to restart talks over possible support of a Babis-government. The combination of Zeman and Babis could, however, strain relations with the EU further as both men oppose further EU integration.

Ongoing political uncertainty is likely to drag on the economy in the short term. Moreover, Babis’ inability to form a government has derailed his plans to implement pro-growth economic policy in a timely manner. Despite the continued uncertainty, economic growth should remain solid this year. Household spending is expected to remain robust and drive growth, while fixed investment is also expected to remain strong. Panelists see GDP growing 3.4% in 2018, up 0.2 percentage points from last month’s projection, and 2.8% in 2019.

ROMANIA | Economy continues to soar, while political turmoil escalates

On 15 January Prime Minister Mihai Tudose resigned following a power struggle with the leader of the ruling Social Democratic Party, Liviu Dragnea. Viorica Dancila was swiftly appointed and on 29 January was confirmed by the parliament, becoming the third prime minister in seven months amid ongoing anti-corruption protests. The economy, however, continued to expand strongly in the final quarter of the year, according to available data. Buoyant external demand from the EU continued to underpin growth: Both exports and industrial production recorded remarkable year-on-year increases in the first two months of Q4, on the back of a strong automotive sector. Household spending also remained buoyant: Retail sales soared in annual terms in both October and November, supported by a tightening labor market and robust wage rises. That said, Romania’s political landscape continues to be troubled.

This year, growth in private consumption is expected to slow. Although wages will continue to rise at a healthy rate and the labor market remain tight, higher inflation, weakening consumer confidence and less favorable financing conditions will likely weigh on consumer spending. On the other hand, an increased absorption of EU funds will fuel a faster expansion in fixed investment. All in all, growth should moderate but remain solid. Downside risks to the outlook come from the weak fiscal position and the possibility of continued unrest. FocusEconomics panelists expect growth of 4.4% for 2018, which is up 0.2 percentage points from last month’s forecast. They see the economy expanding 3.5% in 2019.   

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HUNGARY | Economy on firm footing as country readies for April vote

Prime Minister Viktor Orbán set general elections for 8 April, a vote which will likely see him installed for a third term. The Prime Minister, who has ruled uninterruptedly since 2010, has overseen a dramatic turnaround of the economy, with unemployment declining, the fiscal deficit narrowing substantially, and public and external debt levels on a more stable trajectory. The ruling Fidesz party is expected to comfortably win the election, although it remains to be seen if they will clinch a two-thirds majority, which would allow them to consolidate power and implement constitutional changes. The latest indicators suggest that economic activity remains on a solid footing, boding well for Orbán’s political ambitions. Unemployment remained steady at an all-time low in November, and economic sentiment hit a new all-time high in January, breaking the previous month’s record.  

Hungary’s growth prospects are bright. A tight labor market, expected wage hikes and credit growth will support growth in private consumption, while inflows of EU funds into the economy will boost growth in fixed investment. Similarly, the external sector is expected to grow on higher external demand. FocusEconomics panelists project the economy will expand 3.6% in 2018, which is up a notch from last month’s forecast. For 2019, the panel sees growth moderating to 3.0%.

MONETARY SECTOR | Inflation drops in December

According to an estimate produced by FocusEconomics, inflation receded in December, after hitting a nearly five-year high in November. Inflation fell from 2.6% in November to 2.3% in December. Lower price pressures were seen in nearly every economy, with the exceptions of Romania and Slovakia.

Higher inflation and tightening monetary policy in the U.S. have caused policymakers in the CEE region to switch gears and begin tightening accommodative monetary policies. In February, the Czech National Bank raised rates. However, in January, Hungary and Poland’s central banks held rates unchanged.

Inflation is seen averaging 2.5% this year, which is unchanged from last month’s forecast. Solid growth and higher commodity prices will drive inflationary pressures this year. In 2019, inflation is seen stable at 2.5%. 

Angela Bouzanis

Senior Economist 

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