Central & Eastern Europe Economic Outlook March 2018

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

March 7, 2018

CEE economic growth hits eleven-year high in 2017


A more comprehensive set of data shows that the Central and Eastern European (CEE) economy rounded off a year of strong growth in the fourth quarter, with GDP expanding 4.9% in annual terms. The figure was slightly below the 5.1% expansion recorded in the previous quarter but marked the second-best performance in shy of a decade. Healthy growth in the Eurozone economy, increased absorption of EU funds, tightening labor markets and loosened fiscal stances across the region boosted the CEE economy, which in 2017 recorded its highest expansion in eleven years, at 4.7% growth.


The region’s fourth-quarter performance was buttressed by improved growth dynamics in a majority of the economies surveyed in CEE, including heavy lifters the Czech Republic, Hungary and Poland. In the Czech Republic, economic growth picked up marginally to the highest expansion in over two years, buoyed by solid employment growth and the external sector. This brought full-year growth to 4.5%, significantly above the 2.5% increase recorded in the year prior. Meanwhile, the Hungarian economy also gained traction in the final quarter of the year, likely benefiting from larger inflows of EU investment funds and strong wage growth. A solid Q4 GDP figure contributed to 2017’s robust growth figure, which at 4.0% was the strongest in three years.


The Polish economy also performed better in the fourth quarter, with household spending benefiting from rising incomes, and capital outlays contributing strongly to growth on the back of increased EU funds and favorable borrowing conditions. The largest economy in the region closed a year of very solid growth, tallying its best expansion in six years despite persistent political noise. Although economic activity decelerated in annual terms in the fourth quarter in Bulgaria, Croatia and Romania, regional growth was resilient overall, while incoming data for the first quarter of 2018 suggests growth mostly carried over into this year.


Indeed, business sentiment remained buoyant across the region’s economies in January and February, which bodes well for the economic outlook and countries’ investment plans. EU funds continued to flow into the region at a faster pace than a year ago, while the tailwinds associated with solid global demand remained in place early in the year. Hard data is also pointing to sustained momentum, with credit growth at robust levels and industrial production showing few signs of mounting slack. Solid economic conditions and upbeat prospects continue to fuel healthy employment growth, which is feeding into consumers’ purses. Borrowing conditions remain favorable, with only the National Bank of Romania and the Czech National Bank in tightening mode. Against this positive backdrop, economic growth is expected to clock in at a solid 4.3% in the first quarter.


Nonetheless, political events continue to cloud the region’s outlook, weighing on medium- and long-term prospects and distorting the upbeat short-term assessment of the economy. In Poland, controversial changes to the judiciary system are putting the government at odds with European authorities, with the European Parliament backing in early March the European Commission’s decision to trigger Article 7 against Poland following the contentious reforms. This followed a proposal made by the Commission to link EU budget funds allocated to Poland to the rule of law, which is likely to generate further friction between the parties and could discourage foreign investment.


In Hungary, general elections are scheduled for 8 April. Although opinion polls place incumbent Prime Minister Viktor Orbán and his ruling Fidesz party in the lead, a recent bellwether local election on 25 February—in a city where Fidesz had ruled since 1990—saw opposition parties unexpectedly emerging victorious. Following the electoral upset, it now remains to be seen if Fidesz and its coalition partners will be able to retain the two-thirds majority they now hold in the National Assembly. Failure to do so would greatly reduce Orbán’s grip on power, limiting his ability to pass sweeping reforms.


Other countries remain similarly beset by political grievances. The Czech Republic remains without a government following October’s elections, with Prime Minister Andrej Babis—who is accused of fraudulent actions for which he could be prosecuted—meeting the Social Democrats in late February in an attempt to form a coalition government. In Romania, large protests were held in late February against the justice minister’s move to dismiss the chief of the anti-corruption directorate, the last chapter in a string of corruption-related scandals that have rocked the country for a year. In Croatia, the government-appointed energy administrator of debt-ridden retail giant Agrokor resigned due to a conflict of interests, prompting a temporary suspension of public trading of the company’s stock and fueling ongoing uncertainty surrounding the firm’s debt restructuring plan.  


2018 growth outlook upgraded for fourth consecutive month


Economic prospects remain relatively bright in the CEE economy as the tailwinds that fanned growth last year remain in place. Robust hiring should see the unemployment rate trending lower this year for most economies in the region, while supportive financing conditions and robust foreign demand are also expected to sustain activity. That said, political uncertainty continues to plague many of the countries in the region, weighing on their economic outlooks. Mounting inflationary pressures will also erode households’ purchasing power this year, while tightening monetary conditions in the U.S. could force the removal of monetary stimulus to prevent sizeable capital outflows.


All told, the CEE economy is expected to increase 3.8% this year, which is up 0.1 percentage points from the previous month’s estimate and marks the fourth consecutive upgrade in as many months. This month’s upgraded 2018 outlook follows upward revisions for 7 of the 11 economies covered in the region, including major players Poland and Romania. No economies were downgraded this month, while the forecasts for Croatia, the Czech Republic, Hungary and Slovakia were left unchanged. For 2019, growth is projected at 3.2%.


Romania is projected to be the region’s top performer this year, with economic growth of 4.5%. Latvia and Poland are also seen achieving fast growth this year, of 4.0%. On the other end of the spectrum, Croatia is projected to be the region’s worst performer, with an expansion of 2.8%.


POLAND | Political uncertainty obscures economy’s solid performance


Annual GDP growth accelerated in the fourth quarter, mainly on the back of buoyant household spending, and was further boosted by fixed investment. Growth for 2017 was 4.6%, the strongest expansion in six years. High-frequency indicators suggest momentum carried over into Q1. In January, year-on-year growth in retail sales picked up steam from the prior month, underpinned by rising incomes and a hike in the minimum wage that came into force in January. Annual growth in industrial production also quickened in January, and business sentiment was upbeat again in February. However, political relations with the EU remain tense. In early March, the European Parliament backed the European Commission’s decision to trigger Article 7 against Poland over controversial changes to the judicial system. This followed a proposal by the Commission in February to link EU budget funds to the rule of law, which risks generating further conflict with the Polish government that could discourage foreign investment.


Household spending is expected to remain strong this year, underpinned by growing wages, a lower retirement age and further inflows of migrant workers from Ukraine. Moreover, increased EU funds should drive up fixed investment, boosting production capacity. On the other hand, external demand should moderate somewhat, while growing political tensions with the EU could weaken business sentiment. FocusEconomics panelists expect GDP to grow 4.0% in 2018, up 0.1 percentage points from last month’s forecast, and 3.4% in 2019.


CZECH REPUBLIC | Government still out of sight five months after election


Recent data for the fourth quarter of 2017 showed that the economy picked up pace in annual terms, although it slowed marginally in quarter-on-quarter terms. The figure brought growth for 2017 to a strong 4.5%, markedly above the pace of expansion in 2016. Economic growth in Q4 was supported by private consumption and the external sector. Last year’s momentum appears to have carried over into 2018. Economic sentiment inched up in February on the back of improving business confidence, and the PMI remained at elevated levels in January and February. Meanwhile, Prime Minister Andrej Babis, who has been accused of fraudulent actions for which he could face prosecution, has not yet been able to garner enough support to form a government. On 28 February, he met with the Social Democrats (SPD) in an attempt to form a coalition that would be supported by the Communist party (KSCM).


Political uncertainty remains a downside risk to the economy; Babis is navigating his legal troubles and a general referendum law is being negotiated between Babis’ ANO party, the SPD and the KSCM that could potentially lead to a referendum on EU membership. Nonetheless, growth should remain solid this year on the back of robust household and government consumption. Babis’ proposed pro-growth plans would further fuel private consumption, if implemented. Panelists see GDP growing 3.4% in 2018, which is unchanged from last month’s projection, and 2.9% in 2019.


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ROMANIA | Economic momentum peters out in Q4


GDP growth continued at a strong rate in the fourth quarter in year-on-year terms, although the pace moderated from the third quarter. While a breakdown is not yet available, buoyant retail sales and declining unemployment in Q4 suggest growth continued to be driven by household consumption. The figure brought growth for 2017 to the highest level in nine years. However, the current account deficit almost doubled from 2016 on surging imports. Robust growth likewise translated into surging profits and declining Non-Performing Loans for Romanian banks, which bodes well for credit provision. In January, new car registrations jumped, putting the important automotive sector on a strong footing at the start of the year. Meanwhile, the political situation remains tense. In late February, there were large protests against the justice minister’s move to seek the dismissal of the chief of the anti-corruption directorate. Unrest, if protracted, could affect investor sentiment.


The economy should shift into a lower gear this year but nevertheless expand robustly, driven by consumer spending, which will be restrained by rising inflation and more moderate wage growth. Fixed investment growth is expected to gain steam on increased disbursements of EU funds and healthy credit expansion. However, a widening fiscal deficit limits the government’s room for maneuver in case of unexpected shocks, while continuing political turbulence constitutes the main downward risk to the outlook. FocusEconomics panelists expect growth of 4.5% for 2018, up 0.1 percentage points from last month’s forecast. They see the economy expanding 3.6% in 2019.


HUNGARY | Surprise local election loss puts Fidesz lead in the April election polls into question


The Hungarian economy shifted into a higher gear in the fourth quarter, expanding at the fastest pace since 2014. While a breakdown by components is not yet available, the acceleration was likely driven by buoyant domestic demand, as the resumption of inflows of EU investment funds and favorable financial conditions lifted business confidence and spurred strong growth in key sectors such as construction. Unemployment that was at a multi-year low, coupled with high consumer confidence and wage hikes, boosted retail sales in Q4, which expanded at the fastest pace in six quarters. More recent data suggests that momentum likely carried over into 2018. In February, economic sentiment hit a new all-time high thanks to a jump in business and consumer confidence. On the political scene, the ruling Fidesz party suffered an unexpected defeat in a local by-election on 25 February. The defeat, which occurred in a regional stronghold, hints that the party’s expected lead in the upcoming general election on 8 April will be narrower than initially anticipated.


A solid domestic economy and a pick-up in external demand should support robust growth this year. FocusEconomics panelists project the economy will expand 3.6% in 2018, which is unchanged from last month’s forecast. For 2019, the panel sees growth moderating to 3.0%.


See the Full FocusEconomics Central and Eastern Europe Report


MONETARY SECTOR | Inflation stabilizes in January


According to an estimate produced by FocusEconomics, inflation was steady in January, coming in at the 2.4% figure recorded in the previous month. This reflected higher inflation in Estonia, Lithuania, Romania and Slovakia offsetting softer price pressures in a majority of the economies in the region, including the Czech Republic and Poland.


Mounting inflationary pressures in some of the countries surveyed in the CEE region and tightening monetary policy in the United States have seen some policymakers shifting to a hawkish stance. In February, the National Bank of Romania increased its key interest rate on the back of building inflationary pressures; the increase was the second in as many months. Conversely, Hungary and Poland’s central banks stood pat in the same month.


Inflation is seen averaging 2.5% this year, which is unchanged from last month’s forecast. Robust economic growth and higher global commodity prices should support inflationary pressures this year. In 2019, inflation is expected to be stable at 2.5%.


Angela Bouzanis


Senior Economist 


 

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