South-Eastern Europe: Economic Snapshot for South-Eastern Europe
April 11, 2018
Economic growth loses steam in the fourth quarter but remains solid
A comprehensive set of GDP data for the economies of the South-Eastern Europe (SEE) region shows growth momentum moderated less than expected in the fourth quarter of last year. Annual GDP growth came in at 5.8%, down from the stimulus-induced 8.4% leap in the previous quarter but still the second-highest reading in just shy of a decade. The resilient regional performance was due to another outstanding expansion in the Turkish economy, which benefited from ongoing fiscal stimulus at the expense of higher inflation and wider current account deficits.
Q4 GDP growth in Turkey was entirely driven by a buoyant domestic economy, as the government commits to maintaining economic growth at full throttle ahead of general elections. The elections are set for November 2019, but speculation is mounting they will be earlier. The singular focus on growth, however, is being accompanied by rising macroeconomic imbalances in the form of sticky inflation and widening current account deficits, which are putting pressure on the lira. They are also increasingly exposing the economy to shifts in global investor sentiment, given the country’s reliance on short-term portfolio inflows to finance its rising external needs. Against this backdrop, Moody’s downgraded Turkey’s sovereign credit rating further into junk territory in early March, while the lira tumbled to fresh record lows later in the same month.
Meanwhile, a second Q4 GDP data release for Romania confirmed that the economy lost some steam but continued to grow at an exceedingly fast pace in the quarter, supported by an accommodative fiscal stance, rising wages and improving labor conditions. In the political arena, however, the Senate approved in late March a reform package to overhaul the country’s judiciary, which opposition figures argue will give politicians excessive influence over the judicial system. The reform could unwind previous efforts to combat widespread corruption and could spark massive protests if enacted, which risks tempering investor confidence.
In the Western Balkans, growth in the fourth quarter was somewhat underwhelming in Croatia, weighed down by knock-on effects on investment stemming from Agrokor’s ongoing debt restructuring process. On a more positive note, recently released GDP data for Bosnia and Herzegovina showed the economy recovered from a trough earlier in the year in Q4, aided by resilient private spending and a mild rebound in capital outlays. The country’s unlocking of IMF funding in late February has increased access to multilateral support from other international bodies, which suggests the economy should perform better this year after a meager 2017 expansion. The Macedonian and Serbian economies also shifted into a higher gear in the fourth quarter, which contrasted slower growth momentum in Albania and Kosovo.
Incoming data for the first quarter suggests growth remained resilient across most economies in the quarter, although March data for Turkey is starting to show the cracks of an overheating economy. Be that as it may, solid employment growth, supportive external demand, increased inflows of EU funds and ongoing fiscal stimulus in some of the region’s heavy lifters should see GDP growth moderating only slightly in SEE, to a still solid 4.5% expansion in the first quarter.
Regional GDP projection stabilizes following three months of consecutive upgrades
Following three consecutive months of upwardly revised 2018 GDP growth projections, this month’s forecast was kept unchanged at 3.7%, well below the 5.8% expansion recorded last year. The smaller expansion mostly reflects a limited scope for policy stimulus in Turkey this year and slower private consumption growth in the Romanian economy, which will be partially offset by a gradual economic pick-up in Greece. Elsewhere in the region, stronger absorption of EU funds across the Balkans, resilient global demand and improving tourist arrival numbers should prevent a harder landing in economic activity. The economy is expected to expand 3.5% in 2019.
Although the regional projection was unchanged, the 2018 GDP estimate was upgraded for the Turkish economy, where the government is aiming for 5.0% growth ahead of a potential early call for general elections. In a bid to sustain strong growth momentum, authorities have already amended the 2018 budget to increase spending and expand tax breaks, while another amendment is widely expected to take place in the coming months. The economies of Cyprus, Kosovo, Montenegro and Serbia also saw their 2018 GDP forecasts upgraded this month. Conversely, the economy of Albania and Bosnia and Herzegovina had their projections cut this month. The forecasts of the remaining five economies surveyed in the region were unchanged.
The economies of Romania and Kosovo are expected to grow at the fastest rates in the region this year, with expansions of 4.5% and 4.3%, respectively. Turkey, the region’s largest economy, is seen growing 4.1% this year. At the other end of the spectrum, Greece is projected to record the weakest expansion in the region, at 2.1% growth.
TURKEY | Economic cracks begin to show as overheating concerns mount
Concerns over an economic overheating are on the rise, with annual GDP growth coming in at a stronger-than-expected 7.3% increase in Q4, and inflation and external metrics quickly deteriorating. Investors’ appetite for risky emerging market assets—on which Turkey depends to finance its external deficits—has also moderated in recent weeks amid fears over a trade war between the U.S. and China, causing the lira to tumble to fresh all-time lows in early April. Nonetheless, authorities remain committed to injecting huge stimulus into the economy in an attempt to keep it humming ahead of general elections, currently set for November 2019 but with signs of a potential snap vote mounting. Against this backdrop, Moody’s downgraded the sovereign credit rating further into junk status in early March, arguing that the government’s focus on short-term measures undermined effective policymaking and economic reform.
The economy is expected to decelerate from last year’s outstanding performance as credit stimulus ebbs and households take a breather following a debt-fueled spending spree last year. That said, the government’s singular focus on delivering strong headline growth ahead of general elections should see fiscal stimulus remaining vigorous this year. Geopolitical noise, widening current account deficits and sticky inflation, however, pose major downside risks to growth. Our panel expects growth of 4.1% this year, which is up 0.2 percentage points from last month’s estimate. It expects growth of 3.8% in 2019.
ROMANIA | Policymakers forge ahead with contentious judiciary reform
A third estimate confirmed that GDP growth cooled somewhat in the final quarter of 2017 although it did remain strong. Economic activity continued to expand robustly in Q1, according to available data. Industrial production increased notably in January on the back of strong performances of export-oriented sub-sectors such as machinery and equipment and automotive industries. In the first two months of the year, the unemployment rate dipped to a multi-year low and retail sales expanded healthily, suggesting that consumer spending remains buoyant. In the political arena, the Senate approved a reform package to overhaul the judiciary, despite recent warnings from the EU that this could undermine judicial independence. The law will now have to be signed by President Klaus Iohannis and parliamentary opposition announced it will challenge the law before the Constitutional Court. If eventually adopted, it could spark massive protests and undermine investor confidence.
Growth is expected to slow but remain robust this year, as the expansion in consumer spending is restrained by higher inflation and a moderation in wage gains. Rising inflows of EU funds will speed up growth in fixed investment. However, imbalances are building up in the economy, as expansionary and pro-cyclical fiscal policies are leading to growing capacity constraints and a widening in budget deficit, posing risks to economic stability. Moreover, high external debt and the sizeable current account deficit leave the country exposed to external shocks. FocusEconomics panelists expect growth of 4.5% for 2018, unchanged from last month’s forecast. They see the economy expanding 3.6% in 2019.
BULGARIA | Solid economic momentum persists in Q1
Revised national account data confirmed that annual growth in the fourth quarter decelerated although it did remain robust. Full-year economic growth for 2017 came in at 3.6%, marking one of the strongest expansions since 2008. The result attests to the country’s healthy economic fundamentals: EU investment funds supported a solid increase in fixed investment while higher wages and a strengthening labor market buoyed private consumption. Adding to the good news, the most recent data from the first quarter of 2018 suggests that economic momentum has picked up. In January, the expansions in industrial production and retail sales accelerated markedly. Survey-based consumer and business confidence remained elevated in March which likely boded well for growth in private consumption and fixed investment throughout Q1.
Strong demand from the European Union and solid growth in private consumption and fixed investment should keep the economy on a steady growth path in the coming two years. FocusEconomics Consensus Forecast panelists expect GDP to expand 3.7% in 2018, which is unchanged from last month’s forecast. For 2019, the panel sees growth moderating slightly to 3.3%.
CROATIA | Agrokor and chief creditor reach agreement amid sovereign rating upgrade
Economic activity likely gained steam in Q1, after a disappointing Q4. In January, tourist arrivals soared in annual terms, a testimony to the strength of the all-important tourism sector. Moreover, retail sales increased robustly in the same month, as tax cuts entering into force prompted a jump in car sales. Available data for February shows that car sales continued to surge in February, although growth in retail sales moderated, and in the same month industrial production rebounded following three months of contraction. Moreover, the clouds on the restructuring plan for retail giant Agrokor are starting to dissipate: On 21 March, the food company and its chief creditor Sberbank reached an agreement that requires the Russian bank to withdraw its lawsuits against Agrokor. Adding to the good news, in late March Standard & Poor’s raised Croatia’s rating from BB to BB+ with a stable outlook, citing as reasons the improved external position—thanks to growing tourist receipts—and fiscal prudence.
An ongoing recovery in the Eurozone and a strong tourism sector are expected to fuel economic activity in the coming quarters and bring growth for the full year 2018 broadly in line with last year, contributing to a declining debt-to-GDP ratio. Moreover, rising inflows of EU funds should drive an acceleration in fixed investment although levels remain well below their pre-crisis peak. Despite recent positive developments, the main downside risks still stem from the possibility of a disorderly restructuring of Agrokor. FocusEconomics panelists project GDP growth of 2.8% in 2018, unchanged from last month, and 2.7% in 2019.
INFLATION | Inflation broadly stable in February
In February, inflation inched up to 6.6% from 6.5% in January, as stronger price pressures in most of the economies surveyed in SEE more than offset lower inflation in Croatia, Serbia and Turkey. Despite the sequential slowdown, inflation in Turkey has fallen less than expected and remains entrenched in double-digit territory, which risks a further deterioration in inflation expectations compounded by the recent weakening of the lira. In Romania, a demand-driven surge in prices pushed inflation well above the Bank’s target range in February, while in Greece consumer prices expanded in annual terms following a year-on-year decrease in January.
Although domestic inflation continued to trend upwards in February, the National Bank of Romania refrained from increasing the main interest rate at its 4 April monetary policy meeting, arguing that the two hikes already delivered this year had yet to fully take effect. The Central Bank of the Republic of Turkey also stood pat at its 7 March policy meeting but sounded marginally more hawkish. Nonetheless, the tumble in the lira and a shallower-than-expected inflation slowdown in Q1 will test the Central Bank’s credibility at its next meeting in late April; its credibility has already been undermined by intense government pressure and President Erdogan’s unorthodox monetary policy.
Inflation in the SEE region is expected to come in at 6.2% this year, below the average of 7.4% recorded in 2017. The estimate for this year is up 0.1 percentage points from last month’s projection, as higher forecasts for Romania and Turkey more than outstripped downward revisions to most economies in the region, including Bulgaria and Greece. In 2019, inflation is expected to moderate to 5.7%.
Written by: David Ampudia, Senior Economist