South Eastern Europe Economic Outlook March 2018

South-Eastern Europe: Economic growth loses some steam in the fourth quarter but remains solid

March 7, 2018

Economic growth loses some steam in the fourth quarter but remains solid

Incoming GDP data for the economies of the South-Eastern Europe (SEE) region suggests growth momentum moderated in the fourth quarter of 2017 following an exceedingly bright third-quarter performance. A preliminary estimate shows annual growth clocked in at 4.7% in Q4, markedly below the stimulus-induced 8.2% surge recorded in Q3 but still the second-highest figure in two years. Indeed, although growth slowed across all the region’s heavy lifters, a combination of healthy global demand, accommodative fiscal stances and improving labor conditions sustained the spell of solid growth seen through previous quarters in Q4. In fact, regional GDP growth for 2017 is estimated at 5.5%, which, if confirmed, would mark the best performance in eleven years.

Available GDP figures show growth moderated from the previous quarter in Q4 in Bulgaria, Croatia and Romania. In Bulgaria, softer capital outlays and soaring imports dented growth, albeit only slightly. The economy’s resilience was largely due to a well-faring domestic sector, with households benefiting from steady declines in the unemployment rate, higher payroll compensation growth and decade-high sentiment. GDP data in Croatia painted a weaker picture in the final quarter of the year, with fixed investment growth halving on the back of knock-on effects stemming from food giant Agrokor’s ongoing debt restructuring process.

Similarly, Romania’s economic growth moderated in the fourth quarter, although the country’s performance was still robust overall. High-frequency indicators pointed to private consumption as the main driver of growth in the quarter, a contribution that is, however, expected to diminish in the quarters to come as inflation creeps up, denting households’ real purchasing power. Meanwhile, and unlike other regional peers, growth in the Serbian economy picked up for a third consecutive quarter on the back of stronger capital outlays. Although the economy’s full-year performance was weaker compared to 2016, an improved fiscal landscape and accommodative monetary conditions spell good news for the country’s outlook this year.

The Turkish economy is expected to have shifted into a lower gear in Q4 from the base-effect and stimulus-driven surge recorded in Q3. That said, with GDP data still outstanding, high-frequency indicators for the quarter have proven particularly resilient. The recent expansion to the Guarantee Credit Fund ensures another sizeable dose of fiscal stimulus this year, which has led some analysts to speculate that authorities may be attempting to maintain growth at full-throttle as they contemplate the possibility of snap elections later this year—elections that are currently scheduled for November 2019.

The possibility of an early election is being increasingly considered following Turkey’s latest military operation in Syria, which aims to expel Kurdish militias from the Syrian canton of Afrin. The operation, which markets have largely shrugged off, has galvanized nationalist support for President Erdogan, providing him with political capital ahead of any potential major electoral event. The prospect that elections may be called earlier than currently scheduled is further reinforced by the pre-election alliance struck by the ruling AKP and the right-wing nationalist MHP on 19 February, paving the way for Erdogan to renew his presidency.

Looking to this quarter, sequential indicators suggest economic momentum in the SEE region persisted in the first two months of the year. Survey-based sentiment indicators picked up across most of the region’s economies in January and remained elevated in February. In Croatia, tourism arrivals grew at a double-digit rate year-on-year in January, while car registrations jumped in the same month in Romania. Turkey’s manufacturing PMI averaged its highest figure in seven years in the first two months of the year, while Greece’s manufacturing PMI was at its best in a decade in January. All in all, spillover effects from a stronger-than-expected Q4 performance and solid growth inertia should see GDP increasing 4.2% in annual terms in Q1.

Third consecutive upgrade showcases region’s economic resilience

Regional GDP growth is projected at 3.7% this year, which is up 0.1 percentage points from last month’s forecast. Although growth is expected to decelerate from last year on the back of ebbing fiscal boosts and mounting economic headwinds in Romania and Turkey, improving economic conditions in Greece, stronger absorption of EU funds across the Balkans, solid global demand and healthy tourist arrivals across the region’s multiple tourism hubs should support growth and prevent any hard landing in economic activity. For 2019, GDP growth is estimated at 3.4%.

The upgrade to 2018 regional growth is the third in as many months and reflects more resilient incoming data than previously expected. Major players Bulgaria and Romania had their forecasts revised upwards this month, as economic data continued to print on the upside in Bulgaria, and data in Romania showed households have so far withstood tighter monetary conditions and quickly mounting inflationary pressures. The Cypriot and Kosovar economies also saw upgraded forecasts this month. Conversely, the economies of Macedonia and Montenegro had their forecasts cut. GDP forecasts for the remaining countries 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 4.2%, respectively. Turkey, the region’s largest economy, is seen growing 3.9% this year. On the other end of the spectrum, Greece is expected to be the region’s laggard, with 2.1% growth.

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TURKEY | Possibility of early election is back on the cards

The economy closed 2017 on a solid note, with industrial production and retail sales data for the fourth quarter pointing to only a very slight moderation in growth momentum in the last stretch of the year. Incoming data for the first quarter of this year is similarly upbeat, with the manufacturing PMI averaging its highest figure in seven years in the first two months of the year, and business sentiment recording back-to-back increases in the same period. Nonetheless, exceedingly robust growth momentum continues to put pressures on core inflation and the current account, with the latter’s deficit widening to a four-year high in December on the back of soaring imports, including of gold. On the political front, the Afrin operation—which aims to expel Kurdish militias from the Syrian canton—has galvanized nationalist support for President Erdogan. Increased political capital, which is compounded by the ruling AKP’s recent alliance with the right-wing nationalist MHP, and robust economic momentum could compel Erdogan to call for snap general elections this year. 

Increased speculation on an early call for elections should keep authorities’ support for the economy robust this year. Nonetheless, Turkey’s excruciating dependence on short-term portfolio inflows to finance its external deficits remains a key risk to growth, particularly as the Fed tightens further this year. The FocusEconomics panel expects growth of 3.9% this year, which is unchanged from last month’s estimate. It expects growth of 3.8% in 2019.

ROMANIA | Economy runs at healthy pace amid persistent political noise

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.

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BULGARIA | Sentiment indicators suggest growth carried over into Q1

A moderation in fixed investment growth and a poor performance by the external sector weighed on annual GDP growth in the fourth quarter. Nevertheless, despite the slowdown in Q4, overall GDP growth for 2017 reached 3.7%, the second-fastest expansion since 2008, pointing to solid economic fundamentals . Strong activity in 2017 was buttressed by declining unemployment, higher wages and the resumption of inflows of EU investment funds, which have spurred fixed investment. Meanwhile, the economic momentum observed last year likely carried over into the first quarter of 2018, as evidenced by survey-based data. In February, consumer confidence saw the best reading since June 2007, and business confidence remained elevated, despite declining slightly.  

The economy is set to grow robustly in the next two years, driven by private consumption and fixed investment on the back of higher wages and increased EU investment funds. FocusEconomics Consensus Forecast panelists expect GDP to expand 3.7% in 2018, which is up 0.1 percentage points from last month’s forecast. For 2019, the panel sees growth moderating slightly, to 3.3%.

CROATIA | Agrokor woes continue to obscure economy’s outlook

Annual GDP growth slowed notably in the fourth quarter, restrained by slower fixed investment growth and a weak external sector. High-frequency indicators suggest, however, that the economy regained some strength in Q1 of this year. In January, the number of tourists grew at a double-digit rate year-on-year, and in February consumer confidence strengthened, boding well for household spending. Moreover, business sentiment jumped in the second month of the year. However, the unemployment rate increased in January, although this was again due to seasonal factors. Uncertainty continues to surround the debt restructuring plan for retail giant Agrokor. In late February, the government-appointed emergency administrator resigned due to a conflict of interest, prompting a temporary suspension of public trading of the company’s stock; a new administrator was subsequently appointed. A deadline for the restructuring has been set for early July. Exceeding it could hurt Agrokor providers and banks’ balance sheets.

A strong tourism sector, rising wages and positive labor market dynamics should underpin consumer spending this year. Moreover, an increased disbursement of EU funds and low interest rates are expected to spur fixed investment. Financing conditions could, however, deteriorate if the Agrokor restructuring process is not successfully accomplished. Public sector wage increases and growing public investment spending will push the public budget back to deficit, although the fiscal stance will remain broadly prudent. FocusEconomics panelists project GDP growth of 2.8% in 2018, unchanged from last month’s forecast, and 2.7% in 2019

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Inflationary pressures ease further in January

Inflation moderated for a second consecutive month in January, with price pressures temporarily waning in Turkey due to a sizeable base effect and softer inflation in most of the economies surveyed in the region. Regional inflation eased to 6.5% in January from 7.6% in December, marking the weakest print in half a year. The deceleration in inflation in Turkey outstripped mounting pressures in Romania, where fiscal stimulus has lifted inflation in recent months. Inflation also strengthened in Montenegro.

In light of quickly accelerating inflation, the National Bank of Romania decided to increase its policy rate by 25 basis points to 2.25% on 7 February, to contain pressures stemming from strong economic momentum, rising wages and supply-side factors. The Central Bank of the Republic of Turkey kept its interest rate scheme unchanged in January, while attempting to sound more hawkish in a bid to build some policy credibility and try to maintain a stable lira. Other central banks in the region also remained on hold in recent weeks.

Inflation in the SEE region is expected to come in at 6.1% this year, below the average of 7.5% in 2017. The estimate for this year was unchanged from last month’s projection, as higher forecasts for Bulgaria, Croatia and Romania were offset by lower estimates for Greece and Kosovo. In 2019, inflation is expected to moderate to 5.6%.

Written by: David Ampudia, Senior Economist


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