Economic Snapshot for Central & Eastern Europe

November 28, 2018

CEE keeps pace through third quarter

Preliminary estimates revealed that growth across Central and Eastern Europe (CEE) held up in the third quarter, defying expectations of a slowdown. Regional growth was penciled-in at 4.2% year-on-year in the third quarter), matching the second quarter as the slowest expansion in nearly two years but beating analysts’ expectations of a more tapered 3.8% outturn nonetheless. Although comprehensive third-quarter national accounts are outstanding throughout the region, available indicators suggest that the region’s economic momentum was sustained thanks to upbeat internal dynamics—and, in particular, due to private-sector spending and public-sector investment. This likely offset weaker external demand, which appeared to ebb through the quarter amid cooling demand from the Eurozone and the unfolding economic crisis in Turkey.

In Poland, third-quarter growth beat analysts’ expectations, tying the second quarter for one of the strongest outturns of the past decade. A tight labor market has been fueling wage growth and likely lifted household spending in turn, while the absorption of EU-linked structural funding is expected to have propelled the further recovery of fixed investment. Meanwhile, similar demand-side dynamics were at play in Romania and Slovakia where growth accelerated from a quarter earlier. In Romania, rising employment looks to have bolstered household spending, while the heavier absorption of structural funds may have brought about a recovery of fixed investment. Public-sector wage hikes, despite blowing up the year-to-date fiscal deficit, appeared to support gains.

Despite strong internal metrics, both the Czech Republic and Hungary saw third-quarter growth tick down from a quarter earlier amid weaker external-sector dynamics. In the Czech Republic, a broader Eurozone slowdown appeared to dent external demand while, in Hungary’s case, exports look to have taken a bruising from the tapering of Germany’s automotive industry. Meanwhile, flash estimates for two of the Baltic economies and Bulgaria hint that sluggish foreign trade—both east- and west-looking—also held back growth in the quarter.

In politics, recent weeks were underscored by competing narratives. In Poland, a rare de-escalation of tensions with the European Union arose on the heels of the government’s decision to backtrack on its controversial judicial reforms and reinstate two dozen of the country’s Supreme Court judges. Events occurred in the aftermath of local elections, and was likely an attempt by the incumbents to fend off an effective line of attack ahead of next year’s parliamentary elections. Analysts viewed the event as a net-positive in the Law and Justice (PiS) government’s ongoing skirmish with European lawmakers and bodes well for warmer relations with the bloc.

On other fronts, anxieties rose. In the Czech Republic, billionaire Prime Minister Andrej Babis survived a no-confidence vote on 23 November brought on by his implication in a fraud scandal. His government, formed in recent months following last year’s election, is anticipated to ride out the controversy although the vote highlighted its instability. Meanwhile, in what analysts labelled a power grab, Romanian Prime Minister Viorica Dancila announced a cabinet reshuffle on 19 November. Ahead of Romania’s ascendance to the European Council (EC) presidency, the move pitted President Klaus Iohannis against his government and is expected to ruffle feathers in Brussels. More broadly, EU-linked investment across the region is on the line as the bloc negotiates its upcoming 2021–2027 budget amid major differences of opinion on democracy, the rule of law and immigration.

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Slowdown still penciled-in for CEE next year

On the heels of a two-year growth spurt, the CEE economy is expected to take a breather next year as the region’s major economies approach the tail-end of the current business cycle. Low unemployment, rising wages and still-cheap borrowing costs should cushion internal dynamics and keep most economies growing above potential, although external-sector uncertainty continues to cloud the outlook. As it stands, a pullback in global trade threatens the region’s export-oriented industries. Meanwhile, sound fiscal metrics across the region—with some exceptions, of course—bode well for the business climate. Emerging-market (EM) capital flight remains a significant downside risk, although beefy current-account balances should shield most of the region’s currencies from a major selloff. Over the forecast horizon, aging populations will remain key structural challenges, as will the region’s tricky relationship with the European Union.

In light of solid third-quarter metrics, analysts upwardly revised their full-year growth forecasts in recent weeks and now peg regional growth for 2018 at 4.1%, up 0.1 percentage points from last month’s forecast. Next year, however, regional growth is expected to moderate to 3.4%—unchanged from last month’s forecast—before easing further to 2.9% in 2020.

Eight of the region’s economies, including regional heavyweights Czech Republic, Hungary, Poland and Romania, had their growth forecasts for 2019 left intact in recent weeks. The remaining three economies—Bulgaria, Estonia and Lithuania—had their growth projections cut. Slovakia and Poland are expected to be the region’s top-performers next year, each expanding at over 3.5%. On the flipside, Croatia and Lithuania are expected to grow at below 3.0%.

POLAND | Buoyant growth defies expectations

Poland’s economy continued defying expectations of an impending slowdown in the third quarter, matching the second quarter to record one of the best readings of the past decade. A breakdown by expenditure is still outstanding; that said, analysts have speculated that domestic demand again drove growth as it has done so over the past several quarters. Household spending and fixed investment likely posted robust gains on lower unemployment and heavy EU-linked structural funding, respectively, and seem to have offset tepid external demand from the European Union. Available data for the fourth quarter has thus far been upbeat: Consumers appear on track for another busy quarter as reflected by retail sales bouncing back in October and the jobless rate stable at its lowest in decades. Nevertheless, analysts have continued to forecast a slowdown in light of deteriorating supply-side metrics.

A maturing business cycle is expected to muffle the growth rate over the next few years amid higher inflation and as gains in the labor market taper. As it stands, fixed investment should benefit from low interest rates and higher absorption of EU-linked funds. However, external-sector anxieties—especially over a broad slowdown across the EU and a further pullback in global trade—pose the key short-term risks. Meanwhile, uncertainty surrounding the 2021–2027 EU budget hangs over the long-term outlook. FocusEconomics panelists expect growth of 3.6% in 2019, which is unchanged from last month’s forecast, and 3.1% in 2020.

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CZECH REPUBLIC | Slowdown amid broader Eurozone tapering

Preliminary GDP data revealed that economic activity cooled slightly in Q3, with annual growth slowing to a near-two year low from an already relatively-weak showing in Q2. The third-quarter expansion was likely driven mainly by solid consumer spending, in which an overheated labor market and buoyant wage growth—partly stemming from public and private sector wage hikes—have propped up households’ disposable incomes. On the other hand, it seems that softer external demand, primarily from the Eurozone, dragged on the headline figure. Available data for Q4, however, hints at slightly more upbeat activity, with economic sentiment edging higher on average in October–November from Q3 due to improved business confidence. Meanwhile, on 23 November, the government survived a no-confidence vote tabled by the opposition over a fraud scandal implicating Prime Minister Andrej Babis thanks to the coalition junior partner’s abstention from the vote, which should reduce political uncertainty ahead.

Although the economy is expected to lose some momentum next year, growth is set to remain strong. Brisk wage gains, in part supported by a planned increase in the minimum wage in 2019, and an extremely-tight labor market will underpin healthy private consumption. This, coupled with strong fixed investment growth, should translate into upbeat domestic demand powering growth. Nevertheless, given the highly-open nature of the economy, a slowdown in external demand could dent export activity and weigh on overall industrial production. FocusEconomics Consensus Forecast panelists see GDP growing 3.0% in 2019, which is unchanged from last month’s projection, and 2.6% in 2020.

ROMANIA | Growth ticks up as fiscal deficit balloons

Economic growth accelerated in the third quarter, likely due to rising public spending. Data for the January-September period, for example, shows that the budget deficit more than doubled year-on-year, mainly due to public salary hikes. The widening deficit, together with the government’s wage and pensions hike plans, prompted the IMF at the end of its November staff visit to suggest that the country undertake substantial fiscal consolidation. In mid-November, Fitch Ratings also cited both points as risks to future macroeconomic stability, although nevertheless affirmed Romania at BBB-, with a stable outlook due to moderate levels of government debt. On 19 November, Prime Minister Viorica Dancila announced a government reshuffle, likely the result of an internal party struggle. The move is expected to give Liviu Dragnea, leader of the ruling Social Democratic Party and kingmaker of Romania’s government, a tighter grip over the cabinet.

A moderation in growth is expected in 2019, mainly due to slowing private consumption amid softening wage growth and weaker job gains. On the other hand, fixed investment should gain steam, although the scope of the acceleration could be limited by weakening business confidence and capital outflows due to the country’s sizeable twin deficits and frequent squabbles with the European institutions over controversial judicial reforms. FocusEconomics panelists expect growth of 3.4% for 2019, which is unchanged from last month’s forecast, and 3.0% in 2020.

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HUNGARY | Firing on all cylinders despite external-sector weakness

The Hungarian economy continued to fire on all cylinders in the third quarter, most likely supported by buoyant domestic demand. Strong wage gains coupled with solid retail sales growth throughout the quarter suggest consumer spending remained in the driver’s seat in Q3. Moreover, solid credit growth, upbeat business confidence and surging construction output point to another quarter of sustained fixed investment expansion, which also likely benefited from rising inflows of EU funds. On the other hand, the external sector weakened, due to a marked cooling in Germany’s automotive industry. Moving to the final quarter of the year, available data suggests business activity remains resilient, while consumer confidence lost some steam, probably due to rising inflation. In order to address rising concerns of a significant slowdown in the real estate sector when the preferential VAT regime expires, the finance minister announced the government will propose extending the reduced VAT for housing from the end of 2019 to the end of 2023.

Although growth is set to moderate next year from this year’s outstanding performance, it will nonetheless remain healthy. The primary driver of the deceleration will be a marked slowdown in fixed investment growth, due to a softer absorption of EU funds. Consumer spending will also likely lose some steam, as wage growth gradually declines and job growth slows. FocusEconomics panelists see the economy expanding 3.2% in 2019, unchanged from last month’s forecast, and 2.6% in 2020.

MONETARY SECTOR | Inflation moderates in October

According to a comprehensive estimate produced by FocusEconomics, regional inflation dipped to 2.6% in October (September: 2.7%). Weaker inflationary pressures were recorded across four economies—including the Czech Republic, Poland and Romania—amid a slower rise in fuel costs.

Upbeat internal demand and higher global energy prices have stoked inflation this year, pushing a handful of central banks to begin unwinding their ultra-accommodative positions. In November, however, contained inflation and nascent signs of economic slowdown led policymakers in Poland and Romania to hold fire on interest rates. Despite rising inflation, Hungary’s policymakers also followed suit, while the European Central Bank (ECB) stayed the course in October and reaffirmed its commitment to halting its quantitative easing (QE) program by the end of the year. On the other hand, Czech policymakers voted to hike rates for a fourth consecutive time amid intensifying upside risks to inflation.

Regional inflation is expected to remain broadly stable over the coming years and is seen averaging 2.6% in 2019, unchanged from last month’s forecast, and 2.5% in 2020.

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Christopher Thomas

Economist