CEE Economic Outlook August 2016

Brexit spillovers threaten CEE's economic prospects

CEE: Brexit spillovers threaten CEE's economic prospects

August 3, 2016

Central and Eastern Europe (CEE) is the emerging market that is most exposed to the fallout from Brexit. All countries in the region are members of the European Union and CEE has strong links to the UK through migration. While the UK only receives 4.7% of the region’s exports, the expected slowdown in the Eurozone will weigh on growth, as over half of the region’s exports are destined for the EU. Moreover, the UK is the third largest contributor to the EU’s budget, while most of the CEE economies receive more than they contribute and any changes in EU funding in the long-run could hamper investment in the region.

Head on over to our Central & Eastern Europe page for more recent economic news on the region.

At this stage, although it is difficult to fully assess the impact of Brexit on the region—the outcome of negotiations between the EU and the UK will be critical—waves of contagion are expected to hit CEE through trade, investment and financial challenges. Lower confidence will impact investment and trade will suffer due to the expected slowdown in the Eurozone. In addition, risk-averse sentiment has put a number of the region’s currencies and bonds under pressure, and financial market volatility is likely to persist going forward. The UK’s decision could also have significant political consequences for the region. Already popular Eurosceptic parties and governments could try to capitalize on the vote and gain further support, increasing tensions between EU countries, while broader EU reforms and policies will likely be put on the backburner as the Union focuses on the UK exit. In the aftermath of the vote, our panelists have revised downward their forecasts for the CEE region, albeit only tentatively at this stage. The panel now sees the CEE economy expanding by 3.0% in 2016, which is down 0.1 percentage points from our pre-Brexit forecast. For 2017, our panelists have also cut their GDP forecast by 0.1 percentage points to 3.0%. Almost all countries in the region saw their prospects for 2017 downgraded as the consequences of Brexit are felt more fully. 

Against the backdrop of weakened economic prospects, policymakers may try to mitigate the adverse effects of Brexit through fiscal or monetary stimulus in the region. Some of our panelists see monetary easing in the cards for Poland and Hungary, whereas the Czech Republic is in a solid financial situation and could enact fiscal stimulus. In addition, Central Banks may try to smooth exchange market volatility through market intervention.

While almost all countries in the region are expected to be affected by Brexit contagion, the extent of it will be divergent as the magnitude of the effect will depend on the degree of openness of the economy, room for fiscal or monetary support and domestic vulnerabilities. 

CEE economy sputters in H1; political risks grow

The economies of Central and Eastern Europe (CEE) started the year on a sour note, growing at the weakest pace since Q4 2014. Regional GDP expanded 2.9% in Q1 over the same quarter of last year, which was below Q4 2015’s 3.7% increase. Growth is expected to have lingered at the first quarter’s low rate in Q2. Although domestic conditions in many of the region’s economies remain healthy, reduced EU development funds are expected to have hampered investment in the region.

At the start of the third quarter, the region is facing elevated risks from high political uncertainty. The Brexit vote has thrown the European Union into unchartered territory and will have economic and political ramifications for CEE. Shaken confidence will likely threaten investment in the region, which is already seen as being weak this year. Besides the dangers stemming from Brexit, domestic politics in many economies are increasing vulnerabilities in the region. Poland’s government has enacted a number of controversial policies and clashed with EU officials over democratic backsliding, which has spooked investors and damaged confidence. Moreover, concerns over fiscal slippage are high as the government pursues an expansionary fiscal agenda.

Meanwhile, Croatia will hold a snap election on 11 September after the Parliament dissolved itself amid clashes within the government coalition. Early polls point to a hung parliament and risks of reform slippage are high as politics takes center stage. In addition, political tensions are high in Hungary ahead of the referendum on migrant quotas scheduled for the fall. The Hungarian government has clashed with EU officials over a number of policies and the EU has threatened to trim funding to members who oppose migrant quotas. 

See the Full FocusEconomics Central and Eastern Europe Report

Political developments dim outlook

The outlook for the economy of Central and Eastern Europe deteriorated this month after having been stable for six consecutive months. The economy is expected to slow this year due to a significant deceleration in investment growth. Reduced EU development funds combined with low sentiment after Brexit will hurt investment in the region. In addition, the expected slowdown in the Eurozone, a key trading partner for the region, is hurting growth prospects. Forecasters surveyed by FocusEconomics foresee a 3.0% expansion in 2016, which is down 0.1 percentage points from last month’s forecast. Next year, our panel foresees steady growth of 3.0%.

This month’s outlook reflects lower growth prospects for 5 of the 11 economies surveyed, including Bulgaria, Hungary and Poland. The remaining countries’ forecasts were kept unchanged this month.

Romania and Poland are expected to be the region’s top performers with growth rates of 4.2% and 3.3%, respectively. On the flip side, Croatia and Hungary are expected to grow the slowest, with more tepid expansions of 1.8% and 1.9% respectively.

CZECH REPUBLIC | Domestic demand to support growth this year

The Czech Republic’s economy hit the brakes at the beginning of this year as the strong contribution of fixed investment to overall economic growth in 2015 began to fade in Q1 2016. Fixed investment significantly accelerated in 2015 thanks to the absorption of EU funds. Meanwhile, industrial production accelerated sharply in May, driven especially by an expansion in the manufacturing of cars. The car industry is fundamentally important for the Czech economy, and a substantial increase in car exports accounted for the lion’s share of growth in total exports in the first five months of 2016. Since the European Union and the UK are major importers of Czech cars, expectations of a slowdown in these two economies due to the Brexit fallout could cause difficulties for the Czech economy. For now, the country can rely on domestic demand: unemployment fell in June and real wages increased in the first quarter, which should buttress private consumption.

Although the economy is expected to decelerate this year as investment slows, strong growth in private consumption should still support a solid expansion. Uncertainties pertaining to the European refugee crisis and the Brexit vote pose downside risks to the outlook. Panelists see GDP growth moderating to 2.5% in 2016, which is unchanged from last month’s forecast. For next year, they see growth ticking up to 2.6%.

HUNGARY | Government mulls fiscal stimulus 

A decline in EU funding and weakness in the automotive sector caused GDP to expand at the slowest pace in three years in Q1, highlighting how much Hungary’s strong growth in recent years has depended on steady inflows of EU funds as an engine for fixed investment. EU funding will likely remain low this year and thus drag on growth, but solid industrial production and export readings for April and May point to a recovery in the automotive sector and thus an upturn in Q2. Support for growth in the remainder of this year could again come from fiscal policy: the government signaled that it might reveal new fiscal stimulus measures in the fall, should this prove necessary to propel growth. In the political arena, a referendum on whether to accept any future EU migrant quotas, which the government has called for early October, will likely increase tensions with the EU.

GDP growth is set to decelerate this year, mainly due to a sharp drop in fixed investment as well as some negative spillovers from the Brexit vote on trade and particularly investment. Private consumption will likely take over as the main growth driver, buttressed by falling unemployment as well as loose monetary and fiscal policy, and sustain a still-solid expansion. Our panelists see GDP expanding 1.9% this year, which is down 0.1 percentage points from last month’s forecast. For 2017, the panel projects a 2.6% expansion. 

POLAND | Controversial economic polices cloud outlook

The Polish economy grew at the slowest pace in two years in Q1 as a sharp decline in EU development funds hit investment. The slowdown looks to have been temporary as recent data suggest that the economy regained steam at the end of the second quarter: industrial production and retail sales both accelerated in June. Meanwhile, political developments in the country are a growing concern. The government continues to clash with European officials over democratic backsliding and is at risk of losing its voting rights in the Union. On top of this, controversial and unclear policies regarding pension reform and plans to deal with USD 36 billion in Swiss-franc-dominated mortgages are worrying investors and adding to pressure on the zloty.      

Political uncertainties are weighing on Poland’s economic outlook. In addition, contagion from Brexit is expected to strain investment and export earnings. The FocusEconomics panel cut Poland’s growth outlook by 0.2 percentage points this month and now see GDP expanding 3.3% this year. For 2017, the panel also sees economic growth of 3.3%.

See the Full FocusEconomics Central and Eastern Europe Report

ROMANIA | Solid fundamentals support growth

The Romanian economy accelerated to a multi-year high in 2015 thanks to a strong fiscal stimulus and substantial EU investment funds. In Q1, the economy expanded at a solid pace as increased government spending ahead of key parliamentary elections due later this year along with tax cuts and wage hikes for public employees spurred a consumption boom. Data from Q2 indicate that domestic demand is still the main driver of growth. In May, industrial production expanded while retail sales tallied their tenth consecutive double-digit expansion. Against this backdrop, Fitch Ratings confirmed Romania’s BBB- rating and stable outlook in July. Fitch pointed out that Romania’s macroeconomic fundamentals remain solid but downside risks are on the rise. Increased pre-electoral spending and reforms to the fiscal code have greatly undermined medium-term fiscal sustainability and are debilitating the country’s external accounts.

Domestic demand will remain the engine of growth this year. The UK’s Brexit vote is expected to have a minor impact on the economy since both countries have limited trade ties and remittances from Romanian workers in the UK are fairly low. Panelists participating in the FocusEconomics Consensus Forecast expect the economy to grow 4.2% this year, which is unchanged from last month’s forecast. In 2017, the panel foresees economic growth moderating to 3.5%.  

INFLATION | Fall in consumer prices eases in June

Almost all of the economies in the CEE region continued to experience falling prices in June, but the extent of the fall moderated significantly. An estimate elaborated by FocusEconomics indicates that consumer prices declined 0.5% in June over the same month last year, which was a less pronounced fall than May’s 1.1% drop and marked the highest reading since January. However, prices remain at historically-low levels and only three countries in the region experienced inflation in June.

Price pressures are expected to pick up slowly over the coming months but remain meagre overall. Economists surveyed this month by FocusEconomics see prices falling 0.1% annually in 2016, which matches last month’s forecast. This month’s projection reflected stable inflation outlooks for 3 of the 11 economies in the region, including major player PolandLithuania and Romania were the only countries to see their forecasts raised, while inflation projections were revised down for 6 economies. Going forward, forecasters predict that inflation will return next year and average 1.7%.

See the Full FocusEconomics Central and Eastern Europe Report

Written by: Angela Bouzanis, Senior Economist

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