Central & Eastern Europe: Investment shifts from economic drag to boost
April 5, 2017
Economic activity is gathering modest momentum in the economies of Central and Eastern Europe (CEE). Monthly economic indicators are pointing to a pick-up in growth at the onset of 2017, after GDP expanded 2.9% over the same period of the previous year in Q4 2016. Tightening labor markets, loose monetary policy and fiscal measures are contributing to a consumption spree in the region, which is being reflected in retail sales and confidence data. Moreover, fixed investment is set for a rebound, after being hampered by lower withdrawal of EU development funds last year. FocusEconomics panelists see GDP expanding 3.1% in Q1 and picking up further in H2 of this year.
As the economy steadily gains traction, political developments are in the spotlight. The European Union and the United Kingdom entered into unchartered waters on 29 March, after UK Prime Minister Theresa May invoked Article 50 of the Lisbon Treaty and triggered the long-awaited Brexit process. Free movement of people between the island and the continent and the trade deal will be the cornerstones of the likely long and tough negotiations, which will shape the future of economic relations between the UK and CEE. Meanwhile, political risks subsided in Bulgaria, as the center-right, pro-EU GERB party won parliamentary elections on 26 March, which should see Boyko Borisov return as prime minister. However, GERB failed to win an outright majority, meaning that the party will have to form a minority or coalition government, and divergent views between parties create a high risk that the government will not live out its full term.
Head on over to our Central & Eastern Europe page for more recent economic news on the region.
Growth to pick up in 2017
The CEE economy should gain steam this year after a healthy 2.9% expansion in 2016. A solid domestic economy and improving activity in the Euro area should fuel faster growth of 3.1%. The 2017 forecast was left unchanged this month, after an upward revision in our previous publication. Next year, the economy is seen remaining on a healthy footing and recording another 3.1% increase.
Three of the 11 economies surveyed in this report saw no change to their growth outlook this month, including regional heavyweight the Czech Republic. However, eight economies saw upward revisions this month, including Bulgaria, Croatia, major-player Poland and Slovenia.
Romania is projected to be the region’s fastest-growing economy this year, with an expected expansion of 3.9%. Bulgaria, Poland and Slovakia are also seen achieving fast growth rates of over 3.0%. On the other side of the spectrum, Estonia is expected to be the CEE region’s laggard, with an expansion of 2.4%.
CZECH REPUBLIC | Growth broadens in Q1
Available data suggest that the Czech economy shifted into a higher gear in the first quarter of 2017, leaving behind the weakness caused last year primarily by a fall in fixed investment due to lower EU funds. January’s notable acceleration in retail sales growth shows that the consumer sector continues to underpin the Czech economy. Private consumption is being supported by a tight labor market—with the unemployment rate reaching a multi-year low in February—and strong wage growth due to a shortage of workers, pay hikes for public sector employees and increased pensions. The economy is also being sustained by a buoyant manufacturing sector and recovering external demand: exports jumped and industrial production grew sharply in January, and the PMI data for February signaled the strongest manufacturing growth in several years on the back of higher new orders and output.
The economy is set to accelerate this year on the back of solid macro fundamentals, despite the constraining effect of sluggish EU growth overall. A tight labor market will push up wages and sustain private consumption, and fixed investment will rebound solidly on the back of an increased absorption of EU funds and a supportive fiscal stance. Panelists see GDP growing 2.6% in 2017, unchanged from last month’s projection, and also in 2018.
HUNGARY | Economy ends 2016 on soft note
Recent data confirm that the Hungarian economy hit a soft patch in the final quarter of 2016, with growth decelerating. The headline figure disappointed market analysts’ expectations and dragged annual GDP to a four-year low. The deceleration, however, seems to be a mere blip in an otherwise solid sequence of economic activity and healthy economic fundamentals. In 2016, all three major credit rating agencies restored Hungary to investment grade, the labor market strengthened considerably and a sustained decline in public and external debt reduced the country’s exposure to economic shocks. The latest data from this year suggests strong growth momentum in the domestic economy and solid growth in exports, which expanded at the fastest pace in over five years.
Hungary’s economic outlook is promising as loose monetary conditions, a planned 15–25% minimum wage hike, tax cuts, increased EU funds inflows and a solid labor market will boost economic growth this year and next. Our panelists forecast that the economy will expand 3.1% in 2017, which is up 0.1 percentage points from last month’s forecast. For 2018, it is expected to grow 3.0%.
POLAND | Government spending seen near EU’s limit
Activity is firming in Poland’s economy after a slowdown in H2 2016. Business confidence hit a 19-month high in March and retail sales posted another month of solid growth in February, as consumers benefitted from government stimulus measures and a tightening labor market. In addition, investment is poised for a rebound in Q1 thanks to quicker absorption of EU funds. While the government’s stimulus measures are supporting a spending spree in the economy, they are likely to strain public finances this year and next, which will be further aggravated by a reduction in the retirement age. FocusEconomics panelists see the fiscal deficit rising close to the EU’s limit of 3.0% of GDP this year.
Growth should edge up from 2016’s 2.8% on the back of a recovery in investment. The FocusEconomics panel sees growth of 3.3%, which is up 0.2 percentage points from last month’s projection. In 2018, the panel also sees GDP expanding 3.3%.
ROMANIA | Consumption spree supports strong activity in 2016
Romania’s position as one of the EU’s fastest growing economies in 2016 was confirmed in March by comprehensive data. GDP growth was propelled by scorching private consumption growth resulting from extensive tax cuts and wage increases. Nevertheless, the data also revealed how unbalanced the expansion was. Fixed investment growth was almost flat, partly as a result of poor EU fund absorption but also because investment decisions might have been postponed in anticipation of tax breaks taking effect in January 2017. In addition, the external sector made a negative contribution to growth as the consumption boom caused import growth to accelerate. Somewhat worryingly, Q4 GDP data showed that private consumption slowed for a second consecutive period, an indication that the government’s income-boosting measures are starting to fade. As a result, the government’s fiscal plans are becoming more and more unrealistic and the IMF in its Article IV conclusions has urged the government to consider cutting expenditure and improving revenue collection, while also implementing structural reforms. For 2017, the government is betting on 5.2% GDP growth and a deficit of 3.0% of GDP, both of which are far more optimistic than our Consensus Forecasts.
Economic growth is expected to moderate this year. Private consumption is set to continue as the main driver of growth but will be weighed down by higher inflation. Our panelists predict an expansion of 3.9% in 2017, which is up 0.1 percentage points from last month’s forecast, with growth of 3.3% penciled in for 2018.
INFLATION | Price pressures rise in February
According to an estimate produced by FocusEconomics, inflation rose to the highest level since July 2013 in February. Inflation in the CEE region rose to 1.9% from January’s 1.4% as the effect of low oil prices waned and all of the economies saw positive price pressures for the second consecutive month.
Higher commodity prices along with booming consumption will fuel inflation this year. The FocusEconomics panel sees inflation of 1.9% this year, which is up 0.1 percentage points from last month’s projection. In 2018, inflation is expected to rise slightly to 2.2%.
Written by: Angela Bouzanis, Senior Economist