Central & Eastern Europe Economic Outlook January 2018

Growth soars to an over one decade high in 2017

Central & Eastern Europe: Growth soars to an over one-decade high in 2017

January 10, 2018

The Central and Eastern European (CEE) economy powered ahead in 2017 and is expected to have grown at the fastest annual rate since 2006. FocusEconomics expects regional GDP to have grown 4.5% last year, notably above 3.1% in 2016. Expansionary fiscal policy, buoyant sentiment and tight labor markets fueled a spending spree across the region, and private consumption is projected to have grown at the fastest rate in over a decade. In addition, strong inflows of EU development funds and low interest rates caused investment to rebound, while fast growth in the Euro area, a major trading partner, boosted exports.


The CEE economy’s notable expansion came even against political uncertainty last year. In Poland, controversial government policies caused the country to clash with EU officials and sparked fears that it was backsliding on rule of law. Romania also experienced political unrest, which was especially heightened at the start of the year after government moves to weaken anti-corruption legislation sparked the largest protests since the end of the Cold War. The government ultimately backtracked on the legislation. In the Czech Republic, elections last October led to a victory for Andrej Babis and his populist ANO party; however, Babis has faced challenges in creating a government amid corruption allegations and has had to opt for a minority government. More broadly, several countries have butted heads with other European Union members over policies, especially concerning the bloc’s migration policies. The ongoing Brexit negotiations have also clouded the region’s outlook.


At the start of 2018, it appears the region’s political scene is likely to remain turbulent this year. In the Czech Republic, Babis’ minority government will face a no confidence vote on 10 January, and many analysts are predicting that Babis will not receive the necessary support. Shaky politics will likely dominate the Czech Republic in the coming months, putting legislation on hold. Meanwhile, Poland’s conflict with the EU persists and could escalate going forward. In late December, the European Commission recommended invoking Article 7 of the EU Treaty against the country, a move that could see some of Poland’s rights within the Union suspended. The Commission has given Poland a three-month window to address its concerns, but the government has so far rejected the Commission’s claims that recent judicial reforms violate the rule of law. However, Poland is unlikely to lose its voting rights in the EU, as Hungary has vowed to support the country. Hungary’s support of Poland highlights the growing divide between some CEE policymakers and their Euro area counterparts, and 2018 could bring increased tensions between the two groups over EU policies.   


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Tailwinds in place for a solid year of growth in 2018


Several of 2017’s growth drivers remain in place this year, boding well for another year of robust economic activity. Strong labor market dynamics, accommodative monetary policies and a favorable external backdrop should support buoyant growth in the CEE region in 2018. However, the rate of expansion is set to slow modestly as inflation picks up and monetary policies turn slightly less accommodative than last year. Growth is seen being largely unaffected by political uncertainties, which are nevertheless a notable downside risk to the outlook. Regional GDP is seen growing 3.6% in 2018, up a notch from last month’s forecast. In 2019, growth is projected to come in at 3.2%. 


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This month’s upgraded 2018 outlook is due to upward revisions for seven of the economies in the region, including major players Hungary, Poland and Romania. Lithuania was the only country to see its prospects downgraded. All other economies in the region saw no changes to their forecasts.


Romania is projected to be the region’s top performer this year, with expected economic growth of 4.2%. Latvia and Poland are also seen achieving fast growth rates of 3.7% and 3.8%, respectively. On the other end of the spectrum, Croatia is projected to be the region’s laggard, with an expansion of 2.8%. 


POLAND | Clash with EU officials escalates


Economic activity continued to expand at a strong pace in Q4, following a buoyant Q3. In November retail sales recorded another noteworthy year-on-year increase, as wages continued to post robust annual growth and the unemployment rate fell further. Moreover, in the same month industrial production expanded at a strong rate over the same period last year, and in December the PMI hit an almost-three-year high, suggesting the manufacturing sector continues to fire on all cylinders. On 13 December, the new Polish government comfortably won a vote of confidence. The new government will have to handle the deterioration in political relations with the EU. On 20 December, the European Commission recommended triggering Article 7 of the EU Treaty against Poland over controversial changes to its judicial system. The government has three months to present its case to avoid the suspension of its voting rights, which is nevertheless highly unlikely, as Hungary declared it would veto the measure.


The economy is set to expand at a healthy pace this year, although growth should decelerate compared to last year. Household spending will continue to increase, but at a slower pace as the fiscal stimulus fades and inflation picks up. On the other hand, fixed investment growth should gain steam thanks to rising EU fund inflows. Political instability could, however, weigh on the outlook. FocusEconomics panelists expect GDP to grow 3.8% in 2018, up 0.2 percentage points from last month’s forecast, and 3.4% in 2019.


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CZECH REPUBLIC | Government unveils stimulus policy agenda 


Andrej Babis, who was sworn in as prime minister on 6 December, was unable to form a majority government, and opted to form a minority government instead. His government submitted the 2018 state budget and presented its policy plans for the short, medium and long term on 19 December. The budget was largely put together by the outgoing cabinet, which included members of Babis’ ANO party, and foresees a sizeable fiscal deficit in 2018, despite pressure from some opposition parties to rein in spending at a time when the economy is growing at a robust pace. Following a strong result in Q3, recent indicators suggest that the momentum carried over into the final quarter of 2017. Industrial production expanded at a double-digit pace in October year-on-year, more than doubling the rate of expansion in the month prior. Meanwhile, the PMI reached a multi-year high in December and indicates strong expansion momentum in the manufacturing sector. In the same month economic sentiment also hit a multi-year high.


Political uncertainty is likely to linger over the next few months. Babis’ policy plans, which are focused on lower taxation and higher public sector wages, should bode well for economic growth, but failing to pass a vote of confidence set for 10 January would derail a timely implementation of those plans. Economic growth is nonetheless expected to remain robust this year. Private consumption is likely to remain solid and buttress growth, while fixed investment is also expected to contribute. Panelists see GDP growing 3.2% in 2018, unchanged from last month’s projection, and 2.8% in 2019.


ROMANIA | Economy fired on all cylinders in Q3


Revised data for Q3 confirmed that the economy posted the fastest annual growth rate since Q1 2008. A surge in household spending on the back of a tightening labor market and expansionary fiscal policy were behind the positive reading. Available data for Q4 suggests the economy continued to perform well in the last quarter of the year. In October year-on-year growth in industrial production jumped from the previous month, led by a strong manufacturing sector. Solid external demand, as reflected by export data, drove the result. Also in the same month, the unemployment rate fell to a new multi-year low. This, together with a further increase in household disposable income, buttressed consumer spending. Retail sales continued to expand annually at a double-digit rate. However, on 29 December the leu weakened to an all-time low against the euro amid unrest caused by protests against government plans to reform the judicial system.


In 2018 the economy is expected to post another year of healthy growth, although the rate of expansion should be more moderate. Growth in household spending will continue to support the economy, but it will likely ease as rising inflation eats into consumers’ pockets. Moreover, fixed investment should pick up as the absorption of EU investment funds improves. FocusEconomics panelists expect growth of 4.2% for 2018, which is up 0.2 percentage points from last month’s forecast. They see the economy expanding 3.5% in 2019.


See the Full FocusEconomics Central and Eastern Europe Report


HUNGARY | Robust economic momentum bodes well for ruling party in spring election


Positive economic data continues to flow in. GDP growth jumped in the third quarter, as government spending turned positive. In addition, investment continued to soar thanks to strong inflows of EU funds, while a tight labor market supported healthy household consumption in the quarter. Available data for the fourth quarter is also bright. Exports surged, and the unemployment rate fell in October. Economic sentiment rose notably in December. The healthy economy will likely help Prime Minister Viktor Orbán in the upcoming spring general election. Orbán’s right-wing Fidesz party is leading in early polls and is expected to come out on top in the April or May vote. Immigration will likely be a key theme in the pre-election debate. Orbán has been an outspoken critic of the EU’s immigration policy and has clashed with European leaders over his refusal to take in refugees.


Rising wages, a favorable global backdrop and accommodative monetary policy should drive solid growth in 2018. FocusEconomics panelists project the economy will expand 3.5% in 2018, which is up a notch from last month’s forecast. For 2019, the panel sees growth of 2.9%.


MONETARY SECTOR | Inflation rises to nearly five-year high in November


According to an estimate produced by FocusEconomics, price pressures in the CEE region jumped in November. Inflation rose from 2.4% in October to 2.6%, the highest rate since January 2013. Inflationary pressures rose significantly in H2 2017 due to rising commodity prices and strong consumption in the region.


Higher inflation and tightening monetary policy in the U.S. are eroding space for accommodative monetary policy. In January, Romania’s Central Bank hiked rates for the first time in a decade. Policymakers in the Czech Republic, Hungary and Poland, however, left policy rates unchanged in recent weeks.


Inflation is seen averaging 2.5% this year, which is up 0.1 percentage points from last month’s forecast. Solid growth and higher commodity prices will drive inflationary pressures this year. In 2019, inflation is seen stable at 2.5%. 


 


Angela Bouzanis


Senior Economist 

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