Central & Eastern Europe Economic Outlook January 2019

Central & Eastern Europe: CEE accelerates in Q3; slowdown anticipated in Q4

January 9, 2019

Defying expectations of a slowdown, a comprehensive estimate confirmed that growth across Central and Eastern Europe (CEE) held up in the third quarter. Regional growth came in at 4.3% year-on-year (previously reported: +4.2% year-on-year), a notch faster than in the second quarter (Q2: +4.2% year-on-year)—the slowest expansion in nearly two years—and beating analysts’ expectations of a tapered 3.8% outturn. By-now familiar dynamics propelled the regional economy: Upbeat internal demand, underpinned by private-sector spending and public-sector investment, outweighed faltering external demand amid the unfolding Eurozone slowdown and economic crisis in Turkey. Available fourth-quarter indicators, meanwhile, suggest that economic activity tapered through year-end on moderating consumer-spending gains and flailing export growth. Moreover, industrial-output readings have been uneven across the region in recent months; FocusEconomics’ first estimate projects growth in the quarter at 3.9%.


Comprehensive national accounts confirmed domestically-driven expansions for all of the region’s major-player economies. In heavyweight Poland, third-quarter growth beat analysts’ expectations and posted one of the strongest outturns of the past decade. Earnings-driven household spending and fixed investment tied to the European Structural and Investment Funds (ESIF) scheme underpinned the reading. In Czech Republic and Hungary, preliminary estimates were revised upwardly on similar dynamics. On the other hand, spending and investment in overheated Romania were contained by spiraling inflation and rising interest rates, respectively.


Elsewhere across the region, third-quarter growth was upbeat on investment and despite a broader household-spending slowdown. In Croatia, an investment-driven outturn was held back by moderate consumer-spending growth—despite low inflation and record-low unemployment. Moreover, Estonia notched its year-to-date fastest quarter on a rebound in fixed investment, which benefited from bustling construction activity. Slovenia, meanwhile, was an outlier in the quarter as external-sector gains drove growth in light of flat consumer spending.


In what has become the region’s defining narrative, recent weeks brought about new complications in its standoff with the European Union. After its government survived a no-confidence vote in late December, Romania secured the bloc’s rotating presidency on 1 January amid widespread concern over corruption and the rule of law in the country. Meanwhile, in late December Hungary’s government approved a series of judicial measures which are certain to inflame tensions with EU lawmakers. Taken alongside other ongoing squabbles, namely between Poland and the European Commission, recent events highlight the growing schism within the bloc at a time when investment in the region is on the line and could be clawed back as the EU negotiates its upcoming 2021–2027 budget.


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CEE slowdown to materialize this year


Following a two-year growth spurt, the CEE economy is expected to moderate this year as the region’s major economies approach the tail-end of the current business cycle. Internally, tight labor markets and low borrowing costs should keep most economies growing above potential, although emerging-market (EM) capital outflows threaten to expose structural weaknesses. External-sector uncertainty looms, and a Eurozone slowdown and a pullback in global trade could upend the region’s export-oriented industries. Notably, fiscal policy will play a major role in the event of a household-spending slowdown as sound fiscal metrics will enable governments to cushion a downturn. Hungary and Romania, however, are unlikely to be afforded this luxury. Over the forecast horizon, aging populations will remain a key challenge, as will the region’s complicated relationship with the European Union.


In light of upbeat third-quarter metrics, analysts now expect full-year regional growth in 2018 to have clocked in at 4.2%. That said, they held firm in recent weeks on economic activity over the short-term and still see regional growth this year and next at 3.4% and 2.9%, respectively—unchanged from last month’s forecasts.


Five of the region’s economies, including Romania, had their full-year growth forecasts for 2019 left intact in recent weeks. On the other hand, five economies—including heavyweight Poland, as well as Hungary—had their growth forecasts raised. Meanwhile, growth forecasts for the Czech Republic were 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 the Czech Republic are expected to grow at below 3.0%.


POLAND | Q4 slowdown likely following upbeat Q3


Third-quarter growth defied expectations of an impending slowdown, matching the second quarter as domestic demand showed little sign of letting up. Fixed investment surged on the continued absorption of EU-linked structural funding, and household spending remained upbeat in light of strong earnings and low unemployment. Notably, inflation hovered below-target through the quarter despite the expansion. Available fourth-quarter data, however, suggests that economic growth may be decelerating. Survey-based data from the manufacturing sector slid through the better part of last year and, most recently, purchasing activity signaled a downturn in November and December. This would appear to align industrial metrics with the recent Eurozone pullback, which has hit export orders and is likely to continue doing so over the short-term. Consumers, on the other hand, have so far been spared and look set to continue driving economic gains; the labor market tightened through November and retail sales thus far appear unscathed.


An uncertain global backdrop and the late-stage business cycle are expected to taper growth this year. Domestically, household spending and fixed investment are seen moderating as employment gains slow and borrowing costs eventually rise, respectively. On the external front, a Eurozone slowdown and, more broadly, weaker growth overseas will weigh on activity. Politically, election-year spending risks stretching the fiscal deficit and perennial squabbling between Warsaw and Brussels, as well as the 2021–2027 EU budget, are bruising long-term economic prospects. FocusEconomics analysts expect growth of 3.7% in 2019, up 0.1 percentage points from last month’s forecast, and 3.1% in 2020.


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CZECH REPUBLIC | Q4 prospects appear bright; 2019 budget passes


Available hard data suggests growth accelerated in the fourth quarter of 2018, following a subdued third quarter in which economic activity was constrained by tepid consumer spending and a negative performance of the external sector. Industrial production rebounded vigorously and export growth soared in October, boosted by strong car production. In the same month, retail sales bounced back, supported by an extremely tight labor market and rising wages. That said, survey-based indicators for October−December still point to a lukewarm expansion, suggesting the scope of the acceleration could be limited in Q4. In view of a possible future economic slowdown—and of its effects on banks’ balance sheets—in mid-December the Central Bank raised the counter-cyclical capital buffer for banks to 1.75%, which will take effect in January 2020. On the political front, on 20 December the parliament finally passed the 2019 budget, which targets a deficit of 0.7% of GDP and includes hikes in pensions and public sector wages.


The economy is expected to maintain a broadly stable and solid pace of expansion this year. Private consumption should continue to expand, although at a somewhat slower rate compared to last year, supported by extremely tight labor market conditions and rising wages. Moreover, the positive economic performance is expected to translate into healthy fiscal parameters. That said, lingering global trade tensions and a faster-than-expected economic slowdown in the EU could hurt the external sector, weighing on GDP growth. FocusEconomics Consensus Forecast panelists see GDP growing 2.9% in 2019, which is down 0.1 percentage points from last month’s projection, and 2.6% in 2020.


ROMANIA | Cabinet introduces measures to curb fiscal deficit


Growth ticked up in the third quarter, although the slight acceleration was due to a surge in inventories which more than offset further cooling in consumer spending, still-falling fixed investment and a negative contribution from the external sector. In an attempt to curb the ballooning fiscal deficit, the cabinet approved a series of measures on 21 December, including a tax on banks’ assets designed to cap money market lending rates; taxes on energy and telecommunications companies; and an overhaul of the retirement system that allows Romanians, under certain conditions, to pull out of the mandatory private pension funds and switch to state management. The measures produced jittery reactions on the stock market, while analysts doubt they will bring the deficit below 3% of GDP. On the political front, the government survived a no confidence vote on 20 December, while on 1 January it took over the EU’s rotating presidency amid criticisms that the government is eroding the rule of law in the country.


Growth is set to slow further this year, as the expansionary effects of fiscal stimulus wane and consumer spending continues to cool due to weakening consumer confidence and smaller wage and job gains. Moreover, although growth in fixed investment is expected to strengthen, potential capital outflows and revisions of companies’ capital investment plans due to the deteriorated and unstable legal framework cloud the outlook. Further risks stem from the country’s sizeable twin deficits and frequent clashes with the EU over the rule of law. FocusEconomics panelists expect growth of 3.4% for 2019, which is unchanged from last month’s forecast, and 2.9% in 2020. 


HUNGARY | Q4 economic activity robust despite turbulent politics


Economic activity seemingly remained robust in the fourth quarter of 2018, after strong consumer spending and surging fixed investment drove the third-quarter expansion. In October, growth in the industrial sector picked up on the back of solid car production and retail sales continued to expand sturdily, buttressed by a tight labor market and soaring wages. Although the economic environment remains bright, the political scenario is more turbulent. In order to address the problem of rising labor shortages, in mid-December the Hungarian parliament approved a law which increases the amount of overtime working hours employers can demand their workers to take on. Moreover, in a move which could spark further clashes with EU institutions, the National Assembly passed another law creating a new court system to arbitrate on administrative matters, which will be overseen by the justice minister. Although both laws prompted opposition parties to take to the streets, protests are unlikely to represent a serious challenge to the government due to the political diversity among the opposition and the high approval rating of Prime Minister Viktor Orban.


Consumer spending is expected to moderate this year, on higher inflation and softer job gains, while the expansion in fixed investment should slow due to a slower absorption of EU funds. Milder domestic demand will lead to a deceleration in GDP growth, which will nevertheless remain solid. Moreover, healthy growth will lead to a further decline in the public-debt-to-GDP ratio. FocusEconomics panelists see the economy expanding 3.4% in 2019, up 0.2 percentage points from last month’s forecast, and 2.6% in 2020.


MONETARY SECTOR | Inflation plummets in November on lower fuel costs


According to a comprehensive estimate produced by FocusEconomics, regional inflation fell to 2.1% in November (October: 2.6%). All economies experienced weaker inflationary pressures amid notably lower fuel costs. Moreover, Poland’s flash release for December hints that pressures continued to ebb through year-end. Falling inflation, in turn, led policymakers in the Czech Republic, Hungary and Poland to hold interest rates at existing levels at their final monetary-policy meetings of last year.


Regional inflation is expected to remain broadly stable over the coming years and is seen averaging 2.5% in 2019, down 0.1 percentage points from last month’s forecast, and again in 2020.


See the Full FocusEconomics Central and Eastern Europe Report


 


Christopher Thomas


Economist

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