Central & Eastern Europe Economic Outlook July  2016

Central & Eastern Europe Economic Outlook July 2016

CEE economy loses steam in Q1, risks to growth intensify in wake of Brexit

The economies of Central and Eastern Europe (CEE) lost steam at the start of 2016, growing at the slowest pace since Q4 2014. Regional GDP growth slid from Q4 2015’s 3.7% to 2.9% in Q1 over the same quarter of last year. The reading was driven by a sharp slowdown in EU development funds as well as unfavorable external conditions. Looking at the individual countries in the region, growth slowed almost across the board with the exceptions of Croatia, Estonia, Lithuania and Romania. Some of the sharpest slowdowns were recorded among the region’s major economies: Hungary and Poland both grew at multi-year lows. Following the soft start to the year, the region is likely to have regained some steam in the second quarter and high-frequency data point to a better performance. The FocusEconomics panel foresees the economy having grown 3.1% annually in Q2.

Political developments in the region and across the globe have taken center stage in recent weeks and are likely to remain in the spotlight in the coming months. The United Kingdom’s 23 June vote to leave the European Union sent shockwaves across the global economy and has increased downside risks to CEE’s outlook. While, at this point, there are massive uncertainties in terms of the economic ramifications of the decision as much of the impact will depend on the arrangements between EU and UK authorities, elevated economic uncertainty is likely to persist for some time. In the immediate aftermath of the vote, risk aversion sentiment hit many of the region’s currencies and bond yields, with Poland, the largest economy in the region, particularly hard hit. The Polish zloty fell to an over-four-month low and Polish bond yields rose. Going forward, contagion from the vote will manifest in the region through high financial market volatility and lower confidence levels—which could impact monetary policy and investment. In the longer term, the impact will depend on how negotiations over trade and immigration play out as well as any changes to the EU’s budget.            

Besides the risks stemming from Brexit, political uncertainty was already high in many countries in the region. In Croatia, the parliament voted to dissolve itself in June after months of clashes within the governing coalition. The vote paves the way for snap elections to take place in the coming months, however, it is unknown if they will solve the political impasse that drove government actions to a near standstill. Meanwhile, in Poland, controversial political policies continue to cast a shadow on the country’s future and a number of uncertainties remain regarding the government’s plan to deal with a burden of USD 35 billion in Swiss franc-mortgages. Political risks will likely continue to play a significant role in growth dynamics in the CEE region in the coming months. 

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Strong fundamentals keep region’s growth prospects stable despite risks

The outlook for the economy of Central and Eastern Europe was steady for the seventh consecutive month. Although the Brexit vote has hit sentiment and increased market volatility, the full effects are not expected to be felt this year. Moreover, solid fundamentals within the region should support growth in 2016 as private consumption continues to benefit from favorable tailwinds. Forecasters surveyed by FocusEconomics foresee a solid 3.1% expansion in 2016. However, downside risks to the forecast are higher in the wake of Brexit and the aforementioned political uncertainty across the region.

This month’s outlook reflects unchanged growth prospects for 4 of the 11 economies surveyed, including Czech Republic and Romania. Four countries’ forecasts were revised down this month, including Poland, the largest economy in the region. In contrast, the projections for Bulgaria, Croatia and Lithuania were raised.

Romania and Poland are expected to be the region’s top performers with growth rates of 4.2% and 3.5%, respectively. On the flip side, Croatia and Hungary are expected to grow at the slowest rates, with more tepid expansions of 1.8% and 2.0%.

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CZECH REPUBLIC | Economic indicators paint positive picture

Government spending associated with the 2007–2013 EU structural funding program boosted GDP growth last year, as public investment increased in order to absorb the funds by the end of 2015. As a result, the Czech economy is expected to decelerate sharply this year in the absence of such a surge in investment spending. The 2014-2020 program is now underway and in order to avoid oscillations in growth, the IMF has stated that the Czech Republic must strengthen its ability to absorb such funding more evenly across the length of the program. Despite the anticipated slowdown, recent data suggest that the Czech economy is performing well. The labor market continues to improve and industrial production increased abruptly in April. Economic sentiment in June declined, however, as Brexit concerns likely affected confidence.

Although the economy is expected to decelerate this year as investment growth slows, strong private consumption growth should support a robust expansion. Uncertainties pertaining to the European refugee crisis, the Brexit vote and financial market turmoil all 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 picking up to 2.7%. 

HUNGARY | Fiscal stimulus to shore up growth likely in the pipeline

Hungary’s economy slowed notably in the first quarter of this year. While the country figured among the EU’s fastest-growing economies in recent years—driven by strong monetary and fiscal stimulus along with solid EU funding—Q1’s slump was caused by a decrease in the EU funding the country had enjoyed and weakness in the automotive sector. Incoming indicators suggest that Q1’s weakness was transitory and that the economy regained momentum in Q2. Industrial production and exports both rebounded in April as they benefitted from a pickup in the vital car industry. Additionally, April’s drop in the unemployment rate to a multi-year low bodes well for private consumption. Meanwhile, in June, economy minister Mihaly Varga signaled that another fiscal stimulus package may be on the cards for the fall in order to shore up growth.

Strong monetary and fiscal stimulus will continue to support the economy this year, but will likely not be able to prevent a slowdown on the back of shrinking fixed investment. FocusEconomics Consensus Forecast panelists see GDP expanding 2.0% this year, which is down 0.2 percentage points from last month’s forecast. For 2017, the panel projects a 2.6% expansion. 

POLAND | Falling sentiment hits zloty

Latest developments were a mixed bag for the Polish economy. GDP expanded at the slowest pace in two years in Q1 driven by a collapse in fixed investment due to reduced EU funds, lackluster public spending and weakness in the external sector. While indicators from April and May suggest an uptick in Q2, political developments are worrisome. Poland did not meet the mid-June deadline to respond to the EU’s negative opinion under its rule of law procedure, which mainly criticized government actions concerning the functioning and composition of the constitutional court, and this could weigh on market sentiment. The UK’s Leave vote was also bad for sentiment. Key concerns include the appreciation of the Swiss franc, as Polish citizens own broadly USD 36 billion in Swiss franc-dominated mortgages, and a potential decline in EU funding. These concerns were reflected in the zloty depreciating to a four-month low against the euro following the Brexit vote.

While lower taxes and looser fiscal policy will be supportive for growth, uncertainties in the political landscape pose a downside risk. Our panelists expect the economy to expand 3.5% in 2016, which is down 0.1 percentage points from last month’s forecast. For 2017, the panel also sees economic growth of 3.5%. 

See the Full FocusEconomics Central and Eastern Europe Report

ROMANIA | Growth likely remained solid in Q2

The Romanian economy accelerated to a seven-year high in 2015 thanks to a strong fiscal stimulus. The economy remains on a solid footing as tax cuts and wage hikes for public employees earlier this year have spurred a consumption boom. Revised data show that the economy expanded a solid 4.3% annually in Q1, exceeding Q4’s 3.8% growth and matching the preliminary estimate. High-frequency data confirm that the positive momentum from Q1 carried over well into Q2 and domestic demand dynamics remain healthy. Retail sales and industrial production expanded robustly in April, with the former tallying double-digit growth rate. In May, unemployment remained fairly low.

Growth this year will be fueled by strong private consumption. However, widening fiscal and current account deficits pose downside risks. Panelists participating in the FocusEconomics Consensus Forecast expect the economy to grow 4.2% this year, which is unchanged points from last month’s forecast. In 2017, the panel foresees economic growth moderating to 3.6%.

INFLATION | Consumer prices fall deeper into negative territory

Almost all of the economies in the CEE region continued to face falling prices in May. An estimate elaborated by FocusEconomics indicates that consumer prices declined 1.1% in May over the same month of the previous year, which was a more pronounced fall than April’s 0.9% drop.

Our panel sees prices continuing to linger in negative territory and expects that inflation will not return to the region until 2017. Economists surveyed this month by FocusEconomics see prices falling 0.1% annually in 2016, which represents a downward revision from the flat growth expected last month. The reduction in this month’s projection reflected cuts to the inflation expectations for 6 of the 11 economies in the region. Hungary was the only country to see its forecast raised. Going forward, forecasters predict that inflation will average 1.7% in 2017.

See the Full FocusEconomics Central and Eastern Europe Report

Written by: Angela Bouzanis, Senior Economist

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