CEE economy grows at slowest pace in over one year in Q1

July 5, 2016

The economies of Central and Eastern Europe (CEE) had a soft start to the year, more complete data showed. In Q1, regional GDP growth fell from Q4’s 3.7% to 2.9% over the same quarter of last year. The result marked the weakest growth since Q4 2014 amid a sharp slowdown in EU development funds along with unfavorable external conditions.

Looking at the individual countries in the region, growth fell to a two-year low in Poland, the region’s largest economy. A pick-up in private consumption, which has benefited from improving labor market conditions, did not compensate for contracting investment and surging imports, which drove the slowdown. The Czech Republic and Hungary also lost steam, with the latter expanding at the slowest pace since Q1 2013. In contrast, Romania was a bright spot in the region and grew at the fastest pace in over one year.  

Despite the soft start to the year, buoyant private consumption and improving exports should support a pick-up in growth going forward and the FocusEconomics panel foresees expansions of 3.0% in Q2 and 3.2% in Q3. However, lower EU developmental funds will likely continue to weigh on the region’s performance and a number of risks are casting a shadow on the outlook. Significantly, as the United Kingdom’s 23 June vote on whether to remain in the EU comes closer, the consequences of a ‘Brexit’ are taking center stage. The impact that Britain leaving the EU could have is unknown and would likely rattle financial markets, which could put the region’s bonds and currencies under pressure. Meanwhile, in Poland, controversial political policies continue to cast a shadow on the country’s prospects and a number of uncertainties remain regarding the government’s plan to solve a burden of USD 35 billion in Swiss franc-mortgages. A proposal is expected to be presented to the Parliament by the end of June and at this time, the consequences for the country’s banking sector are unknown. 

See the Full FocusEconomics Central and Eastern Europe Report

Region’s growth prospects remain stable

After growing at the fastest pace since 2008 last year, the economy of Central and Eastern Europe has lost some steam in 2016, although growth will remain solid overall. The slowdown in EU funds will hamper investment in the region, although private consumption will continue to benefit from favorable tailwinds. Forecasters surveyed by FocusEconomics foresee a solid 3.1% expansion in 2016, which is in line with last month’s forecast. Key downside risks to the forecast include slower-than-expected Eurozone growth, faster-than-expected tightening of U.S. interest rates and rising political uncertainty. 

This month’s outlook reflects unchanged growth prospects for 5 of the 11 economies surveyed, including Poland, the largest economy in the region. Romania’s forecast was raised this month, while analysts cut their projections for Hungary.

Romania and Poland are expected to be the region’s top performers with growth rates of 4.2% and 3.6%, respectively. On the flip side, Croatia and Slovenia are expected to grow at the slowest rates, with more tepid expansions of 1.7% and 2.1%.

CZECH REPUBLIC | Plummeting investment drives GDP slowdown

As part of the 2007–2013 EU structural funding program, the Czech Republic was allocated EUR 26.7 billion in EU funds, which had to be absorbed by year-end 2015. This resulted in a surge in public investment throughout last year, which boosted GDP growth to an eight-year high. The sharp increase in investment was transitory, however, and has not carried through into 2016 and economic growth decelerated in Q1 from 4.0% in Q4 to 3.0. However, there is still much to be positive about in the Czech economy. The labor market has firmed up since the beginning of the year, with the unemployment rate dropping to an over-seven-year low in April, and economic sentiment improved in May.

Growth is expected to slow substantially this year, although the economy will still likely post robust expansions as a broader recovery in the Eurozone takes hold. Consumption was the main driver of growth in Q1 and it should continue to support the economy as the labor market improves. 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 | Improved external position fuels rating upgrade

Hungary’s economy shifted into lower gear in Q1, with GDP decelerating sharply and recording the smallest annual expansion in three years. According to preliminary data, weakness in the construction and industry sectors caused the slowdown. While a breakdown by expenditure is still outstanding, a notable drop in investment due to lower absorption of EU funds was likely behind the disappointing result. Nevertheless, Q1’s dip was likely temporary and GDP growth is expected to pick back up in Q2. On a positive note, Hungary recovered its Fitch investment-grade status as the agency lifted the country’s rating from BB+ to BBB- in May. Key reasons for the upgrade include a notable improvement in Hungary’s external balance sheet, reduced external vulnerability, a gradual decrease in public debt and a more stable banking sector.

Following the release of the weak Q1 GDP data, FocusEconomics Consensus Forecast panelists revised Hungary’s economic growth forecast down for this year by 0.2 percentage points and now see GDP rising 2.2%. For 2017, the panel projects a 2.7% expansion. 

POLAND | Plunging investments behind weakest growth in over two years

Poland’s economy started 2016 on a weak footing as in Q1 GDP expanded at the slowest pace in over two years. Fixed investment deteriorated notably on the back of reduced EU funds, public spending decelerated and the external sector weakened in Q1. Conversely, private consumption, which has been the backbone of Poland’s strong performance in recent quarters, remained solid. Data from April and May were more encouraging and point to a pickup in Q2. In April, industrial production and retail sales strengthened notably, while the unemployment rate continued to fall. Businesses remained confident and the PMI pointed to expansionary conditions in May. Meanwhile, Moody’s decision in May to cut the outlook on Poland’s A2 credit rating from stable to negative represents a setback for the economy. Moody’s main reasons for the cut were increasing fiscal risks due to a notable rise in expenditures and that the new Government’s shift to less predictable policies and legislation have led to a weaker investment climate.

Poland’s economy is set for another fast expansion this year thanks to its solid economic fundamentals. However, uncertainties surrounding the new government’s policies represent a downside risk. Our panelists expect the economy to expand 3.6% in 2016, which is unchanged from last month’s forecast. For 2017, the panel sees economic growth broadly stable at 3.5%.

ROMANIA | Fiscal stimulus boosts economy

The Romanian economy accelerated to a seven-year high in 2015 thanks to a strong fiscal stimulus. The economy remains on a strong footing as tax cuts and wage hikes for public employees earlier this year have spurred a consumption boom. Preliminary data show that the economy expanded a solid 4.3% annually in Q1, exceeding Q4’s 3.8% growth. The government’s expansionary fiscal policy has raised concerns in the EU Commission that the country could violate the bloc’s fiscal responsibility rules, but most analysts see the fiscal deficit staying in line with the 3.0% limit. 

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 up 0.1 percentage points from last month’s forecast. In 2017, the panel foresees economic growth moderating to 3.6%. 

See the Full FocusEconomics Central and Eastern Europe Report

INFLATION | Consumer prices fall deeper into negative territory

The majority of the economies in the CEE region continued to face falling prices at the start of Q2. An estimate elaborated by FocusEconomics indicates that consumer prices declined 1.0% in April over the same month of the previous year, which was a slightly more pronounced fall than March’s 0.9% drop. Low oil prices have driven eleven consecutive months of falling prices and have led to record low interest rates in the region.

Price pressures are expected to remain contained this year and not pick-up significantly until 2017. Economists surveyed this month by FocusEconomics expect zero inflation in 2016, which represents a downward revision from the 0.1% expected last month. The reduction in this month’s projection reflected cuts to the inflation projection for 6 of the 11 economies in the region. Croatia was the only country to see its forecast raised. Going forward, forecasters predict that inflation will average 1.7% in 2017.

Written by: Angela Bouzanis, Senior Economist

 

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