Central & Eastern Europe Economic Outlook October 2016

Economic momentum firms, all eyes on U.S. elections

Central & Eastern Europe: Economic momentum firms, all eyes on U.S. elections

October 5, 2016

Growth momentum seems to have firmed in the economies of Central and Eastern Europe (CEE). Robust consumption boosted GDP growth in the second quarter and the economy expanded 3.3% over the same period last year, up from the 2.9% increase in Q1. Continued improvements in labor markets, accommodative monetary policy and fiscal loosening are supporting the domestic economy and high frequency indicators suggest that growth has remained buoyant in Q3. Retail sales data has picked up notably in Poland—the region’s largest economy—as households are benefiting from the government’s ‘Family 500 plus’ benefit scheme, while public sector wage hikes and other stimulus measures have contributed to a spending spree in Romania, one of the region’s bright spots. Although investment is expected to remain a sore point due to a lower drawdown of EU developmental funds, fears of a Brexit-induced shock to the region’s economy have yet to materialize. The FocusEconomics panel of analysts sees regional GDP growth moderating slightly to 3.1% in Q3.     

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In addition to the favorable domestic economic environment, political risks from domestic politics have abated recently in CEE. The results of the 11 September snap elections in Croatia point to a market-friendly government, although a coalition has yet to be formed. The conservative Croatian Democratic Union party (HDZ) won the most votes and will likely renew its alliance with the centrist Bridge of Independent Lists (MOST). The end of the political deadlock that has gripped the country over the past year should bode well for Croatia’s economy as the government can now turn its attention to much-needed economic reforms. In Hungary, the low turnout for the 2 October referendum against EU migrant quotas was a setback to Prime Minister Viktor Orbán and should interfere with the government’s ability to demand changes from EU authorities—reducing potential tension in the Union. In Poland, the government’s market-friendly proposal of how to convert foreign-currency mortgages has soothed market analysts’ fears of a large shock to the country’s lenders. It also underscored how earlier worries over the government enacting controversial policies may have been overblown.

While a tentative calm has emerged in domestic politics, external risks to the region’s outlook are sharpening. A surprise outcome to the United States’ tumultuous presidential election in November would increase volatility in the financial markets, sparking a rush to safe haven assets, which could spur a selloff of CEE assets. In addition, an expected increase in U.S. interest rates has the potential to hurt CEE financials and tighten global liquidity conditions. Brexit negotiations expected in 2017 are also likely to send shockwaves through financial markets.  

Growth outlook unchanged on solid domestic demand data

This month, the economic growth prospects for Central and Eastern Europe were stable for the second consecutive time. Positive data from the domestic economy continues to shore up the region’s growth prospects despite an unpredictable external backdrop. Solid household spending as well as fiscal and monetary stimulus will support robust growth in the region, despite substantial weakness in fixed investment. Panelists surveyed by FocusEconomics project a 3.0% expansion in 2016, which is unchanged from last month’s forecast. Next year, our panel foresees steady growth of 3.0%.

This month’s outlook reflects that upward revisions to the growth prospects for 6 of the 11 economies surveyed were balanced out by three downgrades. The GDP projections were revised up for BulgariaCroatiaHungaryRomaniaSlovakia and Slovenia, while the region’s largest economy—Poland—along with Estonia and Lithuania experienced downgrades. No changes were made to the forecasts for the Czech Republic and Latvia.

Romania will likely be the region’s fastest-growing economy this year, with an expected expansion of 4.7%. Poland and Slovakia are also seen achieving fast growth rates of above 3.0%. On the other side of the spectrum, CroatiaEstoniaHungaryLatvia and Slovenia are expected to be the CEE region’s laggards, with expected expansions of around 2.0%. 

See the Full FocusEconomics Central and Eastern Europe Report

CZECH REPUBLIC | Labor market gains bode well for private consumption

GDP growth remained healthy but decelerated in Q2, mainly due to the drying up of EU investment funds. On the upside, the external sector continued to be a bright spot. High-frequency data for Q3 paint a mixed picture. Industrial production plunged in July, although the data were distorted by company-wide holidays. In September, the Manufacturing PMI moved further into positive territory, but it nevertheless remains at historically low levels after showing significant volatility in the past few months. In more positive news, economic sentiment improved in September and hit a seven-month high, reflecting substantial stability in business sentiment and a significant advance in consumer confidence. In August, unemployment declined, remaining at historically low levels. The labor market is in good shape, which is pushing up wages. This, together with low inflation, is increasing disposable income.

The economy will lose steam this year, dragged down by declining investment, but solid private consumption and buoyant exports will still guarantee a healthy pace of growth. The main downside risks come from the slowdown in the EU economy and the drying up of FDI that could stem from a badly handled Brexit. Panelists see GDP growth of 2.5% in 2016, which is unchanged from last month’s forecast. For next year, they see growth ticking up to 2.6%.

HUNGARY | Improved growth and fiscal stance lead to ratings upgrade 

Hungary’s economy regained traction in Q2, expanding 2.6% in annual terms (Q1: +1.1%). A notable rebound in the external sector, which was supported by a recovery in the auto industry, and buoyant private consumption helped to overcome a sharp contraction in fixed investment due to lower EU funding. The picture for Q3 is mixed. A strengthening labor market, as evidenced by July’s multi-year low unemployment rate, bodes well for household spending. However, signs for caution came from July’s slumps in industrial production and exports as well as September’s subdued economic sentiment. S&P Global Ratings surprisingly decided to upgrade Hungary’s credit rating to investment grade in September, citing improvements in economic growth and the country’s fiscal position. The forint appreciated in response to the upgrade. In the political arena, 98% of the voters who participated in a referendum on 2 October voted against EU migration quotas. However, the low turnout of 40% made the result unbinding and represents a setback for Prime Minister Viktor Orbán.

A sharp deceleration in fixed investment will cause GDP growth to slow this year. The economy will still expand at a robust pace, on the back of healthy private consumption, fiscal stimulus and loose monetary policy. Our panelists forecast that Hungary’s economy will expand 2.1% this year, which is up 0.1 percentage points from last month’s projection. For 2017, they see GDP growth picking up to 2.6%.

POLAND | Government stimulus supports growth

Poland’s economy likely kicked into a higher gear in Q3, after recording weak growth in H1. High frequency data point to surging consumption and retail sales expanded at the fastest pace in over two years in August. Behind the rise is a tightening labor market and the government’s ‘Family 500 plus’ benefit scheme, which began providing cash injections to families in July. While government stimulus should shore up the domestic economy in the face of flagging investment, concerns over the size of the fiscal deficit are high. In September, the European Commission ordered Poland to suspend a new tax on supermarkets, which is under investigation for breaking EU rules. In addition, the revenue estimates in next year’s expansionary budget seem overly optimistic and the budget is based on a higher growth estimate than that projected by FocusEconomics.

A reduced drawdown of EU development funds will hamper investment and Poland’s economy is expected to decelerate somewhat this year. The FocusEconomics panel sees GDP expanding 3.1% this year, which is down 0.1 percentage points from last month’s projection. For 2017, the panel sees economic growth inching up to 3.3%..

See the Full FocusEconomics Central and Eastern Europe Report

ROMANIA | Corruption scandals increase political uncertainty

An expansionary fiscal policy, public sector wage hikes and low prices have spurred a consumption spree. Revised data confirmed that annual economic growth in Q2 accelerated to an almost eight-year high of 6.0%, making Romania the most dynamic economy in the region. The latest indicators suggest that the positive momentum from Q2 carried over into Q3. While industrial production faltered in July, retail sales logged another double-digit expansion and unemployment came in at an over eight-year low in August, pointing to a still-solid domestic economy. The political arena has, however, been more turbulent. The leader of Romania’s Liberal Party, the country’s second-biggest party, stepped down in late September over corruption allegations. The resignation is expected to weaken the party just months shy of the 11 December parliamentary elections. 

Although strong domestic demand will support growth and shield Romania from economic headwinds, Brexit-related uncertainties and waning growth in the Eurozone pose downside risks in the short-term. Growing macroeconomic imbalances such as a deterioration in the public and external accounts constitute medium-term risks to the outlook. Panelists expect the economy to grow 4.7% this year, which is up 0.2 percentage points from last month’s forecast. In 2017, the panel foresees economic growth moderating to 3.5%.

INFLATION | Annual decline in consumer prices moderates in August

In August, consumer prices posted the smallest fall in annual terms since December, as the effect of low oil prices waned. According to an estimate elaborated by FocusEconomics, consumer prices fell 0.3% in August over the same month of last year, which followed July’s 0.5% drop. While the variation in prices was negative in most countries, three of the region’s economies recorded inflation.

Price pressures will likely remain muted throughout this year and only increase very gradually. The panelists polled this month by FocusEconomics expect that consumer prices will drop an annual 0.3% in 2016, which is down 0.1 percentage points from last month’s projection. This month’s outlook reflected downward revisions to the inflation forecasts for five countries in the region. The remaining six countries, including regional heavyweight Poland, saw no change to their inflation outlook. Analysts expect that inflation will return to the CEE region next year, forecasting average inflation of 1.6%. 

See the Full FocusEconomics Central and Eastern Europe Report

Written by: Angela Bouzanis, Senior Economist

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