South Eastern Europe Economic Forecast

Economic Snapshot for South-Eastern Europe

July 3, 2019

The Turkish downturn set to drag on regional activity

A prolonged downturn in the Turkish economy is seen weighing on regional economic activity and masking otherwise still-solid fundamentals; chiefly, tightening labor markets and robust wage gains should support private consumption. Lingering trade and geopolitical tensions, slowing EU growth and a potential further deterioration in Turkey cloud the regional outlook.

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Turkey Economic Outlook

In mid-June, Moody’s downgraded Turkey’s credit rating owing to an increased balance of payment risk, while the economy likely remained in the doldrums in Q2. Industrial production fell again in April due to ongoing weakness in the manufacturing sector, further underlined by May PMI data showing an intensifying downturn in the sector. Retail sales continued to fall in April, while weak credit growth through May and pervasive consumer pessimism through June suggest household spending was downbeat in the quarter. Feeble domestic demand was further highlighted by the year-on-year narrowing current account deficit in April, which was mainly due to faltering imports. On the political front, the opposition candidate Ekrem Imamoglu convincingly won the re-run of the Istanbul mayoral election on 23 June. Following a year of economic malaise, the result symbolizes the weakening of Erdogan’s support base.

Collapsing domestic demand will see the economy contract this year as high inflation, rising unemployment and a depreciating lira continue to eat into consumer spending. In the final stages of the year, however, the economy should bounce back as inflation eases and the Central Bank loosens credit conditions. Currency volatility and geopolitical tensions cloud the outlook, however.

FocusEconomics Consensus Forecast panelists expect the economy to shrink 1.4% in 2019, which is down 0.1 percentage points from last month’s forecast, and to expand 2.6% in 2020.

Romania Economic Outlook

The economy grew at the fastest pace in more than a year in the first quarter on red-hot domestic demand. Household spending powered the expansion, buttressed by a tight labor market, while fixed investment rebounded on what appeared to be an improved absorption of EU-linked structural funds. In contrast, exports slowed in Q1, on hobbled demand from the Eurozone. Turning to the second quarter, momentum seems to have moderated a notch. Softer retail sales growth in April hint that spending took a breather. Meanwhile, the current account deficit widened further in April, as merchandise imports once again surpassed exports. In the political arena, Prime Minister Viorica Dancila was elected leader of the ruling Social Democrats (PSD) at the party’s congress on 29 June, after surviving a no-confidence vote in mid-June.

Growth is projected to continue cooling this year despite recovering fixed investment as slower employment growth and labor shortages weigh on domestic demand. Rising labor costs will further restrain growth, while fiscal and current account deficits will remain a concern going forward, especially in the event of a downturn in the EU economy.

Our analysts see growth at 3.7% in 2019, which is up 0.2 percentage points from last month’s forecast, and at 3.0% in 2020.

Croatia Economic Outlook

Momentum seems to have held up quite well in the second quarter, after domestic demand drove an upturn in the first quarter. Healthy wage growth in April, coupled with improving consumer confidence and a falling unemployment rate in the first two months of the quarter, suggests household spending remained in the driver’s seat. Moreover, record tourist numbers over the Easter period point to a strong external sector. That said, softer business sentiment in April−May, on average, indicates investment growth could have peaked in Q1. Meanwhile, last year’s fiscal outperformance and favorable macro conditions prompted Fitch Ratings to raise the country’s rating to investment-grade level on 7 June, by one notch to BBB-, with a positive outlook. On the political front, after meeting with EU officials, Prime Minister Andrej Plenković said the country could join the European ERM II within a year, a prerequisite for joining the Euro area.

Growth ought to remain solid this year, supported by robust domestic demand and a positive performance in the important tourism sector. Investment activity will be boosted by rising EU fund inflows, while a tighter labor market will spur consumer spending. Weaker-than-expected growth in Italy and Germany—the country’s main trading partners—pose downside risks.

FocusEconomics analysts expect growth of 2.9% in 2019, which is up 0.4 percentage points from last month’s forecast, and 2.5% in 2020.

South-Eastern Europe Monetary & Financial Sector News

Inflation in the region eased to 10.5% in May from 11.0% in April on the back of softer price pressures across most countries in the region, partly on lower oil prices and waning economic momentum. In the months ahead, inflation should continue to ease mainly on the back of muted domestic demand in Turkey; however, currency volatility remains a key risk to the outlook.  

Regional central banks stayed put in recent weeks amid lingering external downside risks and dovishness among core central banks. Turkey’s Central Bank, however, effectively loosened monetary conditions trough a lira liquidity facility in mid-June and is expected to cut its policy rate in the months ahead, pushing the average regional interest rate down.

Regional currencies are largely seen losing ground against the USD as the European Central Bank turned more dovish; most currencies in the region are pegged to the euro. Moreover, the free-floating currencies of Turkey, Romania and Albania should also depreciate—the depreciation of the lira and leu in particular should cause the average regional exchange rate to weaken.

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