Economic Snapshot for South-Eastern Europe

September 5, 2018

Economic growth ebbs in Q2, currency crisis in Turkey threatens outlook

According to a preliminary estimate by FocusEconomics, South-Eastern Europe’s (SEE) economy lost steam in the second quarter and grew 4.0%, down notably from Q1’s 5.4% expansion. This is largely due to an expected sharp slowdown in regional powerhouse Turkey, which accounts for around half of the region’s GDP. All Turkish indicators from the quarter, such as the manufacturing PMI, business sentiment and retail sales, corroborate this picture.

In contrast, recent data shows that the region’s other economies performed well, supported by healthy domestic demand. Serbia’s economy recorded another quarter of stellar growth, thanks to soaring fixed investment and solid wage growth which buoyed private consumption. An upward revision to Q1’s GDP reading means growth in H1 has averaged close to 5%, among the fastest in South-Eastern Europe.

In a similar vein, a flash estimate for big hitter Romania shows growth momentum was maintained. Although a detailed breakdown of the reading has yet to be published, sturdy retail sales figures throughout the quarter suggest private consumption was a key driver, as consumers enjoyed bumper wage gains. In Bulgaria, growth in the second quarter was supported by private consumption, while the Croatian economy accelerated in Q2 on the back of a rebound in exports.

Looking to the third quarter, most economies in the region are likely to maintain a robust growth trajectory, supported by solid activity domestically and strong external demand. However, recent developments in Turkey will likely once more cause growth in Q3 for SEE as a whole to slow abruptly. The Turkish lira has collapsed over the last month amid rising tension with the U.S., magnifying difficulties for the country’s corporates who have borrowed in foreign currency, sowing economic uncertainty and raising concerns about the vulnerability of the banking sector. Attempts by the government and Central Bank to restore order in the FX market have so far proved fruitless.

The latest indicators for the Turkish economy make for grim viewing. In August, the manufacturing PMI moved further into contractionary territory and economic sentiment among consumers and firms tanked, while vehicle sales plummeted in July.

On the political front, Macedonians will vote in a referendum on 30 September over whether to back the country’s name change recently agreed between the Macedonian and Greek governments. If voters give the proposal their blessing, this would open the door to EU accession.

Growth seen decelerating markedly through the remainder of the year on worsening dynamics in Turkey

The regional economy is seen expanding 3.6% this year, down 0.1 percentage points from last month’s projection, and 3.0% in 2019. However, 2018’s full-year outturn will be largely thanks to a positive H1, and growth is set to decelerate in the second half. Turkey’s economy looks to be deflating rapidly on worsening economic sentiment, tighter financial conditions and soaring inflation. In contrast, the region’s other economies should continue to perform well, supported by wage gains, a stronger absorption of EU funds, healthy tourist arrivals and robust external demand for goods. External risks stem largely from greater global trade protectionism and a possible sharp slowdown in the EU, while a continuing deterioration of economic conditions in Turkey is the key internal risk.

This month, panelists revised up their 2018 growth forecasts for Bulgaria and Serbia, while downgrading their projections for Bosnia, Macedonia and Turkey. Forecasts for the region’s remaining economies for this year were unchanged.

Kosovo and Romania are expected to record the fastest growth among the region’s major economies, at 4.1%. At the other end of the spectrum, Greece is projected to record the weakest expansion in the region, with 2.0% growth.

See the Full FocusEconomics South-Eastern Europe Report

TURKEY | Economy is losing momentum fast amid recent chaos in the currency market

The most recent indicators suggest the economic panorama is darkening rapidly. In August, business and consumer sentiment nosedived and the manufacturing PMI moved deeper into contractionary territory on lower output and new orders, while vehicle sales plunged by over 50%. Economic imbalances remain glaring: Inflation continued to flare in August and the budget deficit surged in the first seven months of the year thanks to election-campaign spending. Most alarmingly, the lira has collapsed in recent weeks, triggered by the announcement from the U.S. administration that it would double tariffs on Turkish steel and aluminum. This has made the corporate external debt burden far more onerous and raises fears of defaults. A series of regulatory changes and Finance Minister Berat Albayrak’s promise to restore fiscal discipline have done little to support the currency in the absence of decisive action by the Central Bank.

Economic growth will likely decelerate markedly in the next few quarters on tighter financial conditions, crumbling sentiment and sky-high inflation. Further exchange rate volatility and an escalation of geopolitical tensions pose significant downside risks. FocusEconomics panelists expect growth of 4.0% this year, down 0.2 percentage points from last month’s estimate. They see growth of 3.0% in 2019.

ROMANIA | Private consumption likely spurs growth in Q2, risks from fiscal slippage remain

Economic growth edged up in the second quarter in annual terms according to recent figures. Although a detailed breakdown has not yet been released, monthly data suggests that the expansion was driven by household expenditure, as highlighted by solid retail sales growth throughout the quarter, while fixed investment growth likely slowed. Private consumption is likely to have been supported by still-low unemployment and strong wage growth through June. On the external front, despite strong merchandise export growth, the trade deficit rose in the second quarter year-on-year on strong imports. In August, Moody’s confirmed the country’s Baa3 credit rating with a stable outlook, citing robust growth potential and a low public debt ratio that ranks among the lowest in the European Union. However, the agency also warned that current pro-cyclical fiscal policy could gradually erode fiscal strength. In the same month, a multi-day anti-corruption protest erupted with protesters demanding that Prime Minister Viorica Dancila resigns amid a backlash over changes to the country’s criminal code.

Growth should be solid going forward but will gradually tail off from 2017’s extraordinarily high level on slower private and government consumption growth. Risks to the outlook stem from widening fiscal and current account deficits. FocusEconomics panelists expect growth of 4.1% for 2018, which is unchanged from last month’s forecast, and

BULGARIA | Economic growth stays solid in the second quarter

The economy grew robustly in Q2 compared to the same quarter a year earlier, although at a slightly slower pace than in Q1, according to a preliminary estimate released by the Statistical Institute. An increase in total consumption, which grew at the fastest rate in two-and-a-half years, drove growth. This was partly due to an over 6% increase in real household incomes, which benefited from higher wages and salaries on the back of a tightening labor market. Meanwhile, fixed investment expanded at a solid pace in Q2, although less than in Q1, supported by low interest rates and economic optimism among businesses. On the external front, as imports of goods and services increased faster than exports, the external sector weighed slightly on overall economic growth in Q2. Looking towards Q3, while growth is likely to remain robust, there are mixed early signals: In July, the unemployment rate remained at June’s multi-decade low, which is likely to support household spending, while business confidence fell for the first time in nearly two years.

Household spending should benefit from lower unemployment and strong wage growth this year. Increased EU funding is expected to buttress fixed investment, which should see further support from an improved business climate and low interest rates. Sound fiscal policy should also secure stronger FDI inflows. FocusEconomics analysts expect growth of 3.7% in 2018, up 0.1 percentage points from last month’s forecast, and 3.4% in 2019.

See the Full FocusEconomics South-Eastern Europe Report

CROATIA | Stronger external sector boosts growth in the second quarter

Recently released GDP data revealed that the economy shifted into a higher gear in Q2, following a solid Q1 performance that was mainly driven by buoyant domestic demand. In contrast, the second-quarter expansion was propelled by the external sector, as exports of goods and services rebounded sharply and outpaced the growth in imports. On the domestic front, private consumption lost some steam but remained robust overall, buttressed by a tightening labor market—the unemployment rate fell throughout the quarter and reached a new all-time low in June—and robust real wage gains which have translated into higher purchasing power for households. Heading into Q3, leading data paints a mixed picture: While consumer confidence improved in July, business sentiment turned less upbeat. That said, however, another likely record-breaking tourism season this year coupled with FIFA World Cup-related surge in consumer spending should prop up overall economic activity in Q3.

Healthy private consumption, supported by a tight job market and rising real wages, and a booming tourism industry are seen as the key drivers of growth this year. Given strong consumer and capital spending and their associated rise in import demand, however, the external sector may drag on overall economic performance. Meanwhile, a key downside risk to the short-term outlook stemming from a disorderly restructuring of the food and retail giant Agrokor, Croatia’s largest private employer, has faded after creditors reached a debt settlement deal in late July. FocusEconomics panelists project GDP growth of 2.7% in 2018, unchanged from last month’s forecast, and 2.7% again in 2019.

INFLATION | Inflation stabilizes in July

In July, regional inflation was unchanged at 9.3%. Higher inflation in Bulgaria, Kosovo, Macedonia, Serbia and Turkey was offset by lower price pressures in Albania, Bosnia and Herzegovina, Croatia, Greece and Romania. In August, inflation in Turkey soared to nearly 18%, which will likely push up regional inflation.

Regarding monetary policy, Turkey’s Central Bank has refrained from raising its main policy rate—the one-week repo rate—despite the plunging lira. The Bank has instead opted to force banks to borrow at its overnight rate, currently at 19.25%, which marks an effective tightening of its monetary stance. On 3 September the Bank made clear that it would tighten its stance further at its 13 September meeting. In contrast, Macedonia’s Central Bank cut rates by 25 basis points to 2.75% following a 14 August policy meeting, in order to support the economy and in view of mild price pressures.

Inflation in the SEE region is expected to average 8.4% this year, a significant upward revision from last month’s 8.0%, mainly on higher expected inflation in Turkey. In contrast, inflation forecasts for Montenegro and Serbia were cut this month. With the exception of Turkey and Romania, price pressures will be mild across the region. In 2019, regional inflation is expected to moderate to 7.4%, with the regional average again distorted by elevated price pressures in Turkey.  

See the Full FocusEconomics South-Eastern Europe Report

Oliver Reynolds

Economist