Economic Snapshot for South-Eastern Europe

October 31, 2018

Regional economy likely lost steam in the third quarter

According to an estimate by FocusEconomics, South-Eastern Europe’s (SEE) economy lost steam in the third quarter and grew 2.6% annually, down notably from Q2’s 4.3% expansion. The slowdown was likely driven chiefly by a moderation in growth in regional powerhouse Turkey, which accounts for around half of the region’s nominal GDP.

Although comprehensive national accounts figures are still outstanding, Turkey’s economy appeared to have a torrid third quarter, rattled by the lira’s collapse which raised corporates’ external debt burdens and sent inflation skyrocketing. Consumer and business confidence have plummeted, and retail sales, industrial production and manufacturing PMI readings have deteriorated sharply.

That said, over the last month there have been some positive developments in Turkey. The lira has clawed back some ground against the dollar, the government acknowledged the need for more constrained fiscal policy in its New Economic Plan published in late September, and the release of a U.S. pastor in early October has tempered seething political tensions with the U.S. However, exchange rate and financial volatility could quickly resume, particularly if the government does not follow through on its promise to rein in spending, the central bank loosens its stance prematurely, or political tensions resurface.

Elsewhere in the region, economies likely performed well, buoyed by wage and employment gains; healthy fixed investment; robust European Union demand for the region’s exports; and strong tourist inflows.

On the political scene, Bosnia and Herzegovina held elections on 7 October for the three-person presidency and the lower house of parliament. Regarding the parliamentary elections, voting ran along ethnic lines and Serb nationalist politician Milorad Dodik—who is advocating the secession of the Serb Republic—won one of the presidential seats. The outcome is likely political instability and legislative gridlock, which could hamper economic reforms.

In Macedonia, in mid-October parliament voted to begin the process of amending the constitution in order to change the country’s name. If the name change becomes reality, it would open the door to EU accession and boost Macedonia’s economic prospects. Greece had vetoed the country’s bid to join the EU over the name dispute. 

Further slowdown likely over next few quarters due to dynamics in Turkey

The regional economy is seen expanding 1.8% next year, down 0.2 percentage points from last month’s projection and marking a substantial slowdown from 2018. More sluggish growth next year will be largely due to a weak performance from Turkey, as high inflation and tight financial conditions hit consumer spending. Moreover, growth is also likely to slow in regional heavyweights Romania and Serbia, albeit staying robust. Turkey aside, South-Eastern Europe’s economy will be supported by wage gains, EU investment, healthy tourist arrivals and robust external demand for goods. External risks stem largely from greater global trade protectionism. Internally, another bout of financial instability in Turkey is a key risk. In 2020, growth is seen recovering to 3.0%.

This month, panelists revised down their 2019 growth projections for Greece, Kosovo, Romania and Turkey, while upgrading their forecasts for Bulgaria, Cyprus, Montenegro and Serbia. Forecasts for the region’s remaining economies were unchanged.

Kosovo is expected to record the fastest expansion next year, while Turkey is expected to be the region’s weakest performer with 0.5% growth, which would be the weakest result in 10 years.

TURKEY | Economy is softening fast; currency market sees brief period of stability

Recent indicators show the economy screeching to a halt as the effects of the currency crisis continue to reverberate. In October, consumer and business confidence moved further into pessimistic territory and marked fresh multi-year lows, although the pace of the decline slowed. Moreover, automotive sales collapsed in Q3, while industrial production and retail sales growth slowed markedly in August. More positively, the lira has gained substantial ground in recent weeks, which should lessen corporates’ external debt burdens somewhat. The appreciation has come on the back of higher interest rates, the government’s commitment to a tighter fiscal stance in the New Economic Plan, and the release of a U.S. pastor in mid-October, which soothed geopolitical tensions with the U.S. Moreover, Turkey was able to raise USD 2 billion in international bond markets recently in an oversubscribed sale, marking an early sign of a gradual return of confidence in the economy.

The economy will perform poorly next year, weighed down by restrictive financial conditions constraining private consumption and fixed investment, and the government’s tighter fiscal stance. However, the external sector should provide some support. Further exchange rate volatility and the possibility of renewed geopolitical tensions pose significant downside risks. FocusEconomics panelists expect growth of 0.5% in 2019, down 0.5 percentage points from last month’s forecast, and 3.4% in 2020.

See the Full FocusEconomics South-Eastern Europe Report

ROMANIA | Economy likely slowed in Q3, risk of further political disagreements with the EU rises

Economic activity seems to have softened further in the third quarter, following a significant cooling in H1. Continued strong inflationary pressures and slowing wage growth were probably behind the marked slowdown in retail sales in July–August, which signaled protracted weakness in household consumption. Moreover, sluggishness in using EU funds and cuts in infrastructure spending were likely behind the unremarkable performance of the industrial sector and the double-digit contraction in construction output in the first two months of Q3. Whereas economic activity is cooling, political and fiscal scenarios are overheating. In early October, the government approved a plan to more than double state pensions by 2022, putting further pressure on already worsening public finances. Furthermore, two weeks after facing strong criticism from the European Parliament for undermining judicial independence, in mid-October the government adopted an emergency decree that appears set to hinder prosecutors’ graft-fighting efforts, increasing the likelihood of further confrontations with the European institutions.

Growth is set to decelerate further in 2019. Slowing income growth due to limited productivity gains and tightening financing conditions will weigh on consumer spending, which should continue to soften. However, investment growth will gain some speed, although a slow absorption of EU funds will limit the scope of the acceleration. On top of that, increasing political uncertainty could weigh on investor sentiment, while sizeable twin deficits and possible capital flight pose further downside risks to the outlook. FocusEconomics panelists expect growth of 3.4% for 2019down 0.1 percentage points from last month’s forecast, and

BULGARIA | Economy performs well in Q3, government approves draft 2019 budget

Available data hints at another strong outturn for domestic demand in the third quarter, on the heels of a solid second-quarter performance. Household spending appears to have remained upbeat, with retail sales notching handsome gains through August and the unemployment rate hitting a fresh one-decade low in September. Moreover, despite a weak extractives sector weighing on gains in industrial output, the manufacturing sector has been recording impressive growth in recent months. Taken together with this year’s heavy absorption of EU structural funding, fixed investment looks set for another robust quarter. Meanwhile, the external sector continued to lose ground though August on waning demand from Europe; stronger imports also helped narrow the eight-month current account surplus significantly from a year earlier. In late October, the center-right government approved next year’s draft budget. Analysts see the government’s proposed boost to public-sector wages and education spending as an effort to shore up support ahead of next year’s European and local elections.

Household spending is expected to slow next year due to slower employment growth and elevated inflation. That said, fixed investment should continue benefiting from cheap borrowing and strong absorption of EU funding. Meanwhile, a pullback in global trade is likely to curb export growth. Over the medium-term, sound fiscal metrics and an improved business climate should translate into greater FDI inflows. FocusEconomics panelists expect growth of 3.5% in 2019, up 0.1 percentage points from last month’s forecast, and 2.8% in 2020.

See the Full FocusEconomics South-Eastern Europe Report

CROATIA | Government presents fiscal stimulus measures

Incoming data suggests a slight loss of momentum in the third quarter, following healthy growth through the first half of the year driven by sturdy domestic demand. After a modest rise in Q2, industrial output contracted, on average, in July–August on the back of lower production of food and metal products, pointing to a disappointing quarter for the goods-producing sector. Meanwhile, growth of retail sales cooled in the same two-month period, despite record-low unemployment and strong real wage gains, hinting at private consumption losing stride in the quarter. In the political arena, the government presented in late September to parliament a third round of tax reforms, which are set to reduce the VAT considerably on essential items and cut taxes on high-income households, potentially stimulating consumption going forward.

Strong consumer spending, underpinned by further tightening of the job market and brisk real wage growth, should keep the economy growing at a solid rate next year. A highly dynamic tourism industry, which is poised to set another record for arrivals this year, should also lend further support to economic activity and contribute to maintaining a healthy current account surplus. Key downside risks to the outlook stem from rising global trade tensions and a potential slowdown in Italy or Germany, the country’s largest trading partners, any of which could bruise external demand. FocusEconomics panelists project GDP growth of 2.7% in 2019, unchanged from last month’s forecast, and 2.5% in 2020.

INFLATION | Inflation surges in September due to price pressures in Turkey

Regional inflation increased from 10.5% in August to 13.9% in September, largely due to an intensification of price pressures in Turkey amid currency weakness. Inflation also rose in Bulgaria, Cyprus and Greece. Price pressures were stable in Macedonia and declined in the region’s remaining economies. 

Regarding monetary policy, central banks stayed put over the past month, in most instances due to muted cost pressures. In Romania, although headline inflation remains elevated and above-target, policymakers left rates unchanged due to lower core inflation. The Central Bank of the Republic of Turkey also kept rates unchanged on 25 October despite soaring inflation, citing softening domestic demand. 

Regional inflation is expected to reach 10.3% in 2019, up 0.9 percentage points from last month’s forecast, propped up by elevated price pressures in Turkey as the pass-through effect from the weak lira continues. Most of the region’s remaining economies will also see price pressures intensify, while inflation is set to dim in Romania following a demand-driven surge in 2018. In 2020, regional inflation is forecast to dip to 6.8%.

See the Full FocusEconomics South-Eastern Europe Report

Oliver Reynolds

Economist