Domestic challenges and external risks will weigh on SEE growth this year

Domestic challenges and external risks will weigh on SEE growth this year

Growth momentum lost steam in the first quarter of the year in South-Eastern Europe (SEE) amid domestic and external headwinds. The region expanded 3.5% annually in Q1, which was below Q4’s nearly-five-year high growth rate of 3.9%. Among the largest economies in the region,growth dynamics weakened slightly in Q1 in Turkey on the back of a deteriorating external sector and rising political uncertainty, which had a negative impact on investment. Moreover, the economic contraction worsened in Greece due to a broad-based deterioration, suggesting that the country is far from a quick turnaround from the crisis. On the upside, dynamics improved in Croatia, Romania and Serbia in Q1.

Taking a closer look at the region’s economies individually, Greece received its first international cash injection since last year in June. While the disbursement represents a bit of breathing room for the battered economy, the government will have to implement further austerity measures to receive another tranche in September. In Turkey, President Recep Tayyip Erdogan’s move to de-escalate political tensions with Moscow, following the downing of a Russian warplane last year, could improve the economic sentiment in Turkey going forward. However, security threats such as the terrorist attack at the Atatürk Airport in Istanbul on 28 June continue to have a devastating impact on the country’s all-important tourism industry.

The direct impact of the United Kingdom’s decision to leave the European Union is expected to be relatively mute in SEE as economic linkages are rather small. The main consequences of the Brexit will likely be through market sentiment and a potential deterioration in the Euro area’s growth prospects. That said, the impact in the mid- and long-term will largely depend on the arrangements between the Euro area and the United Kingdom. Moreover, the reduction of funds from the United Kingdom could reduce cash transfers from the Euro area to some members in the SEE region.

In the coming months, growth dynamics in the region will be dominated by rising political uncertainty in Turkey, in particular if Erdogan goes ahead with his plan to establish a presidential system, and the impact of mounting security risks in the country. Greece’s long-lasting recessionwill represent a handicap for the country’s economic outlook. Moreover, the ongoing refugee crisis has the potential to destabilize the region. Economic prospects in the SEE region will also depend on the pace of recovery of the Eurozone and further policy action by the European Central Bank. Our panel of analysts expects the SEE region to have expanded 2.5% in the second quarter.

Read our most recent news on the SEE region

OUTLOOK | Growth prospects stabilize in July

This month, the outlook for South-Eastern Europe’s economy was left unchanged following an upgrade last month. FocusEconomics panelists still expect growth in South-Eastern Europe to be 2.8%. Panel participants maintained their projections for 5 of the 12 countries in the survey stable, including RomaniaSerbia and Turkey. The outlook was revised upward for Bulgaria,Croatia and Cyprus, while panelists downgraded their views on GreeceKosovoMacedonia andMontenegro. For 2017, our panel of economists foresees the economy expanding 3.0%.

Romania’s economy is expected to grow at the fastest this year, followed by Montenegro. The worst performers are expected to be Greece, Cyprus and Croatia, in that order. Among the other major economies in the region, Turkey will likely grow the fastest, with a projected expansion of 3.4%.

See the Full FocusEconomics South-Eastern Europe Report

BULGARIA | Growth remains solid in Q2

Bulgaria’s economy decelerated slightly in Q1 as a steep fall in government spending and fixed investment offset a healthy expansion in private consumption. Meanwhile, the external sector’s net contribution to the overall economy was positive in Q1, although weaker than in Q4. Data suggest that the economy remained on solid footing in Q2. Growth in industrial production was broadly stable in April and unemployment fell for the third consecutive month in May. In the political arena, parliament passed an anti-corruption bill on 30 June, which should be fully implemented within the next six months.

The domestic economy is expected to moderate this year. However, there is a risk that negative ripple effects may emerge from the economic consequences of the Brexit. FocusEconomics Consensus Forecast participants expect GDP to expand 2.7% in 2016, which is up 0.1 percentage points from last month’s forecast. In 2017, they see growth of 2.8%.

CROATIA | Voters head to fresh elections following dissolution of Parliament

The Croatian economy gained steam in the first quarter of 2016, growing 2.7% on an annual basis (Q4: +1.9% year-on-year), thus expanding for the sixth consecutive quarter. Growth was supported by stronger private consumption and fixed investment, as well as by a less negative contribution from the external sector. Nevertheless, the positive economic momentum is endangered by the political crisis that hit the country in mid-June. On 16 June, non-partisan Prime Minister Tihomir Oreskovic lost a no confidence vote, which was put forward by the Croatian Democratic Union party (HDZ), the biggest party in the government coalition, following months of political conflicts between the HDZ and the Bridge of Independent Lists party (MOST)—the junior coalition partner. On 20 June, the crisis finally resulted in the Parliament adopting a self-dissolution decision, which will take effect on 15 July. On that date, President Kolinda Grabar-Kitarovic will have to call early parliamentary elections, which will take place within thirty to sixty days.

Robust domestic demand will support growth this year. However, the political crisis could negatively affect Croatia’s economic prospects. FocusEconomics panelists expect GDP to grow 1.8% in 2016, which is up 0.1 percentage points from last month’s forecast. The panel expects economic activity to inch up to 1.9% growth in 2017.

ROMANIA | Policy support continues to propel growth in Q2

The Romanian economy accelerated to a seven-year high in 2015 thanks to a strong fiscal stimulus. The economy remains on a solid footing as tax cuts and wage hikes for public employees earlier this year have spurred a consumption boom. Revised data show that the economy expanded a solid 4.3% annually in Q1, exceeding Q4’s 3.8% growth and matching the preliminary estimate. High-frequency data confirm that the positive momentum from Q1 carried over well into Q2 and domestic demand dynamics remain healthy. Retail sales and industrial production expanded robustly in April, with the former tallying double-digit growth rate. In May, unemployment remained fairly low.

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 unchanged from last month’s forecast. In 2017, the panel foresees economic growth moderating to 3.6%.

See the Full FocusEconomics South-Eastern Europe Report

TURKEY | Economy expands at a healthy pace in Q1

Despite decelerating slightly, growth remained robust in Q1 on the back of strong domestic demand. Private consumption continues to be the backbone of Turkey’s economic growth due to a hike in the minimum wage and the government’s policies to bolster household spending. On the downside, political uncertainty, geopolitical threats and widespread insecurity in the country are weighing on investment. More recent data paint a mixed picture of the economy as industrial production slowed in April, while consumer confidence improved in June. Moreover, low inflationary pressures this year promise to strengthen real wages. Furthermore, on 27 June, President Recep Tayyip Erdogan expressed regret over the downing of a Russian jet fighter in November in an attempt to improve the damaged ties between the two countries and ease the economic sanctions that Russia imposed against Turkey in January.

While decisive government support is boosting economic growth, there are some clouds on the horizon. Terrorist attacks in the country and Erdogan’s intention to establish a presidential system have the potential to fan political unrest, while a disordered Brexit could unnerve financial markets. FocusEconomics Consensus Forecast panelists forecast that the economy will grow 3.4% in 2016, which is unchanged from last month's projection. In 2017, the panel sees growth remaining unchanged at 3.4%.

INFLATION | SEE inflation accelerates in May for first time in four months

Inflation in South-Eastern Europe inched up from April’s multi-year low of 2.8% to 2.9% in May, which represented the first pick-up in inflation since January. The acceleration was mainly due to higher inflation in Albania and Serbia. Although 9 of the 12 countries in SEE posted a negative annual variation in consumer prices, most of the countries recorded softer declines as the fall in energy prices is gradually abating.

This month, our panel of analysts cut the 2016 inflation projection for South-Eastern Europe by 0.2 percentage points and now expects inflation to average 4.2% this year. This reflects downward revisions to 10 countries’ inflation forecasts, including Bulgaria, Croatia, Romania, Serbia and Turkey. The estimates for Greece and Macedonia were left unchanged. For next year, the panel expects inflation to accelerate to 4.8%.

See the Full FocusEconomics South-Eastern Europe Report

Written by: Dirina Mançellari, Senior Economist

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