South Eastern Europe Economic Outlook June 2017

SEE economy tootles along in Q1

South-Eastern Europe: SEE economy tootles along in Q1

June 7, 2017

Preliminary data suggests that the economy of South-Eastern Europe plodded along at a moderate pace in the first quarter of the year, weighed down by Turkey’s uneven economic recovery and Greece’s never-ending debt saga. GDP grew at 2.8% annually in Q1, below Q4’s 3.0% expansion, marking a poor reading by historical standards. Romania spearheaded the region’s economic growth in the quarter thanks to a tighter labor market, tax cuts and public sector wage increases, which all buttressed private spending. The Bulgarian economy also contributed positively to the headline figure, growing at a steady clip as a result of robust household consumption and a pick-up in EU-funded investment. Meanwhile, the Cypriot economy recorded its strongest expansion since the height of the financial crisis.

In contrast, Croatia’s economy lost some of the wind in its sails in Q1 as it decelerated to an over one-year low, owing to a surge in imports linked to strong domestic dynamics. Likewise, momentum in the Serbian economy petered out in the first quarter as the external sector’s negative contribution more than offset gains in household consumption. In Greece, a smaller contraction in the first quarter compared to Q4 did little to allay creditors’ concerns regarding the economy’s health and debt sustainability. Elsewhere in the region, official GDP data is not yet available, but our analysts expect activity to have decelerated slightly in the all-important Turkish economy. Although households benefited strongly from the government’s counter-cyclical measures in Q1, political noise reached fever pitch in the run-up to the 16 April referendum, which likely weighed on capital expenditure and kept consumer and business sentiment subdued.

Meanwhile, political distress is gradually easing across South-Eastern Europe. In Albania, a three-month parliamentary boycott came to an end in late May as the main parties finally agreed to hold elections on 25 June. Incipient signs of a political turnaround were also seen in Macedonia, where the country’s president granted the opposition the mandate to form a government following a two-year political rift. In Kosovo, the fractious government led by Prime Minister Isa Mustafa was forced to call a snap election after a no-confidence motion was passed in early May, which could clear the way for a new government to defuse tensions with Serbia and Montenegro as well as make progress in EU accession talks. 

Projections upgraded for second straight month

This month, the outlook for South-Eastern Europe’s economy was upgraded from last month’s 2.7% to 2.8%, mirroring the GDP growth figure recorded in 2016. This was the second upward revision in a row after reduced political uncertainty in Turkey had fueled last month’s upgrade. FocusEconomics panelists left their projections unchanged for next year, when they expect the economy to grow 3.0%.

Glimmers of hope in the Albanian political arena resulted in an upgrade to the country’s economic forecasts, while the outlook for the Cypriot and Romanian economies were upgraded on the heels of Q1’s strong GDP prints. On the other hand, the panel’s forecasts for Macedonia and Montenegro were downgraded slightly, although both economies are still expected to expand at a faster clip than last year. The projections for the rest of the economies were left unchanged in May.

Kosovo and Romania are expected to be the fastest growing economies in 2017 with expansions of 3.8% and 4.2%, respectively. On the other side of the spectrum, major-player Greece and Cyprus are expected to be the worst performers, growing 1.0% and 2.6% respectively. 

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BULGARIA | Robust domestic demand buttresses growth in the first quarter

A recently released flash estimate showed that Q4’s positive momentum has carried over into 2017 as the economy grew 3.4% in Q1, mirroring Q4’s print. While data on GDP components is not yet available, Q1’s result is expected to have been driven by robust private consumption growth as well as by higher investment, following the pickup in EU fund absorption. Adding to the good news, on 26 May, credit rating agency Moody’s affirmed Bulgaria’s sovereign debt rating, citing the country’s resilient economy and strong medium-term growth prospects as factors behind its decision. The agency also lauded the government’s low and declining debt level and its significant fiscal reserves.

Higher inflows of EU funds and strong private consumption growth will largely keep the economy on its stellar growth path. A slower-than-expected absorption of EU funds poses the main downside risk to Bulgaria’s economy. FocusEconomics Consensus Forecast panelists expect GDP to expand 3.2% in 2017, which is unchanged from last month’s forecast, and 3.1% in 2018.

CROATIA | Economy keeps up robust performance in Q2 despite looming threats

The economy continued to fare reasonably well at the beginning of the second quarter, building on a healthy performance in Q1, with private consumption supported by a further tightening in labor market conditions, rising public wages and the effects of the personal income tax reform. Adding to the positive news, on 22 May the European Commission recommended the closure of the excessive deficit procedure for Croatia, as both the budget deficit and public debt dropped in 2016. However, things aren’t all plain sailing; although over the first quarter as a whole the tourist sector continued to grow in annual terms, in March it gave signs of weakening, probably as VAT increases started to bite. Moreover, the perilous situation of agro-food giant Agrokor, the Balkans’ largest employer, could have unwelcome spillover effects if the company goes under. After being put under state management in April, higher-than-expected debts were found by the state commissioner, prompting the company’s suppliers to threaten to halt deliveries unless some debt is repaid.

This year the economy is expected to broadly replicate last year’s performance. Strong tourist inflows together with lower income taxes should support household spending, while fixed investment should benefit from growing FDI and EU funds. Nevertheless, Agrokor’s restructuring could increase the vulnerability of the banking sector and weaken confidence, thus restraining growth. Analysts expect GDP to grow 2.9% in 2017, unchanged from last month, and 2.6% in 2018.

ROMANIA | Growth picks up momentum at the outset of the year

The Romanian economy surprised analysts with a strong performance in the first quarter. According to a preliminary estimate released by the Statistics Institute, annual GDP growth came in at 5.7%, only slightly less than Q2 2016’s multi-year high of 6.0%. While detailed national accounts data have yet to be published, sequential data for the first quarter suggests growth was fueled by strong domestic demand, as well as an improving external sector. Unemployment continued on its downward trend while wages grew strongly on the back of tax cuts and public sector wage increases, all of which will have served to stimulate household consumption, as evidenced by the fast pace of retail sales growth. Industrial production also grew strongly in Q1, stimulated both by stronger demand from Romania’s traditional trading partners and by the implementation of tax cuts on investments, the expectation of which had caused fixed investment to contract steeply in Q4. Despite the strong pace of growth, tax revenues have not followed suit according to the head of the country’s fiscal watchdog, meaning the fiscal deficit could exceed 3.0%, as forecast.

The economy should record another year of robust growth this year, though risks of overheating are increasing. Our panelists predict an expansion of 4.2% in 2017, which is up 0.3 percentage points from last month’s forecast, with growth of 3.5% penciled in for 2018.

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TURKEY | Looser fiscal policy fuels economic recovery 

The authorities’ efforts to shore up economic activity are bearing fruit, at least for now. The unemployment rate eased in February from January’s seven-year high as the government’s employment campaign began to yield results, while economic sentiment reached an 18-month high in May on account of growth-inducing policies. The government’s guaranteeing of loans to small businesses has not only proven a boon to SMEs but to banks as well, prompting loan growth to reach a six-year high in the first quarter. However, policymakers’ severe deviation from prudent macroeconomic policies is worrying analysts, who argue that unrestrained credit growth could lead to a wider current account deficit and put renewed pressure on the Turkish lira. These risks have been largely downplayed by government officials, with Deputy Prime Minister Nurettin Canikli recently disclosing preliminary plans to allow the Central Bank to purchase securitized loans in order to inject further liquidity to the banking system.

The economy is expected to continue benefitting from ample government support, notwithstanding the risks it poses to the fiscal and current account balances. This will shore up private spending to an extent, just as incipient signs of a turnaround in the tourism sector, coupled with multi-year high capacity utilization rates, suggest that growth will be broad-based this year. FocusEconomics panelists expect GDP to expand 2.7% in 2017, which is unchanged from last month’s estimate, and 3.1% in 2018.

INFLATION | Inflationary pressures continue unabated in April 

Inflation in the South-Eastern Europe region continued to creep up in April, reaching 7.4% (March: 7.0%), the highest figure since September 2010. The figure reflected higher price pressures in a majority of countries despite their weak economic performance overall, including in Turkey—the largest economy in the region. Albania, Greece and Montenegro were the only countries where inflation decelerated.         

This month, our panelists left their 2017 inflation outlook unchanged at 5.8%. Increases in the forecast for eight countries were offset by a decrease in Turkey, while the remaining four countries’ forecasts were kept the same. For 2018, the panel still expects inflation to ease to 5.4%. 

See the Full FocusEconomics South-Eastern Europe Report

Written by: David Ampudia, Senior Economist

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