South Eastern Europe Economic Outlook May 2018

Economic growth likely continued to ease in first quarter but remained robust

South-Eastern Europe: Economic growth likely continued to ease in first quarter but remained robust

May 9, 2018

Economic growth likely continued to ease in first quarter but remained robust

South-Eastern Europe’s (SEE) economy is expected to have grown 4.7% in Q1, down from Q4’s impressive 5.8% expansion, which had marked the second fastest rate in nearly a decade. Although hard GDP data is still outstanding for virtually all the countries in the region, a loss of momentum in Turkey likely drove the slowdown. The Turkish economy appears to have lost steam on tighter credit conditions—as Turkish banks were unable to maintain last year’s blistering pace of credit growth—and elevated inflation dampening purchasing power. This comes after fiscal stimulus caused growth to come in markedly above potential last year. However, the regional giant’s pace of growth remained robust, with business confidence still firmly in positive territory throughout the quarter and industrial production solid in January and February.

A similar picture likely prevailed in Romania, the region’s second-largest economy, where there are also signs pointing to a loss of momentum in Q1. The government’s loose fiscal stance has caused inflation to spike so far this year, eating into wage growth and taking the shine off private consumption; retail sales growth dimmed notably in the first three months of 2018. In addition, ongoing political uncertainty is making investors wary. In early May, the president refused to sign the government’s controversial legal reform package, instead referring the bill to the constitutional court. The EU has raised concerns that were the law to pass it could reduce the independence of the judiciary and hamper anti-corruption efforts. Furthermore, the administration’s insistent criticism of the Central Bank’s tighter monetary stance raises concerns about the Bank’s future independence.


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In contrast, Serbia’s economy gained significant momentum in Q1 according to a recent flash estimate, with growth of 4.5% year-on-year. The performance was likely aided by the National Bank of Serbia’s markedly looser monetary stance and solid external demand. Meanwhile, Croatia likely had an improved quarter on stronger tourist arrivals and robust domestic demand. Furthermore, the restructuring process of conglomerate Agrokor made headway: On 10 April, the company announced it had agreed on a framework for the settlement process with creditors. Greece’s economy also seems to have strengthened, with PMI readings averaging higher in Q1, and double-digit export growth in January and February.

In the political arena, Turkish President Recep Tayyip Erdogan’s decision to call snap presidential and parliamentary elections for 24 June has captured headlines. Although earlier than most analysts had expected, the move to bring elections forward from next year was widely anticipated, particularly given rising concerns over the potential negative impact on the economy of sustaining such vigorous fiscal stimulus until 2019—when elections were originally scheduled. Despite being the clear favorite to emerge victorious, Erdogan is taking no chances and aims to keep the economy running at full tilt in the run up; the government recently announced two stimulus packages worth nearly USD 40 billion to boost investment and private consumption.

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Regional GDP forecast revised up

The regional economy should expand a robust 3.9% this year, up from last month’s 3.7% growth projection. However, this would still be well below the 5.8% expansion recorded in 2017, largely because growth in Turkey and Romania is set to slow from unsustainably high levels as the impact of expansionary fiscal policy gradually fades and higher inflation hurts purchasing power. On the other hand, the Greek economy should continue to gain momentum this year. Elsewhere in the region, stronger absorption of EU funds across the Balkans, resilient global demand and improving tourist arrival numbers should prevent a harder landing in economic activity. The regional economy is expected to expand 3.5% in 2019.

The upgrade to the regional GDP forecast reflects faster expected growth in Turkey this year, following the recent announcement of further government stimulus measures. The economies of Bosnia and Herzegovina, Cyprus and Romania also had their projections upgraded this month. In contrast, Croatia, Greece, Kosovo and Serbia saw their forecasts cut, while the region’s remaining economies saw their forecasts unchanged.

The economies of regional heavyweights Romania and Turkey are expected to grow at the fastest rates in the region this year, with expansions of 4.6% and 4.4%, respectively. At the other end of the spectrum, Greece is projected to record the weakest expansion in the region, at 1.9% growth.

TURKEY | Erdogan calls snap elections and announces a ramp-up in spending

President Erdogan recently called snap elections for 24 June, against the backdrop of an economy beginning to show signs of strain from the government’s fiscal stimulus drive. The manufacturing PMI crashed into negative territory in April on lower new orders and employment, while the current account deficit ballooned in annual terms in the first two months of the year. In addition, the lira fell to an all-time low against the dollar in early May, prompting the Central Bank to tweak banks’ reserve requirements in an attempt to halt the decline. Citing worsening external metrics and rising imbalances, on 1 May Standard and Poor’s downgraded Turkey’s credit rating; this came after a similar move by Moody’s in March. More positively, industrial production growth was solid in February, while business sentiment remains elevated. In addition, economic growth in Q1 was likely robust, despite a moderation from Q4’s blistering pace. Ahead of polling day, the government is turning the fiscal taps on full blast, and it recently announced major new spending initiatives.

The economy is expected to lose momentum this year after performing above potential in 2017, as credit growth ebbs amid tighter financial conditions, and fiscal stimulus gradually dims. Exchange rate volatility, geopolitical tensions, a widening current account deficit and elevated inflation pose downside risks. FocusEconomics panelists expect growth of 4.4% this year, which is up 0.3 percentage points from last month’s estimate. They see growth of 3.9% in 2019.

ROMANIA | Economic momentum remains robust, but political clouds are gathering

In the first quarter growth likely moderated further but remained solid, according to available data. Softer growth in retail sales suggests consumer spending lost some steam. Although supported by a strong labor market and rapidly rising wages, consumer spending was restrained by soaring inflation stemming from an overheating economy. Industrial production also moderated, reinforcing evidence that growth is easing from last year’s blistering pace. In mid-April, President Klaus Iohannis refused to comply with the interior minister’s request to fire the head of the country’s anti-corruption agency. Moreover, in late April Iohannis asked Prime Minister Viorica Dancila to step down due to foreign policy disagreements; she refused. Compounding political tensions, in early May the president announced he will not approve a controversial judicial reform sponsored by the government, a source of protracted friction between Romania and the EU. If political tensions persist, they could hit investor confidence.

This year growth should remain strong but moderate, held back by growing capacity constraints. Consumer spending will remain the main driver of growth, although it will be weighed down by rising inflation, while a pick-up in EU-backed investment projects will underpin fixed investment. However, a widening budget deficit due to an expansionary fiscal stance and a large current account deficit pose the main risks to economic stability. FocusEconomics panelists expect growth of 4.6% for 2018, up 0.1 percentage points from last month, and

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BULGARIA | Economy appears to cool at the end of Q1 but stays solid

Following a strong start to the year, available data suggests the economy slowed somewhat by the end of the first quarter on easing consumption and industry metrics. Household spending, a linchpin of growth last year despite a slowdown in the fourth quarter, appears to have lost further momentum given underwhelming retail sales through February. Furthermore, consumer sentiment, which hit a one-decade high in February, cooled in March and April. That said, it remained elevated, and low unemployment was broadly stable from the fourth quarter, suggesting any moderation in household spending is likely to be modest. Meanwhile, industrial output posted a rare annual contraction in February on weakness in the utility and extractive sectors; manufacturing, on the other hand, was resilient. Furthermore, elevated business confidence readings in recent months suggest fixed investment continued supporting growth at the outset of the year, building on last year’s strong absorption of EU-linked funding.

Household spending should benefit this year from a tight labor market and public-sector wage hikes, although inflation will eat into gains somewhat. An improving business climate and low interest rates bode well for investment, while EU-funded outlays will lend support to growth over the medium term. Furthermore, sound public finances should attract stronger FDI inflows, while upbeat growth across the EU is expected to bolster exports. FocusEconomics Consensus Forecast panelists expect the economy to grow 3.7% in 2018, unchanged from last month’s forecast, and 3.3% in 2019.

CROATIA | Agrokor agrees on draft settlement terms with creditors

Recent indicators show signs of a recovery in the first quarter, following a weak economic performance in the last quarter of 2017. Although industrial production growth posted only marginal gains in Q1, this marked an improvement from a near-stagnant showing in Q4. Furthermore, tourist arrivals grew at a double-digit pace in January–February, signaling a continuation of the sector’s stellar performance last year. In addition, robust retail sales in Q4 largely carried over into Q1, which, alongside falling unemployment and healthy real wage growth, suggests that consumer spending was strong in the first quarter. Meanwhile, significant progress was made in the restructuring process of conglomerate Agrokor on April 10, as creditors agreed on draft settlement terms. They will vote on the final deal by July 10; Russia’s state-owned Sberbank is expected to obtain the largest equity stake.

Economic growth should remain robust this year, underpinned by a dynamic tourism sector and solid household spending. Moreover, fixed investment growth is expected to accelerate on the back of higher absorption of EU structural funds. Downside risks to the outlook include, however, the possibility of a disorderly restructuring of Agrokor, although this has lessened somewhat recently, and a slowdown of external demand if political and economic uncertainties reemerge in the EU. FocusEconomics panelists project GDP growth of 2.7% in 2018, down 0.1 percentage points from last month´s forecast, and 2.7% again in 2019.

INFLATION | Inflation unchanged in March

In March, regional inflation remained at February’s 6.5%. Stronger price pressures in Romania—where inflation is now significantly above the Central Bank’s target due to a demand-driven surge—and Bulgaria were offset by lower price pressures in Albania, Macedonia and Serbia. Inflation in Turkey was largely unchanged in March, although recent data shows it surged in April on the weak lira, a loose fiscal stance and insufficient monetary tightening. In March, prices declined in annual terms in Greece, as demand-push price pressures remained feeble.

In response to sticky double-digit inflation and the depreciation of the currency, in late April the Central Bank of the Republic of Turkey (CBRT) hiked its late liquidity window rate from 12.75% to 13.50%. However, the move will almost surely be insufficient to bring inflation back to target. Amid President Erdogan’s continued criticism of high interest rates, all eyes are now on the 7 June meeting to see whether the CBRP continues to assert its independence and tighten its monetary stance. Romania’s Central Bank also increased its policy rate in early May to tame intensifying price pressures, and it finds itself in a similar predicament to the CBRP: attempting to counteract the impact of fiscal-stimulus induced inflation while enduring criticism from political leaders over the direction of monetary policy. Meanwhile, Albania’s Central Bank left rates unchanged at their current low level amid mild inflationary pressures and the recent appreciation of lek.

Inflation in the SEE region is expected to come in at 6.4% this year, below the average of 7.4% recorded in 2017. The estimate for this year is up 0.2 percentage points from last month’s projection, as higher forecasts for Romania and Turkey more than outstripped downward revisions to most economies in the region, including for Albania, Greece and Serbia. In 2019, inflation is expected to moderate to 5.8%.

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Written by: David Ampudia, Senior Economist

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