South & Eastern Europe Economic Outlook October 2017

Regional economic activity growth remains solid, led by a strong Turkish economy

South & Eastern-Europe: Regional economic activity growth remains solid, led by a strong Turkish economy

October 4, 2017

The economy of the South-Eastern Europe (SEE) region rounded out a strong first half of the year, according to more comprehensive data. A complete view of the regional economy shows that growth was 4.3% annually in Q2, mirroring the expansion recorded in Q1. Economic growth was spearheaded by Romania, where growth was confirmed at 5.9% in the second quarter, and Turkey, which churned out a second consecutive quarter of growth above 5.0%. On top of a robust H1 performance, leading data suggests that economic momentum carried over into the third quarter, with regional GDP growth estimated to accelerate to 4.7%.

The Turkish economy roared through the first half of the year, with GDP growth coming in at 5.1% in annual terms in the second quarter. First-quarter growth was also revised up two-tenths of a percentage point to 5.2%. Economic activity was largely driven by construction-related investment and upbeat dynamics in the external sector. The leap in construction investment offset a fourth consecutive contraction in machinery and equipment investment. It was facilitated by soaring bank lending growth, which was in turn induced by the government’s Credit Guarantee Fund (CGF). The external sector, in turn, pulled its weight in the second quarter as the region’s behemoth continued to benefit from solid European demand, a weakened lira and a revival in the tourism sector.

The remaining major players in the region also performed robustly in Q2. Romania’s economic growth accelerated to its second-fastest clip in nearly a decade, with growth fueled by pro-cyclical tax cuts and wage hikes. In spite of the positive short-term effects, the government’s spending spree has caused the fiscal deficit to balloon in recent months. Coupled with contentious discussions over further tax cuts next year, this is weighing on business sentiment and puts the economy at risk of overheating. In Bulgaria, GDP growth accelerated in the second quarter as the country benefited from strong household consumption and significant export growth. On an encouraging note, economic dynamics appear to have remained strong in Q3, with the unemployment rate dropping to an all-time low and industrial production growing at a healthy clip at the outset of the quarter. 

The region’s economy is expected to have expanded at a solid clip in the third quarter on account of faster growth in Croatia, Turkey and Serbia as well as resilient performances in Bulgaria and Romania. Leading data from Turkey suggests that economic momentum continued well into the third quarter, while a favorable calendar effect stemming from the slump caused by the failed coup d’état in July 2016 suggests a robust Q3 GDP outturn. However, growth is expected to slow moving forward as the CGF runs dry and temporary VAT cuts on consumer durables expire, which will reduce the government’s fiscal stimulus in the fourth quarter. In addition, geopolitical tensions have been on the rise. Turkey’s opposition to the Kurdish independence referendum in Iraq risks renewed military conflict in the region.

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Projections upgraded on firmer growth in Turkey and Greece


The FocusEconomics panel expects growth in the South-Eastern Europe economy to come in at a solid 4.1% this year as a result of soaring growth in Romania and Turkey and a better-performing Greek economy. GDP growth is expected to moderate next year, with our panel projecting regional growth of 3.3%. The estimate was a notch above last month’s 3.2% forecast and reflected stronger growth projections for major players Greece and Turkey. Elsewhere in the region, the economic outlook for 2018 was also upgraded for Albania and Croatia. Conversely, 2018 growth projections were revised down for Bosnia, Bulgaria, Montenegro and Serbia.

The economies of Albania and Kosovo are expected to grow at the fastest rates next year with expansions of 4.0% and 3.9%, respectively. Turkey, the region’s largest economy, is expected to grow a resilient 3.5% next year. On the other end of the spectrum, Greece is expected to be the region’s worst performer, only growing 1.9%.

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TURKEY | Economy continues to perform robustly on soft credit and solid external sector

The country’s upbeat economic performance throughout H1 was confirmed in mid-September as data showed the economy expanded 5.1% in annual terms in the second quarter. GDP growth in Q2 was buttressed by a surge in construction-related investment and noteworthy growth in exports, which benefited from robust European demand and soaring tourist arrivals. Solid leading data, coupled with a favorable calendar effect stemming from the slump caused by the failed coup d’état in July 2016, points to a similarly strong Q3 GDP outturn. Economic growth, however, is expected to cool as some of the government’s stimulus measures expire and the impact of the credit guarantee fund facility dwindles. On 27 September, the government announced it intends to increase some indirect taxes next year in a bid to reign in the fiscal deficit, which could also put a damper on growth to an extent.

Near-term economic prospects remain positive as the country benefits from an upturn in European demand for Turkish goods and a revival in the tourism sector. FocusEconomics panelists expect GDP to expand 4.8% in 2017. As growth-inducing policies draw to an end, however, growth is expected to shift into a lower gear. Panelists expect growth of 3.5% in 2018, which is up 0.1 percentage points from last month’s forecast.

ROMANIA | Political wrangling over tax cuts threatens investment

Romania drew attention in H1 as the fastest-growing country in the region, defying expectations. However, political wrangling has recently dominated headlines as the government attempts to lay out fiscal policies for public sector wage hikes, tax cuts and increased infrastructure spending. Contentious discussions over 2018 tax cuts are creating the impression of unpredictability in the political arena, which could push away investors. Business sentiment has worsened, and analysts were more pessimistic about current economic and business conditions in August. Furthermore, without significant amendments, the government’s ambitious spending plans could put it over the European Commission’s established 3% of GDP deficit ceiling, which could result in an excessive deficit procedure and hurt Romania’s markets and credit ratings. Chaotic policy making could put the economy at risk of overheating if economic growth is unsustainable.

The economy is expected to slow slightly in H2, but will continue to be supported by strong domestic demand. Higher wages could dent Romania’s competitive edge in labor costs as wages rise above neighboring countries’ and if they are not matched with gains in productivity. Furthermore, investment has remained stagnant and is much needed to revive aging infrastructure. Our panelists predict an expansion of 5.2% in 2017, with growth of 3.8% penciled in for 2018, which is unchanged from last month’s forecast.

BULGARIA | Households expected to have buttressed growth once again in Q3

The Bulgarian economy ended the first half of year on a strong note, according to complete GDP data published by the Statistical Institute in September. Annual GDP growth was confirmed at 3.6% in Q2, a marginal improvement from Q1’s result. Growth continued to be driven by healthy household consumption and export growth, and leading indicators suggest the momentum will be sustained throughout the rest of the year. Unemployment rested at its lowest level ever in August, which would point to household consumption remaining one of the main engines of growth over the medium term. Industrial production also continued to grow at a robust annualized pace in July, albeit slightly below the high rates seen in H1.

A higher uptake of EU funds and strong private consumption growth will ensure the economy remains on a dynamic path. Growth should also be supported by the cyclical upswing in the region, translating to higher demand for Bulgarian goods. FocusEconomics Consensus Forecast panelists expect GDP to expand 3.5% in 2017 and 3.2% in 2018, which is down 0.1 percentage points from last month’s forecast.

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CROATIA | External and domestic dynamism shore up economic activity

The economic expansion carried over into Q3, after accelerating in Q2. The tourism sector, which underpinned GDP growth in H1, continued its robust performance in July, translating into another month of remarkable retail sales increases. A record tourist season was also reflected in tighter labor market conditions; the unemployment rate is hovering at multi-year lows. Furthermore, the strong economy is having a positive impact on public accounts: The budget deficit was just 0.4% of projected GDP in H1 according to the Ministry of Finance. Because a significant decrease in income tax revenues—resulting from the tax reform that came into effect this year—was more than offset by higher corporate tax and VAT revenues, overall tax proceeds grew at a faster rate than total government expenditures. The positive fiscal and economic dynamics led S&P Global Ratings to improve Croatia’s outlook from stable to positive on 22 September, while maintaining its credit rating unchanged.

The economy should continue to grow at a healthy pace this year and next, buttressed by a growing tourism sector, solid household spending and increased EU funding. Nevertheless, some downside risks to the outlook remain, from multiple lawsuits associated with the Agrokor crisis and a possible tightening cycle by the ECB. Panelists project GDP will grow 2.9% in 2017 and 2.7% in 2018, up 0.1 percentage points from last month.

INFLATION | Inflationary pressures strengthen in August

Inflation in the South-Eastern Europe region regained traction in August following three consecutive months of dwindling price pressures. Inflation rose from 6.2% in July—the lowest reading since January—to 6.6% in August as a result of faster inflation in Turkey and stronger price pressures in a majority of countries in the region. Softer inflation was only seen in Albania, Greece, Romania and Serbia, while Kosovo was the sole country that saw steady inflation this month.

Inflation is expected to reach a six-year high of 6.1% this year due to soaring inflation in Turkey, which is suffering from lagged pass-through effects of the weaker lira and strong demand-pull pressure. Next year, inflation is expected to ease slightly to 5.6%, which is up 0.2 percentage points from last month’s forecast. The revision reflects higher inflation projections for Cyprus, Romania and Turkey, which more than offset lower estimates for Bosnia, Bulgaria, Greece and Serbia. The rest of the country inflation forecasts were kept unchanged this month. 

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Written by: David Ampudia, Senior Economist

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