The growth dynamic in the economies of Central and Eastern Europe (CEE1 ) has largely decoupled from that in global emerging markets such as Brazil, Russia, India, China (widely known as the BRICs), or Indonesia, Mexico and Turkey 2, according to the newly published “CEE’ing Past the BRICs” report issued by Erste Group’s CEE Research team.
“CEE economies are at different stages of the economic cycle than the global emerging markets, which is the main reason why the impact of the global slowdown is not weighing equally on both groups,” said Juraj Kotian, Head of CEE Macro/FI Research and one of the report’s co-authors.
For the period 2010-2015, the global emerging markets enjoyed very strong growth on the back of high commodity prices and credit growth, while the growth in CEE was comparatively subdued as countries in the region were fixing their imbalances. With CEE economies likely to continue performing below their potential until either this year or 2017, the region’s economies are still far removed from the peak of their economic cycles.
For this reason, they are less prone to being hit hard by a cyclical downturn along the lines of the 2009 recession. In contrast, emerging markets economies like the BRICs have performed above their potential in recent years, coupled with a notably high investment share (currently close to 35% of GDP vs. 21% of GDP in CEE).
In addition to the influence of the economic cycle, described by output gaps and investment shares above, Erste Group analysts have pointed out five additional factors that have contributed to the decoupling:
Stage of financial cycle: CEE countries are at a different stage not only of the economic cycle, but also of the financial cycle, as their economies have experienced a credit-less recovery. Benign credit growth and a cleanup of balance sheets in CEE indicate that NPLs should remain well anchored or even decline in the region. In contrast, global emerging markets may face some deterioration of credit quality in the aftermath of the strong credit growth they experienced over the past five years.
Low commodity prices: The CEE economies, which are strong net oil importers, are benefiting from the sharp dip in commodity prices. A positive supply shock is still supporting household consumption in CEE, while keeping the region’s current accounts in good shape, thus limiting the CEE economies’ external vulnerability. In global emerging markets, the impact of that supply shock has been a mixed bag.
Currency developments: The most obvious divergence between CEE economies and global emerging markets can be observed in the development of their currencies. Those in CEE have remained relatively stable over the past two years and weathered the “China storm”, while many global emerging markets have seen their currencies depreciate 30-50%.
Inflation developments: Another prominent difference between global emerging markets and CEE is visible in their diverging rates of inflation, which is obviously related to the FX developments. Over the past two years, consumers in CEE have benefited from a low inflation environment (inflation has been hovering around 0%), with households enjoying increased purchasing power with their money. In contrast, consumers in global emerging markets have been coping with average inflation rates above 4%, and in some cases (e.g. Russia) even in double-digits.
Portfolio capital outflows: In 3Q15, global emerging markets experienced the strongest portfolio capital outflow since 2008, driven by outflows from BRICs and Turkey. In contrast, the average volume of portfolio investments in the CEE region remained stable, supported by ongoing inflows into the Czech Republic. Hungary, thanks to its strong current account surplus, continued to reduce the HUF debt held by non-residents to a large extent without having any major impact on its currency.
While the economies of Central and Eastern Europe are in a completely different situation than most emerging markets, one cannot ignore a potential spillover of the global emerging markets downturn into CEE via the trade channel and worsened sentiment.
However, “CEE’ing past the BRICs” co-author Zoltan Arokszallasi, Chief Analyst, CEE Macro/FI Research team clarifies: “We see spillover risks as relatively contained, as the CEE region’s direct trade linkages with global emerging markets on the export side are not very strong. Moreover, dependence on foreign capital inflows in CEE has been falling in recent years. For CEE countries, the development of growth dynamics in the euro area will be of much greater importance as far the economic outlook of the region is concerned.”
CEE growth of 3.1% in 2016 should surpass that of euro area (1.6%) despite slowing EU fund inflows
Looking ahead to this year, the growth perspectives for the CEE region look slightly more subdued: EU funds will very likely flow in more slowly, while there are question marks around external demand. However, household consumption is expected to become even stronger, based on solid employment increases and real wage growth. In 2015, the average unemployment rate in the CEE region fell into single-digit territory for the first time since 2009 and is expected to decline further in 2016. As CEE countries are net importers of energy, the recent decline of oil prices is also growth-positive for them. In some countries (Poland, Romania), fiscal loosening is also helping domestic demand to improve.
Taking a look at individual countries, GDP growth could speed up in Romania (2016 estimate: 4.1%) and Serbia (1.5%), while Poland (3.6%) and Slovakia (3.5%) are expected to roughly maintain their pace. Romania could be the fastest-growing economy in CEE, but this comes at the expense of fiscal loosening and prospects of monetary tightening. We see a slowdown in Hungary (2.2%) and particularly in the Czech Republic (2.5%) due to declines in the inflow of EU funds to these economies. Some slowdown is also expected in Slovenia (1.9%). Overall, the economies in the CEE region are expected to expand by an average of 3.1% in 2016.
While the average annual growth forecasts for the global emerging markets in 2016 are higher (BRICs: 4.6%, EAGLES: 4.1%), it is worth noting that these forecasts reflect cuts by the leading international financial institutions, with BRIC’s growth target lowered 0.8pp and that for the EAGLES lowered 0.6pp versus previous estimates. Commodity exporting emerging markets have seen their growth forecast slashed by 1.7pp. In contrast, the growth forecast for the CEE region has actually been revised upwards, namely by 0.10pp, while that for the euro area dipped by 0.1pp.
