WIIW Forecast: A time of moderate expectations

Contrary to expectations, near-stagnation has continued in the euro area. Certain forecasts for 2015 repeatedly suggest some moderate improvement, while others do not envisage any meaningful measure of acceleration.

Extraordinary measures announced by the euro area authorities that have already been factored in remain inconsequential. Furthermore, the drop in energy carrier prices and a slight depreciation of the euro do not seem to have helped very much either. The euro area – and hence the EU as a whole – has been seized by secular stagnation. The current misfortune, although triggered by the impact of the global economic crisis, has much deeper roots. The growth slowdown in Europe can be attributed to policy reorientation that started back in the mid-1970s.

In all likelihood, growth in CESEE will follow the unimpressive growth pattern displayed by the euro area. The longer-term convergence of income levels in those countries can no longer be expected to be as rapid as was assumed a decade or so ago.

The current performance of the CESEE economies is also only moderately satisfactory. Growth in the period 20152017 is not going to deviate substantially from the pace recorded in 2014. On the other hand, most of the countries in the region are also expected to evade the dangers of runaway inflation, fiscal deficits or excessive foreign borrowing that often plagued them in the past.

Depressed aggregate domestic demand has been the major factor behind anaemic growth. This is evidenced by disinflation (or even mildly deflationary tendencies) across much of the region, as well as the persistence of fairly high unemployment.

There is some evidence of a ‘race to the bottom’ in terms of wage setting. While wage moderation strengthens profitability and external competitiveness, it also weakens disposable household incomes and thus slows down growth in domestic demand. Apparently, there is a trade-off between improvements in the trade balance and more rapid growth in domestic demand. Overall, GDP growth is being held ‘on a short leash’.

Growth in public gross fixed capital formation (GFCF) may be supporting economic growth, especially in those new EU Member States (NMS) that have access to EU funds. However, a proper tangible rebound in private-sector GFCF is still lacking. Weak private-sector GFCF cannot be attributed to a ‘profit squeeze’ in the corporate sector. On the contrary, the corporate sector has been doing very well, at least in those NMS, for which relevant data are available.

The corporate sector as a whole still tends to lend rather than borrow. The means available to the corporate sector appear to be plentiful at present – but the sector still prefers to lick its wounds inflicted by former excessive borrowing or extend loans (primarily to the public sector) rather than to invest productively.

Loans are stagnant even in those instances where interest rates are relatively low. With a few exceptions (largely on the region’s periphery) the stocks of loans to the nonfinancial corporate sector increased marginally at best in 2014. This may reflect firms’ pessimistic assessment of future growth in demand, increased ‘liquidity preference’ or the relative abundance of the means at their disposal.

Non-performing loans are linked to a high share of borrowing in foreign currencies. The recent strengthening of the Swiss franc will bear some negative consequences for those firms and households that borrowed heavily in that currency in the past. Thus far, the shares of non-performing loans in total loans extended to households and the non-financial corporate sector have not changed perceptibly. However, there does seem to be a positive link between the share of non-performing loans and the share of loans denominated in (or indexed to) foreign currencies. A rise in the share of non-performing loans is likely.

New evidence supports the claim that the countries with floating exchange rates fare better in the medium-to-long term. They tend to avoid irreversible currency overvaluation, whereas the countries with fixed exchange rates do not quite avert it. It is argued, however, that despite the rigidity of the exchange rates, overvaluation can be avoided - at least in the medium term.



All the CESEE countries run up fiscal deficits. Over the past few years, Belarus used to be an exception. Recent European Commission projections, however, envisage fiscal deficits in all NMS in 2015 as well. Current account deficits are still depressed. Net national lending in the NMS tends to be positive. This is a consequence of current savings in the private sector in the NMS generally running ahead of gross capital formation in that sector.

On average output growth across the NMS will become more uniform in 2015 – albeit not any faster. Some acceleration in marginal growth is to be expected in the biennium 2016-2017. Unemployment in the NMS will recede only gradually. Low inflation will prevail in 2015, but it will gradually return to more normal levels in 2016. Under sustained – albeit rather anaemic – growth, the current account balances will deteriorate (although they will still remain comparatively low).

Growth is hardly accelerating in the (current and potential) EU candidate countries either. Output in those countries is not expected to grow faster than in the NMS. Turkey, Macedonia and Kosovo may fare slightly better than the rest of the group. However, with the exception of Turkey, those countries seem to have put high inflation behind them. Nonetheless, their unemployment figures continue to be dismal (less so only in Turkey). They will also run high (or even very high) current account deficits.


Most of the successor states to the Soviet Union will perform rather badly in 2015. Ukraine’s output will continue its free fall as many of the country’s industrial centres have since become battlefields. The decline in world market prices for energy carriers will negatively affect both Kazakhstan and Russia, with real output in the latter country dropping sharply. The same fate will befall Belarus: a country that relies heavily on exports to Russia and Ukraine. However, assuming a peaceful resolution to the Ukrainian conflict in 2015, it is expected that all the successor states will resume moderate growth in 2016 or 2017. 

Country summaries
Economic activity in Bulgaria remained sluggish throughout most of 2014; weak GDP growth is likely to continue in 2015, driven mainly by household consumption and net exports. Some acceleration of economic activity might be expected over the period 2016-2017 on account of improving external conditions. The newly elected government that lacks strong political backing faces the challenge of implementing an ambitious reform agenda in a weak economic environment.

In Croatia GDP fell for the sixth consecutive year; however, the country is likely to return to a slightly positive growth path in 2015. Household consumption remains subdued owing to high and persistent unemployment and continued deleveraging. Economic recovery will hinge primarily on external demand, and a revival in investment activities following increased absorption of EU funds. Fiscal consolidation and an overly indebted enterprise sector are the key obstacles to more robust growth.

The Czech economy has finally recovered from the effects of fiscal consolidation. Given the relatively low level of debt burden in both the government and private sectors and the ‘growth-friendly’ monetary and fiscal policies, recovery over the period 2015-2017 seems assured. Acceleration of growth, however, may only be gradual as fixed investment is unlikely to expand at a markedly high rate. Doubts have recently been voiced about the country’s foreign trade performance in the years to come.



Given sluggish external demand, economic growth in 2015 compared to the previous year is not expected to accelerate. However, an increase in earnings and thus household consumption will keep the economy afloat, which is projected to grow by 2% in 2015. From 2016 onwards, we expect an investment revival and positive developments in terms of exports.

Even though Hungary has left recession behind, it has not yet embarked on a sustainable growth path. The strong external stimulus to growth lent by the EU helped to resuscitate private investment and employment. However, with the stimulus from the EU cohesion policy weakening as of the current year, it is expected that other private (domestic and external) factors will drive recovery; however, the conditions conducive to that happening are far from favourable. Medium-term growth is unlikely to reach more than 2% in the biennium 2016-2017.


Prospects for the Latvian economy in 2015 have gradually deteriorated over the past few months. The major devaluation of the Russian rouble and the Russian economic slump will drag down the volume of Latvian exports. Entrepreneurs will thus be reluctant to expand their investment activities - at least not before 2016. It is expected, however, that household consumption will keep the Latvian economy buoyant, increasing by 2.1% in 2015 before a revival in external demand sets in and revitalises economic activity overall.

The setback in the neighbouring countries to the east, which hit exporters hard last year, will continue and economic growth will decelerate in 2015. Both public and private investments will increase at a slow rate, while household spending will secure a rise in employment; the net result will be 2.4% growth in real terms in 2015. An upward trend in economic activity driven by exports and investment is to be expected in the years thereafter.

Driven by a major increase in gross capital formation, the Polish economy has entered a phase of moderately faster growth, which is likely to extend into 2016. In the medium term some deterioration of external balances can be expected. The outcome of the elections to be held in 2015 is still uncertain. Should the present liberalconservative coalition lose to the nationalist-populist opposition, the economic and social policy may take an unpredictable track.


Expanding private consumption and a good harvest softened the economic slowdown generated by an investment slump. Further slowdown is expected in 2015, should there be no major turnaround in terms of investments. Increased political and economic stability will benefit longer-term economic growth, yielding an increase of some 3%.

Domestic demand replaced exports as the main engine of growth in 2014. This pattern will be maintained in the years to come. A major contributory factor is a number of substantial social measures taken by the government in the run-up to parliamentary elections. Stronger household consumption will also encourage import growth. Exports will remain sluggish in 2015, as low growth will prevail in the euro area and regional uncertainties persist. Growth should pick up thereafter, although risks will remain.

The Slovene economy returned to growth in 2014 after two years of contraction. The rebound has been driven by rising external demand and a revival in investment activities supported by EU funds. GDP growth in 2015 and 2016 will weaken once again on account of lower investments. Exports and the gradual recovery of household consumption will remain the main engines of growth.




Insufficiency of domestic demand: the main factor behind recent developments in the NMS

Growth in 2015-2017 is not going to deviate substantially from the pace recorded in 2014. As can be seen from Figure 1 GDP growth rates calculated for the 11 NMS for 2014 and 2015-2016 are essentially the same. Moreover, GDP forecasts for the candidate countries also display remarkable stability. Understandably, forecasts for Russia and Ukraine are less stable. In itself the stability in question as forecast could be seen as a positive development. However, it must be conceded that those growth rates are rather modest. Growth at the rates forecast still yields a comparatively high level of unemployment (Figure 1). It should also be noted that the differential between the average growth rates in the NMS and euro area is expected to decline systematically. This is hardly a positive development because the convergence in growth rates (NMS compared to the euro area) undermines any prospects of convergence in the levels of GDP (Worse still, even convergence of CESEE income levels with the euro-area average level would not be a truly satisfactory outcome. Were the euro area to lose out to the rest of the world, the CESEE countries would be losing out to the rest of the world as well).

Depressed aggregate demand has been a factor behind anaemic growth. In 2014 the vast majority of CESEE countries experienced moderate deflationary tendencies coming after a period of relatively marked disinflation in the biennium 2012-2013 (see Figure 1). The 2014 inflation rate in the NMS was even lower than that in the euro area. Both were positive – but rather symbolic in nature. In both cases, weakness in aggregate demand (and in the demand for consumer goods and services, in particular) must have been an important reason for the unusually strong ‘price moderation’. Weak aggregate demand tends to accompany ‘wage moderation’ and stable or falling unitlabour costs. Inflation is now forecast to return gradually to normal (i.e. ‘desirable’) levels (around 2 per cent) by 2016. However, in most cases, inflation in 2015 is expected to remain very low indeed, indicating continuing slack in aggregate demand. Of course, this may not apply to the notorious inflationary outliers (Turkey, Belarus, Russia and Ukraine) where the cost-push considerations (for example, in relation to steep currency depreciations) may prevail over the consequences of inadequate aggregate demand. The expectation of high and rising inflation may feed on itself too, by prompting precautionary purchases. In Ukraine, these factors may be combined with a reduction in aggregate supply, caused by the destruction of some of its productive capacity (and disrupting production, exchange and payments).

The drop in oil prices has not had a significant impact on disinflation (and deflation). A drop in (and very low) inflation is not necessarily an outcome of lower oil prices. In a number of CESEE countries, disinflation was quite marked in 2013 – prior to the fall in international prices for crude oil and other energy carriers. Of course, the decline in energy carrier prices in the second half of 2014 is likely to affect overall inflation in 2015.


Feeding the lower energy prices into the final inflation index will take time, while not necessarily being complete.

Moderate deflation may have supported growth to a certain degree. Major extensive and rapid (‘galloping’) deflation is believed to have the potential to deepen recession because, under such conditions, households might tend to postpone purchases of certain consumer items in expectation of their prices dropping still more. However a moderate (and largely unexpected) deflation of the type recently observed might have a rather positive impact on consumer demand. Nominal wages and social benefits tend to adjust, even if not fully, to moderately rising consumer prices, while they adjust fairly sluggishly to cost-of-living indices – if at all. Nominal wages and social benefits, however, do not appear to be adjusting to occasionally falling consumer prices and cost-of-living indices.


It follows that mild deflation could increase the real purchasing power of wages and social benefits, thereby supporting some growth in aggregate demand. The return to ‘inflationary normalcy’ in the period 2016-2017 would eliminate additional ‘unexpected’ gains in terms of the purchasing power of wages and other regular income. 

Growth in public gross fixed capital formation (GFCF) may be encouraging overall growth. Public sector GFCF in the NMS is consistently higher than in Germany, for example. This is obviously related to: (i) the badly needed upgrading of physical infrastructure in those countries; and (ii) the availability of EU funds directed towards such upgrading programmes. In 2015, public infrastructural investment co-financed by the EU under the 2007-2014 framework may still be quite high. It is less certain whether the new projects to be realised under the current multi-year framework can guarantee a sufficiently large volume of public GFCF in 2016.

There is also some uncertainty about the relationship between the volume of private GFCF and that of public GFCF. The notion that high public investment tends to be associated with high private investment suggests that public policy (on investment) is actually pro-cyclical. The comparatively high levels of public investment in the NMS in the period around 2007-2008 (just at a time when private investment also peaked) support the notion that public and private investments tend to ‘complement’ each other. However, on closer scrutiny the data available indicate that the correlation between the annual growth rates of public and private GFCF was not statistically significant in any of the NMS, at least not after 2009.