Peaks and Troughs in 2015 with lasting impacts
The prospects of growth in the euro area have improved albeit at a slower pace than previously hoped for. It is based on a mix of private and public consumption, as well as investment expansion, supported by a further easing of the European Central Bank’s monetary policy and fiscal relaxation. As a result, demand for products from new member states increased and exports expanded. The recent collapse of all major commodity prices reflects a lack of demand and an oversupply in the respective markets with major impact on both exporters and importers. Net importers of oil and gas have lower energy bills, while netexporters suffer serious losses of revenues.
The EU Member States in Central and Eastern Europe (EU-CEE) group registered its highest rate of economic growth in 2015 since the outbreak of the financial crisis. In 2016-2017 the group will experience some modest growth deceleration on account of the recent consumption boom coming to an end and a temporary decline in EU transfers (Table 1). Growth will be most robust in Romania and Poland, given the solid household consumption in both countries; growth will also recover in the Baltic States that have since digested the Russian shock, yet most other countries will experience some slowdown on account of the lower volume of EU transfers. As for 2018, the EU-CEE countries will pick up some speed thanks to the inflow of new investments and EU transfers.
Countries in the Western Balkans WB) also picked up speed in 2015 and will thus maintain positive growth rates in 2016 and beyond. They will grow at an average rate of 3%, except for Serbia where growth will be depressed on account of stabilisation. However unimpressive it may be compared to their need for catching-up, the average growth rate in the WB countries (excl. Serbia) will not lag behind that in the EU-CEE countries. Turkey will continue down its modest growth path. It will maintain its fragile stability, despite relatively high inflation and a high current account deficit, while facing increasing challenges emerging, for instance, from the war in Syria, the refugee crisis and the loss of export and tourism revenue owing to the Russian trade sanctions.
In the CIS, Russia and Belarus will face yet another year of recession in 2016. Russia will continue to suffer from low oil prices, high inflation, currency depreciation, sanctions and fiscal austerity. As usual, structural change and institutional reforms will be slow and half-hearted, incapable of offsetting the losses. Ukraine’s economic growth, after the dramatic fall over the past years, will stabilise as the country will by and large have completed the adjustment process that was triggered by the country decoupling from Russia and the occupied territories. The Russian annexation of the Crimea and the conflict in East-Ukraine look set to last. Export markets lost will not be regained even in the medium term, nor will the volume of exports to the EU increase.
The divergence of economic performance between the EU-CEE and the Western Balkans plus Turkey on the one hand and Belarus, Kazakhstan and Russia (CIS-3) and Ukraine on the other hand will continue in 2016 and beyond. The difference between the two large country groups, however, will not take on more pronounced dimensions.
Household consumption the major growth driver, but investments also revive
The leading role attributed to household demand is driving economic growth in the EU-CEE and WB countries in 2016 and beyond (Figure 1). Deflationary expectations have not come to the fore; consumers took advantage of lower prices rather than postponing consumption in anticipation of even lower prices. With commodity prices levelling out, inflation will return to modestly positive rates. Population decline and ageing is a widespread problem that may curtail economic growth. Employers started to offer higher wages to overcome labour shortage. Unemployment is on the decline but still stubbornly high in regions with competitiveness problems especially in the WB.
As fiscal consolidation and more rapid economic growth have been achieved, fiscal space has widened in several countries, thus granting governments more room in which to implement and support investments. Even highly indebted countries managed to adopt a less restrictive fiscal stance. The CIS-3 and Ukraine are outliers in this respect as well; they have started cutting back on expenditures so as to reduce their fiscal deficits.
In the years to come, exports may well expand with external demand recovering, but imports may grow even more rapidly as consumption and investment expand in the EU-CEE and WB economies. Thus net exports will not be a strong driver of economic growth. Meanwhile, foreign investors’ income may rise again. Remittances to the Western Balkan countries and labour income from abroad in the EU-CEE countries are increasingly important sources of current account revenues. The present relatively low current account deficits may increase in the future without major problems in being financed.
Gross fixed capital formation was the most significant engine of growth in Albania and the Czech Republic. In 2015 it contributed positively to growth also in most other countries, even if only marginally in Hungary. Its contribution was negative in Estonia and Slovenia, which had already invested a significant portion of their EU transfers earlier, as well as in Turkey where increasing economic and political uncertainties discouraged private investors. Bulgaria, Croatia and Hungary are expected to implement more investments in 2017- 2018 than before, still they will remain in the group of slow-growth countries. In countries such as Poland, Slovakia and Romania, which have already attained and will maintain a GDP growth rate of 3% or more over the forecast period, the contribution of gross fixed capital formation will be stronger, about 0.8-1 pp.
A medium-term investment revival is expected in most of the CESEE countries in both the public and private sectors. FDI has already shown some signs of emerging from stagnation as shown by the rising number of green-field projects. Conditions for sustained private investment growth have started to improve owing to: (i) falling input prices in the manufacturing sector that allow for higher profits; (ii) declining private sector debt; (iii) shrinking nonperforming loans; (iv) conversion of foreign currency loans; and (v) increasing availability of new credits on better terms. However, a return to the lax banking practices of the pre-crisis era is unlikely.
Fiscal space for growth stimulation exists in at least half of the countries
Fiscal policy is a tool for stimulating growth and structural change that governments often leave untapped. In countries that have adopted the euro or pursue a fixed exchange rate regime, fiscal policy is the only tool they can use, whereas other countries may also resort to the use of monetary policy. In terms of scope, fiscal policy is often not a matter of choice. Its use is restricted in countries with high debts and onerous debt-service burdens or simply by virtue of EU regulations. In fact, even countries with high government debt can shape the structure of their budgets in order to attain their economic or social goals instead of being guided by inertia and vested interests.
In the wake of fiscal consolidation over the past few years and thanks to faster economic growth, countries with high debt and high fiscal deficits have diminished in number. Assuming we regard as meaningful the EU limits on debt (60% of GDP) and general government deficits (3% of GDP), Croatia, Serbia, Albania and Montenegro, the four countries in the upper left quarter of Figure 2, faced excessive debt and deficit levels in 2015. Slovenia, Hungary and Ukraine, the three countries in the upper right segment of Figure 2, reported high debts, but moderate fiscal deficits. The remaining countries in the lower right segment are safe as long as GDP is on the rise.
Countries with low government debt and low deficits enjoy some fiscal manoeuvring space, but only Romania makes increasing use thereof. In 2015 Romania still had a primary surplus, but as of 2016 its course is set on fiscal expansion, the fiscal outcome being a general government deficit of close to 3% of GDP. The deficit in Bulgaria, Poland and Slovakia came close to the 3% limit in 2015, half of which was primary deficit supporting domestic demand. The Baltic States continue to produce primary surpluses in periods of low overall fiscal deficits not warranted by their debt levels. The Czech Republic might well have some fiscal manoeuvring space as well that it could use to good effect by boosting economic growth via public spending.
Apart from Romania, Hungary and Poland are also among those countries whose governments are actively introducing novel features in their fiscal systems. In 2016 Hungary will lessen the fiscal burden on banks, introduce measures to support private investment via low interest loans and increase housing grants. Poland’s new government is about to follow the earlier example of Hungary by levying extra taxes on financial institutions and supermarket chains. Generous social programmes could be financed by drawing on profits accruing to the national bank in 2016, an additional fiscal gap of about 1% of GDP may open up the following year.
Public investment in the EU-CEE depends, to a considerable extent, on EU transfers, thus it will go into decline in 2016. General government gross fixed capital formation exceeded 5% of GDP in those years when capital transfers peaked. In Estonia and Latvia they peaked in 2012, while in the Czech Republic, Romania and Slovakia they peaked in 2015. It transpired that the peak for Romania was lower than in other countries as the government was unable to disburse about 20% of the eligible funds under the 2007-2013 financial framework, especially those devoted to governmentfinanced infrastructure projects. Highdisbursement years are usually followed by a low-transfer year 2016. The exceptions are Estonia, which is already disbursing 2014-2020 funds, and Croatia, which joined the EU at a later juncture and has just started receiving transfers from the EU budget.
More inflow of EU funds than of FDI
In 2014-2015 net FDI amounted to only 1.5- 2% of GDP in Poland and Romania and close to zero in Hungary and Slovakia. At the same time, the inflow of EU funds through the capital account amounted to about 2% of GDP in the Czech Republic, Poland and Romania, to 3% in Bulgariaand 4% in Hungary.
The inflow of foreign direct investment fluctuates greatly from one year to the next. The number of countries reporting increases and decreases in 2015 was almost equal compared to the previous year. The typical order of magnitude for FDI inflows in the EU-CEE countries is 10% of gross fixed capital formation, less than half of the volume recorded prior to the financial crisis.
Inflows recovered recently from very low levels in Lithuania and Slovakia, while Romania reported a notable increase in 2015. Some WB countries report much higher inflows per GFCF than the EU-CEE, the most notable being Montenegro (86%) and Albania (31%), but both Kosovo and Bosnia and Herzegovina are also on the high side. Those poor countries have a relatively low level of domestic savings, thus imported capital takes on greater importance than in the more affluent countries. Russian FDI dried up due to recession, the Western embargo and the devaluation of the Rouble.
After years of stagnation, the CESEE countries witnessed an increase in thenumber of greenfield FDI projects publicly announced in 2015: a clear indicator of investor confidence in a host country. Five of the EU-CEE destinations and Turkey hosted more new investment projects than before, while Poland registered the same number as in 2014. Russia still boasts a relatively high and increasing number of investment projects, especially in the manufacturing sector. Trade embargo has stimulated local production while some long-term investors also stayed. China ranks second among the investors in new
FDI projects in Russia just behind Germany. Ukraine has registered only a few projects of very low value, thus implying that most of the reported FDI inflows must have been related either to take-overs or financial flows that did not really add to gross fixed capital formation. A major change compared with the previous year was the drop in retail investments: something that was most probably due to the slump in consumption.
Owing to the sluggish investment activity across Europe as a whole, FDI in the EU-CEE is not expected to become a major engine of growth in the way it used to be before the financial crisis. Foreign companies are still rather reluctant to invest, although the host countries’ attractiveness persists.
Even if the amount of FDI inflows is not expected to boom, modest increases in the course of the overall European recovery are very likely to occur. Saturation has set in as most markets have been captured by foreign banks or retailers. Only Croatia, Romania and Slovenia have relatively low stocks of FDI, which may yield further opportunities.Given that foreign ownership is dominant in most segments of the EU-CEE economies, any new FDI will depend mainly on growth in demand across Europe. Relocation of capacities will continue, even if no direct link can be discerned between the opening of a new plant in an EU-CEE country and the closure of capacities in an ‘old’ Member State (viz. the recent example of the Jaguar plant in Slovakia). Inflows of new FDI into shared service and consumer service centres will continue in those CESEE countries that offer competitive wages for high-skill labour (Bulgaria, Romania). Potentially Ukraine is the most promising location in the region, given its size and low wage-levels, provided it manages to stabilise and improve the legal and other business conditions.
Summary
In 2016, economic growth is expected to decelerate somewhat in most of Central Europe, yet recover in the Baltic States. The latter economies will digest the Russian shock and return to a 2-3% GDP growth rate. Another country displaying more rapid growth will be Romania that has introduced fiscal measures that boostconsumption, thus postponing the slowdown for another year. In other countries in the region, the end to the consumption boom and the temporary decline in EU transfers have given rise todeceleration. Bulgaria, the Czech Republic, Hungary and Slovakia will be the countries most affected by the loss of the EU-funded engine of growth in 2016. The European Fund for Strategic Investment (‘Juncker Plan’) may only marginally be available of the EU-CEE. As for 2017 and 2018, the EU-CEE will pick up some speed based on new investments funded via EU transfers. Romania will be the only country in which we expect slower growth in 2017, by which time the impact of the current tax cuts will have faded out and fiscal policy will adopt a course heading towards stabilisation. The growth differential between the EU-CEE and the euro area will narrow in the years to come. The EUCommission forecast predicted modest acceleration of GDP growth for the euro area from 1.6% to 1.8%, while the wiiw forecast for the EU-CEE average shows a deceleration from 3.4% in 2015 to 3% in 2016 – and then to 2.9% in 2017. This implies certain reservations concerning the transmission of growth from the euro area and some scepticism about drivers of longer-term growth in the region.
Country forecasts for the EU members of Central and Eastern Europe by wiiw in Summer 2016
ALBANIA
Given the ongoing weakness of private consumption, only moderate growth of investment (largely due to the pipeline construction) and fiscal consolidation, our GDP growth forecasts for 2016-2018 have been revised downwards. Still, GDP growth above 3% can be expected from 2017 onwards. External demand will contribute positively to GDP growth, if international oil prices stabilise at the recently recovered level.
BELARUS
The economy touched bottom around the turn of the year and the decline decelerated in the first months of 2016. In April gross industrial output even registered positive year-on-year growth. The policy stance was tightened on all fronts: incomes, public finances, and monetary stance. Real exchange rate depreciation continued, contributing to an improvement in international competitiveness. If positive trends continue, the economy may bottom out in 2017, opening the way for a recovery thereafter.
BOSNIA AND HERZEGOVINA
The country is doing better than its two bigger neighbours, Serbia and Croatia. Growth of GDP is expected around 3% this year and is going to stay there in the medium term. The risks are on the upside primarily because of the improved prospects for the neighbouring countries and in the region. Exports are performing well and investments too.
BULGARIA
GDP grew by some 3% in the first quarter of 2016, driven by private consumption while the pace of exports lost steam. The upturn in private consumption was supported by the improved situation in the labour market with growing employment and rising real incomes. The recovery in manufacturing also continued and was mirrored by improving economic sentiment in the sector. Most indications are that modest demand-driven growth will continue in the short to medium run.
CROATIA
GDP growth, gaining momentum in 2016, will slightly accelerate over the forecasting period, up to 2.3% by 2018. Thanks to the economic recovery, unemployment will continue to decline. The current account will remain in surplus, but is expected to gradually narrow as domestic demand and consequently imports will strengthen. The ongoing political instability may negatively affect the creditworthiness of the country.
CZECH REPUBLIC
Moderate and broadly-based growth will continue over the period 2016-2018, with GDP growth averaging some 2.4%. 2017 is likely to end the management of the exchange rate. Renewed fiscal consolidation is not entirely implausible.
ESTONIA
In 2016 a slight upswing of GDP growth to 2% in real terms is expected to be driven by continuously vibrant household consumption, while external demand and investment activity remain stagnant. Rising goods imports will push the current account balance once more into deficit. For 2017 and 2018 we forecast a modest upswing to 2.3% and 2.4%, respectively. An expansion of investments will be facilitated from 2017 onwards by public outlays co-financed by EU funds.
HUNGARY
First-quarter GDP increased by 0.9%, a disappointment after the formidable annual growth in 2015, and a 3.2% expansion in the previous quarter. This is a combined adverse effect of outgoing EU co-financed projects, a setback in the automotive cluster and a generally unfavourable climate for business investment. A likely improvement in industrial and export performance and the growth stimulating efforts of the government may show effect, lifting the annual GDP growth to 2% in 2016.
KAZAKHSTAN
The economy continues to suffer from low oil prices and anaemic demand in its main trading partners. Household demand has weakened, too, due to increasing prices and falling incomes. The exchange rate of the tenge has stabilised recently, but the monetary stance remains tight in light of persisting macro-financial risks. In 2016, the economy will barely grow, by 0.4%; in 2017-2018, as the external environment improves, growth may speed up to 2% and 3%, respectively.
KOSOVO
The SAA between the EU and Kosovo entered into force on 1 April 2016. It is expected that this will create substantial investment opportunities. Given the strong drop in metals prices and export revenues and an overall dampening effect of government activities, we expect a slowdown of GDP growth to about 3.3% for the whole year 2016. However, if metals prices rebound and if FDI inflows soar due to the SAA, a GDP trend growth rate of around 4% can be expected for both 2017 and 2018.
LATVIA
The protracted downturn in Russia drags on Latvia’s export performance, while construction of residential buildings and public infrastructure is declining in 2016. However, household consumption is rising thanks to strong wage growth. The expected acceleration in economic activity will only materialise in 2017 driven by higher public investment. Thus we had to reduce our GDP growth forecast for 2016-2018 to 2.5%, 3% and 3.3%, respectively.
LITHUANIA
As wages develop at a steady pace, household consumption remains the main engine of GDP growth. Due to the delayed absorption of EU funds, public investment is slowing down. Until investment picks up momentum, GDP growth will be supported by rising exports. In 2016 the Lithuanian economy is expected to grow by 2.8% and about 3% in the upcoming two years.
MACEDONIA
In the first quarter of this year investment declined by close to 10% and growth slowed down to 2%, from 3.7% in 2015. Private consumption continued to expend as did public consumption and exports too. If investment recovers going forward, GDP may expand by 3.4% as forecasted. The medium-term growth rate may settle at closer to 3% rather than 4%. A swift resolution of the political crisis may push growth up, however.
MONTENEGRO
Political instability notwithstanding, growth is hovering somewhat above 3%, mostly due to investment and exports of services. This year’s revenue from tourism is expected to be a record one. The somewhat improved economic situation in the neighbouring countries is also supporting the tourist industry. Inflation is subdued as in the region. In the medium run, growth should remain above 3% per year barring political or financial shocks.
POLAND
Moderate and broadly based growth will continue over the period 2016-2018, with GDP growth averaging some 3.2%. The year 2017 will prove critical for the public finances unless the increase in social spending is offset by higher taxation.
ROMANIA
The current economic boom generated by fiscal stimuli is expected to subside in the second half of the year. With domestic demand turning out stronger while foreign demand weaker than earlier assumed, we see no reason to increase the wiiw GDP forecast of 4.0% for 2016. A marked deceleration of economic growth, to 3.2%, is forecasted for 2017, should the 3% fiscal deficit limit be obeyed.
SLOVAKIA
In the first quarter 2016, GDP rose by 3.4% year on year, at a slightly slower pace than in 2015 (3.6%) but still faster than in most other European countries. As the high growth rates of gross fixed capital formation cannot be sustained, we expect a slight growth decline to 3% for the whole year 2016. Domestic consumption will be the main engine of growth for the years to come. Growth acceleration can expected with the start of production at the new Jaguar Land Rover plant from 2018/19 onwards.
SLOVENIA
Despite a sharp contraction of investments, GDP is expected to grow by about 2% in 2016 and accelerate to close to 3% by 2018. The main drivers of growth will be the recovery of private consumption as well as investments fuelled by EU transfers. The high current account surpluses are expected to decline once domestic demand strengthens.
SERBIA
In the first quarter 2016 GDP grew by 3.5% year on year, but only by 1.6% over the previous quarter. All components of GDP contributed to growth – public consumption by 3.2%, private consumption by 0.7%, but investment by 7.9% and net exports by almost 3%. However, the first quarter of 2015 was quite bad, so growth going forward will moderate. Looking ahead, recovery should strengthen somewhat and medium-term growth of around 3% is realistic.
TURKEY
Turkey’s growth performance was 4.0% in 2015 and will probably rise to 4.1% with the help of household final consumption due to the rise in hourly real wages, and ongoing higher government spending. Because of a slight rise in oil prices, the slowdown in gross fixed capital formation for the last couple of years and weakening but positive domestic demand, we expect a deceleration of GDP growth for 2017 and 2018, to 3.7% and 3.5%, respectively.
RUSSIA
The economy is finally bottoming out; the expected recovery in the second half of 2016 will be weak and fragile. The outstanding structural reforms are still on the drawing board and a renewed plunge of oil prices could cause another slump. Given the absence of reforms and modernisation investments, economic growth will remain sluggish even in the medium term.
UKRAINE
The economy has probably bottomed out, as inflationary pressures eased markedly thanks to exchange rate stabilisation and fiscal policy became less restrictive. With the new government in place, a resumption of the IMF programme looks now almost certain. However, a visible economic recovery cannot be expected until at least next year, with inflation subsiding further, fiscal policy becoming more accommodative and export re-orientation away from Russia potentially starting to bear fruit.
