No. 2/15 July 2015 Analysis of the economic situation in the countries of Central and Eastern Europe No. 2/15 July 2015 Analysis of the economic situation in the countries of Central and Eastern Europe Authors: Beata Bierut Marcin Grela Marcin Humanicki Marcin Kitala Tomasz Michałek Edited by: Marcin Grela Anna Kosior Beata Bierut Economic Institute Warsaw 2015 Contents Summary 3 Countries of Central and Eastern Europe – macroeconomic outlook 4 Economic growth 4 Business cycle indicators 6 Inflation 8 Lending market 9 Financial markets 10 External balance 10 Fiscal policy 11 Monetary Policy 13 Forecasts 14 Bulgaria – links with Greece as a serious threat to the weakened economy 16 Croatia – a slight GDP growth expected after six years of recession 18 Czech Republic – unconventional monetary policy fosters economic recovery 20 Estonia, Lithuania, Latvia – strong links with Russia weaken economic recovery 22 Romania – investment slowdown comes to an end due to regulatory and tax changes 24 Slovakia – expected growth in exports and industrial production to strengthen economic growth 26 Slovenia – recovery weakened by effects of debt crisis 28 Hungary – recovery strongly supported by the active policy of the state 29 Statistical Annex 31 Summary Summary Economic recovery in the Central and Eastern (funds must be used until the end of 2015). In Po- Europe (CEE), initiated in the second half of 2013, land, the Czech Republic and Slovakia a faster in- continues, although its pace varies in individual crease in fixed capital formation of the private sec- countries. tor is observed. In some CEE countries private in- vestment is hindered by the process of deleveraging A faster growth is achieved by economies in of enterprises and households. which no significant imbalances had built up before the crisis: Poland, Slovakia and in the recent Monetary and fiscal policy are supporting domes- period also the Czech Republic. GDP growth in tic demand growth. In response the deflation and these countries stays vivid, due to the recovery in the ECB asset purchase programme, central banks the euro area and fiscal consolidation efforts being from the CEE region decided on further cuts in scaled down. GDP also grows fast in Hungary and interest rates. With the abrogation of the excessive Romania, fostered by policy measures. The weakest deficit procedure against the majority of the CEE economic growth is observed in the Baltic states, countries over the recent years, the scope of fiscal affected by the recession in Russia, as well as in consolidation has been clearly limited. Bulgaria and Croatia. Bulgaria still suffers from the effects of bankruptcy of a large domestic bank, Deflationary pressure in the CEE countries is whereas in Croatia the economic growth is ham- gradually fading away. The increase in commodi- pered by high private and public debt. ties prices on global markets are translating into a slow increase in consumer prices in the CEE coun- Economic recovery is driven by growing domestic tries. Core inflation remains low, although its grad- demand, mainly the consumption of households. ual growth is projected in 2015, which is to be sup- Consumption is fostered by the growth in employ- ported by the closing output gaps. ment and disposable income. It is associated not only with growing nominal wages and the decline The pace of economic growth in the CEE countries in consumer prices, but also with measures under- is expected to be maintained in the forthcoming taken by CEE governments aiming at spurring con- years. The domestic demand will remain the major sumer demand. growth engine, although the expected improvement in the external environment will affect the accelera- Increased absorption of EU funds has also had a tion of exports. The major risk factors for growth positive impact on economic activity over the re- include the negative scenarios related to resolving cent years. A slowdown in public investment the crisis in Greece, mainly the uncontrolled default growth in the CEE region is expected, due to expira- and the exit of this economy from the euro area, as tion of EU financial perspective for 2007-2013 well as the conflict in Ukraine and its aftermaths. 3 Countries of Central and Eastern Europe – macroeconomic outlook Countries of Central and Eastern Europe – mac- roeconomic outlook Economic growth also noted in Hungary and Romania, which is sup- ported by domestic economic policies stimulating Economic recovery in the Central and Eastern demand. On the other hand, in countries where the Europe (CEE), initiated in the second half of 2013, consequences of problems with banking sector sta- continues. In Q1 2015 GDP growth reached 3.3% bility continue to make a negative impact on the y/y, i.e. it has been the fastest growth since 2008 current economic situation, the recovery is clearly (Figure 1.1). GDP acceleration resulted, on the one weaker. This refers mainly to Croatia, slowly recov- hand, from the one-off strong growth in the Czech ering from recession, but also to Bulgaria. The GDP Republic, where regulatory changes related to ex- growth is also low in the Baltic states, whereas in cise goods were first reflected in the decline in in- their case it is mainly the effect of strong trade links ventories in Q4 2014, followed by their growth in with recession struck Russia and Finland, as well as Q1 2015.1 On the other hand, the increase in GDP of the uncertainty associated with the geopolitical growth in the CEE region was driven by the recov- situation. ery in the Slovak export sector and the acceleration of investment in Romania, fostered by the imple- Figure 1.2. GDP and its components in the CEE coun- mented regulatory and tax changes. In the largest tries (y/y, in % and pp). economies of the region, Poland and Hungary, the growth rate remained stable. Figure 1.1. GDP in the CEE countries and EU-15 (in %, y/y) Source: Eurostat Fast growing domestic demand is the source of recovery in the CEE region (Figure 1.2). It is sup- Source: Eurostat ported by: the beneficial impact of the decline in consumer prices and the growing demand for la- Individual economies of the CEE region are at bour on the real income of households, accommo- various stages of recovery. Economies in which no dative monetary policy and, in some economies, excessive imbalances accumulated before the crisis also the measures of governments aimed at stimula- (Poland, Slovakia and, in the recent period, also the tion of demand. Over the recent period, the recov- Czech Republic) grow faster. High growth rate is ery in the CEE region has also been supported, 1 GDP in the Czech Republic in Q1 2015 increased by 2.5% q/q although still to a moderate extent, by the im- which indicated the acceleration of annual GDP growth provement in the economic situation in the other from 1.3% in Q4 2014 to 4.0% in Q1 2015. EU countries. 4 Countries of Central and Eastern Europe – macroeconomic outlook Since the beginning of 2014 households' consump- garia the growth in investment is falling also due to tion in the CEE countries has been on a rise. It has risks originating from strong links with the Greek been fostered by: growing employment and the economy. relatively high growth in nominal wages, as well as the improvement in income purchasing power as Growing public investment, co-funded by the EU a result of decline in consumer prices. funds, contributed to the increase in gross fixed capital formation in 2014. It was supported by the Investment growth in the CEE countries reached a growing consumption of funds associated with the high level. Fast growth in gross fixed capital for- overlapping of two financial perspectives. In con- mation started as early as the second half of 2013. In nection with the approaching deadline for the dis- bursement of funds under the 2007-2013 perspec- the subsequent quarters investment growth contin- tive, a weakening of public investment growth in ued to increase. However, the recovery of invest- the region is expected. In some countries (the Czech ment is observed only in some CEE countries. Republic, Poland and Slovakia) private investment started to increase, due to the growing domestic The fastest growth in investment is recorded in demand as well as the recovery of foreign demand. countries where no significant imbalances was accumulated (Poland, the Czech Republic and Figure 1.3. Exports of CEE countries to major trade Slovakia) as well as in Romania. Strong invest- partners (y/y, in %) ment demand in three economies of the Visegrad Group results, inter alia, from high levels of capaci- ty utilisation, enforcing new investment after a period of weak growth in fixed capital formation. The growth rate of corporate investment in Roma- nia clearly increased in Q1 of 2015 due to the intro- duction of tax changes. In the other CEE countries the growth in fixed capital formation is slowly decreasing. Recession Source: Eurostat in Russia and the uncertainty associated with the conflict in Ukraine were reflected in the decline of Recovery in the euro area affects the situation of investment in Latvia and Estonia. Only Lithuania the export sector in the CEE region. In Q1 2015 managed to maintained a high growth in fixed capi- exports growth in the CEE countries has accelerat- tal formation. A visible weakening of investment ed. This was mainly related to exports within the growth occurred in Q4 2014 in Hungary, which was EU, i.e. exports to the euro area and trade among connected, on the one hand, with public investment CEE countries (Figure 1.3). On the other hand, ex- limitation and with the completion of large projects ports outside the EU continued to decrease in con- in the automotive sector on the other.