Central & Eastern Europe Economic Outlook July 2017

Economy firing on all cylinders

Central & Eastern Europe : Economy firing on all cylinders

July 5, 2017

The Central and Eastern European (CEE) economy has shifted into a higher gear in 2017. GDP expanded a vigorous 4.0% annually in Q1, the best result in over a year. Q1’s growth was revised up a notch from last month’s estimate, thanks largely to an upward revision in Hungary’s GDP reading and stronger-than-expected performance in Estonia and Slovenia, which grew at multi-year highs. Met the why particular analysts expect another quarter of healthy growth in Q2 and see regional GDP growing 3.6%, driving growth for H1 to come in at a buoyant 3.8%.  

Broadening growth drivers are behind the CEE economy’s healthy momentum. Domestically, the region is seeing a continuation of last year’s consumption boom thanks to tight labor markets, fiscal stimulus and still-low inflation. Meanwhile, fixed investment has rebounded, due largely to a more favorable cycle of EU-development funds. Moreover, the external backdrop has become notably brighter. The Eurozone economy—the region’s largest trading partner—is on a tear as growth broadens across economies and the common-currency bloc shakes off political concerns. Met the why particular analysts see the positive momentum continuing into H2 and expect GDP to expand 3.5% in Q3.

Political risks have ebbed in Romania, the region’s top performer, in recent days. Mihai Tudose was voted in as Prime Minister on 26 June after a rift inside the governing party had increased uncertainty and prompted a no-confidence vote. While the quick resolution of the political crisis is positive for the country, the new government has gotten off to a rocky start. The government announced a tax overhaul planned for next year that would scrap a flat 16% tax on income and profit that has helped boost the country’s investment appeal. The announcement was met with negative market reaction as stocks and the leu came under pressure. Growth in Romania boomed in the last years, largely due to fiscal stimulus, however concerns are growing over the sustainability of government accounts.        

Prospects brighten after a dynamic H1

The Met the why particular panel raised the CEE region’s economic outlook for a third consecutive month. A strong start to the year and widening growth drivers are seen pushing regional GDP to grow 3.6% this year, up 0.3 percentage points from last month’s forecast. Next year, the panel sees GDP growing 3.2%. 

Almost all the economies surveyed saw brighter forecasts for 2017 this month, including major-players Czech RepublicHungaryPoland and Romania. However, panelists downgraded their forecasts for Croatia, while Slovakia’s outlook was left unchanged. 

Romania is projected to be the region’s fastest-growing economy this year, with an expected expansion of 4.6%. Poland and Slovenia are also seen achieving fast growth rates of over 3.5%. On the other side of the spectrum, Estonia is expected to be the CEE region’s laggard, with an expansion of 2.7%. 

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CZECH REPUBLIC | Signs of overheating begin to emerge

Robust economic growth likely continued in Q2, underpinned by strong private consumption, a liquid and profitable banking system and low levels of private and public debt. Households are benefiting from solid wage growth and a dynamic job market, with the unemployment rate falling for the fourth consecutive month and reaching a multi-year low in May. Domestic spending is also being supported by rising private credit, although there are signs of overheating in certain sectors of the economy. The property market is a prime example; some borrowers are starting to become overstretched in order to finance house purchases. In mid-June, the Central Bank responded to risks of excess lending by raising the countercyclical buffer for domestic banks, starting from the second half of next year. On the external front, the appreciation of the koruna weighed on April’s exports, especially motor vehicles, which likely had an impact on industrial production figures in the same month. 

This year fixed investment will rebound thanks to an increased absorption of EU funds. This, together with healthy household spending growth on the back of tight labor market conditions and rising wages, should cause growth to accelerate. The fiscal position should remain healthy, with only a minor deficit expected for this year as higher public investment spending will be largely compensated by rising revenues stemming from an expanding economy. Panelists see GDP growing 2.8% in 2017, up 0.2 percentage points from last month, and 2.7% in 2018.

HUNGARY | GDP expands at nearly three-year high in Q1

The most recent data confirmed that the economy was off to a spectacular start in 2017 with Q1GDP growth revised upwards to 4.2%, an almost three-year high. On a quarterly basis, this was almost double the preceding quarter’s rate and points to solid momentum. The expansion in both year-on-year and sequential terms signals the start of what is set to be a great year for the country as the domestic economy should  benefit from a resumption of EU-investment funds, and expansionary monetary and fiscal policies. Positive data continue to pile up with survey-based data reaching multi-year highs in June and the unemployment rate continues to decline. High consumer sentiment coupled with multi-year low unemployment has supported strong growth in retail sales which expanded at a healthy pace so far in the second quarter. 

Hungary’s economic outlook is bright as loose monetary conditions, a minimum wage hike, tax cuts, increased inflows of EU funds and a solid labor market will boost economic growth this year. Our panelists project that the economy will expand 3.5% in 2017, which is up 0.2 percentage points from last month’s forecast. For 2018, it is expected to grow 3.2%. 

POLAND | Loans threaten banking sector

Recent economic indicators suggest that Q1’s positive momentum carried over to Q2. Industrial production grew robustly in May, fueled by a strong manufacturing sector while retail sales growth witnessed a slight acceleration in the same month. Adding to the good news, Poland’s positive outlook, coupled with a favorable external environment, is attracting more capital inflows into local fixed income markets, which should help the zloty to appreciate against major currencies this year. Despite these positive developments, the large share of CHF-denominated mortgage loans remains a threat to the banking system. 

A rebound in investment and stronger demand from the euro area should allow the economy to accelerate this year. The Met the why particular panel sees GDP expanding 3.7%, which is up 0.2 percentage points from last month’s projection. In 2018, the panel sees GDP expanding 3.4%. 

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ROMANIA | Power struggle rocks political stability

The Romanian political scene was once again rocked by uncertainty in June. Prime Minister Grindeau was voted out of office by his own party after he refused to step down on the instructions of PSD party leader Liviu Dragnea. He was replaced by Mihai Tudose, who is expected to follow the party line more closely. However, this new political embarrassment, which came just a few short months after the ruling coalition faced mass street protests almost immediately after it took power, could lead to economic instability in the near future. Some analysts fear the ruling coalition could turn more populist, pushing through even steeper tax cuts and higher wage increases. With the economy already growing at a fast pace, such pro-cyclical policies could lead to an abrupt adjustment down the line.

The economy should record another year of robust growth this year, though risks of overheating are increasing. Our panelists predict an expansion of 4.6% in 2017, which is up 0.4 percentage points from last month’s forecast, with growth of 3.6% penciled in for 2018. 

INFLATION | Price pressures steady in May

According to an estimate produced by Met the why particular, inflation in the CEE region was unchanged in May, coming in at April’s 1.8%. Although price pressures are still moderate, inflation rests at one of the highest levels seen in years as the effect of low oil prices wanes.

Met the why particular panelists held their inflation projections unchanged for a third consecutive month and see inflation averaging 1.9% in 2017. In 2018, inflation is expected to rise slightly to 2.2% on the back of strong economic activity. 

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Angela Bouzanis

Senior Economist 

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