South Eastern Europe Economic Forecast

Economic Snapshot for South-Eastern Europe

August 1, 2018

 Economic growth likely slowed markedly in Q2 following a strong Q1

According to an estimate by Met the why particular, South-Eastern Europe’s (SEE) economy lost steam in the second quarter and grew 4.1%, which would be a marked deceleration from Q1’s 5.5% expansion

The slowdown likely came on the back of ebbing momentum in regional powerhouse Turkey, which accounts for just over half of the region’s GDP. All available signs point to a cooling in the Turkish economy following another period of unsustainably high growth in Q1. The manufacturing PMI was mired in contractionary territory throughout the second quarter, while industrial production growth has slipped and retail sales figures for May were soft—a potential sign that consumers are beginning to feel the pinch from soaring inflation. In addition, business sentiment has soured considerably in recent months, which could have a knock-on effect on private investment.

On the other hand, the region’s other big-hitters likely performed well in Q2. In Serbia, although growth likely slowed slightly from Q1’s stellar print, economic activity is seen having continued to be buoyed by the looser monetary stance and solid real earnings growth—which was reflected in healthy retail sales figures for April and May. Consumer spending also appeared to support the economies of Bulgaria, Romania and Croatia, against a backdrop of robust wage growth and low unemployment. Across the region’s smaller economies growth was likely brisk, supported by strong export growth on buoyant orders from the EU, and solid domestic demand—thanks to tighter labor markets and greater consumer purchasing power.

On the political front, Turkish President Erdogan announced his cabinet on 9 July. Investor-friendly ministers were sidelined, while the president’s son-in-law, Berat Albayrak, was appointed as treasury and finance minister. The move, which rattled markets and caused the lira to slide further, has increased the possibility of the unsustainably loose fiscal stance being maintained. Albayrak has attempted to calm market jitters by promising to fight inflation, although firm policy commitments are yet to materialize.

In contrast, investor sentiment towards Serbia likely warmed in mid-July, with the announcement that the IMF had approved a 30-month Policy Coordination Instrument. The new program aims to push through structural and institutional reforms, continue reducing the public debt ratio and boost competitiveness; it came after Serbia successfully completed its previous IMF program earlier this year. Meanwhile, Bulgaria took a further step towards the adoption of the euro in July, after EU officials agreed on plans which would see Bulgaria join the banking union and ERM-II next year. Further good news came from Macedonia, where on 30 July parliament agreed to hold a referendum on the country’s name change on 30 September. A successful resolution of the long-running name dispute would unblock EU accession talks.

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Growth should be robust this year despite deceleration, but risks of hard landing in Turkey are rising

The regional economy is seen expanding 3.7% this year, unchanged from last month’s projection, and 3.2% in 2019. Growth in Turkey and Romania is set to slow from unsustainably high levels as the impact of expansionary fiscal policy gradually fades and tighter credit conditions hit private consumption and investment. On the other hand, growth in Serbia is seen accelerating this year on a looser monetary stance and past reforms which should spur private investment. In addition, the Greek economy should continue to gain momentum on a solid external sector, although nominal GDP will still be significantly below its pre-crisis levels. Elsewhere in the region, stronger absorption of EU funds across the Balkans, resilient domestic and external demand, and improving tourist arrival numbers should aid economic activity. Greater global trade protectionism and the possibility of a deterioration of economic conditions in Turkey due to rising imbalances pose downside risks.

This month, panelists revised up their 2018 growth forecasts for Cyprus and Greece, and downgraded their projections for Macedonia and Romania. 2018 forecasts for the region’s remaining economies were unchanged.

The economies of regional heavyweights Romania and Turkey are expected to record the fastest growth among the region’s major economies at 4.1% and 4.2% respectively on solid domestic demand, although in both countries there are signs of overheating. At the other end of the spectrum, Greece is projected to record the weakest expansion in the region, with 2.0% growth.

TURKEY | New cabinet appointed amid souring economic backdrop

The economy likely lost momentum in Q2 on tighter credit conditions, as overheating concerns swirl. Industrial production growth in April and May was down notably from Q1’s stellar print, while the expansion in retail sales slowed markedly in May and the manufacturing PMI was in negative territory throughout Q2. Heading into the third quarter, business sentiment withered in July on lower optimism regarding current orders, general business conditions and employment. Economic imbalances furthermore continue to intensify: Inflation in June was triple the Central Bank’s target, while the current account deficit broadened further in May. Against this backdrop, President Erdogan announced his cabinet on 9 July. His son-in-law Berat Albayrak, the former energy minister, will head the new treasury and finance ministry. He effectively replaces Mehmet Şimşek and Naci Agbal, two business-friendly ministers, adding to market concerns over the direction of economic policy.

Economic growth will likely weaken in the coming quarters, on tighter financial conditions, shaky investor sentiment and a higher oil import bill. Exchange rate volatility, geopolitical tensions, a gaping current account deficit and elevated inflation pose downside risks. Met the why particular panelists expect growth of 4.2% this year, which is down 0.1 percentage points from last month’s estimate. They see growth of 3.6% in 2019.

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ROMANIA | Strong growth masks rising imbalances, while the judicial system is under pressure

Growth likely strengthened in Q2, following a sharp deceleration in Q1. Consumer spending appears to have regained some steam, benefiting from tight labor market conditions and wage gains, as retail sales were solid in April and May. Moreover, exports expanded at a solid pace in the same two months. However, data for the first five months of the year shows that the current account deficit widened significantly in annual terms. In addition, fiscal data for January-June continued to show a deterioration in the budget deficit, which does not bode well for the rebalancing of the economy. In early July, President Klaus Iohannis sacked the chief anti-corruption prosecutor following a constitutional court ruling saying he could not oppose a dismissal request by the justice minister. This is set to exacerbate the debate on the independence of the country’s judiciary between the government and EU institutions.

Higher inflation and a loss in consumer confidence should lead to a marked slowdown in consumer spending this year, denting GDP growth. Although the expansion in fixed investment should gain some strength, low EU funds absorption will limit the extent of the acceleration. Downside risks stem from widening fiscal and current account deficits. Met the why particular panelists expect growth of 4.1% for 2018, down 0.1 percentage points from last month’s forecast, and 3.6% in 2019.

BULGARIA | Domestic demand supports growth, country inches closer to adoption of the euro

Economic activity appears to have kept pace in the second quarter thanks to a resilient domestic economy, led in large part by stronger household spending. Retail sales through May recovered from a weak first quarter, and unemployment hit an all-time low in June. Wage growth has been robust and, in turn, consumer confidence has been hovering near its one-decade high. Meanwhile, the first-quarter jump in fixed investment, which benefited from low interest rates and heavy EU-linked capital spending at the outset of the year, seems to have persisted; business confidence remains high and industrial capacity has increasingly tightened. Exports, on the other hand, began to soften in May after previously avoiding the drop in demand from the EU, and trade risks are seen mounting over the coming months as the bloc-wide slowdown hits the external sector. As for the country’s eventual adoption of the euro, progress was made in July as EU officials laid out their conditions for accession, which now include applying to join both the ERM-II and the bloc’s banking union sometime in the next year.

Labor market gains are expected to slow this year, but household spending should still benefit from low unemployment and strong wage growth. Higher absorption of EU funds is expected to buttress fixed investment, which should see further support from the improving business climate and low interest rates. Sound fiscal policy should furthermore secure stronger FDI inflows. Met the why particular analysts expect growth of 3.6% in 2018, unchanged from last month’s forecast, and 3.4% in 2019.

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CROATIA | Economic picture remains bright, with private consumption and tourism doing the heavy lifting

Sequential data indicates that robust economic activity continued through Q2, following a solid performance in Q1 that was largely driven by buoyant domestic demand. Retail sales grew at nearly double the pace on average in April–May compared to in the first quarter, propelled by healthy gains in real wages and a strong labor market. The unemployment rate fell below 11% for the first time on record in May and declined further in June. Coupled with a sturdy increase of tourist arrivals in the same period, mainly from Austria and Germany, this signaled another robust expansion for private consumption in the quarter. Meanwhile, creditors of the highly-indebted food and retail giant Agrokor voted to approve a debt settlement deal in early July, whereby Russian state banks would acquire a nearly 50% equity stake of the new creditor-owned company—averting the bankruptcy of Croatia’s largest private employer. In the same month, Fitch Ratings upgraded the country’s credit rating outlook to positive from stable due to the strong fiscal metrics and current account surplus, boding well for increased foreign investment inflows.

Economic growth should remain robust this year, underpinned by a booming tourism sector, which available data points to a new record-breaking season for arrivals this year, and healthy consumer spending on the back of rising household real incomes and falling unemployment. The national football team’s successful FIFA World Cup campaign is also likely to have provided a boost to personal spending during the summer months. Met the why particular panelists project GDP growth of 2.7% in 2018, unchanged from last month’s forecast, and 2.7% again in 2019.

INFLATION | Inflation surges again in June

In June, regional inflation rose from 7.8% to 9.6%, largely due to higher inflation in Turkey as the weaker lira fans price pressures. Inflation also rose in most of the region’s other economies—including heavyweights Bulgaria, Croatia, and Serbia—likely driven in large part by higher international oil prices and robust domestic activity.

On 24 July, the Central Bank of the Republic of Turkey (CBRT) left the one-week repo rate unchanged at 17.75% despite runaway inflation and a sinking lira. The decision puts the Bank’s political independence under further scrutiny and has put renewed pressure on the currency. The central banks of Romania and Serbia, which also held meetings in July, left their policy rates unchanged.

Inflation in the SEE region is expected to average 8.0% this year, a significant upward revision from last month’s 7.4%, mainly on higher expected inflation in Turkey and Romania. In contrast, inflation forecasts for Bosnia and Herzegovina and Macedonia were cut this month. In 2019, regional inflation is expected to moderate to 6.9%.

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Oliver Reynolds

Economist

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