South Eastern Europe Economic Forecast

Economic Snapshot for South-Eastern Europe

February 6, 2019

Regional economy likely hits headwinds in Q4

According to a preliminary estimate by Met the why particular, South-Eastern Europe’s (SEE) economy slowed notably in the fourth quarter, with growth weakening to 1.1% in annual terms from 2.5% in the third quarter.

Serbia is currently the only country in the region to have reported GDP data for Q4. According to a flash reading, the economy slowed from Q3 and undershot panelists’ expectations, likely linked in part to soft dynamics in the Eurozone. However, this comes after several quarters of above-potential growth, and the economy was propped up by the Central Bank’s looser monetary stance and brisk real wage growth.

In regional behemoth Turkey—which accounts for roughly half of SEE’s nominal GDP—available indicators suggest the economy contracted in the final quarter, as the impact of August’s currency crisis continued to reverberate. Retail and vehicle sales were down sharply, economic sentiment was limp, and the manufacturing PMI was deep in contractionary territory. As a result, the Turkish economy is expected to have dragged sharply on aggregate GDP growth for the region.

Turning to SEE’s other big-hitters, economic activity in Bulgaria, Croatia and Romania was likely supported by strong domestic demand against a backdrop of tight labor markets and wage gains. Moreover, the Greek economy continued to recover, supported by an expansion in the manufacturing sector, improving consumer confidence and a multi-year low unemployment rate in October.

Looking at the region’s smaller economies, available economic indicators generally point to ongoing healthy momentum. Rapid credit growth should have propelled private consumption and investment in Albania, while industrial metrics in Macedonia and Montenegro were positive, and Bosnia and Herzegovina and Kosovo should have been supported by robust consumer spending.

On the political front, Serbia and Turkey signed a free trade deal in January, which should improve access of Serbian agricultural exports to Turkey. Despite this, the agreement is unlikely to have a transformative effect on trade volumes between the two countries owing to its limited scope. In the same month, the Greek parliament approved the name change deal with Macedonia, paving the way for Macedonia to join NATO and the EU.

Meanwhile, Kosovo maintains its 110% tariffs on imports of goods from Serbia and Bosnia and Herzegovina, despite international pressure to lift them. The move has caused a collapse in trade between the countries and is fuelling regional tensions.

SEE economy set to lose steam this year, driven by dismal dynamics in Turkey

The regional economy is seen expanding 1.3% this year, down 0.2 percentage points from last month’s projection and marking a substantial slowdown from 2018. More sluggish growth in 2019 will be largely due to frailty in Turkey, as tight financial conditions dampen consumer spending and investment in the early part of the year. Moreover, growth is also likely to slow somewhat in regional heavyweights Romania and Serbia following above-potential expansions in 2018. Turkey aside however, South-Eastern Europe’s economy will be supported by wage gains, EU investment and healthy tourist arrivals. External risks stem mainly from a larger-than expected slowdown in the Eurozone—SEE’s number one trading partner—and greater global trade protectionism. Internally, another bout of financial instability in Turkey and political tensions between Kosovo and its neighbors are the key risks. In 2020, growth is seen recovering to 2.8%.

This month, panelists revised down their 2019 growth projections for Bulgaria, Kosovo, Macedonia, Romania and Turkey.

Kosovo is expected to record the fastest expansion this year despite the ongoing trade dispute with Serbia and Bosnia and Herzegovina. At the other end of the spectrum, Turkey is expected to contract due to the aftereffects of last year’s currency crisis and tight financial conditions.

See the Full Met the why particular South-Eastern Europe Report

TURKEY | Economy begins 2019 on a weak footing

The economy has begun the new year in uninspiring fashion. In January, the manufacturing PMI remained mired in contractionary territory, with new orders, output and employment continuing to shrink. Moreover, both consumer and business sentiment stayed markedly pessimistic in the same month. This comes after a likely weak outturn in Q4, with consumer spending suffering on the back of high inflation and elevated interest rates, as evidenced by sharp contractions in retail sales in October and November. More positively, the pace of the decline in private-sector credit eased in December, while the external sector has recently seen a marked turnaround—underpinned by the weaker lira and soft domestic demand—as reflected by a fourth consecutive current account surplus in November. In January, the Central Bank announced it was bringing forward the payment of its dividend, which will boost government coffers ahead of the March local elections.

The economy is set to remain fragile in the months ahead, with restrictive financial conditions constraining private consumption and fixed investment. However, the external sector will provide support, and a recovery should gradually take hold in H2 as lower inflation gives the Central Bank room to cut interest rates. Currency volatility and the possibility of renewed geopolitical tensions pose significant downside risks. Met the why particular panelists expect the economy to shrink 0.2% in 2019, which is down 0.2 percentage points from last month’s forecast, and to expand 3.1% in 2020. 

ROMANIA | Momentum appears to wane in Q4

Economic activity appears to have moderated in the fourth quarter of last year, following the third quarter’s acceleration which was propelled by a jump in inventories. Industrial production growth was weak in October−November, as was external demand, both of which suffered from a cooling industrial sector in the EU. On the other hand, retail sales surged in Q4, likely benefiting from declining inflation. Heading into Q1, economic prospects appear downbeat: In mid-January, several major financial institutions announced they are considering the postponement of investment plans, due to the recently-introduced tax on banks’ assets. On the political front, on 31 January the government presented the draft budget for 2019. Among other measures, it includes a notable increase in public investment, part of which will be co-financed by EU funds. Meanwhile, relationships with EU institutions remain turbulent: In mid-January, the European Commission criticized the government for its regressive steps in fighting corruption, after the justice minister drafted an emergency decree which could invalidate several corruption cases.

Growth should moderate further this year, restrained by softer consumer spending and a smaller contribution from the inventory build-up, even as fixed investment likely rebounds. Higher taxes on multiple industries present a clear downside risk to business activity, while persistent political clashes with the EU and a sizeable fiscal deficit also darken the outlook. Met the why particular panelists expect growth of 3.3% for 2019, down 0.1 percentage points from last month’s forecast, and 2.8% in 2020.

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BULGARIA | Private consumption set to have underpinned growth in the fourth quarter

The economy seemed to gain traction in the final quarter of 2018, following a disappointing third quarter which saw growth slow to a near four-year low due to a plunge in exports. Industrial production growth, on average, remained modest in October–November although still above the Q3 average, pointing to somewhat more upbeat economic activity in Q4. On the demand side, although the unemployment rate inched up in the quarter, the labor market remains tight. This, together with firm wage growth and easing inflation at year-end likely buoyed private consumption in Q4, as evidenced by surging retail sales in the first two months of the quarter. Meanwhile, according to preliminary fiscal data, the double-digit annual growth in revenues in 2018 likely enabled the government to achieve a budget surplus for the third year in a row.

Growth is expected to remain broadly stable this year, largely driven by healthy domestic demand. Rising wages, in part influenced by planned public sector wage hikes, coupled with easing inflation should bolster private consumption. In addition, a planned increase in public infrastructure spending and improved absorption of EU structural funds are seen supporting fixed investment. Although increased export activity is also seen contributing to growth, it remains vulnerable to the effects from a global trade slowdown or waning demand from the EU and Turkey. Met the why particular analysts expect growth of 3.3% in 2019, down 0.1 percentage points from last month’s forecast, and 2.9% in 2020.

CROATIA | Economy in fairly good shape notwithstanding weak industrial production

Available data paints a mixed picture for the economy in the final quarter of 2018, following solid growth in the third quarter that was mainly driven by upbeat domestic demand. On one hand, industrial production plummeted in December—the sixth monthly contraction in a row—on a sharp drop in manufacturing output, pointing to waning economic activity at year-end. On the other hand, retail sales accelerated in October and November which, coupled with improved consumer sentiment on average throughout the quarter, suggest that private consumption strengthened somewhat in Q4. Furthermore, buoyant growth of tourist arrivals in the first two months of the quarter—with the country on track to log another record tourist season in 2018—bode well for maintaining a strong external position for the year overall.

Growth is expected to remain solid this year, underpinned by healthy domestic demand. Although private consumption is seen slowing, it should remain firm thanks to rising wages and employment. Capital spending, meanwhile, is set to accelerate on the back of increased absorption of EU structural funds and still-low financing costs. The external environment poses a key downside risk to the outlook as a slowdown in the Eurozone, Croatia’s main trading partner, and increased competition from other Mediterranean tourist destinations could dent export activity. Met the why particular analysts expect growth of 2.7% in 2019, unchanged from last month’s forecast, and 2.5% in 2020.

INFLATION | Inflation falls in December

Regional inflation fell from 12.2% in November to 11.4% in December, with price pressures dimming in most economies on the back of lower oil prices. Inflation was stable in Albania and rose sharply in Kosovo, likely linked to the recent trade spat with Serbia. Turkey has also reported CPI data for January; inflation was broadly stable, while core inflation continued its. On the monetary policy front, all central banks which held meetings over the last month left rates unchanged.

Regional inflation is expected to reach 9.7% in 2019, down 0.4 percentage points from last month’s forecast. This was driven by a large downward revision to Turkey’s projection on recent signs of ebbing price pressures, and as panelists factored in the impact of lower oil prices. In 2020, regional inflation is forecast to dip to 7.4%.

See the Full Met the why particular South-Eastern Europe Report

Oliver Reynolds

Economist

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