A multispeed recovery in Southeast Europe, but politics a consistent risk

A multispeed recovery in Southeast Europe, but politics a consistent risk
By bne IntelliNews December 22, 2015

The picture across Southeast Europe’s (SEE) economies for 2016 is generally positive, although forecast expansion rates vary widely. While the EU member states in the region are showing good signs of recovery, it is only Romania that looks likely to exceed the 2% GDP growth average predicted for the wider bloc. Most of the economies outside the EU, meanwhile, are forecast to expand more quickly.

Romania is shaping up to be one of the fastest growing economies in the EU. At 4.1%, the pace of GDP growth is likely to be second only to Ireland according to the European Commission’s latest forecast. Even at the other end of the spectrum, Croatia - the regional economy in the worst shape recently - finally emerged from a six-year recession to resume growth in 2015, and is set to accelerate.

The expected drivers for growth vary widely. In Romania, the government’s fiscal stimulus is the key factor, as it looks set to boost domestic consumption. Exports are more important in Bulgaria, Croatia, and particularly Slovenia, which has benefitted from the wider Eurozone recovery, now in its third year.

Meanwhile, in some of the smaller countries, economic expansion is largely expected to be driven by major investment projects, such as the Bar-Boljare motorway in Montenegro and the Trans-Adriatic Pipeline (TAP) pipeline in Albania. In both Bosnia & Herzegovina and Serbia, the recovery of industry following the massive floods in 2014 is a central factor.

According to the World Bank’s October Europe and Central Asia Economic Update, the Western Balkans region is expected to see acceleration in growth to 2.3% in 2016, up from 1.7% in 2015. That’s decent, but still considerably below the 3.3% forecast for Central Europe.

Analysts are generally positive on the region. East Capital says it is “relatively bullish” about Romania for 2016, citing “the combination of solid macro backdrop, attractive valuations, strong expected earnings growth and a currency that should appreciate against the euro.”

However, the analysts are keen on several other countries in the region also. “We see similar opportunities in other parts of the Balkans – with all economies out of the long recession,” they write, before cautioning that they also “remain selective”.

Raiffeisen is also positive on Romania, forecasting that “economic activity should remain on an upward trend in 2016 and the subsequent years as both domestic demand and exports … continue growing.”

Political risk

At the same time, political uncertainty is an issue virtually across the board. There are a few notable exceptions, however. That includes Serbia, where Prime Minister Aleksandar Vucic’s government has a strong mandate allowing it to forge ahead with fiscal consolidation, privatisation and other reforms.

On the other hand, Croatia has been struggling to form a new government, and was still in limbo a month after the November elections. Moldova, which has been in a state of almost permanent political chaos, also looked likely to end 2015 as it began the year, namely without a government.

Following the resignation of Victor Ponta’s government on November 4, Romania will have a technocratic government in place until general elections in autumn 2016, the outcome of which remains highly unpredictable. Parliamentary elections are also coming up in Macedonia and Montenegro, while both Bulgaria and Kosovo will appoint new presidents. Uncertainty and delayed decision-making can be expected in all these countries.

In several countries, the opposition has stepped up its pressure on the government with mass demonstrations and increasingly aggressive demands for the authorities to resign. That is possibly a precursor for further instability in 2016.

A stabilising factor, however, is the fact that EU entry is still the overriding foreign policy goal of most countries in the region yet to achieve membership. Convergence with the EU is also a long-term economic trend that all are chasing.

Serbia made significant progress in its effort to join the club in 2015, opening its first two accession chapters on December 14. The country is expected to benefit from the kind of pre-accession boom previously seen in Bulgaria and Romania. The signing of Stabilisation and Association Agreements in both Bosnia and Kosovo, meanwhile, is expected to support the two countries by sending out a positive signal to investors.

The notable exception is Moldova, where it is currently unclear whether the three pro-EU parties represented in parliament will be able to form a new government. Currently, two pro-Russian parties lead the polls, indicating there could be a reversal of the progress made in 2014 towards EU integration if Moldova ends up holding a new round of elections in 2016.

Romania kicking the can down the road

The region’s largest economy, Romania, is likely to expand at a pace exceeding the EU average, as well as most other states in Southeast Europe, over the next few years. Consensus expectations indicate the country’s GDP will rise by 4.1% in 2016 after a robust 3.5%-3.6% advance in 2015.

The stimulus measures in the country’s new fiscal code, which include substantial VAT cuts and a significant rise in the public payroll, are likely the main drivers for growth in 2016. This poses, however, the problem of costly fiscal consolidation in the coming years, as well as increased vulnerability to external shocks implied by additional public debt.

Consequently, the consensus on the magnitude of growth further out is weaker. While the government predicts above 4% p.a. after 2016, there are also more cautious independent projections as low as 2%. The European Commission forecasts GDP growth at 3.6% in 2017.

Subdued investment has also weakened the potential growth rate. Net investment in the first three quarters of 2015 equalled just 8.9% of GDP, far below the 15.7% in the same period of 2008. The International Monetary Fund (IMF) evaluates potential growth of investment at 3% p.a. with an additional 0.5pp conditioned on structural reforms.

At the same time, the streamlining of the public administration, mainly, but not limited to, spending prioritisation on key investment projects, is a major opportunity to help boost investment and growth, the international institution suggests.

Bulgaria up in the air

Summarising the macroeconomic forecasts for Bulgaria is complicated by the fact that the country’s statistics office has made a significant upward revision of GDP growth figures for the first two quarters of 2015. Real annual growth was revised to 2.6% in  both Q1 and Q2. In addition, GDP increased by a robust 2.9% y/y in Q3.

The only available forecasts taking into account the new data were published by Fitch Ratings and Standard & Poor's in early December. Both doubled their growth projections for 2015, to leave them standing at 2.5% and 3%, respectively, but disagree fundamentally in their outlook for the next couple of years.

Fitch forecasts pace will be maintained over the medium term. It pitches growth at an average of 2.6% for 2016 and 2017. “However, compared with 2015, the composition of GDP growth should be more balanced,” the rating agency adds.

However, S&P expects GDP growth to decelerate to 1.5% in both 2016 and 2017 on the back of weaker public investment.

Croatia’s stuttering recovery stalked by politics

Modest growth of around 1% is expected in Croatia in 2016, supported by stronger domestic demand due to accelerated absorption of EU funds. The central bank expects 1.2% GDP expansion, pitching it squarely in the middle of the European Commission (1.4%) and the IMF (1%).

Private consumption started to pick up in 2015 – it rose 1.4% in the third quarter - helped by lower energy prices, as well as changes in income tax and other government measures aimed at increasing disposable income. That should help consumption continue to recover in 2016, however, the expansion is likely to slow in as the one-off effects of the tax changes fade. On the other hand, investment, which started to recover in the second quarter of 2015, looks set to accelerate.

Exports should continue to grow, but at a slower pace than in 2015. Sales abroad are likely to be impacted by the still fragile recovery in the Eurozone, the struggles in emerging markets, and the high tourism base in 2015.

Meanwhile, economic performance is clearly at risk due to the political uncertainty stalking the country since the inconclusive results of the November elections. As the main parties represented in the new parliament continued in late 2015 to struggle to form a government, the prospect of another national vote is lurking in the background.

EU funding drop to hit Slovenia

International financial institutions (IFIs) expect Slovenia’s growth to moderate in 2016 following a likely 2.3% in 2015. The IMF, the World Bank and the European Commission forecasts average around 1.9%, although a modest revival is expected the following year.

While public consumption is expected to increase in both 2016 and 2017, public investment is forecast to decrease after exceptional growth in 2014 and 2015. This reduction in public investment is a result of the end of the latest programming period of EU funding, and will contribute significantly to the forecast deceleration in GDP growth.

Slovenia is expected to proceed with the ongoing privatisation of 15 state-controlled firms under a plan adopted in June 2013. Companies due to come up for sale during 2016 include the country’s largest bank Nova Ljubljanska Banka and flag carrier Adria Airways.

Serbia driven by FDI

Moving outside the region’s four EU member states, forecasts from key IFIs for Serbian GDP growth in 2016 average slightly over 1.5%. The main driver of economic growth should be foreign direct investment, with the forecast based on expectation of an improved external environment. However, Serbia still needs to improve domestic investment if it is to achieve sustained economic recovery.

The opening of the country’s first EU chapters in December is likely to be an additional motivation for foreign investors. In 2015, FDI contributed some 4.4% to GDP, but this could increase by 1pp in 2016 if the Eurozone remains stable.

Growth could be further boosted in the case of positive developments at Serbia’s top exporters. Belgrade is hopeful that Fiat Kragujevac will manage to secure a deal on exports to Russia allowing the automaker to boost production, while the potential takeover of the country’s only steel mill Zelezara Smederevo by China’s Hebei Iron and Steel Group (HBIS) is also in the pipeline.

The government made significant progress on fiscal consolidation in 2015, as agreed under its €1.2bn three-year stand-by arrangement with the IMF signed in February. Public debt remains a major risk to financial stability, however. The burden sat at 75.3% GDP on October 31, illustrating the challenge Belgrade faces in achieving its target to drop the ratio to 45% within the next few years.

Politics in the driving seat

Among the smaller countries in the region, the IMF expects Bosnia’s economy to grow 3.0% in 2016, accelerating from a projected 2.1% rise in 2015. The country hopes to sign a new arrangement with the IMF in the coming year, which would include €1bn financial package, much needed by the country’s two political entities – the Muslim-Croat Federation and the Serb Republic.

Bosnia also hopes to meet the criteria to formally apply for EU membership in 2016. However, there is concern over the country’s stability after several announcements from Republika Srpska indicating it could cease adherence to the Dayton agreement that ended the civil war in 1995.

Albania is expected to continue reforms to bring the country closer to the EU, prompting Prime Minister Edi Rama to express hope negotiations on membership could start in the coming year. Tirana targets an increase in GDP growth to 3.4%, which would help slash the budget deficit to 2.2%.

Facing pressure from the IMF to increase budget revenues via other channels, the government plans no tax hikes. Measures include an intensification of the campaign against the informal economy. Meanwhile, the launch of construction on the TAP gas pipeline, which crosses Albania, will provide a further boost to the economy.

Montenegro’s growth - projected at 4.1% by the European Commission - will also be supported by major projects. The construction of several large tourism resorts should help add momentum, alongside the launch of construction on the 169km Bar-Boljare motorway.

A strong recovery is also expected in Macedonia, where both the European Commission and the country’s central bank expect GDP growth to accelerate to 3.5% in 2016. The expansion should be driven by domestic demand, whereas net exports are forecast to have a negative contribution, despite Skopje’s efforts to attract export-led FDI.

However, there is some uncertainty ahead. Macedonia will hold early parliamentary elections on April 24, according to the July 2015 agreement that resolved the political crisis in the country. An interim government - led by the ruling VMRO-DPMNE but not current Prime Minister Nikola Gruevski - will be sworn in on January 15 with a mandate to organise the elections.

Kosovo enters 2016 amid a deepening political crisis. The opposition demands the government either cancel key agreements with Serbia and Montenegro, conduct a referendum, or agree to early elections. That pressure may be stepped up around the appointment of a new president in March.

Despite the political instability, Kosovo’s GDP growth is expected to accelerate from 3.2% in 2015 to 3.8% in 2016, according to the IMF. Pristina is also close to securing the country’s largest-ever investment, with US-based ContourGlobal set to buy into the €1bn Kosova e Re power plant.

Bank fraud, corruption and political instability plague Moldova, where the economy faces a 2% contraction in 2015. The recovery in 2016, if any, depends on low base effects, due to the poor 2015 harvest.

Longer term projections are premature, although the IMF projected 4% y/y medium-term potential growth for Moldova in its October World Economic Outlook. However, the country’s economic recovery essentially depends on aid from development partners, which in turn depends on Chisinau’s commitment to reforms to promote the rule of law and the market economy – very ambitious targets.

Price stability and public finances are the country’s main macroeconomic issues. The government is due to convert around €625mn (or 11.8% of GDP) of emergency aid, extended by the monetary authority to three troubled banks, into public debt. The new bonds will triple domestic public debt, while bringing overall public debt close to 40% of GDP.