After five years of declining growth rates in the region, the economies of Central & Eastern Europe/Commonwealth of Independent States (CEE/CIS) have started to recover, but the process will be slow and patchy, the EBRD said in its latest “Regional Economic Prospects” report, which was released on May 11 at the development bank’s annual general meeting in London.
Acting Chief Economist Hans Peter Lankes said the economic picture is becoming increasingly divided between east and west, driven by the fall in oil prices as the countries in Eastern Europe and Cenral Asia are heavily dependent on hydrocarbons. Lankes speculated that if oil prices recover then the economic dichotomy that has opened up could close again.
Politics of the last year has also driven a wedge down the middle of the continent and forced many countries to take sides in Russia’s confrontation with the US and EU. At the same time, Russia’s economic problems have spilled over to affect many countries in the region, especially impacting on remittances (Russia-Central Asian remittances were down 20% in 2015 in local currency terms) and trade across the region.
“Even in central and south-eastern Europe, where the economic performance has been steadier than growth further east, the pace of expansion is inadequate… The real issue is growth and it is not strong enough to achieve convergence with more advanced economies,” Lankes said.
Growth in the CEE/CIS region as a whole slowed sharply, from 1.9% in 2014 to 0.5% in 2015, broadly in line with the projections published in the November 2015 issue of “Regional Economic Prospects”, and the outlook is for only a mild improvement this year.
“The recovery expected for 2016 is slightly weaker than forecast six months ago,” Lankes said. “The EBRD’s latest Regional Economic Prospects report sees average growth across the Bank’s 36 countries of operations of 1.4% in 2016, a shade below the 1.6% seen last November but above the 0.5% result for 2015. A further strengthening is seen to 2.5% in 2017.”
Nascent growth has been hurt by another round of the collapse in commodity prices – oil dropping to $28 in January has affected the hydrocarbon producers in the region – as well as problems in the global economy, especially in the US and China, which is dragging down growth everywhere.
The International Monetary Fund (IMF) warned in its “World Economic Outlook” in April that the world was facing the threat of “global stagnation”, to which the EBRD adds that what recovery there is in its region remains patchy at best. These problems are easiest to see in global trade volumes, which grew at a rate of 2.5% in 2015, compared with an annual average of 5.0% over the previous two decades.
Russia and the CIS
Russia has been front and centre of global events for the last couple of years, starting with its annexation of Crimea in 2014, its intervention in Ukraine, and its short war in Syria in the second half of 2015. The economy is also under enormous stress because of the collapse of oil prices in December 2014, and the subsequent recession will spill over to this year. Russia’s poor performance is dragging down growth in all its neighbours.
The EBRD is more pessimistic than the Russian government, predicting a contraction of 1.2% for the Russian economy in 2016, with modest growth of 1% in 2017. The 2016 forecast is in keeping with the bne IntelliNews consensus forecast of -1.22%, from a poll of 13 leading international financial institutions (IFIs) and investment banks, but the 1.0% growth in 2017 is below our 1.38% consensus forecast for that year.
The EBRD’s previous chief economist, Erik Berglof, said Russia remains an “investment node” and its recession hurts the other countries of Central Asia, Eastern Europe and the Caucasus, with lower remittances and trade from Russia as the main transmission mechanism. Lankes updated this idea saying that: “A one percentage point [pp] decline in Russia’s growth translates, over a period of a year, into a 0.55pp deceleration in the Baltic States and a 0.2pp lower growth in Central Asia and EEC. The effects are strongest in the case of Armenia and weakest in the case of Azerbaijan and Mongolia.”
Following a huge flow of investment over the last few years, the region has a similar relationship with China, which is now more important for growth than Russia in some places: “A similar deceleration in China is estimated to translate into a decline in growth of 0.2 pp in the Baltic States and 0.4 pp in Central Asia excluding Kazakhstan. The effect is strongest for Mongolia and weakest for Azerbaijan, Belarus and Kazakhstan.”
The greatest victim of Russia's aggression and showdown with the West has been Ukraine, which saw its economy contract by 6.8% in 2014 and 9.9% in 2015. However, the EBRD expects Ukraine to return to growth of 2% this year and next – depending on how much progress is made putting through badly-needed reforms. An IMF team was due to arrive in Kyiv on May 10 and everything depends on whether the stand-by loan programme that was de facto suspended last August is restarted.
The wish list is long: the fight against corruption has yet to begin, but the government has already scored a major success with the stabilization of the macroeconomic situation and reforms in the banking sector. The decision of the new administration of Prime Minister Volodymyr Groysman to hike domestic gas prices in May is a good sign that the government will make a concerted effort to get the IMF money flowing again.
The two other big oil producers in the region, Kazakhstan and Azerbaijan, have been hurt as much as Russia, with both expected to improve growth this year over last year (1.1% to 2.4% for the former and -3% to 1% for the latter), but the rest of Central Asia, hidden behind the fortresses that their autocratic leaders have built, have been much less affected by the jarring swings of the global economy and most are putting in consistently strong growth, albeit from low bases.
Central and Southeast Europe
The dividing line in Europe has become more pronounced as the economies of Central and Southast Europe, including the Baltics and Balkans, are more dependent on the EU than Russia, and consequently have fared much better.
Growth in this region was 3% in 2015, virtually unchanged from 2014, compared to the slowdown for the region as a whole, which was held up by strong consumption and recovering investment, said the EBRD. EU structural funds also helped bolster growth.
Central Europe is expected to maintain its steady growth rate at 3.1% this year and next, Southeast Europe will improve its growth from 2.4% to 2.9%.
All these countries are benefiting from lower energy costs and the European Central Bank (ECB) decision to cut rates and flush the system with money, so their outlook for this year and next is better than their peers to the east. The ECB’s monthly purchases of assets have been scaled up to €80bn and now also cover selected corporate bonds. The deposit rate has been cut to -0.4%, and banks are getting long-term funding at negative interest rates under TLTRO II (targeted long-term refinancing operations).
Croatia’s economy expanded for the first time in seven years in 2015 thanks to a strong tourism season and it may benefit again in the upcoming season together with Macedonia, as Russians in particular hunt for a new affordable summer holiday destination to replace their former favourites of Turkey and Egypt.
Turkey is being hit by multiple whammies, with its row with Russia proving to be by far the most damaging. The EBRD predicts Turkey’s growth will slow to around 3.2% this year from 4.0% in 2015, with a small improvement to 3.4% next year. The country is vulnerable to a slowing of international capital into emerging markets, but more immediately the Kremlin’s decision to effectively stop trading with Turkey and keep its 3mn-4mn tourists a year away, after Ankara shot down a Russian bomber in November 2014, has already cost Turkey’s current account several billion dollars in lost revenues – money it can ill afford to lose.
On the other side of the fence, Russia has long been the most important foreign investment destination for Turkish companies, especially in construction. These are being effectively locked out of the market, which means they will miss out on the 2018 World Cup construction bonanza.
Turkey is not alone in losing out from tourism receipts, which remains an important source of hard currency income for many southern states. “Weaker tourism receipts partly due to security concerns and the slowdown in global trade are clouding the outlook in southern and eastern Mediterranean (SEMED) as well as Turkey,” the report said.
The North African states the EBRD covers will all improve already strong growth from between 2.3% to 3.3% and put in even better results in 2017, according to the EBRD. Tunisia is the worst performer in this region, but even there will see growth improve from 1.6% this year to 2.5% next year.
Prospects for growth
Prospects for an early or strong recovery are poor. The banking sector across the region in particular is struggling, with low lending levels knocking through to low levels of investment.
“Recent surveys of lenders indicate that credit conditions in the region have tightened further, albeit less so than in other emerging markets. Credit growth remained subdued in most countries in the [Central Europe and he Baltics] and SEE regions. High levels of non-performing loans continued to constrain the ability and willingness of banks to provide fresh credit. Some countries have made progress in terms of removing non-performing loans from banks’ balance sheets, although in some cases these assets may remain on the books of special vehicles fully owned by the originating banks,” the EBRD said in its report.
While the region is clearly coming out the other side now, the above problems are already seen as a drag on faster growth. But ongoing political tensions around the region introduce a high degree of uncertainty into the equation.