CEE set to drive EU recovery, says European Commission

By bne IntelliNews February 26, 2014

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The member states of Central and Eastern Europe are set to return to their role as the engine of EU growth this year and next, the European Commission forecasts in its latest outlook for the bloc. Although the recovery from crisis remains fragile, the executive notes, the outlook is for a moderate step-up in economic growth.

After exiting recession in spring 2013 and three consecutive quarters of subdued recovery, the EU should finally start to see some significant quickening of its economy, Brussels predicts in its Winter 2014 forecast. Overall, it now expects to see the 28-member bloc's GDP growth rise to 1.5% this year, and 2% next.

"After two years of contraction, domestic demand is gently firming, as the crisis' legacy of excessive debt, financial fragmentation, economic uncertainty and the need for adjustment and fiscal consolidation fades, and confidence is improving," the report reads. "The fiscal stances of the EU and euro area this year are expected to be broadly neutral. At the same time, rising import demand means that external trade's contribution to growth will become more muted."

The rebalancing of Europe's growth engine will be confirmed as domestic demand overtakes exports as the main thrust, the report notes. "The strengthening of domestic demand, though still expected to be modest in 2014, will be fueled by all components, both private and public. Investment growth, in particular investment in equipment, is projected to significantly strengthen, as the main impediments to firms' demand and profits (uncertainty, financing conditions, deleveraging needs) are slowly receding, and the improvement in the economic outlook is confirmed."

Table toppers

That broadening base for economic growth will help CEE, and the Central European and Baltic states - which are set to top the performance tables in 2014-15 - in particular. The commission improved its economic growth forecasts for Poland, Hungary, Slovakia, Slovenia and Bulgaria, while it left forecasts for the Czech Republic and Croatia unchanged.

Low inflation should help the region's chronic domestic demand from its knees at the same time as the country's track the broader recovery in their main export markets, which remain inside the bloc. Inflation in the EU is now expected to dip to 1.2% in 2014, before rising again to 1.5% in 2015.

As is recent tradition, Latvia and Lithuania are set to lead the EU growth table at 4.2% and 3.5% respectively in 2014, following that up with 4.3% and 3.9% next year. Estonia is ready to up its game to move closer to its Baltic cousins with 2.3% and 3.6%.

Amongst the larger economies, with its robust domestic demand driving, Poland should retake its crown as the regional star. "The improving economic outlook in the main trading partners and the resulting pick-up in Polish exports are set to invigorate private investment and the labour market, which in turn is expected to support the recovery of private consumption," the report suggests.

"Real GDP growth is forecast to accelerate to 2.9% in 2014 and to 3.1% in 2015, slightly above current estimates of potential output growth," it continued. Meanwhile, continued low inflation should salve the nerves at the hawkish central bank.

To the south, Slovakia is set to retake the strong expansionary path it veered from last year, as the country's car industry pushes it to 2.3% growth in 2014. Despite unemployment persisting above 13%, a rebound in domestic demand, which has been on the floor for years, should see it follow that up with 3.2%.

Domestic demand already became the main driver of Hungarian growth in 2013, and with the government's employment and investment schemes and the central bank's Funding for Growth Scheme to SMEs, that trend is likely to extend over the next two years, with growth plotted at 2.1% in both 2014 and 2015. The effect of government policy on investment is seen as the biggest risk to the forecast - both in positive and negative terms.

By way of contrast, exports will remain in the driver's seat in the Czech Republic. Already one of the region's most dependent on external trade, the weakening of the crown in late 2013 should allow the country to take even greater advantage of the Eurozone recovery than its peers.

Although domestic demand should contribute a little more than seen recently to growth of 1.8% this year, fragile consumer confidence and investment constrained by credit growth is likely to hold this element back until 2015, when it will push economic growth to 2.2%

Romania was the star of the fourth quarter of 2013, with its economy expanding a whopping 5.6%, driven by exports and an abundant harvest. Unsurprisingly, the country is not expected to keep up that stunning pace, but growth of 2.3% this year and 2.5% next still puts it some way ahead in southeastern Europe. With investment set to speed up in 2014, and product and labour market reforms boosting confidence, Romania is another country set to see domestic demand increase its standing in the economic mix.


Elsewhere in Southeast Europe, the weak banks, political issues and lack of reform are all set to curtail the economies. Although at 1.7% and 2.0% Bulgarian growth will outstrip much of Western Europe, the base is clearly a long way behind those peers. Annual growth is projected to have reached 0.6% in 2013. "This remains well below the estimated potential growth rate of the economy," the report notes.

Again, it's domestic demand that the European Commission expects to see drive the improvement over the next two years, to reinforce what it calls "the export-driven growth momentum". However, recovery is expected to remain slow compared to many other converging economies, as a significant population decline (due to ageing and emigration) continues to erode potential.

The EU's newest member - having joined in July - sits even further back, with Croatia forecast to manage no more than 0.5% growth in 2014, followed by 1.2%. With 2013 looking likely to have finished with a 0.7% contraction, the country has been in recession for a full five years.

Domestic demand should see some recovery in 2014, mostly on the back of EU funds accelerating public investment, private investment will remain subdued due to fragile domestic demand and ongoing bank deleveraging. While Croatia should benefit to some extent from improving growth in the Eurozone, the fact that its main trading partners are in the periphery - e.g. Italy - means that exports will also struggle to offer much momentum.

At the same time, some in CEE remain a drag on overall EU growth. Slovenia is one of only two EU countries - Cyprus is the other - still expected to register negative annual GDP growth in 2014. While Ljubljana desperately needs to see growth in order to help it with the ongoing restructuring of state finances and the banking sector, it will have to wait a little longer, the report suggests.

The analysts forecast a contraction of 0.1% of GDP for Slovenia this year - a long way ahead of Cyprus, whose fellow bank busted economy is set to fall 4.8%. By 2015 all EU economies are expected to be in growth once more, with Slovenia pushing to a 1.3% expansion, and Cyprus managing 0.9%.

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