bne -

Economic recovery in the EU is set to push onwards, the European Commission forecast on May 5, with Emerging Europe set to lead the growth. However, the expansion is set to remain limited, it admitted, and "external threats" - in other words the crisis in Ukraine - are growing.

The EU executive's 2014 Spring Forecast points to "continuing economic recovery in the European Union following its emergence from recession one year ago. Real GDP growth is set to reach 1.6% in the EU and 1.2% in the euro area in 2014, and to improve further in 2015 to 2.0% and 1.7% respectively." 

The gradual nature of the recovery "is in line with previous recoveries following deep financial crises," the Commission notes, though fiscal management has made good strides, and that it expects to see deficits and debt levels continue to fall.

Reflecting recent outlooks by the likes of the International Monetary Fund, the Commission sees domestic demand as central. "Overall, domestic demand is expected to become the key driver of growth over the forecast horizon," the report reads. "Consumer spending should progressively add to growth as real income benefits from lower inflation and the stabilising labour market. The recovery in investment should continue to support growth, with gains in both equipment and construction investment." 

Commission Vice-President Siim Kallas said: "The recovery has now taken hold. Deficits have declined, investment is rebounding and, importantly, the employment situation has started improving. Continued reform efforts by Member States and the EU itself are paying off."

As several states in Central and Eastern Europe celebrate their 10-year anniversary in the EU, Kallas lauded their progress on the back of reform, and suggested it as a good guide to the current situation. "This ongoing structural change reminds me of the profound adjustment that the central and eastern European economies undertook in the 1990s and in subsequent years, linked to their joining the EU exactly 10 years ago," he notes. "Their experience shows how important it is to embrace structural reforms early on and to stay the course, whatever challenges may be faced along the way. In this spirit, we must not lessen our efforts to create more jobs for Europeans and strengthen growth potential."

League leaders

Indeed, those Central European nations that joined the bloc in 2004 lead the growth forecasts. At 3.8%, Latvia is expected to put in the best performance out of the 28 member states in 2014, followed by Lithuania at 3.3%. Poland rounds out the top three with estimated growth of 3.2% this year. The forecasts for 2015 see the trio growing at 4.1%, 3.7% and 3.4% respectively. 

With growth likely at 2.3%, Hungary will lead the Czech Republic this year, the report adds. However, reflecting analysis that the Hungarian recovery will soon run out of steam due to a lack of investment - provoked by the government's unfriendly policies towards foreign investors - that ranking will turn on its head in 2015, when the Czech economy will likely grow by 2.4%, but Hungarian expansion slow to 2.1%.

Slovakia will beat them both to record the fourth quickest growth in the bloc at 2.2% this year, to be followed by 3.1% in 2015, the European Commission said. However, reflecting his persistent refrain over the past two months, Prime Minister Robert Fico was swift to warn that the forecast is under threat from EU sanctions against Russia. 

“We have been struggling for two years and we are getting results,” the PM told reporters in Bratislava, according to Bloomberg. “Were the strictest sanctions to be imposed, economic growth would slow by almost one half.” Slovakia - whose strong connections with Russian gas giant Gazprom has seen it baulk at Ukrainian requests to supply it with large volumes of gas from the EU to help it resist Russian pressure - has consistently spoken out against Brussels' efforts to stymie Moscow's efforts to destabilize the interim pro-Western government in Kyiv.

Balanced risk?

However, Fico declined to specify estimates of the level of impact of potential further sanctions, saying the government’s deliberations are confidential. Brussels is not ready to put a figure on it either - for obvious reasons - and the European Commission is keen to flag up the potential for raised domestic demand to help offset to possible threat from "escalating conflict in neighboring Ukraine and a possible recession in Russia."

Those threats are clearly largest for those in the east end of the EU however, with most hugely dependent on Russian oil and gas, while the likes of the Baltics also have large exposure to Russian trade. By those same tokens, Germany - which takes by far the largest chunk of exports out of the CEE economies - is also vulnerable. 

That makes the Commission's half-hearted admission that the likes of Poland "might" be affected look somewhat optimistic. "The risks to the forecast are broadly balanced," the Commission noted of Poland. "On the upside, a stronger depreciation of the zloty would further boost exports and enhance import substitution. On the downside, new tensions in Ukraine could weigh on economic activity."

The release of the report came on the heels of PMI reports that suggested a sudden and unexpected drop in activity in Polish manufacturing, despite the Czech sector heading the other way. While analysts are wary of putting the fall at the door of the Ukraine crisis, it's hard to see alternative explanation, especially given Poland's much larger exposure to the east in comparison with the neighbouring Czechs. 

Croatia stuck in a rut

Dipping down into Southeast Europe, Croatia is the only country in the EU that Brussels expects to remain in recession this year. GDP is forecast to contract a further 0.6% in 2014, before entering positive territory (a modest 0.7%) next year. Domestic demand is stuck in a quagmire and will outweigh any positive impact from exports, the report suggests, adding that the anticipated recovery in 2015 “hinges on external demand”. 

Slovenia, which "started emerging from recession in 2013," will likely grow by 0.8% this year, the Commission writes. That said, the current revival of political turmoil could jeopardise the country’s privatisation and delevraging processes to add to any risks on the outlook.

By way of contrast to those in the Western Balkans, rising domestic demand is expected in both Romania and Bulgaria, gradually replacing exports as the main driver for growth. 

Romania’s economy, which put in something of a stellar performance in 2013 as it expanded 3.5%, is now being overtaken by others in the region, with growth set to slow to a more modest 2.5% in 2014. That's still “above potential” however, according to the Commission, and is based on improved confidence and the gradual benefits of structural reforms such as the liberalisation of energy markets. At the same time, credit growth is expected to “remain constrained” the report warns. 

Like the wider bloc, Bulgaria is set to see its gradual recovery continue, according to the forecasts. Growth should accelerate from the 0.9% seen in 2013 - despite contractions for both consumption and investment - to 1.7% next year, when both those elements are expected to move back into expansion. The wider EU recovery should also provoke an increase in exports. However, the Commission also sounds a note of caution: “Most significantly, the country's energy dependence on Russian gas imports could become a burden to growth in case of supply disruptions.”