Central Europe can expect little help from Eurozone

By bne IntelliNews February 6, 2015

Tim Gosling in Prague -


The oil price slump and aggressive action from the European Central Bank has prompted the European Commission to raise its growth forecasts for the EU and Eurozone in its latest update released on February 5. However, the bloc clearly remains sluggish, and risks remain, the analysts in Brussels caution. That leaves those in Central Europe largely to fend for themselves.

For the first time since 2007, the economies of all European Union member states are expected to record growth this year, the European Commission's winter forecast reports. Over the course of this year, economic activity is expected to pick up moderately in the EU and in the euro area, before accelerating further in 2016.

Growth in 2015 is forecast to rise to 1.7% across the EU and to 1.3% in the Eurozone. In 2016, annual growth should reach 2.1% and 1.9% respectively, on the back of strengthened domestic and foreign demand, very accommodative monetary policy and a broadly neutral fiscal stance, the EU executive predicts.

Since the autumn, "a number of key developments have brightened the near-term outlook", it suggested. "Oil prices have declined faster than before, the euro has depreciated noticeably, the ECB has announced quantitative easing, and the European Commission has presented its Investment Plan for Europe. All these factors are set to have a positive impact on growth."

At the same time, growth prospects remain limited by a weak investment environment and high unemployment, it warned. Meanwhile, geopolitical tension, financial market volatility on the back of diverging monetary policy across major economies - in other words the drift towards a possible rate hike by the US Federal Reserve - and incomplete implementation of structural reforms hang over the EU.

"A protracted period of very low or negative inflation would also be detrimental to the growth outlook," the EU also worries.

Carrying the can

However, a forecast of just 1.3% economic expansion in the Eurozone for 2015 leaves Central Europe's mostly small and open economies to fend for themselves in many ways. The region's heavy dependence on exports to the single currency area means that they will depend on revived domestic demand for most of their growth.

Consumption and domestic investment in Czech Republic are showing strong signs that they will be able to carry the can, as domestic demand climbs out of the deep hole in which it has sat through the crisis years. That trend helped the Czech economy return to growth in 2014, after two years of contraction.

The EU says GDP is expected to have grown by 2.3% last year, and forecasts it will accelerate to 2.5% growth this year and 2.6% in 2016. HICP inflation is forecast to average 0.8% in 2015 and to rise to 1.4% in 2016.

Despite the lift given to exports by the central bank's currency intervention regime in the first half of 2014, net exports are seen unlikely to contribute significantly to growth this year - despite the continued suppression of the koruna - due to sluggish Eurozone demand. With the labour market continuing to improve, consumption is set to plough onwards. Meanwhile, state investment - on the back of EU funds - looks set to lead a trend that will help buoy robust corporate investment.

It's a similar story across the rest of the region. Next door in Slovakia - which has a similarly structured economy to the Czech Republic - continued improvement in persistently high unemployment over recent years should also mean domestic demand pushing forwards, with the effects of cheaper oil helping low inflation to add to the impetus.

Export growth slowed dramatically in the second half of last year, and is expected to continue to sink in 2015, before a revival the following year. That should sustain domestic investment, the analysts hope.

"After having slowed down in 2013, growth in Slovakia picked-up in 2014 with real GDP expected to have increased by 2.4%," the report notes. "Growth is expected to be at 2.5% in 2015 and to increase to 3.2% in 2016, driven by the continuing recovery of domestic demand."

Improving labour market conditions and rising real disposable incomes should also continue to push the Polish economy over the next couple of years, the commission forecasts. The biggest country in the region, Poland has long been far less dependent on exports than the others in Visegrad, although it is also more exposed to the Russian and Ukrainian markets. 

Consumption and domestic investment likely helped GDP grow 3.3% in 2014, according to the report. Private consumption accelerated, as the initial confidence impact of the Russia-Ukraine crisis on households turned out to be less important than expected. That said, the spillover from the crisis to the east is likely to become "more tangible" in early 2015, according to the EU.

Rising employment and higher real wages should continue to push consumption in the coming years, the EU outlook predicts. Meanwhile, "lower financing costs and the long-delayed renewal and expansion of production capacities, amid high capacity utilisation levels, has fuelled a rebound in corporate investment."

Overall, GDP is forecast to expand by 3.2% this year, and 3.4% in 2016. "The risks to the forecast are balanced," the commission sums up. "On the upside, a depreciation of the Polish zloty against the currencies of main trading partners in the wake of the Russia-Ukraine crisis would boost exports and support import substitution. On the downside, a new escalation of the Russia-Ukraine crisis could weigh on economic activity through lower exports and higher gas prices. By contrast, a possible appreciation of the Polish currency in the wake of the ECB QE might hamper exports."

While Hungary shares similar dynamics to its peers regarding the likely role of imports and exports in medium term growth, its economy is the only one in the region forecast to see a sharp drop in growth. After growing by an estimated 3.3 % in 2014, economic expansion is forecast to slow to 2.4% this year and then to 1.9% in 2016.

While growth last year came in better-than-expected, it remains overwhelmingly state driven and reliant on "one off" factors, the commission notes. "Higher absorption of EU funds and the central bank's Funding for Growth Scheme of subsidised loans to SMEs," are amongst them.

While EU funds may continue to drive state investment in early 2015, a decrease in cash arriving from Brussels "seems unavoidable in 2016", the report notes. The recent forced conversion of forex loans should help spur growth in private consumption to make up some of the ground, it adds.

Lithuania in the lead

Lithuania is likely to post economic growth of 3% in 2015, slightly faster than Baltic peers Latvia and Estonia, the report suggests.

Latvian GDP should grow 2.9%, while Estonia's is forecast to remain at the back of the pack at 2.3%, the Commission said. All three Baltics states will continue growth throughout 2016, the report adds. Lithuania will expand by 3.4%, Latvia by 3.6% and Estonia should rise to 2.9%.

With the external environment still a risk, mainly due to tensions with Russia, the regional economies will continue to hinge on domestic demand. Private consumption should be the driving force, riding on the back of rising wages and improved employment.

Inflation is likely to remain below 1% across the region this year, with Lithuanian and Estonian prices managing a hike of no more than 0.4%. Latvia should be the star, despite CPI being capped at 0.9%. In 2016, the Commission expects inflation will pick up to 1.6% in Lithuania and Estonia, and push to 1.9% in Latvia.

Lithuania and Latvia will both share similar rates of gross public debt of 41.8% and 36.5%, respectively in 2015. Estonia's 2015 gross public debt will come at 9.6%. In 2016, these figures will change only slightly.

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