Central Europe set for limited acceleration, forecasts IMF

By bne IntelliNews April 14, 2015

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Central Europe's economies should have steady, if subdued, growth this year and next, forecasts the International Monetary Fund in the April edition of its World Economic Outlook released on April 14.

Overall the report raises the forecasts for the region made in October, with the recovering Eurozone and sunken oil prices offering potential momentum, but those forces look likely to remain limited, especially in the current climate of geopolitical tension, the report forecasts.

Global growth is forecast at 3.5% in 2015 and 3.8% in 2016, however uneven prospects across the main countries and regions are likely to persist. While the distribution of risks to global growth is now more balanced relative to the October 2014 WEO, it is still tilted to the downside.

"After weak second and third quarters in 2014, growth in the euro area is showing signs of picking up, supported by lower oil prices, low interest rates, and a weaker euro," the IMF notes.

At the same time, the outlook for the Eurozone is broadly unchanged relative to the October 2014 WEO, the report points out. The report pitches Eurozone growth at 1.5% in 2015, following the slump last year to just 0.9%. The single currency area's economy is then seen inching up to a 1.6% expansion the following year. Germany – the vital market for Central Europe given the region's role in the European heavyweight's exports supply chain – is in very similar territory, just 0.1 pp higher in both years. Still, external demand remains subdued, the report cautions.

The decline in global oil prices could boost activity more than expected, the IMF suggests. However, geopolitical tensions continue to pose threats. Central Europe is clearly on the frontline here – in particular Poland and the Baltic states.

At the same time, risks of prolonged low growth and low inflation in the Eurozone remain. Both will inevitably oversee the fate of Central Europe's economies.

On top of that, the likelihood of tightened US monetary policy this year could yet disrupt growth and financial markets. Still, the European Central Bank's massive quantitative easing programme looks to be working for the moment, the IMF notes. "Preliminary indications are that ECB action has stalled the decline in inflation expectations and led to even more supportive financial conditions," the analysts write.

However, the effort to offer stimulus to activity and prices is set to continue for some time, both on the part of regional central banks and in Frankfurt. "Accommodative monetary policy - including through unconventional means - remains essential to prevent real interest rates from rising, and the recent decision by the European Central Bank to expand its asset purchase program through sovereign asset purchases is welcome," the IMF suggests.

"Monetary policy space, where available, should be used to support domestic demand," the report demands, "while countries with weak fiscal positions should shore up sustainability to counter risks of potential market volatility." Rate setters in Poland and Hungary have the space to act further, the IMF points out.

Meanwhile, no international institution worth its salt would offer its forecasts without also calling for continued reform. The IMF demands global measures to support capital accumulation (such as removing infrastructure bottlenecks, easing limits on trade and investment, and improving business conditions).

Raising labour force participation and productivity (through reforms to education, labor, and product markets) is another major issue – and a regular challenge posed to CEE's economies. It's a particular issue for the Baltics, where demographic pressures are now seen putting investment at risk because of spiraling wages growth.

Lower oil prices offer an opportunity to reform energy subsidies but also energy taxation, the IMF adds. That appears unlikely in Hungary, where the government has made lowered energy bills a cornerstone of its popularity.

No change Czechs

The Czech economy should grow by 2.5% this year, accelerating from 2% in 2014, the IMF said, keeping its October outlook unchanged.

Growth is forecast to further strengthen to 2.7% in 2016. That pitches growth in the country as much faster than the average for advanced European economies, where expansion is projected at 1.7% in 2015 and at 1.8% in 2016.

At the same time, the IMF is less optimistic than the finance ministry, which is looking for 2.7% this year. The Czech central bank sees the economy expanding by 2.6%.

Meanwhile, the IMF slashed its 2015 inflation forecast to -0.1% from the 1.9% it said in October it expected. CPI is seen returning to positive territory in 2016 when it should reach 1.3%. That will still leave it, however, below the Czech National Bank’s 2% target.

After posting its first ever full-year surplus in 2014, the Czech current account balance should continue improving, the IMF said. The surplus is expected to widen to 1.6% of GDP in 2015 from 0.6% last year.

Labour market expectations have also improved amid the accelerating economy. The IMF pitches the jobless rate at 5.7% in 2016, down from 6.1% 2014.

Hungary still running out of steam (just more slowly)

Lower investment growth and less supportive fiscal conditions should slow Hungary’s economic growth to 2.7% this year from 3.6% in 2014, the IMF forecasts. Still, the outlook represents an improvement from October, when the institution pitched growth at 2.3%.

Yet economic expansion will drop to that level the following year, the report predicts. That will put Hungarian growth below the average for Emerging and Developing Europe, where growth is projected at 2.9% in 2015 and at 3.2% in 2016.

"With output still below potential and persistent disinflation pressures, Hungary has scope for further cautious monetary policy easing," the IMF said. The Magyar Nemzeti Bank (MNB) kicked off a new monetary policy easing cycle on March 24 as it cut its benchmark by 15bp to a record low of 1.95% and flagged more loosening is on the way to fight deflation.

The fund sees CPI at 0.0% this year before sharply accelerating to 2.3% in 2016. In October, the IMF had expected inflation to revive to as high as 2.3% in 2015.

The fund again warned that Hungary’s public debt remains high, underscoring the need for fiscal consolidation, including via spending restraint. State debt fell to 76.9% of GDP in 2014 from 77.3% in 2013. In a recent country report, the IMF said it expects debt to decline to 75.5% by the end of 2015.

The IMF sees Hungary’s current account surplus widening to 4.8% of GDP in 2015 from 4.1% in 2013. In October it had projected this year’s surplus at 2.0%.

Labour market expectations, however, are a bit less optimistic. The fund slightly lowered its unemployment forecast to 7.6% for 2015 from the 7.8% it had expected in October.

Poland in pole position

Poland should rank in the European top three for economic growth in 2015 and 2016, with growth projected at 3.5% in both years. That will put it on a par with Iceland and only behind Ireland in 2015. The expansion is set to be supported by domestic demand as well as improved economic conditions in its main trading partners – i.e. the Eurozone - the IMF says.

Growth risks include a deepening of the recession in Russia and a slowdown in the Eurozone, while “sudden increases in the US term premium and US dollar fluctuations could trigger market volatility in countries whose fiscal and external deficits are still sizeable,” the IMF warns. Poland is still struggling to escape the EU’s Excessive Deficit Procedure, but has confidently predicted it will quash its deficit to below 3% of GDP this year.

On the other hand, the ECB's monetary easing programme could have a stronger positive impact than currently forecast, should its effect on Eurozone growth and inflation accelerate.

The IMF predicts the central bank's fiscal policy should remain “accommodative, given the benign inflation outlook and quantitative easing in the Eurozone”. Poland is expected to have persistent deflation throughout 2015, finishing the year at -0.8%, in line with the projection of the monetary policy board.

A return to inflation is expected in 2016, coming in at 1.2%. The ongoing rise in domestic demand is likely to keep the current account balance negative in 2015 at 1.8%, before it widens to 2.4% the following year.

One of the major drivers for the expected rise in consumption – falling unemployment-  is expected to continue the strong decline of 2014. The IMF forecast the jobless rate will come down to 8% in 2015, and squeeze further to 7.7% in 2016.

Slovakia speeding up

The 2015 growth forecast for Slovakia was raised to 2.9% in the April edition of the WEO from the 2.7% projected in October. The fund expects Slovak economic growth to speed up to 3.3% next year.

The IMF sees the Slovak economy speeding along as the third fastest in the Eurozone, beaten only by Ireland (3.9%) and Malta (3.2%) this year. Greece and Estonia are likely to outpace the Central European state in 2016.

The projected modest growth in the Eurozone reflects both demand- and supply-side constraints and is largely driven by crisis legacies, the report notes.

The IMF forecast is more pessimistic than the Slovak National Bank, which has recently raised its outlook for 2015 and 2016 to 3.2% and 3.8%, respectively, supported by stronger demand both domestic and foreign. The European Commission forecast in January that Slovakia’s economic growth will strengthen to 2.5% in 2015 and 3.2% next year.

The fund added that it expect consumer prices in Slovakia to stay flat in 2015, significantly cutting its 1.3% projection made in the previous report. That leaves the country's CPI just below the Eurozone average, which is projected at 0.1%. However, consumer prices are expected to grow 1.4% next year, faster than the 1.1% across the single currency area.

Unemployment, the bane of the Slovak economy for years, is set to remain high this year, the IMF warns, although it is projected to fall by 0.8pp compared to last year to 12.4%. The fall should accelerate even further in 2016, with the jobless rate shrinking to 11.7%.

Mixed bag in the Baltics

The Baltic states are a mixed bag in the medium term, the IMF suggests. While growth rates are set to remain in the upper echelons of EU readings, they're likely to remain subdued, the report suggests.

Lithuania and Latvia are projected to have a slight slowdown, with the former forecast to drop to 2.8% growth in 2015, after recording 2.9% last year. The Latvian economy should expand by 2.3% this year, after the 2.4% seen in 2014. Only Estonia – lacklustre over the past couple of years - is likely to pick-up to finish 2015 at 2.5%.

However, the IMF is much more optimistic for Latvia and Estonia than the respective governments. Riga and Tallinn have recently lowered 2015 growth projections to 2.1% and 2% respectively.

All of the trio should have growth once more above 3% in 2016, the IMF outlook says. Lithuania should hit 3.2% and Latvia 3.3%, while Estonia should finally shake off its shackles to motor to 3.4%.

The Baltic states face the same risks as other Eurozone countries, the report warns. Top of the list is “the possibility of stagnation and persistently low inflation” weighing on growth. Shocks coming from slower global growth, geopolitical events – very much dominating the headlines at the moment in the Baltics – or political and policy uncertainty could lower inflation expectations and “trigger a debt deflation dynamic”, the institution frets.

However, the base case assumes inflation across the region will pick up more decidedly in 2016, to 1.7%-2%. However, it's likely to continue to struggle this year. Deflation is forecast for Lithuania, with CPI stuck at -0.3%, while inflation in Latvia and Estonia is estimated at 0.5% and 0.4%, respectively.

Unemployment is on a downward trajectory in all three Baltic economies, although Lithuania and Latvia will likely not manage to push it below 10% over the next couple of years. However, Estonia's outlook is for 7% this year and 6.8% in 2016. While many across CEE would welcome mid-single digit joblessness, the demographic drain in the Baltics makes it a risk. Analysts are currently fretting that spiralling wages could deter investment.


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