Economic growth steady but unspectacular in Visegrad and Baltics, forecasts EU

By bne IntelliNews November 9, 2016

The European Commission expects economic growth in Central Europe and the Baltics to remain steady but unspectacular, according to its Autumn 2016 Economic Forecast: Modest growth in challenging times, which was released on November 9.

The EU executive dropped its forecast for average economic growth across the EU to 1.6% in 2017, 0.3pp below its prediction in May, while maintaining an outlook for 1.8% this year. The 2016 forecast for the Eurozone was raised 0.1pp to 1.7% but the prediction for next year suffered a similar cut to that for the full 28-state bloc, bringing it down to 1.5%. That will not help the Central European states, which are so heavily linked to the single currency region via supply chains.

While the commission notes economic growth is expected to continue at a moderate pace thanks to labour market gains and rising private consumption, that momentum is being "counterbalanced by a number of hindrances to growth and the weakening of supportive factors".

Political uncertainty, slow growth outside the EU, and weak global trade all weigh on growth prospects, the report warns. Moreover, in the coming years, the European economy will no longer be able to rely on the exceptional support it has been receiving from external factors, such as falling oil prices and currency depreciation.

Economic growth in  the Czech Republic is now expected to fall to 2.2% in 2016 from 4.5% in 2015, largely due to the drop in investment linked to EU funds. Growth is expected to pick up to 2.6% in 2017 and 2.7% in 2018 as investment activity recovers, while consumption continues to push activity higher. The headline government deficit is forecast to decline to 0.2% in 2016, from 0.6% in 2015, the report suggests, despite recent statements from officials in Prague that the budget is due to record a surplus. With elections scheduled for late 2017, the gap is likely to creep upwards next year, the EU forecasts.

The commission is less certain of momentum in Hungary. The forecast cuts the prediction for 2016 GDP growth by 4pp compared with six months ago to 2.1%. The likely deceleration from last year's 3.1% expansion will be mainly due to a the lull in EU-funded investment. The commission projects 2.8% GDP growth next year, mostly driven by robust household consumption.

In line with the Magyar Nemzeti Bank’s latest projection, the commission plots a 0.4% rise in CPI this year. The report forecasts inflation will only gradually close in on the central bank’s 3% target by 2018.

The general government deficit is projected to decrease to 1.5% of GDP this year. Based on the 2017 budget, the gap is expected to increase to 2.3% next year, due to raised spending ahead of the 2018 elections and rising co-financing needs as EU-funded projects get underway. The EU executive notes that delays in the implementation of large scale investment projects may result in lower-than-expected deficit outcome, while the fiscal effects of the government’s new housing scheme and measures to combat tax avoidance remain uncertain.

Political risk

Despite growth expectations slowing to 3.1% in 2016 and 3.4% in 2017, Poland is set to remain the second fastest growing economy in Central & Eastern Europe, the European Commission predicts. Still, these are considerable revisions from the forecasts of 3.6% and 3.7% made in May.

Private consumption should remain the dominant growth driver, with further improvement in the labour market and an increase in stimulus - notably the new child benefit scheme introduced earlier this year  - expected to boost disposable income and improve consumer confidence. However, consumption is projected to slow towards the end of the forecast period as the temporary effects of new social transfers fade.

Unemployment data remains positive, with the EU executive pitching joblessness at 6.2% in 2016 and 5.6% in 2017. Deflation – in place since 2014 – will not disappear in 2016, with CPI at -0.2%, but prices are then expected to pick up speed and expand 1.3% in 2017.

Political risk is significant risk for the forecasts, the commission admits, noting in particular issues relating to economic policy. There are also looming questions on the rule of law, such as the ongoing standoff between the government and the Constitutional Tribunal, which could affect economic activity “more negatively than currently foreseen,” the EU executive suggests. On the upside, public and private investment could accelerate faster than currently projected.

While deficit will likely be contained in 2016 at 2.4% of GDP, that will be largely due to a one-off income from the sale of mobile internet frequencies. With no similar income in sight for 2017, the deficit is expected to swell to 3% in 2017.

GDP growth in Slovakia this year looks solid, underpinned by strengthening household demand and net exports, the report notes. Economic expansion is expected to remain above 3% between 2016 and 2018. It's thought likely to finish this year at 3.4% and drop to 3.2% next year, before surging to 3.8% in 2018, powered by buoyant investment in the car industry and a rise in public investment spending, including large infrastructure projects.

A particular issue for Slovakia over recent years, the analysts suggest labour market conditions will continue to improve. Sustained job creation should help bring the unemployment rate below 8% by 2018, the commission forecasts. Consumer prices are expected to continue declining this year before inflation turns positive in 2017. The government deficit is expected to decline to reach a balance in 2018 in a revenue-driven consolidation.

Limited traction

All three Baltic states are expected to see economic growth gain pace in 2017, but the 2016 forecasts for Estonia and Latvia predict slower expansion than last year. Progress is also likely to remain limited next year, as the trio continues to struggle to gain significant traction in their recoveries from the 2009 meltdown.

The Latvian economy will likely expand 1.9% in 2016 and 2.8% in 2017, the report suggests. In Lithuania, economic growth will come in at 2% and then 2.7%.

Laggard Estonia is predicted to see GDP expand 1.1% in 2016 – a revision that is 1.3pp below the May forecast. For 2017, Estonian growth is expected to pick up speed to 2.3%, as “external demand, especially from Finland and the other two Baltic states, gathers pace and international oil prices rise.” Private consumption growth is, meanwhile, expected to slow, while investment from companies should pick up.

Investment will also play a bigger role in Latvia and Lithuania in the next couple of years, it is thought. In Latvia, the expected rebound in the investment cycle is set to lift growth to around 3%, supported by an improving labour market. In Lithuania, growth will also be fuelled by investment recovery. On the other hand, higher inflation is forecast to dampen private consumption, and that may prove a drag on growth.

Inflation should remain subdued in 2016, ranging from -0.1% in Latvia through 0.7% in Lithuania and 0.8% in Estonia. In 2017, however, prices will grow considerably faster, with Lithuania and Latvia expected to see CPI rise 1.7% and 1.8%, respectively, while the Estonian index will push to 2.6%.

Unemployment is set to remain below 10% across the region, the report predicts. Estonia is likely to retain its lead in that respect, as joblessness sits between 6% and 7%. No dramatic changes are expected for fiscal indicators across the region. Estonia is expected to retain Europe's lowest level of debt at around 9.5% of GDP in 2016 and 2017.

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