Polish bond yields are rising amid concerns that the current government cannot match campaign promises without increased deficits and growing speculation a second rating agency is set to downgrade the country. Hungary has tabled a budget that will see its deficit increase next year and Eurostat says Slovakia’s 2015 deficit missed its target by some 20%. In short, years of fiscal tightening look to be at an end in Central Europe, with erratic politics posing the biggest threat to economic stability.
A recent analysis from Moody’s Investors Service pointed to “fiscal loosening and unorthodox policymaking” as a regional risk, though they nonetheless were still offering stable or positive outlooks for most of the Central and Eastern European states in mid-April, with Croatia as the lone exception. And yet there are persisting concerns about political developments, including populism and unusual coalition governments as a threat, with relatively strong economic growth staving off bigger problems for now.
The gap between election pledges and financial reality is particularly apparent in Poland and Slovakia, both of which have new governments. In Poland, Moody’s has warned of “measures targeting the country's institutional and legal framework erode business confidence and investment”, and expressed concern about the scramble to find revenue to support the Law and Justice government’s spending programme. Standard & Poor’s downgraded the country’s credit rating from ‘A-’ with a positive outlook to ‘BBB+’ with a negative outlook in January, citing the same concerns now drawing Moody’s attention.
Meanwhile, Eurostat claims that Slovakia’s 2015 budget deficit was 2.97% of GDP, well over the 2.49% estimated by Prime Minister Robert Fico’s previous government. That variation, in an election year, has brought added scepticism to a pledge by the new coalition government to balance budget by the end of its four-year term. A series of pre-election measures by Fico, including mailing rebates to households for lower-than-expected wholesale gas prices just weeks before the vote, indicate the government’s priorities, says Radovan Durana, an economist with the Institute for Economic and Social Studies in Bratislava. “Slovak politicians are afraid of the 3% threshold that draws attention from the EU, but they don’t care about a balanced budget,” he explains. “They dramatically raised revenues in 2013, and since then they have been adding expenses.”
In the short term, looser fiscal policies are expected to boost domestic consumption and drive what already are Europe’s fastest growing economies. Moody’s estimates that the so-called CEE-8 will see 3% GDP growth this year as compared to the EU and Eurozone averages of 2% and 1.8%, respectively. There looks to be little worry in most of the region that anybody will surpass the 3% deficit threshold that would trigger intervention by the EU via the Stability and Growth Pact. “Current GDP growth is sufficient to keep inflation and credit risks in check,” says Marcin Mazurek, an economist with M Bank in Warsaw.
Still there is little to dispute that there is a general shift in policy underway. While the Polish government is looking to boost spending to meet campaign promises, in Hungary Viktor Orban is looking to use state spending to help boost his reelection prospects in 2018. The Budapest government has tabled a budget proposing a 2.4% deficit in 2017, which is a reversal on plans it submitted to the European Commission last year which looked to push deficits below 2%. The plan calls for cuts on VAT for food and a boost in housing subsidies for families. There is also speculation that the government could intervene to cut regulated household energy prices as the election approaches.
The Czech Republic has done little to spark concern from deficit hawks with a 0.4% deficit last year – a number that approaches a surplus when accounting for inflation. While the current centre-left coalition government is harvesting the benefits with record low yields, most of the hard fiscal consolidation took place under Miroslav Kalousek, the former centre-right finance minister from 2007-09, who “decreased the deficit during the recession, and paid a high price for it”, notes David Marek, chief economist with Deloitte in Prague.
“So far [Finance Minister Andrej] Babis hasn’t worsened it,” Marek adds. “Elections are approaching and we will see an increased effort to buy votes with higher social benefits or pensions – it’s only a question of time.”
Though short-term risks in the CEE region look to be political rather than fiscal, the medium- to long-term pressure from changing demographics is likely to make budgetary – and deficit – concerns ever more acute, with social security systems straining to keep up with aging populations. Though the Czech Republic remains a regional star in terms of budgetary responsibility, even the Czechs are expected to see their ratio of workers to retirees halve between now and 2060.
With room for manoeuvre amid economic growth and cheaper borrowing costs, there is an opening for bigger tax or pension reforms, but little optimism that leaders are prepared to expend the political capital necessary to make such changes. “The problem we need to solve now is 25 years ahead,” sighs Marek. “But there is no political will. Politicians look four years ahead.”