EU raises growth forecasts for Central Europe and Baltics

By bne IntelliNews May 3, 2016

Despite - or in some cases due to - building political risk and loosening fiscal consolidation, the European Commission raised its growth forecasts for both Poland and Hungary in its latest economic outlook, published on May 3. Reflecting expectations that low inflation and tightening labour markets will continue to support consumption, and loose fiscal policy power investment, the forecasts for other Central European and Baltic states were also raised, save that for the Czech Republic.

Poland is predicted to remain the leader of the pack by posting the quickest economic growth in 2016 and 2017 by the EU executive in its European Economic Forecast: Spring 2016. However, the country also faces significant risks, the European Commission warns.

The Polish economy is forecast to expand 3.6% in 2016 and 3.7% in 2017, both forecasts having been raised from 3.5% for both years in the previous forecast from November. Consumption is set to remain the dominant growth driver, propped up by further improvements in the labour market and an increase in government transfers - the new child benefit in particular. Private investment is expected to grow moderately, helped by a “relatively high degree of capacity utilisation, strong corporate profits and low interest rates,” the Commission notes.

However, the report warns that investment decisions could be affected by uncertainty over the “future direction of economic policies,” that are raising eyebrows internationally. It names the impasse that has frozen the constitutional court since early in the year, and worries that there are several election pledges of the PiS government – including lowering of the retirement age and a conversion of foreign-currency at the expense of banks – that could also weigh on economic activity.

Those issues also threaten to push the deficit above the European Union’s threshold of 3% in 2017, the Commission forecasts. That implies Poland’s escape last year from the Excessive Deficit Procedure will be shortlived.

Unemployment data remains positive, with the EU executive pitching joblessness at 6.8% in 2016 and 6.3% in 2017. Deflation – in place since 2014 – will only end later this year, with CPI likely to come in flat at the end of December. Inflation should push to around 1.6% in 2017.

The European Commission also expects more from Hungary. The spring forecast pushes the prediction for GDP growth for this year 4 pp higher compared with six months ago to 2.5%. The deceleration in 2016 from last year's 2.9% expansion is mainly due to decreasing EU fund absorption and external demand. The EC forecasts 2.8% GDP growth in 2017, mostly driven by robust consumption.

Headline consumer price inflation will likely remain well below target in 2016. In its latest inflation report, the Hungarian central bank Magyar Nemzeti Bank (MNB) dropped its prediction for 2016 to 0.3% from the previous outlook of 1.7%. The European Commission plots a 0.4% rise in CPI for the year. Unemployment is expected to continue to decrease to finish 2016 at around 6%.

Despite suggestions from Budapest in recent weeks that fiscal policy will loosen, Hungary's deficit is projected by the report to remain at 2.0% of GDP. Based on a unlikely looking assumption of no policy change, the budget gap is seen at the same level in 2017.

However, the risks are hinted at in the report; the ruling Fidesz party has clearly guided for increased spending ahead of elections in 2018. The EU executive notes that the government has "budgetary breathing space is set to increase considerably" but says that will likely be used up by tax cuts and spending - including a new scheme to support, infrastructure investment and spending on education in a bid to diffuse teacher protests.

The updated outlook for Slovak growth was also raised, although minimally. Domestic demand, gaining support from steady increases in employment and solid real wage growth, is expected to continue to drive the economy in both 2016 and 2017.

The previous outlook suggested 2.9% expansion in 2016 and 3.3% in 2017. GDP growth is now likely to push to 3.2% this year, says the new report, while the prediction for next year remains the same.

The accelerated absorption of EU funds drove Slovak GDP to grow 3.6% in 2015, on the back of a surge in investment activity and robust private consumption. Investment accounted for 2.9 percentage points of total output growth last year, the highest such contribution since 2005.

Labour market conditions are expected to continue to improve, but unemployment levels still remain high. From an average of 11.5% in 2015, joblessness is projected to fall below 10% in 2017. Still, overall household consumption growth is expected to reach 3.6% in 2016 and to slow only marginally the following year.

Consumer prices declined 0.3% in 2015 as energy prices fell sharply. Deflationary pressures are expected to dissipate gradually, in line with the pickup in household demand and solid nominal wage growth.

With large investments scheduled over 2016 to 2018 in Slovakia’s automotive industry, FDI looks primed to drive overall investment growth. The trade balance is forecast to turn positive this year, but in 2017 imports should accelerate as the announced investments peak.

Missing boost

Heading the other way, the already weak forecasts for the Czech Republic over the next couple of years were reduced 0.1pp compared with the autumn outlook. The EU expects Czech GDP growth to decelerate to 2.1% in 2016 after expanding 4.2% last year. Next year, growth is anticipated to rebound, but to no higher than 2.6%.

The strong growth last year was largely thanks to an exceptional boost from EU financed public investment, a motor that will be largely absent this year. As elsewhere in the region, consumption – on the back of ongoing tightening of the labour market and low inflation – is set to remain in the driver’s seat.

Czech unemployment fell to 5.1% in 2015, and is projected to fall to 4.5% this year and then by another basis point in 2017. But the scope for further employment growth is diminishing and projected to slow to 0.3% in 2017 as the working age population decreases. Tight labour market conditions over the forecast horizon are expected to accelerate wage growth.

However, the scale of the reduction in public investment could be larger than the 0.5pp drop currently expected, the report admits, and that poses a downside risk to the forecast in 2016. The highly open Czech economy is also exposed to external downside risks.

The trade surplus fell 0.7pp to 4.7% of GDP in 2015, as imports grew faster than exports, reflecting the high import-intensity of consumption and investment in the Czech Republic. Reduced investment activity should contribute to weaker import growth and to a rising trade balance for the coming years, with the surplus pushing to around 5.1% in both years.

All three Baltic states are expected to see economic growth gain pace throughout 2016 and 2017. Laggard Estonia is predicted to see GDP expand 2.4% in 2016, after a very disappointing 1.9% in 2015. Its neighbours, however, will once again grow more quickly. Latvia and Lithuania are both forecast to grow 2.8% this year and 3.1% in 2017.

In Estonia, the “large contribution of private consumption to growth will likely diminish in 2016 and 2017 as consumer price inflation picks up. Domestic demand, however, is projected to remain the main growth driver over the forecast horizon”. Inflation is likely to finish this year at 0.8%, before accelerating to 2.9% in 2017.

Consumption and investment are the factors expected to push growth in Latvia. Households are also anticipated to remain in the driving seat in Lithuania, but a recovery in exports – the country is the most exposed EU state to the embargo battle with Russia – should also contribute.

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