VISEGRAD: Central European consumers left to carry the weight

VISEGRAD: Central European consumers left to carry the weight
Consumers in Hungary and the rest of Visegrad are largely alone in driving economic growth.
By Tim Gosling in Prague November 16, 2016

GDP growth slumped in the third quarter of the year, data released around Central Europe on November 15 showed. With economic growth dragged to multi-year lows by the collapse of investment and signs of slowing industry, consumers are left carrying the weight.

While the slowdown in growth carries clear shorter-term risks for the economies in the region, it also threatens a political spillover. Sluggish convergence with the rest of the EU has already helped raise populist governments across the region as Czechs, Poles and others increasingly feel let down since they joined the bloc in 2004. A slowdown in their chase to catch up with income levels in Western Europe is only likely to provoke that anger further.

Poland’s third quarter growth led the shocks stemming from the flash estimates. The country’s GDP fell to a three-year low of 2.5% in July-September, and suggests the economy is likely to undershoot the government’s original target for the year of 3.8% by around 1pp.

The Czech Republic’s 1.9% gain was the slowest in two years, while Hungarian economic expansion dropped to 2%. At 3%, Slovak growth led the region, but slowed dramatically compared to the 3.8% recorded the previous quarter.

While the estimates did not offer details, it’s clear that investment dived across all the Visegrad markets, once more leaving household consumption to drive what growth there was. Consumer spending is robust thanks to low inflation and tightened labour markets.

The poor results were only likely amplified by struggles in industry, as data has suggested throughout the autumn. That is all the more palpable in the face of a recovery in the markets that provide a huge bulk of export demand.

The poor results came “despite ‘normal’ growth rates in the [Eurozone]” points out Andreas Schwabe at Raiffeisen Bank International. The weighted real growth rate for CE decelerated from 2.7% y/y and 3% in the first two quarters to just 2.3%, by far the slowest pace of growth so far this year, he notes.

The hope now is that the consumer can continue to pick up the slack as the region waits for investment to get back on track. The key to that is expectation that absorption of EU funds is set to accelerate. Following a rush to claim the last cash available under Brussels’ 2007-13 budgetary window over the past couple of years, EU financed projects have been slower than forecast to get up and running in the new window that came into effect in January.

The race is on

That sets up a race. While consumption looks set to remain healthy, its growth is likely to slow as inflation rises and labour markets run out of space to tighten further. Deepening labour shortages now threaten investment and economic development, while inflation is steadily - if slowly - rising after at least two years in the doldrums.

The absorption of EU funds was meant to accelerate after the first six months of the year, according to many commentators. OTP Bank notes that its forecast of 2.4% growth in Hungary was likely undermined by an overestimation of the pace of absorption in quarter three.

The Polish finance ministry insists it still expects the acceleration of EU funds' inflow to help push GDP significantly higher next year. Tenders for projects co-financed by the EU are only now being finalised, officials point out, according to Reuters.

They were also quick to note that the EU's current seven-year budget cycle “only” kicked off in 2014, and that it takes time for funds to start flowing. Yet the Visegrad states are notorious for their sloth in absorption; it was that poor track record that sparked the rush in 2014-15 to use or lose the funds from the window that started back in 2007.

Meanwhile, private investment is also on the floor. In Poland, many believe that is the result of increasingly erratic policymaking. Since taking power late last year, the Law & Justice (PiS) government has levied new taxes on banks and retailers, and pushed utilities into a rescue of the beleaguered coal industry. Hungary’s government has regularly battered certain sectors, largely those populated by foreign investors, since the Fidesz government took power in 2010.

Yet even in markets with more predictable policymaking, investors are wary, even with interest rates at historic lows. That may take some time to overcome. The National Bank of Slovakia suggests “investors' hesitance is likely to persist”, in comments on the Q3 results.

Threatening to validate those concerns, industry struggled through the third quarter, especially on the back of lowered export demand in the summer due to the holiday season in Germany. However, surveys show confidence in the German economy jumped at the start of the fourth quarter. That offers hope for Visegrad suppliers in the short term.

However, there are as many challenges as opportunities waiting down the line. Export demand out of the UK is at risk from Brexit, depending on the route that London takes to leave the EU. While Britain doesn’t buy a huge chunk of CE exports - Slovakia’s ratio is highest at around 5% - the region is exposed via the potential effect on the Eurozone, and especially German car exports to the UK.

On top of that, the jury is out on the potential global effects that could be on the way from the US. President-elect Donald Trump has suggested a protectionist economic stance, which could again hit CE both directly and via the Eurozone supply chain should the US rock the boat on trade.

Erste analysts clearly note the risk to Hungary’s outlook. “Increased uncertainties around global growth prospects, stemming from Brexit and the Trump presidency in the US, could negatively affect the performance of the Hungarian economy,” they wrote following the GDP growth figures.

Catch up

The Polish finance ministry insists its target of 3.6% for growth next year remains "realistic”. However, doubts are building.

Analysts at BZWBK sum up the grim mood. “The fourth quarter may not be any better if private consumption and investments do not recover sharply,” they write. “Probably, another wave of downward revisions of GDP growth forecasts for Poland is coming.”

"Poland's further economic growth hinges on a rebound in investments, but I see no sign that could herald such growth," the CEO of one big Polish bank told Reuters.

“Consensus growth forecasts for [the region in] 2016 had already been revised down over the past couple of months when PMI and industrial output data surprised to the downside,” analysts at Commerzbank worry. “Weaker-than-expected hard data on GDP will now focus attention on the 2017 outlook.”

“If the slowdown proves to be of a less temporary nature, economic growth in CE might fall to a lower range between 2% and 3% in 2017,” suggests Schwabe at RBI.

Apart from the risks to short-term growth, however, there are also likely to be political ramifications should Visegrad fail to shake off its stupor. Weakening economies will do little to alleviate the populist sentiment - led first and foremost by euroskepticism - across the region. Joining the bloc in 2004, Central Europeans were largely led to believe that membership would prove a panacea that would soon see their living standards equal to that of the Germans, French and British.

While that clearly underestimated the long road of development ahead, the financial crisis hit pushed them wildly off track. At an average of 6.4%, GDP growth in Central and Eastern Europe doubled the EU average in the years before 2008, according to a report issued by the Association for Financial Markets in Europe (afme). Since 2010, growth in the region has slowed to an average of 1.9%, compared with 1% for the rest of the bloc.

In other words, convergence has slowed to a crawl. In the seven years before the crisis, GDP per capita in CEE rose from 28% of the EU average to 37%, albeit the figures for Visegrad are significantly higher. Although GDP per capita has flatlined since 2010, CEE’s catch up has slowed to just 0.5pp per annum.

Inequality adds another layer of strife. The European Bank for Reconstruction and Development (EBRD) notes in its Transition Report 2016-17 that just 27% of people in post-communist countries have actually experienced the average income growth achieved in their country. “Those in the bottom 23% of income distribution are still worse off today than they were in 1989,” the report warns.

The irony is that weakening economic growth would normally result in punishment for the incumbent government at the polls. The PiS government in Poland had targeted growth of 3.8% this year, but the economy looks likely to flop in comparison. The staunchly conservative and nationalist ruling party spoke during its successful election campaign last year of plans to return GDP expansion to 5% per year, the kind of levels seen before the financial crisis.

However, the ultimate advantage of many of the ruling parties across Central Europe is that the opposition is fractured and largely inept. That makes even a sharp slowdown in growth no guarantee that the populists now in power will face any backlash from voters. Instead, the electorate is likely to be encouraged to direct its anger outwards, focusing once more on Brussels, foreign investors and immigration.