bne IntelliNews -

The gradual Eurozone recovery and a fall in international energy prices will lift growth in Central and Southeast Europe over the next three years, while the threat of escalated tensions with Russia poses the main downside risk, a new World Bank report says.

Overall, growth across the Europe and Central Asia region is expected to revive from 2.4% in 2014 to 3% in 2015, accelerating further to 3.8% in 2016-2017, according to the World Bank’s Global Economic Perspectives report released on January 13. This follows a worse than expected performance in 2014 amid the slow Eurozone recovery and the stagnation of the Russian economy.

Growth in Central and Eastern Europe (CEE) was slightly above the regional average, remaining broadly steady at an estimated 2.6% in 2014, reflecting close trade ties to struggling core Eurozone countries, the report notes. In particular, Central Europe's role in the German manufacturing supply chain has huge influence on the economies.
 
In the World Bank's baseline scenario, the expected contraction in Russia in 2015 and gradually tightening global financial conditions are expected to be offset to some extent by a modest recovery in Eurozone demand, diminishing political tensions, and the benefits of lower international energy prices on net importers.
 
All of which looks likely to work to the benefit of Central Europe. Most countries are set to see higher growth in 2015-17, the report forecasts. That said, recovery in the Eurozone is anything but a done deal, while "Russia’s ban on food imports from the EU could affect in particular some of the Baltic countries, Hungary, and Poland to varying degrees".
 
Hungary is the only country in Central Europe and the Baltics currently classed as "developing", with the rest recently upgraded to "high income". While the country has seen macro-economic indicators spike in 2014 – the World Bank expects GDP growth of 3.2% in 2014 – that is set to come to a sudden stop because momentum remains largely state driven. The report sees growth dropping to just 2% this year, before rising to 2.5% in 2016.
 
In addition, with the highest debt ratio in CEE, Hungary is also vulnerable to financial market volatility. In particular, the World Bank points out that the country has currency and maturity mismatches on its balance sheet. Budapest's crude efforts to redress that is only helping to deter banks and investors further, however.
 
The Baltic states have led EU growth charts in recent years as they recover from the deep hole into which they tumbled in 2009. Indeed, Lithuania should lead CEE with a 3.2% expansion in 2015, the World Bank suggests; however Latvia (2.6%) and Estonia (recovering to 2% from a rough couple of years) are starting to lag.
 
In their place comes Poland,  with a 3.2% growth forecast for this year, extending to 3.3% in 2016 and then 3.5% the following year. Strengthening domestic demand in the small open economies of the Czech and Slovak Republics should help compensate for lower exports to the Eurozone, lifting growth to the middle ground of 2.7% in 2015. At 3.4%, Slovak growth is set to outstrip that of its neighbour by 0.7pp over both following years.
 
As in CEE, the oil-importing countries of Southeast Europe are set to benefit from lower energy prices, with expected improvements in their balance of trade, in contrast to the sharp deterioration expected in the CIS.

Also driven by the gradual Eurozone recovery, growth in Southeast Europe is expected to be somewhat faster than in CEE, with some exceptions, notably Croatia and Serbia. The World Bank anticipates Croatia will only exit its lengthy and severe recession in 2015, while growth is not expected to resume in Serbia until 2016 following serious floods last year. Growth in Bulgaria will also remain subdued, slowing to 1.1% in 2015, before reviving slightly in the following two years.

It’s a more positive picture in the region’s largest economies, with growth in Turkey expected to gradually pick up in 2015-2017 on the back of stronger private consumption, despite remaining below its historical average. The World Bank projects GDP growth of 3.1% for 2014 and 3.5% for 2015, which will steadily increase over the following two years to reach 3.9% in 2017. Turkey is, however, among the countries most vulnerable to financial market volatility, given its reliance on short-term foreign capital.

Romania is also set to see a steady acceleration in GDP growth rates from 2.6% in 2014 to 3.9% in 2017. Domestic demand will become an increasingly important growth driver in Romania, supported by better labour market conditions, growing consumer confidence, and EU-funded infrastructure investments.

By contrast, other Southeast European countries including Bulgaria, Bosnia and Herzegovina, Macedonia and Serbia will continue to rely on external demand to drive expansion. “Consumer and business confidence [will] remain weak over lingering political uncertainty, chronically high unemployment, and still-fragile banking systems saddled with high non-performing loans,” the World Bank forecasts.

Several of the smaller economies in the region are expected to see growth speed up over the next four years, passing the 4% mark in Albania, Macedonia and Moldova by 2017.

However, government efforts to tackle fiscal deficits and high public debt may dampen future growth in countries such as Albania, Serbia, and Macedonia; as the report points out, “Efforts so far to reduce public expenditure have focused on cutting capital investment rather than tackling structural rigidities such as large public wage bills and poorly targeted social benefits.”

Along with the CIS, Southeast Europe also includes some of the countries whose banking sectors are afflicted by an overhang of non-performing loans, with Serbia, Albania, Bulgaria and Romania all continuing to struggle with this pre-crisis legacy.

Across Europe and Central Asia, the World Bank warns that risks remain tilted to the downside, citing further escalation in political tensions with Russia as the primary risk to the CEE and SEE regions. Others include persistent stagnation in the Eurozone or a sudden tightening of global financial conditions.

While gas supplies to the Central and Southeast European countries that rely on Russian imports have not so far been disrupted this winter, the threat continues to hang over the region. Moscow’s December 2014 decision to cancel the planned South Stream gas pipeline project, which would have delivered Russian gas across the Black Sea, bypassing Ukraine, has further raised concerns. “Should sanctions materially disrupt the gas sector, protracted weakness in both EU and Russia could ensue, with negative spillovers to the entire region,” the report warns.

The major concern stalking the CEE region currently is deflation, which threatens to knock spending and investment and therefore derail growth. "Many CEE countries are in or near deflation, because of negative output gaps, significant cuts in regulated energy prices – the Czech Republic and Hungary included - and declining food and fuel prices," the report reads. In Southeast Europe, Bulgaria, Croatia and Macedonia face similar deflationary pressures.
 
Deflation is hitting already struggling investment in the region, the World Bank suggests. "The escalating economic sanctions between Russia and other high-income countries reduced confidence and slowed FDI inflows," the report notes. "Investment was further damped by sluggish bank lending, and by rising real interest rates as inflation approached zero or even turned negative."