EBRD dismisses Ukraine-Russia crisis as it lifts growth forecast for Central Europe

By bne IntelliNews September 18, 2014

Tim Gosling in Prague -

 

The European Bank for Reconstruction and Development's (EBRD) latest economic forecast for Central Europe raises expectations for 2014 growth, powered by Poland and Hungary. However, while the development bank joins the ranks of those unconvinced that the Ukraine crisis is hitting Poland hard, it also warns that the Hungarian economy is being propped up by the government, the effects of which are only likely to be temporary.

The EBRD notes the positive impact of domestic demand across Central Europe, as was predicted by many earlier in the year. It also suggests quantitative easing in the Eurozone is likely to help strengthen the recovery in the region - which could be read as a cack-handed admission that the single currency area could yet drag on growth due to the strong links with the region.

However, the EBRD latches onto the better-than-expected pace of recovery seen in the first half of the year to raise its outlook for Polish GDP growth by 0.2 percentage points to 3% for the whole of 2014. Hungary gets an even bigger boost, leaping to 2.8% from the 1.6% the development bank predicted in May.

That sees Central Europe pushing ahead of the EBRD region as a whole. The report sees growth slowing to 1.3%, with a modest pickup to just 1.7% in 2015. The overriding issue behind that is the crisis in Ukraine.

"Permanently higher military spending in the transition region over the medium term, in response to the renewed geopolitical risks, could erode the peace dividend from the dissolution of the Soviet Union," the report states.

"Just when national governments remain financially strapped in the wake of the global financial crisis, any new buildup in military spending will be an additional fiscal burden that will stand in the way of the recovery and economic reforms for the future," the bank's chief economist, Erik Berglof, said.

The fighting in Ukraine, and the sanctions imposed on Russia, will do the most to reduce economic activity across the whole region, the bank says. However, while they admit that any impact on the Eurozone economy from the deterioration in relations with Russia would also feed through to Central Europe, the analysts are unconvinced that the region's major economies will suffer too much.

"Countries in Central Europe are expected to continue recovering at a moderate pace," the report sums up. "[P]ositive influences from the eurozone [will be] only partly offset by the weaker demand from Russia and the impact of a ban on some food exports to Russia."

In the face of continued recovery in other Central Europe states, much has been made of dwindling macroeconomic data out of Poland in the summer. However, the EBRD joins the crowd of analysts rejecting suggestions that reduced exports to Russia and Ukraine are behind the slowdown.

The food embargo put in place by Moscow in July "will weigh somewhat on Polish growth," the analysts write, before pointing out that the country's exposure to its eastern neighbours is limited. "[F]ood exports to Russia only account for 0.2% of GDP," the report states.

Due to the fact that a far greater share of their economies are dedicated to exports to Russia, the Baltic states will not escape so lightly, the EBRD worries. "They have already have been more directly impacted by the sanctions and the significant slowdown in Russia," reads the report. "In addition to agricultural firms with large export exposure to Russia, transport firms shipping goods between European countries and Russia may also be severely affected."

To the south, Hungary has been even less affected by the sanctions than Poland, but the EBRD notes that there are other elements of concern. The government's populist policymaking targeting large foreign investors has left the state as the prime driver of the economic recovery, and many worry that it could run out of steam in the mid-term without tempting new investment and bank lending.

"[I]n addition to being driven by exports, the Hungarian economy ha[s] been supported by a number of effects that [are] only temporary," the EBRD frets. Those measures include "public infrastructure spending funded through EU grants and administrative price cuts as well as mortgage debt relief... provided at a cost to the banks."

Meanwhile, jumping on the actions of the European Central Bank in recent months in a bid to jolt the Eurozone recovery back to life, the EBRD highlights the potential positive knock on effects for Central Europe of an effective policy of quantitative easing.  

"The case for quantitative easing has become compelling to support the still fragile recovery in the Eurozone, to which much of the (Central Europe and Baltic and south eastern European) regions are strongly linked," the analysts write. "An effective Eurozone QE may help lessen the risk of setbacks in the recovery of those regions."

 

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