Much of Emerging Europe faces a new equilibrium of low growth and high inflation, according to the autumn forecast of the Vienna Institute for International Economic Studies (wiiw) released on October 11.

Since its summer forecast, the wiiw has cut its growth forecasts for Central Europe, while raising them for the Western Balkans, Turkey, Ukraine and the Commonwealth of Independent States (CIS).

For 2023, the wiiw has cut its forecast average growth by half to 0.6% for the region’s EU members – virtually the same as it predicts for the euro area (0.5%). But the wiiw has raised its forecast for the Western Balkan average growth rate to 2.1%, and for Turkey to 3.2%.

The institute said that despite their previous resilience to the economic consequences of Russia’s war in Ukraine, the economies of Central, Eastern and Southeastern Europe (CESEE) are coming under increasing pressure.

"The recession in Germany, a deteriorating international environment, persistently high inflation, monetary tightening and inadequate fiscal policy measures are all weighing on the economy," said Branimir Jovanović, lead author of the forecast.

Growth was being dragged down by household consumption and exports, while government spending and investment were providing only a modest dynamic.

In Central Europe, after an already weak first quarter, the Hungarian, Latvian and Estonian economies continued declining in the second quarter, while Poland and Czechia slipped into negative growth.

"In view of a possible recession across the entire euro area, this negative dynamic could gain momentum, especially in the Visegrád countries, which are closely intertwined with the weakening German industry," said Jovanović.

Southeastern European EU members Romania (2.5%) and Croatia (2.5%) are doing much better, the report points out, while Western Balkan growth is being boosted by remittances, FDI and tourism. Turkey is predicted to grow by 3.2% this year and 2.7% next year.

Ukraine’s economy has weathered the Russian invasion better than initially anticipated, the wiiw says. It has raised its forecast to 3.6% growth for 2023, pointing to the 16% rise in agricultural exports from July to August.

For Russia, the wiiw predicts the economy will expand by 2.3% this year, thanks to the booming arms industry.

"The huge increase in military spending is fuelling an arms boom, which – in combination with sharply rising real wages, due to an acute labour shortage – is dragging the economy upwards," said Vasily Astrov, Russia expert at wiiw.

For 2024, the institute has cut its  forecasts for all the regions of Emerging Europe, with EU member states in the region now expected to grow by  2.5% on average, helped by NextGenerationEU funds. However, it warns that there remain significant downside risks.

“A sharper downturn in the euro area, stubbornly high inflation rates, military escalation in Ukraine or an intensified trade war between the EU and China could jeopardise the recovery next year,’ said Jovanović.

Inflation has now passed its peak in most countries, the wiiw says, but will  remain high for the foreseeable future.

“We are converging to a new equilibrium that is characterised by lower growth and higher inflation than before the pandemic,” said Jovanović.

The inflation driver is now food prices, rather than energy, which is creating ever-greater social problems.  Jovanović put the blame on higher profit margins of food businesses, with food inflation above 10% everywhere despite disinflation in global food prices.

Inflation will be persistent, it says, with core inflation (which excludes food and energy) now exceeding headline inflation in most countries of the region.

Falling inflation and rising wages have meant that real wages are now rising across most of the region, after severe falls reaching nearly 20% in Czechia and Slovakia between Q421 and the second quarter of this year.

The wiiw warns that if companies, whose profits are at a historically high level, were to respond to this with further price rises, that could lead to an entrenchment of inflation.

The institute points out that given the rise in budget deficits from dealing with the effects of the COVID-19 pandemic and the cost of living crisis, together with rising yields, fiscal policy will not be able to be so supportive of growth going forward. This could worsen the rising poverty caused by higher food and energy prices.

At the same time monetary policy will stay restrictive, creating a risk of prolonged recession.

Jovanović said the institute predicts an end to the hiking cycle but this does not mean that monetary policy will be loose. “Cuts will be minor and rates will be elevated all next year. It won’t go back to 0% rates any time soon.”