OUTLOOK 2022: Central Europe and the Baltic states

OUTLOOK 2022: Central Europe and the Baltic states
By Robert Anderson in Prague January 17, 2022

Central Europe faces a critical year in 2022, with a key election in Hungary in April in which Prime Minister Viktor Orban, the region’s high-profile strongman, is seeking a fourth consecutive term, while rumbling political instability in Poland and Slovakia could lead to early elections. This could be a make-or-break year for the region's radical right-wing political forces, which will have an impact right across the EU and the Balkans.

These potential political changes come as the region, especially the Baltic states, faces a much more dangerous geopolitical environment, as neighbouring Russia menaces Ukraine and tightens its grip on Belarus.

Central European states – which already have some of the highest deaths per capita from coronavirus (COVID-19) in the EU – are also bracing for the sweeping eastwards of the Omicron version, at a time when businesses are already struggling to recover, government budgets are under huge strain, and people are increasingly ignoring restrictions or even marching against them.

Political instability and social unrest could also be worsened by rises in inflation, energy prices and interest rates. These will hurt living standards – which have stagnated since the global financial crisis – and slow down Central Europe’s already protracted convergence with Western European levels.

International politics

The radical right-wing governments in Budapest and Warsaw remain locked in conflict with Brussels over a range of issues sparked by their attempts to consolidate their rule – notably by limiting judicial independence – and pursue populist culture wars against sexual minorities that violate EU values. Orban’s Hungary is also in the dock for rampant corruption and its failure to prosecute it.

The European Commission finally seems to have found a credible weapon to fight the populist contagion by threatening to hold up financial flows if the rule of law is breached and EU money put at risk. Unless the Commission cravenly backs down, it is difficult to see a solution to this impasse until there is political change in both countries, something that still unfortunately appears uncertain.

Warsaw and Budapest have also become more isolated in the EU following the electoral defeat of populist governments in Slovakia in 2020 and in Czechia at the October 2021 general election, as well as the replacement of German Chancellor Angela Merkel by a centre-left coalition. The Visegrad Group of the four Central European countries, which Orban has weaponised in his battles against the EU, looks likely to become increasingly moribund now, though the V4 might still occasionally unite to fight Brussels’ policy on climate change or on migration, if there is another wave.

Hungary faces becoming more and more isolated and irrelevant in the EU, not least over foreign policy, where it continues to pursue closer relations with Beijing and Moscow at a time when, following the German election, the bloc is more and more united on the threat both countries pose.

Domestic politics

Radical right-wing parties have been a malignant cancer in Central Europe since Orban returned to power in 2010 determined to build a semi-authoritarian regime to entrench his rule. He was joined by Jaroslaw Kaczynski’s Law and Justice Party (PiS), which closely followed his lead after it won the 2015 Polish election. Both governments have formed a united front to oppose the EU’s values, and have tried to encourage similar political forces in neighbouring countries, the Balkans and across the EU.

Radical right-wing populism continues to be fuelled by social disparities created by the transformation from communism, the cultural shock from accession to the EU and its values, as well as phantom fears about migration and other topics spread by misinformation. But this year both radical right-wing governments face their toughest challenges yet as Orban confronts a united opposition and the ruling Polish coalition continues to crumble.

Both governments have struggled to cope with the COVID-19 pandemic, partly because they have been reluctant to impose tough restrictions, which would have been unpopular with their often elderly and rural voters, many of whom have refused to be vaccinated because of distrust of the state as well as online misinformation.

In Poland the vaccination rate is around 57%, the worst in Central Europe after Slovakia, whose take-up is just 48%. Hungary’s vaccination record is better – at 63%, roughly the same as the Czech Republic – but the country has the second-worst death rate in the EU after Bulgaria. In the Baltic states, vaccination rates are higher still – with Lithuania and Latvia achieving almost 69% – but their current infection rates are among the worst in the region.

With their voters frustrated by the continuing COVID-19 restrictions and the soaring cost of living, both radical right-wing governments have tried to divert attention by reviving fears over migration. This has had diminishing success – the influx of several thousand refugees from Belarus to Poland last year seems to have done little to boost PiS support. Now both governments are turning more to cultural issues such as abortion and homosexuality to whip up support, which is bringing them once again into conflict with EU values.

Opposing them, civic organisations have led huge protests and opposition parties have forged wide coalitions, usually led by centre-right parties (with the region’s left-wing parties out of power and marginalised).

The Slovak opposition mobilised to oust left-wing populist Robert Fico in 2020, and the Czech opposition joined in two coalitions of the centre-right and the centre to defeat ‘technocratic populist’ Andre Babis at the 2021 election. Poland’s opposition parties may form centre-right and left-wing coalitions ahead of the general election there in 2023. Meanwhile in Hungary, after three election defeats the opposition has finally united and will fight April’s election under one list and one candidate for premier, the liberal conservative Peter Marki-Zay.

Orban is currently ahead in the opinion polls ahead of the April 3 general election, which will be fought on a very crooked playing field, with a gerrymandered electoral system, as well as a great imbalance of campaign funding and media coverage. If Orban wins a fourth consecutive term, this will likely embolden him to become even more obstructive towards the EU; if he is defeated, this would mark a dramatic political shift in the region back to liberal democratic values.

Poland could also have an exciting political year if Kaczynski’s PiS calls – or is forced to call – early elections as its coalition crumbles. At the moment it too is ahead in the opinion polls, but in both countries the political mood could change as the cost of living crisis worsens and the pandemic drags into a third year.

Nevertheless, populism – whether of the right, centre or left – remains a powerful force in the region, and it could even mount a return in some countries that have already shaken it off.

The Slovak coalition is also looking fragile as the split between the two right-wing populist parties and their centre-right partners widens, though it is expected to try to stagger on as long as it can, given the lead in the opinion polls for the two rival left-wing opposition parties of onetime allies Robert Fico and Peter Pellegrini. Unless the government can somehow pin corruption on top figures in the preceding Smer government in which both premiers served, its chances of staying the distance and retaining power at the next election look slim.

In Czechia all eyes will be on the candidates for the January 2023 presidential election, with a real risk that Andrej Babis, the agro-chemical billionaire and former premier, will triumph. He may be given a helping hand if the new centre-right government goes too fast in cutting the budget deficit. This could also enable Babis’ “technocratic populist” ANO party to return to power at the first attempt at the next general election.

In Latvia, the October general election is anticipated to increase political fragmentation, with a raft of new populist parties jostling to enter the Saeima. Populism is also on the rise in neighbouring Lithuania as well as Estonia, where the far-right EKRE party is riding high over migration fears.

Macro-economic environment

Over the past two years Central European governments have been helping businesses and employees cope with the economic impact of the pandemic; now, as their economies begin to recover fast, they are starting to be concerned about the rise in budget deficits and public debt and are considering tightening their belts, even though the pandemic is still far from over.

On top of this challenge, businesses and households are coming under new pressure from rising inflation, energy prices and interest rates, which are crimping margins and hurting living standards. Budapest and Warsaw are now imposing price caps on energy and other staples, but these moves will only have a short-term effect. Inflation is expected to hit 10% in Poland in February.

The three independent central banks in the region are particularly worried by the yawning deficits and rising inflation and have been hiking interest rates, creating tension with governments and leading to an inconsistent policy mix. What especially concerns the central banks is that there is a risk that the return of higher inflation rates will push inflationary expectations upwards, generating a vicious cycle of wage-push inflation. Wage growth is also fuelled by the region’s tight labour markets, worsened by migration to Western Europe and low birth rates.

This will make inflation that much more difficult to restrain and hurt export competitiveness, creating current account deficits and currency depreciations. The Hungarian forint has already lost 10% of its value in 2019 and 2020 versus the euro, making it one of the worst-performing currencies globally.

As well as rising interest rates and wages and the continuing pandemic, many of the region’s biggest export industries – notably the automotive sector – have also been struggling with supply bottlenecks and rising input prices caused by the shortage of semiconductors and other components and materials. This makes economic growth even more fragile – as it will be based largely on domestic consumption – and more prone to generating external deficits. 

These overheating risks are greatest in Poland and Hungary, where the populist governments are stoking pre-election booms and will worry about belt tightening afterwards. Viktor Orban’s government has unleashed the biggest package of handouts and cheap loans in the region, leading to a forecast budget deficit of 8% of GDP last year.

Both countries eventually risk hard landings, especially if the international financial environment becomes less forgiving and more volatile, as it is likely to do. This should all give Brussels more leverage – if it keeps its nerve – as it withholds recovery fund money to force Warsaw and Budapest to abide by EU values.

For the full report, click here.