Strong growth but a risky outlook for Central and Eastern Europe

Strong growth but a risky outlook for Central and Eastern Europe
By Clare Nuttall in Bucharest March 14, 2018

All economies in the Central, Southeast and Eastern Europe region (CESEE) experienced positive growth last year, for the first time in a decade, as they benefitted from global growth. This trend is set to continue, as major international economies, specifically the Eurozone, China and the US, are simultaneously expanding for the first time since 2010, says a new report from the Vienna Institute for International Economic Studies (wiiw). “The coordinated global upswing has further to run, and we expect CESEE economies to continue to benefit in the coming years,” writes the institute.

“The global economy is in a sweet spot. This will continue to provide a big boost to economic activity across the CESEE region in the coming years,” commented wiiw economist Richard Grieveson. “After several false starts, a real recovery is under way across Europe, including in most of CESEE. It is not an overstatement to say that some countries in the region are experiencing a boom.”

During a webinar on March 13, economists talked of the region being at a “very strong phase of the cycle” at the moment, as reflected in 2017 growth figures being better than expected, while wiiw has revised upwards its projections for most of the region. The positive trend is expected to continue this year, though will probably peak soon, to be followed by some tailing off in 2019 and 2020.

On the other hand, viiw warns of significant downside risks to regional growth. Its economists challenge assumptions that risks are low, listing a range of risks at both global and regional level. 

“Our biggest concerns are a potential trade war and that global central banks do not exit safely from their ultra-loose monetary policies. Any spike in global interest rates would be dangerous for the numerous countries in CESEE with high private and/or public external debt,” said Grieveson. 

The report also singles out potential risks from East/West EU splits, the undermining of institutional independence in some countries, geopolitical tensions, the Ukraine crisis, and potential spill-overs from a renewed outbreak of volatility in the eurozone, or a Chinese debt crisis. 

The populist politics of some CEE countries, notably Hungary and Poland, have already put their leaders on a collision course with fellow EU members. One risk elaborated on by wiiw economists during the webinar is the potential impact of these populist politics on FDI inflows, particularly from Western Europe. While the region has seen a rebound in investment recently, Grieveson notes that “anecdotally, on the private side we are seeing a lot of caution related especially to challenges to the rule of law” in Poland … this may not be affecting FDI now but probably will become increasingly more the case over time”, especially given that a possible tailing off of private investment could be masked by the current strong inflows of EU funding. 

This could change when the next EU funding programme starts, with less money available post-Brexit. “I would not underestimate the extent of irritation with eastern EU member states in certain Eestern European states, for example France. A lot of things are being brushed under the carpet in the EU because of Brexit, but that will not be the case indefinitely.” 

Growth across the board 

wiiw’s data shows that economies across the CEE region expanded at a healthy pace in 2017, with most hovering around 4% y/y and even the slowest — Slovakia — growing by 3.4%. This is set to continue though at a slightly more moderate pace in 2018, when growth rates are pegged to range from 3.5% in Lithuania to 3.8% in Hungary, Latvia, Poland and Slovakia. 

By contrast, the CIS countries assessed in the report — Belarus, Kazakhstan and Russia — plus Ukraine are the “regional laggards” and are set to remain as such, though a continued gradual recovery is anticipated. 

There is a rather mixed picture from Southeast Europe, with the SEE9 — EU members Bulgaria, Croatia and Romania plus the six aspiring members from the Western Balkans — expected to grow at an average of 4%, ahead of both the Visegrad 4 and the Baltic regions. Growth in SEE will range from 2.8% in Serbia, which has struggled with structural reforms in recent years, to a buoyant 4.7% in Romania, which is holding onto its title as the fastest growing economy in the wider region, albeit at a slower pace than in 2017. 

Romania also has the highest inflation forecasts for the Central and Southeast Europe region, and is among three countries — the others being the Czech Republic and Turkey — seen as being at risk of overheating. This is of less concern in the Czech Republic, but “we see imbalances clearly there” in Romania and Turkey, Grieveson told participants in the webinar, though added that, “we are still quite far away from this becoming really serious”. 

Longer-term pitfalls 

Despite these concerns, overall the region is growing fast at present, contributing to convergence with Western Europe, even with the robust growth in Germany and elsewhere in the Eurozone. But while convergence with Western Europe is expected to continue during the forecast period until 2020, wiiw sees some significant long-term challenges to convergence. 

The first is the demographic decline across the region, which wiiw anticipates could be a constraint on growth by the 2020s. 

The recent period of rapid growth and plummeting unemployment in CEE, especially the Visegrad 4 countries, has already created labour shortages, with major manufacturers looking to import workers to enable them to ramp up production. 

The emergence of these labour shortages risks becoming growth constraining, according to wiiw. To offset that, there is growing migration within the region from countries such as Serbia and Ukraine to the countries where labour markets are tightest. Ukrainian migrants now represent an important part of labour markets in countries in the region, helping to prevent too much constraint on growth in the short term, the institute says. 

Then there are the implications of the high level of specialisation in parts of the supply chain where a where relatively small amount of value. By contrast, Western European countries have specialised in areas where very high value is created, says wiiw. As a result, there is a “risk of CEE having broken out of the middle income trap to become stuck in centre-periphery trap,” Grieveson warns.