Cash & Investment Management

Central and East Europe Focus – Q2 2017

Wednesday 7th June 2017

The economies of Central and Eastern Europe began 2017 on a positive footing. Outside the Commonwealth of Independent States (CIS) and Turkey, growth has remained strong, driven by accommodative policies. Meanwhile, Russia and the rest of the CIS are finally on the road to recovery, with firming oil prices lifting activity. Growth in Turkey has rebounded partially after dropping sharply in the wake of elevated political uncertainty. Data showed GDP for Central and Eastern Europe expanded 3.3% on the previous year’s quarter in Q1, which is well above the 2.8% increase recorded in Q4 2016. Lithuania’s economy grew at the fastest pace since Q2 2014, on the back of strong domestic demand thanks to wage increases and strong credit growth. In addition, GDP growth in Latvia accelerated.

Although official GDP data was unavailable at the time of writing for the remaining economies, monthly indicators suggest that activity firmed in most of the region’s major economies including Hungary and Poland. In addition, growth is anticipated to remain robust in Romania, although below Q4’s pace. Overall, fiscal stimulus and easy monetary conditions are supporting spending in the region, and improving external demand is boosting activity. GDP is anticipated increase 3.1% in Q2.

Politically, the past few of months have been busy for Croatia and the Czech Republic. In Croatia, Finance Minister Zdravko Maric narrowly survived a no-confidence vote on 4th May, avoiding a second snap election in one year. The government has been at the brink of collapse since MOST (Bridge of Independent Lists) quit the governing coalition on 28th April. While a snap vote has been avoided for now, the government’s slim support is a poor sign for political stability going forward.

The Czech Republic has also been embroiled in a political crisis due to a clash between Prime Minister Bohuslav Sobotka from the Social Democratic Party and Finance Minister Andrej Babis from ANO 2011. After announcing that his government would resign, Sobotka abruptly changed course on 5th May and announced that he would seek to only remove Babis. While the political noise has been high, the disturbance is not expected to have any large effects and elections are already scheduled for October.

The Central & Eastern Europe’s economic outlook was upgraded this month. Economists now see regional GDP expanding 3.2% in 2017, as a solid domestic economy and improving demand from abroad act as tailwinds. In addition, positive data from the beginning of the year supported the upgrade. Next year, economists see the economy remaining on a healthy footing and growing 3.1%.

Romania is projected to be the region’s fastest-growing economy this year, with an expected expansion of 3.9%. Bulgaria, Hungary, Poland and Slovakia are also seen achieving fast growth rates of over 3.0%. On the other side of the spectrum, the Czech Republic and Estonia are expected to be the Central and Eastern European region’s laggards, with expansions of 2.6%.

The Czech economy accelerated in Q1 according to available data, with the manufacturing sector helped by strong domestic and external demand and private consumption benefiting from rising wages and a multi-year-low unemployment rate. Momentum looks to have carried over into the second quarter, with encouraging PMI and economic sentiment readings for April. The positive economic panorama is set to continue despite the recent political turmoil. After announcing that he and his entire cabinet would be resigning as a means to oust Finance Minister Andrej Babis, Prime Minister Bohuslav Sobotka of the Centre-left Social Democratic Party swiftly backtracked on the decision after an intervention by head of state Milos Zeman. Elections were already scheduled for October and early polls suggest that Babis’ centrist ANO 2011 party will win despite some controversy over his wealth and alleged involvement in corruption scandals.

The economy will likely pick up this year, underpinned by solid household spending, stronger external demand and a partial recovery of EU investment funds. Nevertheless, a shortage of labour supply might restrain the economic momentum, while the political uncertainty surrounding the outcome of next elections could discourage investment. Economists are predicting GDP growing around 2.6% in 2017.

Recent data releases confirmed that the Hungarian economy hit a soft patch in the final quarter of 2016, with growth decelerating. The headline figure disappointed market analysts’ expectations and dragged annual GDP to a four-year low. The deceleration, however, seems to be a mere blip in an otherwise solid sequence of economic activity and healthy economic fundamentals. In 2016, all three major credit rating agencies restored Hungary to investment grade, the labor market strengthened considerably and a sustained decline in public and external debt reduced the country’s exposure to economic shocks. The latest data from this year suggests strong growth momentum in the domestic economy and solid growth in exports, which expanded at the fastest pace in over five years in January.

Hungary’s economic outlook is promising as loose monetary conditions, a planned 15–25% minimum wage hike, tax cuts, increased EU funds inflows and a solid labor market will boost economic growth this year. Economists forecast that the Hungarian economy will expand 3.2% in 2017

Poland’s economy is gathering steam. A revival in investment and construction activity is supporting activity and recent economic indicators are positive. Business confidence came in at the highest level in seven years in April and the manufacturing PMI pointed to improving business conditions. Moreover, accommodative fiscal and monetary policies are adding impetus to consumption and retail sales expanded nearly 10% in March. The upturn in data comes after GDP slowed in H2 2016 as plunging investment curtailed economic activity. Looking forward, while improved conditions in the labour market will continue to fuel household spending, growth is expected to wane in H2 as the effects of the Family 500+ child care benefit scheme fade.

Recovering investment and healthy Euro area demand should fuel higher growth this year. Many commentators and economists sees GDP expanding around 3.4%.

There is potential for some upside from stronger external demand, notably higher growth in the euro area and the United States, and a firmer recovery in commodity prices, which would help the area, and lower political uncertainty following key elections in Western Europe. Key downside risks include a global shift toward inward-looking policies and protectionism, a sudden tightening in global financial conditions, new shocks in advanced European economies, and further wage increases that could hurt competitiveness.