EasternEurope
Vol. 23. No.1. 2014
KOPINT-TÁRKI
Economic Research Limited
Budapest
Economic Trendsin Eastern Europe
2014 No. 1 May
Published by KOPINT-TÁRKI Economic Research Institute Limited
Responsible Publisher:
Éva Palócz
Authors:
International Environment
Katalin Nagy
Chapter 1: Central and Eastern Europe
Katalin Nagy, Péter Vakhal
Chapter 2: The Hungarian Economy
Zoltán Ádám, Zoltán Matheika, Ágnes Nagy, Éva Palócz
Edited byÉva Palócz
Closed on May 2014.
Economic Trends in Eastern Europe is an insightful publication providing subscribers with a comprehensive picture of Eastern European economic developments.
Economic Trends in Eastern Europe is written by the research team of the Kopint-Tárki Economic Research Institute – the same group that has authored the previous 22 volumes of this publication. Each issue provides an analysis of the current economic situation as well as of the specific problems of economic growth and institutional changes in Eastern Europe.
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©Kopint-Tárki Budapest 2013
Economic Trends in Eastern Europe
No. 1 2014
Budapest, May 2014
1. International environment
Since the middle of last year, the global economic outlook has become more and more optimistic. Growth in developed counties seems to be more stable and robust than in the emerging part of the world, where climate indicators show a rather mixed picture. Global economic growth might be around 3.6% this year, according to the various projections (IMF, IfW) and it might accelerate to 4% in 2014. The volatility of the sentiment indicators is a signal that the economic upturn is still vulnerable and special factors e.g. hard winter conditions in the US or the capital outflow from the emerging countries may have substantial effects.
The present trends in emerging countries seem to be a substantial downwards risk to our forecast: growth rates slowed down in most of the emerging economies during the last year, and the short-term prospects of the different regions vary greatly. It is hard to assess the future impacts of the slow tapering of the Fed’s asset purchases and the consequences of the capital outflow from the emerging countries. As a direct consequence, the currencies of the emerging economies have become more volatile and substantial monetary tightening became necessary in some of the emerging countries.
Also the expansion of the world trade accelerated in 2013, but it remained sluggish compared to the average of the last 20 years (5.4%) and it remained below 3%. The growth was primarily driven by an improvement of economic situation in the developed countries, although imports and exports of the emerging countries showed also a dynamic increase. In line with more optimistic global forecasts we expect an increase of 4.7% of world trade for 2014 and a 5.2% growth for 2015 with downside risks. Our assumption is based on a steady growth in developed countries, especially on the upsurge of the US and a recovery of the European economy, and simultaneously we assume that economic performance in emerging countries will slow down only slightly.
Despite of more dynamic economic growth we expect only a moderate increase of inflation. Moreover, in some regions (e.g. Eurozone) even the threat of deflation appears. In general, the rate of inflation will remain higher in emerging countries than in developed countries, but a moderation of inflation rates will be general.
The prices of raw materials were determined primarily by the weak demand on behalf of emerging economies. The commodity index of the IMF declined by 1.6% as compared to the last year, following the change of prices (-1.8%) of dominant energy resources (63%). In the fourth quarter the price level was by 1.5% lower than in the previous quarter, and the monthly indices (month-over-month) were varying between 2.6% and -2.1%.
The slowly growing demand for fuel will push oil prices only slightly upwards. Crude oil price has decreased by more than $10 per barrel since the last year’s peak. At present, it is about 106 US dollar. According to the last forecast of the IEA the demand may rise by 1.35 million barrel per day in non-OECD members, while it is expected to decrease by 500 thousands barrel per day in OECD members. According to our forecast the oil price will remain stable since there will be no demand push from the emerging countries and the demand for oil will be below the level of 2010 (47 million barrel per day) in the developed countries. Our forecast for 2014 is 109 USD/barrel and we expect a slight upward shift in 2015. Since we do not expect any pressure on the demand side; although geopolitical risks persist in several regions, we assume that oil price remains relatively stable in the coming months.
Prices of non-fuel commodities dropped by 1.2% last year. In the fourth quarter the price level was by 0.5% lower than in the preceding quarter; in January this year it decreased by 1.1%, whilst in February it increased with same percentage. In the first two months, industrial metal prices – primarily iron and copper – declined due to concerns about slower Chinese economy and ample production. Agricultural prices were slightly fluctuating without any tendency. However the prices of wheat were increasing significantly due to poor weather condition in USA, low Canadian and Argentinean sales and the conflict of Russia and Ukraine. The price level of coffee rose because of the Brazilian drought, while cocoa prices increased due to the growing demand. On the short run, the non-fuel commodity prices may turn downwards due to the decreasing demand of industrial countries (especially China) and improvement in agricultural supply. Therefore we do not expect any inflation push from the non-fuel commodities market.
The global financial market can be shaken any time by little turbulences, despite the apparent relative stability at the moment. The announcement of the Fed entering into the ‘tapering off’ phase caused significant capital outflow from the emerging countries and put some of the national currencies under pressure. Therefore, central banks in some of the emerging countries were forced to raise the reference rates substantially. In the developed countries, however, expansive monetary policy and low reference rates continue to be dominant. The Fed does not plan to change the reference rate in the short run either, whilst the ECB maintains full-scale monetary easing, citing the deflationary threat and the still far from impressive growth forecasts. Other leading central banks (Bank of England, Bank of Japan and Swiss National Bank) will continue the policy of monetary easing as well.
The euro has appreciated against its main trade partners’ currencies since the beginning of 2014, despite of the depreciation of the last few days. Movements in exchange rate are affected by expectations concerning the reference rate and growth forecasts. We expect an average USD/EUR rate of 1.37 for 2014 and a similar rate for 2015.
Fiscal difficulties are likely to remains in most developed countries, and public debts will increase in many countries, despite the previous efforts. However, the intensity of fiscal restriction will decrease compared to the preceding years, and therefore its negative effect on economic growth will become less marked.
The growth outlook outside the EU is improving but there are substantial downside risks as well. In the US we expect a faster growth and improving labour market. For 2014 we reckon with a GDP growth rate of 2.9%; which may accelerate to above 3% in 2015. Both monetary policy and fiscal policy will support growth, and substantial fiscal restrictions are not expected at last until 2015 as a compromise could be reached in respect of the debt ceiling. In Japan the growth rate remains sluggish, the budget deficit and the enormous national debt make the fiscal consolidation inevitable which in the future may have negative impacts on economic growth. The outlook of the Russian economy can be influenced by the escalation of the conflict between the Russia and the Ukraine. At the moment we expect a slightly accelerating growth, but the low fuel prices can pull back the growth of the asymmetrically structured economy. The fiscal consolidation will also give mitigating impulses. Similarly to other emerging countries’ currencies the rouble is under significant pressure at the moment, the inflation will decline somewhat but it remains still high compared to other countries. The forecasts on theChinese economy were optimistic in the beginning of 2014, due to the significant growth in the second half of the year. However, since the first half of March when the disappointing January-February economic data were published and negative signals came from the financial sector as well, most of the analysts turned pessimistic concerning growth outlooks. The structural reforms launched by the Chinese government with the aim of reining in activities that rely on ample credit supply and neglect efficiency consideration may contribute to a slowdown of overall growth; other measures, however, encouraging domestic demand via public expenditures on infrastructural development, public health, education or the modernisation of energy production, may counterbalance these impacts. Also the recovery of external demand will have positive effect on exports. In the first quarter the economic growth will certainly be lower than expected, and a number of negative trends (e.g. non-performing loans, shadow banking activity, anomalies on the real estate market) will cause downward risks, yet we still expect that the official growth target of 7.5% for this year can be met.
The sentiment indicators show upward trends in the EU and in the Eurozone: economic growth is expected to accelerate in the next few months. The differences between the growth rates of the member states will remain substantial. Old member states outside the Eurozone will continue to have faster GDP growth than the Eurozone average. According to our forecast the GDP of EU-18 will expand at a rate of 1.1% in 2014 and some acceleration up to 1.5% is likely for 2015. In case of the EU-28 we expect a GDP growth of 1.5% this year and 1.7% for 2015. The growth in the euro area will be fuelled by expanding domestic demand; especially, the expansion of investments will be dynamic compensating for of the negative rates of the last years. Net export will contributes to overall growth moderately, since reviving domestic demand will bring about a recovery of imports as well.
The inflation rate will remain moderate; the threat of deflation may appear. However, we do not expect a serious deflation due to four factors: the core inflation will stay stable (1%), the drop of prices mainly reflects the decline in energy prices and reliving demand may raise the general price level, expected rise of wages in some countries may push inflation rates upward. However, during the forecast period the inflation rate is likely to move under the 2% target of the ECB.
The budget deficit of the Eurozone countries will be reduced further and the level of fiscal debt is stable, or even declines in some of the countries. Only Germany will achieve a budget surplus. The fiscal problems are still present, however: the expected improvement will be the result of the cyclical upturn, while the structural problems in most countries remain unresolved.
Labour market will stay under pressure in most of the EU countries despite of the expected economic improvement. The unemployment rate of the EU-18 will be around 11.6-12%: in 9 countries double-digit unemployment rates are likely to occur.
In Germany - after the 0.4% GDP growth in 2013 – we expect a GDP increase of 1.5% in 2014 and 2% in 2015. Private consumption and investment are going to be the driving forces of the economic boom. Primarily, external risks may divert the outcome. The external economic environment may sour either because of the unresolved debt problems still haunting some of the Eurozone countries, or – as a new phenomenon – because of the escalation of Ukrainian conflict and a deterioration of relations with Russia. One has to keep in mind that last year Russia was the 11th largest trade partner of Germany, and 31% of the German oil and natural gas import is coming from Russia.
2. Central Eastern European New Member States
The region is on a growth path again, with Baltic states at the lead
Along with the Eurozone, the Central Eastern European member states saw their quarterly growth rates turn to positive during 2013, with the exception of Cyprus (with its economic fortunes closely tied to Greece) and Croatia. These countries (and possibly Slovenia) are likely to experience stagnation in 2014. Four countries were in recession in 2013 as a whole: the Czech Republic (-0.9%), Croatia (-1%), Slovenia (-1.1%), and Cyprus (-5.4%). On the other hand, Lithuania, Romania and Latvia boasted the highest growth rates last year (3.3%, 3.3%, and 4.1%, respectively). while the regional average was 1.1%. Latvia joined the Eurozone in the summer of 2013, after years of strict fiscal and monetary policy after the global crisis. As a result, 6 countries out of the 13 new member states have already become members of the Monetary Union. Among the rest, Lithuania is the closest to meeting the convergence criteria at present: its fiscal deficit amounted to 2.2% of GDP in 2013, and the Lithuanian government projects a deficit as low as 1.5% of GDP for 2014. With excellent growth prospects throughout the Baltic region, Lithuania is likely to become the next EMU member state, possibly in 2015. Apart from Lithuania, only Bulgaria meets the Maastricht targets but the Bulgarian EMU accession is still years to come, since Bulgaria is still to go through the obligatory two-year period of ERM II membership.
GDP growth in the new member states far outpaced the average growth in the EU-15, which means a renewal of the former trend of real convergence. At the same time, the relative levels of development within the region are quite different from the relative levels before the crisis. The Baltic states are the most developed economies within the region now, while the Visegrad countries, except for Slovakia, have been diverging from the EU average since the outbreak of the crisis. Even Poland, which managed to get through the global crisis without recession, experienced the virtual freezing of its economic growth since 2012.
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The economic structure in the Baltic states differs markedly from that in the Visegrad countries. They run sizeable external deficits, and only Estonia Boasts an outstanding stock of inbound FDI (86% of GDP), while the FDI stock in Latvia and Lithuania (47% and 37% of GDP, respectively) is significantly lower than in the V4 countries. Their fiscal stance, on the other hand, is outstandingly prudent: apart from the crisis years, the fiscal deficit remained below 3% of GDP. The fixed exchange rates (against the euro) made “inner devaluation” necessary, which precipitated the burst of the housing bubble. International migration and labour market measures (such as the public sector wage cut in Estonia) helped ease the unemployment. Consumption and exports are the main drivers of economic growth in the Baltic states, accompanied by growing productivity. Besides, these countries are among the most developed within the CEE region in terms of institutional effectiveness.
Improving short-term risk perception, substantial currency depreciation
Investors’ assessment of the region improved substantially in 2013. CDS premiums have reached their lowest level since the beginning of the crisis, despite the fact that Slovenia and the Czech Republic – the two most developed countries within the region – was in recession, and Poland – the biggest economy of the region – stagnated. Long-term yields have reached their historical low. Abundant liquidity – fed by the FED and by the low Eurozone interest rates – prompted financial investors to turn to the moderately risky CEE region. Still, the relative position of the new member states in terms of credit rating is unfavourable compared to the EU-15 countries, mostly due to the macroeconomic imbalances. Gross debt levels are on the rise, household and corporate borrowing is still stagnating at best, and investment growth rates deteriorated in many of the regions countries. The short-term outlook has improved with the revival of economic growth in Europe but not without a substantial depreciation of local currencies and declining consumption, in some cases accompanied by a decrease in net real wages (in the Czech Republic for example, by 2.9%).