During 2015, the uncertain economic recovery in the Eurozone and the weakness of global trade will continue to accentuate the differences between the individual countries of Central and Eastern Europe (CEE). In particular, growth opportunities are foreseen for economies engaged in reform projects, while states with evident structural problems will find themselves in recession.
These are the main conclusions of the latest “CEE Quarterly”, a quarterly report on CEE countries published by UniCredit Economics & FI/FX Research and dedicated to economic activity in the region. Central Europe and the Baltics once again stand out on a positive note as they boast a sizeable recovery, better fiscal parameters and reliable sources of external financing. Overall, the economy of Central and South-Eastern Europe is expected to grow by 2,5% this year and by 2,9% in 2016, while the figure for the whole region stands at 0,2, 2,2% and XNUMX% due to contraction in Russia.
Global export offers limited support
In contrast to the beginning of 2014, for many CEE countries net exports are now more of a brake than a stimulus to economic growth. In fact, the strengthening of domestic demand causes an increase in imports, while the uncertainty of the economic recovery in the Eurozone, the weakness of demand from other emerging markets and the conflicts in Ukraine and the Middle East hinder exports and will allow the global exports grew by just 3-4% per year in 2015 and 2016.
“The low export growth rate means that prices are playing an increasingly important role. In this context, the depreciation of the euro against the US dollar could temporarily favor exports from CEE countries outside the EU. If this were not enough, Central and Eastern European states could weaken their currencies with flexible exchange rates against the euro in order to loosen monetary policy”, commented Dan Bucsa, economist at UniCredit.
In the long term, however, the European economies of the Central and Eastern region will have to evolve into more sophisticated production centers with higher added value. As regards capital flows, the availability of EU funds is the key difference between member states and other emerging markets, since foreign direct investment is scarce. In the past, it was easier for CEE countries to expand their market shares within the European Union than to expand into new markets. This is especially true for the newest members of the monetary union, which have gained their commercial space in EU markets by taking shares away from peripheral countries, such as France and the United Kingdom. In 2015, newcomers to the Union could even surpass peripheral countries in terms of intra-European export market share thanks to factors such as lower production costs, more flexible labor markets, geographical proximity and lighter taxes.
Nonetheless, the growth rate of exports from CEE countries to the EU will amount to just above 5% in 2015. The hopes of CEE countries are therefore pinned on the United States and Germany. Even if on the one hand UniCredit analysts expect a strengthening of growth in the USA, this expansion will have positive effects on CEE countries only to a limited extent, through the demand coming from Germany. Despite a gradual acceleration in quarterly growth, the annual data on German economic activity is likely to fall to 1,2% in 2015, versus 1,5% in 2014, before rising again to 2,0% next year.
Trade sanctions against Russia could be lifted this year
In addition to the elections in Greece and the uncertain growth prospects in the Eurozone, a further problem of no small importance for the CEE countries is represented by the international sanctions against Russia. These measures could be withdrawn if the 28 EU member states fail to agree on their extension. In the event that trade sanctions are partially lifted, Russia in turn could ease restrictions on food imports. Conversely, the financial sanctions will remain in place until the United States sees a satisfactory resolution of the Ukrainian crisis.
“The impact of the conflicts in Ukraine and the Middle East on CEE countries' trade has so far been rather mild. Even though seasonal energy imports from Russia likely caused a widening of the trade balance deficit in CEE countries in the last quarter of 2014, we are comfortable ruling out a substantial deterioration in the balances,” Bucsa said. "The Ukrainian crisis represents a greater risk for Central and Eastern Europe when viewed through the effects it has on the economic prospects of the Eurozone and Germany in particular".
Russia, for its part, is already exposed to a risk of a short-term recession and a decline in potential growth in the near future. This is largely due to the fact that Russia is heavily dependent on commodity exports in a global economy that makes less and less energy intensive use. An increasing share of GDP is in fact generated by the tertiary sector and emerging markets are reducing the role of heavy industry to switch to higher value products. At the same time, Russia cannot give up its energy exports to Europe, which are hard to replace. For example, the last two supply contracts signed with China together are equivalent to around 60% of the annual gas exports to Europe expected for 2018 alone.
Domestic demand – everything depends on the completion of the reforms
If exports disappoint in 2015, CEE markets will need to rely on strong domestic demand. So far, however, not all countries have developed this shock absorber. It will be difficult for Ukraine, Serbia and Croatia to weather the recession given their weak fundamentals and unresolved fiscal problems. In Russia, consumption and investment will not be able to compensate for the drop in commodity prices and the shortage of external financing. In the most recent EU member states, the maintenance of growth will largely depend on the factors driving consumption and investment, the effects of which were already seen in 2014, and specifically low inflation, the dynamic development of labor markets and accommodative monetary policies.
