While challenges remain, CEE countries are making progress in managing the many growth challenges. The region is adjusting to the slower growth rate of its trading partners, but there are already signs of improving economic activity. These are some of the main findings that emerged from the latest quarterly report on CEE countries published by UniCredit Economics & FI/FX Research. The growth of the manufacturing industry has accelerated, while credit is close to recovery.
The process of deleveraging of external liabilities by banks has significantly eased in the new EU Member States. Finally, it should be kept in mind that the years prior to 2008 were an extraordinary period in terms of growth and that pattern is now unrepeatable. However, the CEE countries are conquering a "new normality", even if the weak external demand and the reduced inflows of foreign capital represent an element of difficulty.
The recovery of manufacturing activity, credit and inflation show significant differences from country to country
In the first quarter, the manufacturing sector recorded better results than at the end of 2012, mainly thanks to the increase in vehicle production. Based on the average manufacturing Purchasing Managers Index in the second quarter, the Czech Republic could continue to maintain the good results achieved and the increase in exports, while all other countries have not matched the performance of the previous quarter. Further improvements are expected, but the process will be gradual and volatile at times. Unused production capacity and increased competitiveness are factors that could play a supporting role, despite the decline in foreign direct investment in the region's manufacturing sector.
Demand remains the main problem and this translates into a loss of export shares globally. As with industry, the impact of credit on domestic demand is also improving, but again this is a gradual process with very mixed trends in the CEE region. “The reduction of external liabilities has slowed down significantly. In many countries the growth of deposits outpaces that of credit and this makes it possible for new credit to rise, although in the countries that have recently joined the EU the phenomenon is slowly materializing”, said Gillian Edgeworth, economist at UniCredit in charge of the EEMEA region. Bulgaria, the Czech Republic, Poland and Lithuania are the only countries in the region to report positive year-on-year credit growth, albeit at low levels. The biggest problems remain the high number of non-performing loans and the low demand for credit.
In Hungary, Latvia, Romania and Croatia, the credit crunch is slowing down, while in Romania and Croatia the economic situation is still unfavourable. The exceptions are Turkey and Russia, where credit growth is more sustained and the presence of foreign ownership in banks is less. However, a distinction must be made: in Turkey the increase in new credit is accelerating, while in Russia it is slowing down due to financial and regulatory constraints. The improvement in manufacturing and credit goes hand in hand with a deceleration in fiscal consolidation. In most countries the budget balance is not a cause for concern. Indeed, some of the greatest progress on a global scale has occurred in the new EU Member States. The Czech Republic, Hungary and Romania, for example, have managed to bring the structural budget balance below 3% of GDP. Many countries are decreasing their commitment to the
consolidation to support economic activity. But in some economies, such as Croatia, Slovenia, Serbia and Ukraine, further consolidation is needed, due to weaker fiscal performance and the risk of missing deficit targets.
Fortunately, the current inflationary environment allows some countries to ease their monetary policy. Indeed, inflationary pressures eased thanks to the drop in oil prices and regulated prices. Lower food inflation and forecasts of good harvests help make the inflation picture less problematic. Many countries have already embarked on major fiscal consolidation measures and therefore tax measures pose less risk of rising inflation in the near future. However, as is the case for other economic sectors, the region is also characterized by marked differences in the ability of central banks to keep inflation in line with the target. While the Czech Republic and Poland remain below the target, Turkey and Russia still face inflation that remains above target.
External financing as a risk to economic recovery
A major risk to the recovery is a deterioration in external financing conditions. Rising risk aversion on global markets is reducing foreign capital inflows to CEE countries. At the same time, as outflows from this region remain high, the risk increases that CEE countries will have to pay off their debt at a higher cost. The situations at the national level are once again very varied. Poland and Türkiye recorded large inflows into portfolios. Croatia and Lithuania can also count on the inflow of foreign capital.
The accumulation of foreign exchange reserves has not kept up with the inflows of capital into portfolios. Most central banks have not adopted a reserve accumulation policy to keep up with the inflows into their portfolios. Despite the improvement in activity in the region and the easing of inflationary pressures on central banks, risks to financial stability are an issue on the agenda for each country and this, given the heterogeneity of situations in the region, will give rise to
different monetary measures and policies. In countries that have already made progress in terms of adjusting to the inflationary target and safeguarding financial stability, such as Poland, Hungary and the Czech Republic, monetary policy will be more accommodative.
“The signs of recovery we are seeing in the region are being jeopardized by less favorable external financing conditions, making it all the more important to ensure safety margins,” noted Gillian Edgeworth. Many countries have low foreign exchange reserves and negative developments both domestically and externally can impact the financial system. The CEE countries must find the right anchorages in order to give stability to their financial context. Support could come from IMF programmes. Another from the envisaged Banking Union within the EU, which has the potential to increase the credibility of financial systems.
