Firm Growth in Central Europe

But Spat With EU on Rule of Law and Asylum Policy: GDP forecast 2016 for Emerging Europe: 3.2%

According to estimates, Q2 growth in 2016 was firm in most of Central Europe: 0.7% in Bulgaria Q-o-Q and 3% Y-o-Y; Czech Republic 0.9% Q-o-Q and 2.5% Y-o-Y; Hungary 1.1% Q-o-Q and 2.6% Y-o-Y; Poland 0.9% Q-o-Q and 3% Y-o-Y; Romania 1.5% Q-o-Q and 5.9% Y-o-Y; and Slovakia 0.9% Q-o-Q and 3.7% Y-o-Y. 

Household consumption is being firmly supported by rising salaries (both in the public and private sectors), more than likely resulting in increased employment, tax cuts and eventually new social allowances. Fiscal and social giveaways are being facilitated by fiscal deficits lower than 3% of GDP. 

While public investment is being temporarily frozen by the gap between two European financing programmes, private investment is holding up well due to subsidised financing and tax rebates (Hungary and Romania), foreign direct investment in Slovakia and the catch-up effects in Bulgaria. This is being assisted by low interest rates as a result of extremely low or negative inflation. 

Despite a slight slowdown due to the impact from a Brexit perspective, Central and Eastern Europe (CEE) sales to Western European markets are holding up well. Countries strongly integrated in the German production chain such as the Czech Republic, Hungary and Slovakia are benefiting from German household consumption and relatively good export performances. 

These countries, as well as Romania due to their strong automotive industry, are benefiting from the booming European passenger car and commercial vehicle market. These exports are also doing well on overseas markets due to the weaker euro with which local currencies that are not part of the Eurozone are fluctuating in tandem.  

These strong export performances are compensating for the rise in imports linked to increased domestic demand. As a result, it is expected that CEE countries will keep their current account surplus or continue with low deficits. 

Risks

Fiscal and social giveaways, if extended, could cause a deterioration in the fiscal position and reverse the progress made since the 2008 economic crisis. This risk has been highlighted by the IMF particularly in the case of Romania and Poland where the deficit is approaching 3% of GDP, considered excessive by the EU. According to the EU, the Stability and Growth Pact the European Council can then decide on a fine and a partial suspension of EU funding. 

Increasing employment and a rise in salaries, if not matched by gains in productivity, will fuel inflation and weigh on competitiveness and regional attractiveness for FDI. 

A strong dependence on the Western European economy, with generally over 50% of exports heading to the Eurozone, is exposing the Central European economy to the potential impact from a disorderly Brexit. The main negative impact would not come

from direct trade with the UK (exports to the UK represent less than 4% of GDP for all countries), but from a slowdown of the Eurozone. 

Moreover, a weakening of the pound, through remittances from the 800 000 Poles and 200 000 Hungarians living in the UK, would weigh on household consumption in their respective home countries. This excludes the possible reversal of migration flows. 

The high dependence on the German economy exposes most Central European countries to German domestic demand (both private consumption and investment) and CEE exports which are absorbing large volumes of CEE-produced intermediate and finished goods. This dependence is particularly acute in the automotive industry.

Anti-EU sentiment has been spreading in many CEE countries, fuelled by the migration crisis and compounded by the Brexit vote and the populist and nationalist discourse of local politicians. 

This has been particularly strong in Poland, Hungary and Slovakia where Western European presence, like everywhere in the region, is strong in the banking and retail sectors. Poland could have its voting rights in the EU suspended if they don’t modify their Constitutional Court legislation.

The reform of the European asylum system and particularly the proposal for a permanent crisis relocation quota mechanism are opposed by many. A referendum is

to be organised on October 2 in Hungary. Should it be approved by the European Council and the Parliament, countries could be fined up to 250 000 euros for each refugee they refuse to take.

The significance of EU cohesion funds, the Russian threat, integration in the German production chain and the risk of being excluded from a tighter Union should limit risk. Conversely, the importance of the region for German manufacturers could induce some leniency from Germany and consequently the EU.