Eastern Europe economy: Eurozone GDP boost set to fade

FROM THE ECONOMIST INTELLIGENCE UNIT

Most east European economies saw their economic recoveries accelerate in the second quarter of the year, and in several cases the performance exceeded expectations. As a result, some economies that seemed on course for a mild contraction this year may avoid that fate, while others are on course for respectable growth rates. However, waning global demand and plans for further austerity in the second half of the year will chill the recovery. Domestic consumption remains fragile across the region, and with credit still tight and public-sector pay cuts on the agenda, there are few reasons to hope that consumers will contribute significantly to the recovery.

The economies of eastern Europe are finally shaking off the worst of the recession, to judge by a batch of preliminary second-quarter GDP data. The Slovak, Czech, Romanian, Lithuanian and Estonian economies all saw an improved GDP performance in the second quarter. Slovakia’s economy expanded by 1.2% quarter on quarter, accelerating from the 0.8% increase of the first quarter, while GDP growth in the Czech Republic climbed to 0.8% from 0.5% in the preceding quarter. Meanwhile, Romania, Lithuania and Estonia all managed to clamber out of recession, with GDP rising by 0.3%, 2.9% and 2% respectively.

Quarter-on-quarter comparisons are not available for Bulgaria, although year-on-year data show that the GDP decline moderated to -1.5% in the second quarter from -2.9% in the first. This was in fact the best GDP performance since 2008. Meanwhile, Ukrainian GDP growth accelerated to 6% year on year from 4.9% in the first quarter, while Russian GDP growth climbed to 5.2% year on year from 2.9%–the marked the strongest growth performance for Russia since the third quarter of 2008 and the strongest performance for Ukraine since the second quarter of 2008.

Eastern Europe: GDP
(quarter-on-quarter % change, seasonally adjusted)
2Q 09 3Q 09 4Q 09 1Q 10 2Q 10
Czech Republic -0.5 0.5 0.5 0.5 0.8
Slovakia 0.8 1.1 1.7 0.8 1.2
Romania -1.5 0.1 -1.5 -0.3 0.3
Hungary -1.4 -0.6 0.2 0.9 0.0
Bulgaria* -5.2 -5.5 -5.2 -2.9 -1.5
Ukraine* -17.8 -16.0 -6.8 4.9 6.0
* Data only available year-on-year
Source: Haver Analytics

Hungary was the region’s only backslider: GDP growth stagnated in April-June, quarter on quarter, after having posted 0.9% growth in the first quarter of the year. Year on year, GDP edged up by 1%, after a minimal 0.1% growth in the preceding three-month period. Although a breakdown of the figures is yet to be released, the strength of both industry and merchandise trade data for the second quarter suggest that the domestic economy held back growth.

Gaining ground

Hungary aside, all the surprises were on the upside. Lithuania returned to growth earlier than expected and so the Economist Intelligence Unit now expects that the economy will have close to zero growth this year (our previous forecast was for a 1.8% contraction). Similarly, the Czech Republic and Estonia both posted stronger-than-expected growth rates for the second quarter. As a result, we now expect the Czech Republic to grow by at least 1.5% this year (our previous forecast was for growth of 0.9%), while we will be raising our forecast for Estonia to around 1% for 2010.

By contrast, Hungary’s performance was in line with the Economist Intelligence Unit’s expectations. So too were the GDP data for the Romanian and Bulgarian economies (we forecast 2010 GDP growth of 0.3% in Hungary, and a contraction of 1.2% and 0.1% in Romania and Bulgaria respectively). Slovakia and Ukraine are still set to achieve their forecast growth rates of 3.5% and 4% respectively.

Still weak and vulnerable

The headline growth figures mask the fragility of the domestic economies in the region. Were it not for the boost from the export recovery, the picture would look much worse. Consumer spending is recovering in these countries, although given the slump of 2009, the domestic economies remain in a poor state. It is hardly a surprise that consumers are reluctant to spend–unemployment remains in the double-digits across the bulk of countries, and in the high single digits in the others. Whilst the jobless rate may have peaked in most, it is still on the rise in Hungary and Lithuania. And with more cuts in government spending and the public payroll to come in both countries, it is not clear when the peak will be reached.

Consumers can hardly resort to credit to maintain spending growth, with the stock of private-sector lending across the region having stabilised, or at best recording subdued growth. Whilst Ukraine has enjoyed a modest revival in lending to the non-financial sector, lending to households continues to fall back in month-on-month terms.

The imperative of further austerity hangs over the region like a dark cloud. Most countries are planning to focus more upon spending cutbacks to rein in their deficits, rather than tax increases, and this choice will probably lead to weaker growth in the short term. Slovakia may be raising taxes, but around two-thirds of its savings are expected to be financed by spending cuts. Bulgaria has opted out of raising taxes completely, choosing instead to freeze wages and pensions. Lithuania has reversed one of its tax rises that it implemented last year (the profit tax) and is now concentrating on reducing spending through public-sector pay cuts. Hungary has opted for a mix of spending cuts and tax rises, but the latter will fall mainly on the country’s banks.

Eurozone drag

Despite some pleasant surprises in the second-quarter data, the outlook for 2011 is basically unchanged. Much of the recent improvement across eastern Europe can be attributed to the resilience of demand for exports from the EU in the second quarter, particularly Germany, where GDP jumped by 2.2% quarter on quarter in the second quarter of 2010–Germany is a large trade partner for many east European economies. Whilst Germany’s growth burst may place that economy on course to notch up stronger growth this year (we raised our forecast to 2.8% from 1.2% previously), this performance will be short-lived and the economy is expected to witness a sharp slowdown in the second half of this year. Indeed, we forecast that EU growth will slow to around 1% next year from 1.4% in 2010, which will constrain Eastern European export prospects going forward.

Although exports will continue to support Eastern European economies in 2011, the boost will be less than that of 2010; world trade growth is forecast to slow to 5.5% in 2011 from 9.6% in 2010. Therefore domestic demand will need to make up for the shortfall. The Czech economy is expected to gain some further momentum in 2011 (it is forecast to grow by 2%), as private consumption and investment strengthen. Similarly, better domestic demand conditions are expected to enable Lithuania to return to growth in 2011 (2.3%), while Bulgaria and Hungary should also manage to record similar rates of growth next year (of 2.6% and 2.5% respectively). Estonia’s GDP growth is forecast to climb to 3.1% in 2011, while growth in Romania is forecast to come in at 3.4%. Ukraine is expected to maintain roughly the same rate of expansion (4% GDP growth forecast for 2010, 3.9% for 2011). By contrast, the Slovak and Russian economies are forecast to lose some momentum in 2011. The former is forecast to grow by 3.3% in 2011 (down from 3.5% in 2010), owing to its exposure and reliance on exports, which have been a key driver of growth in recent years. Whilst Hungary and the Czech Republic are also very much export-oriented, they are not as exposed as Slovakia to the automotive sector. Meanwhile Russian growth is forecast to slip to 4% from 4.8% in 2010 once the effects of the large stimulus package fade and external demand wanes and slightly lower oil prices.

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