CEE economies well placed to resist second wave risks
Fears of another spike in coronavirus cases are dampening optimism that Central and Eastern European economies would charge out of recovery. But a strong starting position and the EU’s huge support packages mean the region is better placed than most
Such was the demand shock from coronavirus that inflation is hardly a topic of discussion in most of the world. “Policy stimulus won’t boost inflation in the near term,” wrote Capital Economics in September, predicting “subdued” price increases over the next few years.
The CEE region did not get the memo. After an initial inevitable hit to headline inflation, prices in many countries rebounded over the summer as the majority of the region controlled the virus quickly.
“While core inflation has been going down almost everywhere, in Eastern Europe we have seen the opposite: demand recovered so quickly that retailers increased prices,” says Marek Drimal, EMEA strategist at Société Générale. “People were spending like there was no tomorrow, which is a heritage of recent years of economic growth, bringing higher wages and purchasing power.”
Core inflation in Poland hit a two-decade high in July. Though acknowledging that there are several factors contributing to inflation in Poland, minister of finance Tadeusz Kościński says this demonstrates that “the economy is still working”.
Indeed, Ed Al-Hussainy, senior interest rates and currencies analyst at Columbia Threadneedle Investments in New York, notes that, by some measures, certain CEE economies were “overheating” in the years leading up to 2020.
A strong starting position allowed CEE to survive the first few months of the coronavirus crisis with less severe economic damage than most of the world.
Several countries in CEE started out with a “very good” fiscal position, and were quick to react to the crisis, says Dan Bucsa, chief economist for CEE at UniCredit.
“Poland stands out for the volume and timeliness of its measures to defend the economy,” he says. “Poland and Romania have some of the most diversified fiscal packages worldwide.”
While CEE’s eurozone members benefit from ECB monetary stimulus, other regional central banks dipped into the unorthodox toolbox: Poland, Czech Republic and Romania joined Hungary in implementing quantitative easing programmes.
Moreover, CEE countries — with some exceptions — mostly brought the spread of the coronavirus under control speedily. In Prague, locals held a farewell party for the virus on June 30, and governments generally lifted restrictions quickly.
By mid-September, however, there were concerns that the region would suffer quite the hangover. Capital Economics said in late September that Czech Republic, Hungary and Slovakia were experiencing some of the worst outbreaks of coronavirus on a per-capita basis. Poland registered its worst day of infections on September 24, only to break that record the following day.
At that stage, at least, governments seemed hesitant to lock down their economies. Bank of America noted after virtual meetings with regional policymakers in mid-September that there was a “bias for a softer approach towards virus containment policies”.
Florin Cîțu, Romania’s finance minister, tells GlobalMarkets the government is prepared for a second wave and would “not be putting the country back in lockdown”, a message echoed by Kościński of Poland, who says that the authorities may look at “localised intervention, if necessary”.
Even if the virus remains under control in CEE countries, however, they will be affected by weaker external demand as the entire world attempts to climb out of recession.
“[CEE economies] were able to absorb the economic shock relatively well, but the recovery from here will very much be a function of how quickly Europe goes,” says Al-Hussainy. “It would be unusual for the likes of Poland and Hungary to go gangbusters without European manufacturing recovering, for example.”
Several CEE economies are highly reliant on the car industry, which accounts for 13% of GDP in Romania and Slovakia, and 10% in Czech Republic, Hungary and Slovenia, according to Scope Ratings. Tourism, one of the world’s hardest hit sectors, is a major driver of GDP in Hungary, Croatia, and other Balkan states.
Poland, too, has important car and tourism industries. Yet the economy is far more diversified — cars account for less than 3% of GDP. This diversification, coupled with the forceful economic policy response, means it is viewed as a likely outperformer.
“The rebound is likely to be stronger in countries where domestic demand plays a more important role in GDP, such as Poland,” says Bucsa of UniCredit. “Slovakia, Hungary and Czech Republic had a deeper trough and are likely to lag in the recovery.”
Minister Kościński says that, on “conservative estimates”, Poland’s economy will contract by 4.6% in 2020, and grow by 4% in 2021.
“By this time next year, the economy will be where it was in December 2019,” he says. “We are going to be a year ahead of some countries.”
Unemployment had only risen to 6.1% by July, up from 5.5% in February, and wages have continued to increase, the minister points out.
Fiscal space remaining
Moreover, though Poland will not be immune from another wave of Covid-19, any further economic hangover could be dealt with. Al-Hussainy believes that, given the fiscal space and the central bank’s capacity to intervene, “there is scope to borrow more” if necessary. Neither analysts nor Ko´sci´nski appear concerned about the increase in Poland’s debt-to-GDP ratio, given its broad access to financing.
So far, the largest economies in CEE seem well positioned to offer further stimulus, should the winter prove to be bleak in terms of the virus.
“If the second wave continues to advance, the question is: are countries going to need a new lockdown, and how bad will it be?” says Drimal. “Though CEE governments will support businesses and others, can they withstand another drop in demand?”
In some cases, fiscal support that has already been announced is likely to last for a while yet.
Marjan Divjak, director general of the treasury at Slovenia’s ministry of finance, says that the ministry’s estimates suggest that “the take-up of [the most important stimulus] measures will come later in the year and will have a positive effect in the recovery phase”. In Romania, minister Cîțu believes that 6% of GDP already announced is “significant” for such an economy, suggesting there will not be a need to expand the stimulus.
Where analysts are asking for more action is Hungary, which Bucsa calls a “clear laggard” in terms of fiscal spending, saying the stimulus arrived late and was mostly covered by transferring funds from other types of budget expenditure.
While Hungary’s central bank continues to expand its bond purchases in the belly of the curve, despite a short-term rate hike in September, it is more important that the country implements a “proper fiscal response” says Drimal. He believes the government has “surprisingly, not been very aggressive”.
“As the second wave continues, we will want to see governments across CEE seeking to prevent massive layoffs and defaults, just like Poland, Czech Republic and Western Europe did in the first wave,” says Drimal.
Even countries struggling with domestic stimulus plans, however, may receive a major helping hand. First, the EU’s €100bn SURE (Support to mitigate Unemployment Risks in an Emergency) initiative will provide loans to countries to ensure businesses can keep their staff.
Yet the largest breakthrough is the €750m Next Generation EU recovery fund, which will provide €390m in grants and €360m in loans and is set to proportionately benefit CEE more than the rest. This is on top of the EU’s standard budget.
Divjak in Slovenia calls the deal “ground-breaking”, noting that the initiative “goes beyond sole emergency measures, by balancing the need for immediate economic support with the objective to provide sustainable and inclusive growth in the future”.
“It also addresses strategic questions like climate change and digital transformation,” says Divjak.
CEE is expected to benefit strongly. Analysts at Erste Group Bank estimate that CEE countries will receive roughly 5% of 2019 GDP in grants, and almost 7% in loans.
Minister Cîțu of Romania says he is “confident” that the Next Generation EU funding will be effective in supporting his country’s economy, and will come at a better cost than other funding. Romania could be a net recipient to the tune of 9.5% of GDP, says ING.
Romania has previously failed to spend all its available EU funding as projects have missed deadlines.
“We have learnt from our mistakes,” says Cîțu. “Romania is lacking EU funding and will be prepared to use all the funds available. Our strategy is to structure the budget in such a way that all EU projects can be fully financed by EU funds.”
Yet Drimal at SocGen — while describing the recovery fund as “amazing news” and a “game-changer” — cautions that support will arrive from 2021 onwards and have no short-term impact on the recovery.
More important for CEE, says the strategist, is the “change in Germany’s fiscal narrative as it starts to spend”.
Europe’s largest economy has announced fiscal stimulus worth about 10% of GDP. Unlike the Next Generation funding, the impact is likely to be felt immediately.
“Such is the strength of trade linkages that CEE is basically a proxy of Germany, meaning this is the bigger news in my view — at least for Hungary and Czech Republic,” says Drimal.
CEE finance ministers therefore want to see the EU be proactive with the disbursement of its grand plan.
“Next Generation EU will only play an important role in the recovery if it’s deployed fast,” says Poland’s Kościński. “If we talk and talk and it happens in five years, the recovery will be long forgotten. The biggest possible problem is the speed.”
Of course, non-EU countries will not have access to the same level of funding from EU support measures, which will result in a “natural lag” in the recovery, says UniCredit’s Bucsa.
“However, if demand recovers in the EU, then this will benefit the exports of the non-EU countries,” he says. “For CEE, Germany’s recovery matters more than that of any other country.”
The long term will bring new challenges. As GDP per capita in some CEE economies closes in on Western European nations, the convergence trade will naturally slow.
“These economies have been driven by outsourcing manufacturing and it’s not clear how sustainable that growth model is, when I think about the next five to 10 years,” says Al-Hussainy. “There’s another wrinkle, which is that these economies are ageing at a dramatic pace.”
There are some potential structural changes that could benefit the region. Some people believe the pandemic could lead to the repatriation of global supply chains — from which CEE would be ideally placed to benefit.
Drimal of SocGen believes the nature of CEE economies will “remain unchanged for many years”, and Bucsa at UniCredit says that the region “remains competitive cost-wise”, meaning its market share in the eurozone has space to increase and change is some way off.
But Kościński is already preparing for the future.
“Covid-19 has not pushed our agenda back,” he says. “Poland needs to keep working on moving from an imitation-based to an innovation-based economy, investing in research and development.
“We are ready to react very quickly to changes in the global economy.”