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In Central Europe, 5-year government bond yields have broadly toned down since the last peak observed in 2022, amidst acute geopolitical uncertainties.
Poland’s economy has generally shown resilience during periods of turbulence since the financial crisis of 2008-2009. For instance, in 2009, the country was able to avoid a recession in contrast to neighbouring countries. Since 2020, successive shocks have constrained GDP growth momentum, but strong fiscal buffers enabled the authorities to implement generous supportive measures. The country remains amongst the best performing economies in the region in the early months of 2024, with its GDP above 11% in Q12024 compared to its pre-COVID levels. Overall, the country reinforced its position in Europe, judging from the increase of Poland’s economic weight in the EU (measured by GDP in purchasing power parity) and gains in market share
The accession of several Central and Eastern European countries to the EU in 2004 has been accompanied by impressive growth in their respective economies. Improvements in labour productivity have enabled real wages to catch up over the last twenty years, but wage pressures have remained very strong over the recent period without, however, affecting the economies' competitiveness to date. The region also remains attractive for foreign direct investment and continues to benefit from nearshoring activities. In the short term, consolidating public accounts is a priority to comply with commitments under the Stability and Growth Pact. Some countries are already under EU's surveillance, with the opening of an excessive deficit procedure.
Economic growth prospects are improving for 2024, but the recovery is likely to be limited by still sluggish domestic demand. On the foreign exchange market, the Hungarian forint has come under downward pressure recently. On public accounts, the fiscal consolidation that began in the summer of 2022 has not significantly reduced the deficit. For 2024, the deficit will probably be less pronounced than last year, but will remain high in any case (around 5% of GDP). As a result, Hungary will probably be subject to an excessive deficit procedure in 2024
In the first quarter, economic growth in Central European countries improved as expected (Poland: +0.4% q/q in Q1 2024; Hungary: +0.8% q/q; Czech Republic: +0.5% q/q; Slovakia: +0.7% q/q; Romania: +0.5%). Although details of the accounts are not yet available, there is strong evidence that growth was primarily driven by consumption, as reflected by the boost in retail sales.
Romania recorded a softer economic growth in 2O23 but remained one of the best performing economies in the region. The short-term outlook is strong. The gradual fall in inflation since the end of 2022 should pave the way for an accommodative but cautious monetary policy. The persistence of twin deficits remains a major concern. So far, the country has been able to rely on a certain resilience in capital flows to partly offset the current account deficit. Fiscal consolidation is one of the government's short-term priorities, although there is limited room for manoeuvre this year given the busy electoral calendar. Public debt is sustainable in the short and medium term.
After an expected recession in 2023, better growth prospects lie ahead in 2024. Economic activity is expected to be driven by both an improvement in domestic demand and a slight rebound in growth in the Eurozone. The monetary easing cycle initiated at the end of 2023 should continue, albeit cautiously, due to the persistence of strong wage pressure. External accounts remain strong, with foreign exchange reserves having increased for several years. Hungary is expected to post a current account surplus in 2023, after a deficit of -8.2% of GDP in 2022. As to public accounts, the budget deficit has continued to deteriorate, and is expected to exceed 5% of GDP in 2023. Like many European countries, Hungary may face an excessive deficit procedure in 2024.
In Central Europe, national accounts for the third quarter were published earlier this week. Hungary has exited recession after 4 quarters of negative growth. Poland continues to experience erratic growth with a rebound this time. However, other Central European countries saw a slowdown in economic activity. Romania is no exception. Q3 GDP growth came in at 0.4% quarter on quarter after 0.9% in Q2. Romania’s economy should overall show resilience this year while some countries such as Hungary and Czech Republic may post a negative GDP growth in 2023.
In Central Europe, capital flows (foreign direct investments, portfolio flows and bank lending flows) have resisted rather well despite geopolitical uncertainties. Similarly, they do not seem to be affected, for the time being, by the weakening of economic activity in the region.
The current government is running for a third term in the general elections on 15th October. Whatever the outcome, the future government will face three major economic challenges: a marked slowdown in growth, a deterioration in budget deficit and an increase in credit risk. However, this increase in risk is not a real cause for concern. There are safeguards against rising public debt. The country also has comfortable external liquidity and the banking sector is strong. The decline in inflation has facilitated the shift in gear in monetary policy, but this seems premature given strong pressure on wages.
Economic activity has weakened significantly in the last three quarters. In Q1 2023, GDP contraction was largely attributed to the drop in domestic demand. For 2023, the scenario of a weak recession seems to be emerging, due to a strong negative carry-over effect. Moreover, prospects for a recovery are weak in the short term, as inflation remains very high and the real estate market is showing signs of weakness. In 2022, budget and current account deficits increased due to the energy shock. However, debt ratios (public and external) worsened slightly. In 2023, external accounts are expected to improve thanks to the easing of commodity and energy prices.
Very dynamic to date, economic growth is now expected to weaken, and the authorities will face several challenges in 2023. Consolidation of public accounts is a priority in the short term, failing which, Romania could be subject to further disciplinary measures by the European Union. Inflation remains high although it has fallen since the end of 2022, which should encourage monetary authorities to favour a status quo. The current account deficit widened to nearly 10% of GDP in 2022, but should ease in the short term due to the drop in energy prices. Despite the size of current account and budget deficits, Romania continues to attract foreign capital flows.
Earlier this week, Hungary published its GDP data for the first quarter. It fell by 0.2 % compared with the previous quarter after -0.6% in Q4 and -0.8% in Q3. This is not a major surprise given that high frequency indicators such as retail sales and industrial production were already pointing to a weakening in economic activity. Elsewhere, in the region, GDP growth was also soft though we observe a better performance in Czech Republic Romania and Poland. The Hungarian economy is experiencing numerous challenges while some positive developments provide some relief.
Despite the war in Ukraine, Poland’s economic growth was relatively solid in 2022. However, it was erratic with a sharp GDP contraction in Q2 and Q4. For 2023, despite a negative carry-over effect, recession will probably be avoided due to continuous fiscal support. Inflationary pressures remain high in the short term due to wage pressures and the return of the VAT rate on energy to its initial rate. The temporary blocking of European funds since 2022 might, at first glance, raise concerns against a backdrop in which public and external accounts have worsened. However, the inflow of foreign direct investment is a notable shock absorber. In 2022, these flows more than offset the current account deficit.
Economic activity weakened in the third quarter. The outlook remains gloomy in the short term. Last September, the central bank ended its monetary tightening cycle in the face of downside risks to growth. This policy is currently not very consistent with the trajectory of inflation. Meanwhile, fiscal policy was tightened in the second half of the year due to the marked deterioration in budget deficit. The EU’s freezing of funds in 2022, depriving the Hungarian authorities of a source of income, has probably weighed on their decision. While this recalibration limits support for growth, it strengthens the credibility of Hungary’s fiscal policy.
GDP growth was resilient in the first three quarters of 2022 but is expected to slow down significantly in 2023. Inflation will be a key feature to monitor as price stability is one of the economic convergence criteria for Bulgaria’s future entry into the Eurozone in 2024. Another point of concern is that the political scene continues to be subject to uncertainty given the many changes in the government over the past 20 months. Investment has suffered as a result of this situation. However, the commitment of the authorities towards reforms does not appear to have been affected.
For several years, Romania has been running a structural current account deficit. This year, the deficit is expected to worsen and could come close to 10% of GDP after -7.3% in 2021. The deficit had already reached EUR 20.2 billion over the first nine months of the year, well above the figure seen for 2021 as a whole. Romania's deficit is the largest amongst Central European countries. The main reason stems from the deterioration in the energy trade balance, which according to the latest figures reached EUR -4.5 billion for the January-July period. Imports of food and industrial goods have also contributed, but to a lesser degree compared to energy. By contrast, imports of consumer durables have remained soft. Exports were still relatively dynamic (up by a year-on-year rate of 26
The economic slowdown is likely to continue in the coming quarters. Poland is facing several challenges. Firstly, the country is highly dependent on coal imports, and the price of this commodity has soared since the end of 2021. The Central Bank has moved towards a less restrictive monetary policy despite high inflationary pressures. Finally, the moratorium on mortgage repayments in 2022 and 2023 will have a negative impact on banks’ balance sheets in the short term. However, the Polish economy does have numerous strengths and should show resilience.
All growth drivers weakened in the second quarter of 2022. With a high exposure to Russia for its oil and gas supplies, Slovakia could be amongst the most affected Central European countries by the consequences of the war in Ukraine. The steep rise in energy costs, as well as supply disruptions, will have an adverse impact on industrial activity, which has not yet returned to its pre-Covid level. Moreover, inflation has increased rapidly but is still more moderate compared to other countries in the region. Finally, public and external accounts will deteriorate in the short term, but this situation remains manageable.
Economic growth remained very dynamic until the first quarter of this year. Strong wages growth and significant government measures to back up purchasing power over this period have supported consumer spending. Inflation rose sharply in recent months but remained lower compared to other Central European countries, due to a price cap on certain food and energy related goods. Economic growth is expected to slow down significantly in 2023, owing to the deterioration in the international environment, monetary and fiscal tightening from H2 2022. The temporary suspension of European funds presents a serious challenge given that budget and current account deficits have increased and external liquidity has eroded.
The last two quarters have been marked by slower growth in economic activity. This is mainly attributed to weaker levels of consumer spending. Furthermore, the country is still very exposed to supply chain disruptions in the automotive sector to a great extent, which adversely impacts both industrial activity and exports. The expected slowdown in the global economy in 2022 will also affect growth given the country’s high exposure to trade. Inflation has probably not yet peaked, which means that monetary tightening is likely to continue in the short term.
Over the past few weeks, Central Europe has experienced a spike in Government bond yields. Five-year yields have surged respectively by 338 bp in Poland, 331 bp in Hungary, 350 bp in Romania and 216 bp in Czech Republic since January 2022 and are at present similar to 2008 levels. The trend is also the same for 10-year yields. The recent move can be explained to some extent by markets’ overreaction as regards to the relatively high exposure of Central European countries to Russia in terms of exports and energy supply. Moreover, their geographical proximity with Ukraine and Russia have contributed to markets’ perception of higher geopolitical risk. In the meantime, monetary policy tightening, a consequence of higher inflationary pressures (respectively +16
