Eastern Europe: Renewed Domestic Demand but Moderate GDP Growth

The export-led recovery of the past year in eastern Europe – which in many places has been stronger than in western Europe – is continuing, according to SEB’s report, ‘Eastern European Outlook’. But the export-oriented manufacturing upturn is now entering a more mature phase, due to decelerating global growth.

Meanwhile domestic demand is awakening, thanks to the resumption of real wage growth, stabilising labour markets and a gradual thaw in still-inhospitable credit conditions. Eastern Europe was the region of the world that was hardest hit by the global credit crisis, mainly due to its relatively large foreign loans. Overall gross domestic product (GDP) growth will continue at a moderate pace in most of the region during 2011-2012.

A special theme article discusses the internal devaluations in the three Baltic countries. Its conclusions are that the wage-cutting process has now largely ended and that the Baltics is recapturing export market shares.

“Despite increased global economic risks, mainly via the US, we continue to have a relatively optimistic fundamental view of eastern Europe. Our GDP forecasts are relatively unchanged since the last ‘Eastern European Outlook’ in March and remain above consensus. Eastern European exports generally appear to be competitive, which is evident because these countries are gaining market shares. In addition, their trade with the US is very small,” said Mikael Johansson, head of central and eastern Europe (CEE) Research at SEB and chief editor of ‘Eastern European Outlook’.

Economic growth in the six countries covered in the report will not, however, return to its previous high rates – which led to severe imbalances – but will instead barely reach its potential level. The report points out structural obstacles to growth, such as sizeable labour market and emigration problems in all three Baltic countries and a slow pace of reform in Russia. In addition, there will be fiscal tightening in Poland and Ukraine and, over time, in Russia as well. In the Baltics, Latvia will stick to fiscal austerity.

“Russia will enjoy decent growth, sustained by high commodity prices and in the short term also by continued expansionary fiscal policies. Consumption has started to rebound this year and will be an increasingly important economic engine. Meanwhile, Russia ought to be capable of achieving higher GDP growth than around 5%. Reform efforts are moving sluggishly, and more would need to be done in education and in the judicial and transport systems, for example,” said Andreas Johnson, Russia and Ukraine analyst at SEB Economic Research.

The new Eastern European Outlook forecasts in brief:

• Russia’s GDP, after rising 4.6% this year, will grow by 4.5% in 2011 and 4.8% in 2012, sustained by continued high but stabilising commodity prices.
• Poland’s economic growth will be increasingly driven by capital spending and will speed up from 3.5% this year to 4.0% in 2011 and 4.5% in 2012.
• Ukraine’s growth, a solid 5.2% this year, will diverge from the pattern in other countries by slowing down a bit to 4.4% in 2011 and 4.2% in 2012, in the wake of austerity measures and reforms required by its lender, the International Monetary Fund (IMF).
• Estonia’s GDP will climb by 2.3% this year and after that by 4.0% annually, but its eurozone accession in 2011 may lead to higher growth via more foreign direct investments. The government will ease its tight fiscal policy next year.
• Lithuania’s economic growth will end up at 1.0% in 2010, accelerating to 4.0% in 2011 and 4.5% in 2012. Fiscal policy will become more neutral after tough belt-tightening.
• Latvia, which is lagging behind Estonia and Lithuania in its recovery and will post a further average GDP decline of 1.5% in 2010, will return to positive year-on-year growth this autumn. GDP will rise 4% in 2011 and 5% in 2012, despite continued relatively tough budget consolidation after the October parliamentary election.

Inflation is now gradually rising from historically low levels in Russia and Ukraine. The Baltics will see a resumption of moderate inflation after earlier deflation pressure. Budget deficits are high but will shrink steadily. Public debt will continue climbing somewhat but is moderate or low compared to western countries. For example, all six governments will end up below the Maastricht debt criterion for the eurozone: no higher than 60% of GDP.

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