Eastern European Outlook: Growth Will Slow - But Not as Sharply as in the West

Eastern (including central) Europe has recovered nicely since the financial crisis and deep recession of 2008-2009. Economic growth is now on its way towards slowing in 2012, in response to weaker global demand, but will not decelerate as quickly as in western Europe. Given relatively low or moderate public sector debts, domestic demand will be fairly resilient, according to SEB in its October 2011 issue of Eastern European Outlook.

Because of more favourable public debt positions, large budget deficits in eastern Europe need not be corrected as sharply and quickly as in parts of western Europe. Poland, Latvia and Ukraine will continue to pursue moderate fiscal austerity next year, while fiscal policy will shift to mildly expansionary in Russia, Estonia and Lithuania. This will help sustain consumption and capital spending relatively well now that export growth is falling markedly. Whereas labour market improvements will encounter obstacles next year, purchasing power will meanwhile strengthen as the energy and food price-driven inflation upturn of the past year fades.

The ambitions of EU countries in eastern Europe to adopt the euro have cooled because of the euro zone debt crisis.

“Partly due to the worsening euro zone debt crisis and the risks of a Greek default, EU member countries in Eastern Europe will probably hold off on converting to the euro. It is unclear in what direction the eurozone is headed, and weaker growth in eastern Europe could make it more difficult to meet the budget deficit criterion for eurozone accession. Latvia is the region’s only euro zone candidate in the near future, and its planned accession in 2014 may still be on track,” said Mikael Johansson, head of eastern European research and chief editor of Eastern European Outlook.

Some eastern European currencies, including the Russian rouble and the Polish zloty, have been squeezed hard during the current global financial crisis. The main reason is general risk aversion, which has hit eastern Europe in particular; confidence in the solvency of these countries has remained relatively stable, with the exception of Ukraine. Their currencies will decline somewhat further in the coming months, followed by stabilisation and gradual appreciation. Total depreciation will not be as large as in the 2008-2009 financial crisis.

In all six countries covered by Eastern European Outlook, GDP growth will drop somewhat below trend in 2012-2013; in 2013 it will level out or bounce back a bit. The risks are skewed to the downside:

• Russia’s GDP will increase by 4.3 % in 2011 and 4.2 per cent in 2012. The economy will continue to be sustained by high oil prices and consumption will rebound after a dip. “We are still relatively optimistic about Russia’s growth in the short and medium term, but long term question marks remain since the pace of reform is slow. There may be some opening for more reforms after the coming parliamentary and presidential elections, when the rhetorically reform-friendly Dmitry Medvedev is expected to take over as prime minister,” said Daniel Bergvall, Russia and Ukraine analyst at SEB economic research.
• Poland’s economy will be increasingly driven by capital spending, but growth will cool from 4.0% this year to 3.4% in 2012, mainly due to slowing German demand. Monetary policy will shift, with two key interest rate cuts in the first half of 2012. Policies will remain generally stable, since we expect the government to be re-elected on 9 October 2011.
• Ukraine will muddle through, with annual GDP increases of some 4%. High steel and agricultural prices will provide support, but austerity requirements from the country’s lender, the IMF, will restrain growth. Relations with the IMF will be stormy, and loan disbursements will stay frozen this autumn before an agreement is reached.
• Estonia will see its growth see-saw from 2.3% last year to 6.5% in 2011 and 3.0% in 2012. As in the other Baltics, recovery has mainly been export-led so far while the upturn in domestic demand has barely begun, partly because private sector debt consolidation is continuing after the bursting of earlier bubbles. With its high export/GDP ratio, Estonia will be relatively harder hit than Latvia and Lithuania.
• Lithuania’s GDP will increase by 6.5% this year and 4.0% in 2012. Consumption and capital spending have shown signs of faster recovery than elsewhere in the Baltics but are not strong enough to offset weaker exports.
• Latvia still lags behind Estonia and Lithuania in its upturn. Growth will slow from 4.4% this year to 3.5% in 2012. The recovery is on reasonably firm ground but will also be restrained in 2012 by budget tightening aimed at paving the way for eurozone accession in 2014.

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