SEB Predicts Steady Recovery and Divergence for Eastern Europe Economies

This autumn nearly all countries in Eastern (including Central) Europe have begun an economic recovery after growth bottomed out during the second quarter of 2013, consistent with the pattern in Western Europe, reports SEB. However, the Swedish bank predicts that their recovery over the next two years will be modest.

Latvia and Lithuania will continue to grow fastest in the region and in the European Union (EU). The three largest economies will diverge: with relatively strong fundamentals, Poland will regain its starring role after an unexpectedly deep growth slump; Russia, increasingly in need of reforms, has downshifted to slower growth than it enjoyed before the global economic crisis; and a pressed Ukraine will devalue its way out of an acute crisis, writes SEB in the latest issue of its twice-yearly Eastern European Outlook (EEO).

“Russia and Ukraine are facing significant challenges: Russia to raise its long-term growth potential, Ukraine to manage an acute crisis that will emerge this winter. Otherwise, the general economic picture of Eastern Europe is turning brighter,” says Mikael Johansson, head of Eastern European research at SEB and EEO’s chief editor.

“Looking ahead, expansion will benefit from good real wage growth and the fact that the region can now shake off the eurozone crisis, which has hampered growth and created instability in banking systems, especially in the central and southern parts of Eastern Europe.”

In most Eastern European countries, the economic upturn is initially being driven mainly by private consumption, but also by increased exports. Consumption is being strengthened by good real wage growth, much of it due to continued low inflation. Unemployment will gradually continue to fall in the Baltic countries, remain relatively unchanged in Poland and Ukraine and increase slightly in Russia. Exports will be fuelled by gradually higher external demand, especially from Germany.

Capital spending will take time to rebound, due to lingering uncertainty about the growth outlook – internationally and in the region – combined with slowly thawing credit conditions. Mainly in the central and southern parts of Eastern Europe, credit conditions have been abnormally tight so far, due to the euro zone crisis and the relatively large foreign ownership of banks.

Gross domestic product (GDP) forecasts for the six countries that EEO covers are as follows:

  • Russia’s growth will speed up somewhat from 1.7% this year to 3.0% in 2015, although SEB’s forecasts are below consensus, as in the March EEO. Falling oil prices (to US$100/barrel two years from now) will provide less support to growth than earlier. “The economy is already hitting its resource ceiling, and the labour shortage is expected to increase,” says Andreas Johnson, Russia and Ukraine analyst at SEB Economic Research. “Meanwhile it will be difficult to reverse the negative demographic trend; more immigration is probably needed. On the whole, far-reaching reforms will be required in order to boost potential growth to president Vladimir Putin’s target of 5-6%.”
  • Poland is now clearly recuperating from a deep domestic slump and moving towards a solid, broad-based recovery. This year, GDP will increase by 1.5%, in 2014 by 3.1% and in 2015 by 3.5%; the latter is in line with potential growth. SEB’s forecasts remain above consensus. The central bank’s sharp key interest rate cuts are contributing to the recovery; because of low, below-target inflation a rate hike will not occur until late 2014.
  • Ukraine is hard pressed by large current account deficits, a depleted currency reserve and sagging foreign confidence. The hryvnia (UAH) will be devalued by at least 10% early in 2014, while Ukraine will receive a new bail-out loan from the International Monetary Fund (IMF). GDP will fall by 0.8% this year. Despite the devaluation, growth will be a reasonable 2.0% next year and 3.4% in 2015.
  • Estonia’s growth will plunge to 1.3% this year in the wake of falling public investments and sagging exports, partly due to weak growth in neighbouring Finland. A continued downturn in EU funds will lead to a weak capital spending picture, contributing to GDP growth that will reach a modest 2.6% in 2014 and 2.9% in 2015.
  • Latvia will remain the fastest-growing of all the EU countries: 4.0% this year and 4.8% annually in 2014-2015. The economy is again well-balanced after the deep downturn of 2008-2010, but weak capital spending is a source of concern.
  • Lithuania’s GDP will increase by 3.8% this year, 3.5% in 2014 and 4.5% in 2015. After a recent sharp downturn in inflation, it is now more likely than not that Lithuania will be the last of the three Baltic countries to convert to the euro – in 2015, according to the government’s plan.
     

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