Recovery in emerging Europe

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With the recovery in the Eurozone now more firmly established, and growth over 1% expected by the end of 2014, emerging Europe is set to benefit. 

GDP growth in central and eastern Europe has closely aligned with the Eurozone since the 2008-09 financial crisis. Recovering economic activity in the Eurozone should therefore aid growth in central and eastern Europe countries. 

The support will come via two main channels: 

  1. Rising demand for exports

The Eurozone is the main export market for central and eastern Europe countries. It accounts for the majority of exports from Poland (53%) and the Czech Republic (63%). The importance of the Eurozone market means that its recovery should translate into higher demand for exports from central and eastern Europe countries. 

Rising demand for exports will boost GDP growth directly. It will also have an indirect effect as exporters increase their demand for labor, investment goods and production inputs. 

  1. Improved banking flows

Firms will need good access to funding to take advantage of the opportunities offered by rising demand in the Eurozone. The health of the banking sector is also an important determinant of growth. 

Banks in the central and eastern Europe are mostly foreign-owned, with the majority of parent banks located in the Eurozone. This could become a significant constraint on growth. 

Eurozone banks in general are still restructuring their balance sheets in the wake of the financial crisis. As a result, parent banks may not be able to accommodate the necessary expansion in their subsidiaries. They might also shift funds to their home markets, using them to increase their capital. 

Czech Republic should reap the benefits of a Eurozone recovery 

Our analysis suggests that the Czech Republic could gain the most from a Eurozone recovery. Its banking sector is among the strongest and the economy is in a good position to benefit from a recovery in Eurozone demand.

However, other factors offset the gains. Possible tensions within the newly formed governing coalition might prolong political uncertainty, holding back business confidence and growth. 

Stronger exports will stimulate domestic demand as firms expand capacity and increase their demand for labor. This will help the economy to grow annually by around 3% from 2015 to 2017. 

Outlook for the other central and eastern European countries 

Poland benefits from well-anchored inflation expectations and easier monetary policy. Rising exports should boost growth, with an expansion of 2.8% in 2014. A sustained period of low inflation is likely to support a rise in household real incomes and, therefore, consumption. 

Low investment will hold back short-term growth in Bulgaria, resulting from significant spare capacity in the residential construction sector. We forecast annual investment growth of around 7% in 2014-17, supported by FDI and rising capacity utilization. 

In the near term, rising real wages will hamper Romania’s growth, eroding its competitiveness. From 2015-17, we expect growth to recover to around 3%, supported by firmer intra-European trade and stronger investment into industry and infrastructure. 

Hungary is likely to see some of the positive effects of rising foreign demand mitigated by a weak banking system. In addition, sluggish investment in the aftermath of the global financial crisis has left it with an eroded capital stock, which will hold back growth. 

We forecast a return to growth in Ukraine in 2014. Exports to European countries will lead the recovery. Industrial sales to the EU and Russia are on course to improve in 2014-15, as metal and chemical demand picks up gradually.