Economic outlook for New Europe: Robust growth will continue in 2005/2006

  • Investments support strong growth
  • Cautious budget policy limits growth but supports decline in inflation
  • Current account deficit remains stable at about 4.5 per cent of GDP
  • Declining trade deficits, rising deficits on income account

Economic growth in 2004 supported by lively investment activity
While consumption was the mainstay of economic growth in most countries in the region in 2003, a significant change occurred in 2004. Fixed investment accounted for about one half of the rate of economic growth in 2004, which reached almost 5 per cent in the NMS81  and more than 6.5 per cent in the candidate countries (CC3)2 . A similar development is expected for 2005/2006. Bank Austria Creditanstalt anticipates a U-shaped economic trend in Central and Eastern Europe: in 2005, GDP will fall slightly, to 4.3 per cent in the new EU member states and 4.8 per cent in the candidate countries; in 2006, growth will rise to 4.5 per cent and 5.6 per cent, respectively.

2005/2006 will be marked by strong investment growth and cautious fiscal policy
In the coming years, investments – though a much less significant factor than private consumption – will make as large a contribution to economic growth as private consumption. This development will be supported by low interest rate levels and the favourable business outlook in connection with EU membership. Bank Austria Creditanstalt proceeds from the assumption that investment growth in the eight new member states will accelerate to an average of 8 per cent or more in 2005/2006. "Poland will see particularly strong growth," says Marianne Kager, Chief Economist of Bank Austria Creditanstalt. In South-East Europe, investment growth will continue to reach a double-digit figure.
On the other hand, the growth of private consumption, which was the main factor driving economic growth in most countries in the region in the past few years, will slow down as a result of the moderate reduction of budget deficits to 4.3 per cent of GDP in 2005 and 3.7 per cent in 2006. In view of plans to join the euro area, the countries may be expected to pursue the relatively cautious fiscal policy which led to a reduction of the public sector deficit in the new member states to an average of 4.8 per cent of GDP in 2004 (2003: 5.7 per cent of GDP).

More restrictive fiscal policy will support price stability
The cautious fiscal policy will support a further decline in inflation. The increase in consumer prices, which reached an average of just over 4 per cent in 2004, will fall to 3.5 per cent in 2005 and 3 per cent in 2006, against the background of a more favourable external price environment compared with the previous year and the continued strength of local currencies. Despite impressive progress made by Romania in reducing inflation, the average rate of inflation in the three candidate countries will be significantly higher, reaching 6.6 per cent in 2005 and 5.2 per cent in 2006.

Current account deficit will remain stable, trade deficit will fall
Overall, the current account deficit of the NMS8 will remain at an average of about 4.5 per cent of GDP in 2005/2006. However, structural shifts in the components of the current account will continue. Since the opening of CEE started, the trade balance – the largest component by volume – had the strongest influence on current account trends. An increase in the trade deficit was always accompanied by an increase in the current account deficit and vice versa. The deficit on visible trade regularly exceeded the amount of the current account deficit. 

"These traditional relationships have shifted over the past two years: in both 2003 and 2004, the current account deficit in the new EU member states was higher than the trade deficit," says Marianne Kager. Moreover, the current account deficit increased, while the deficit on visible trade fell to an estimated 3.5 per cent of GDP, thus more than halving compared with the peak figure at the end of the 1990s (1999: 7.6 per cent of GDP).

Successful exports
Substantial inflows of foreign direct investment estimated at EUR 160 billion from 1990 to the present day have made a significant contribution to establishing a competitive export industry. This has reduced the chronic trade deficits in many countries. Over the past ten years, euro exports of the new member states have more than tripled, growing by an annual average of 14 per cent. Hungary and Estonia have recorded the strongest export growth, while Slovenia is lagging behind other countries in the region. Nevertheless, Slovenia's exports doubled between 1995 and 2004.

Strong export growth led to substantial market share gains in the "old" EU-15 countries. The new EU member states and the candidate countries account for 13.5 per cent of total imports of the EU-15 countries (excluding intra-EU trade), up from 8 per cent in 1995. During the same period, the US and Japan experienced significant market share losses. Those countries which recorded the largest inflows of foreign direct investment achieved the largest market share gains.

The other side of the coin is that profits of foreign companies bear on the income account, resulting in a strong increase in the deficit registered in this component of the current account over the past years. From just under 1.5 per cent of GDP in 1995, the deficit doubled to more than 3 per cent of GDP in 2004. However, a large part of the profits is invested in the countries, giving fresh impetus to economic growth in the long term."

"Current account deficits in Central and Eastern Europe are still high, despite the structural changes in their composition. This will remain a characteristic feature of the strongly growing economies in the region for the foreseeable future. In this respect, however, the focus is shifting from the new EU member states to the countries in South-East Europe," says BA-CA's Chief Economist Marianne Kager. In the three candidate countries in South-East Europe, the current account deficit in 2004 averaged an estimated 6.2 per cent of GDP. This figure is expected to rise to 6.8 per cent of GDP by 2006.

1 NMS8 (New Member States) = Hungary, Slovenia, Slovakia, Czech Republic, Poland,
Estonia, Latvia, Lithuania

2 Candidate countries (CC3) = Croatia, Romania, Bulgaria

Enquiries: Bank Austria Creditanstalt International Press Relations
Edith Holzer, tel. +43 (0)50505 57126
e-mail: edith.holzer@ba-ca.com