UniCredit Economics & FI/FX Research:
CEE countries must work upon economic convergence
- EMU may well have reached a turning point, as real economies are adjusting and the ECB has delivered a credible 'firewall'
- More concern about increasing uncertainty on the pace of global growth, generated by signs of a slowdown in Germany and emerging markets globally
- CEE countries are struggling with weaker external demand and uncertain consumers, whereas in most cases fiscal policy is under control
- Labour productivity, costs and competitiveness of CEE region give reason for optimism
The past couple of quarters unmistakably reminded CEE countries of the fact, that the post-crisis growth path is neither smooth nor guaranteed. Trade and financial linkages with the EMU act as a drag and though this should improve from here, the path will at best be gradual. That is one of the key findings from the current issue of "CEE Quarterly" published by UniCredit´s Economics & FI/FX Research. As the concerns of UniCredit researchers towards the EMU crisis are easing, they take down their regional GDP forecast for CEE in 2012 and 2013 by 0.1 and 0.3 percentage points to 2.5 and 3.1 percent respectively due to an increasing uncertainty on the pace of global growth and weaker CEE data in recent months. Nevertheless there are numerous reasons in terms of regional labour productivity, costs and competitiveness to be optimistic.
Though a period of multi-year adjustment remains ahead, the Euro Area has achieved a considerable amount in terms of structural reform over the past two years, much of which is now being captured in the closure of current account balances in periphery economies. The ECB has already provided a large amount of liquidity to smooth this adjustment in the face of rapid portfolio outflows from periphery economies but on 6 September it detailed a more ambitious plan, which has more chances to remove tail risk from sovereign bond markets than its previous interventions via the Securities Markets Programme.
Increasing uncertainty can be seen on the pace of global growth, generated by signs of a slowdown in Germany and emerging markets globally. Within CEE the slowdown in growth, and in some cases recession, represents the primary concern for policy makers at this stage. "The total of all these factors has prompted us to reduce our growth forecast for EMU for this year and next in order to reflect a more gradual recovery in economic activity," states Gillian Edgeworth, chief EEMEA economist at UniCredit, "We have reduced 2012 and 2013 by 0.1 and 0.3 percentage points to minus 0.5 and plus 0.3 percent respectively. We expect the fourth quarter of this year to represent the bottom in the cycle, with GDP on a quarter-on-quarter basis to show gradual recovery throughout next year. For the US we forecast growth at 2.1 and 2.3 percent respectively." Although the past four quarters will represent the period with the lowest growth rates in the CEE region in a decade, it is going to significantly outperform EMU 2012 and 2013 by GDP gains of plus 2.1 and plus 3.5 percent respectively.
Manufacturing and portfolio inflows
Industry is also suffering from weaker external demand. This is in sharp contrast to 2011, when industry provided a key aid to overall GDP gains. July industrial production data showed some modest improvement but the sustainability of this remains in question. The August manufacturing PMI data remained weak, while global forecasts suggest that such a recovery will begin to materialize gradually in 2013. In many cases this weakness in industry comes along with a weak consumer, reflecting a combination of poor sentiment, weak labour markets and sluggish credit extension. Weak labour markets are a key contributor to weak consumption trends as the consumer is constrained by a combination of higher inflation and weak nominal wage growth. And without a convincing recovery in external demand, employment and wage prospects remain uncertain, with smaller countries more vulnerable than larger economies.
The positive news is that the region continues to enjoy strong portfolio inflows. This is part of a broader global emerging markets trend, much of which should be structural in nature. Emerging markets fund flows saw a cumulative inflow of USD 20bn over the 5 years to 2008, almost USD 80bn since 2009. CEE data for the first three months 2012 shows that in total capital flows to the region were negative but portfolio inflows stood at EUR14.7bn, equivalent to total inflows in 2011. For those countries with data available for the second quarter, flows remained positive but not as strong as in the first quarter.
The lacklustre growth environment means that countries are entering budget season facing GDP growth rates below what they planned this time last year. Year-to-date in a number of countries has been limited with the deterioration in fiscal positions, despite growth often coming in below what countries had originally hoped for. Even weak growth performers like Croatia and Czech Republic have managed to narrow their budget deficits. Public debt to GDP stood at 46 percent end last year in CEE ex-CIS and at 13 percent of GDP in CIS. In terms of scope to use fiscal policy to aid activity from here, this is largest in Russia and Kazakhstan, followed by Turkey, Czech Republic and Poland. There is some evidence already emerging of countries pushing out fiscal consolidation plans. Unfortunately for many of the weaker credits in the region, this sort of counter cyclical fiscal policy is not possible. Hungary, Ukraine, Serbia, Croatia and Slovenia must continue to tighten.
Global growth remains an opportunity for CEE countries
It is not only governments but central banks that are keen to aid the downturn but this is complicated by persistent inflation pressures. Particularly striking is the fact that despite such a sluggish period of growth, inflation is above target in the region with the exception of Romania. At this stage growth takes priority but inflation has delayed easing over recent months. However, there are numerous reasons for optimism. "CEE countries must act to maximise their ability to take advantage of improvements in global growth", says Gianni Franco Papa, Head of the CEE Division at UniCredit, "In terms of labour productivity, costs and competitiveness, there are plenty of bright spots in the region." Although amongst those CEE economies in the EU the rate of growth of labour productivity has slowed since the crisis, in the vast majority of cases it still continues to significantly outstrip Germany. Meanwhile labour costs remain competitive, though Slovenia remains an exception. In this environment, just as is needed in EMU, CEE countries must continue to act to maximise their chances of sustainable medium to long term growth, even if this materialises at rates well below those experienced pre-fourth quarter 2008.
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