31 January 2013

Regional Economic Prospects in EBRD Countries of Operations: January 2013

Annual growth in Central Europe and the Baltics (CEB) has further decelerated as expansion in Poland declined substantially. But the Baltic states all grew by well over one per cent quarter-on-quarter, better than expected for all three countries. And importantly, all CEB countries including recession-stricken Hungary and Slovenia performed somewhat better in the third quarter of last year than a quarter earlier. These small improvements might signal that the negative impact of the eurozone  crisis, at least on some of the most vulnerable countries, is beginning to bottom out as the single currency area is itself showing signs that its recession is also drawing to a close. In contrast, South-eastern Europe (SEE) performed worse than expected, with Romania and Serbia returning to a contraction and Bulgaria slowing down as well. This sub-region remains under continued external pressures from eurozone countries.

The euro area crisis will continue to negatively impact growth in the transition region, but as the eurozone recession bottoms out economic activity in the transition countries that depend on it is likely to stop deteriorating. The  projection assumes a baseline scenario of continued slow and uneven progress towards containment of the eurozone crisis. The policy decisions over the past  months, including the ECB’s readiness to help countries under pressure on the  sovereign debt markets have both reduced the probability of a further substantial deterioration of the crisis and increased the chances that the single currency area may  see a very slow and gradual improvement of its economy in the baseline. Real activity in the eurozone will still continue to suffer in the near term both due to fiscal contraction and credit decline. But renewed stability in the financial and interbank markets as well as recent growth in equity markets together with the ECB’s continued low interest rate policy may slowly start bearing fruit. It could mean that the eurozone recession has started to bottom out and that the negative impact of the crisis on the transition region will decrease in magnitude both through the export and the cross border lending channels.

In the baseline scenario, countries that are the most integrated with the euro  area will continue to see weak growth. While feeble demand and potentially growth in the eurozone may not translate into further substantial decreases in exports from CEB and SEE countries, neither will it spur export growth in 2013.

A possible further deterioration of the eurozone crisis still poses the largest downside risk to the outlook. Any worsening beyond the baseline assumptions could have serious negative consequences for growth across the entire transition region. In a downside external scenario – largely unchanged since October 2011, though at this point substantially less likely – the eurozone troubles become much worse before they are ultimately resolved. In this scenario, the crisis would spread to larger single currency area members, which in turn renders several large European banks insolvent.

Major parent banks would accelerate deleveraging in the region, triggering a credit crunch and recession in emerging Europe. This scenario implies prolonged market  turmoil and a severe western European recession with swift negative spill-overs for the global economy, resulting in lower growth in advanced and emerging economies and lower commodity prices. A negative eurozone crisis scenario would affect CEB and SEE countries via the same channels as in the baseline, including depressed exports and financing inflows, only more severely.

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