Growth forecasts for Eastern Europe deteriorated again this month and remained on the downward trajectory that began over a year ago. FocusEconomics Consensus Forecast panelists cut their projections for the region by 0.1 percentage points over last month and now expect GDP to expand 1.4% in 2014, marking the 11th downward revision to the regional outlook in the last 12 months. Once again, deteriorating prospects are mainly due to downward revisions for Russia and Ukraine as the negative economic impact of the political crisis is becoming increasingly evident. In addition, 3 more of the 14 countries surveyed also experienced downward revisions. The forecasts for four countries remained unchanged and the forecasts for five economies, including Turkey, improved. Economists are less upbeat about the prospects for 2015 as well. They cut the regional GDP growth forecast for 2015 by 0.1 percentage points over last month to 2.5%, which marked the seventh cut in a row and mainly reflected deteriorating sentiment for Russia.
Poroshenko, Facing Tough Economic Challenges, Commits to Restoring Peace in Eastern Ukraine
Ukraine experienced the strongest downward adjustment within the region this month. FocusEconomics Consensus Forecast panelists trimmed their GDP forecasts by 0.6 percentage points over last month and now expect the Ukrainian economy to contract by 4.7% this year. Even though the country secured a sizeable international aid package to stave off bankruptcy last month, the economic and political challenges are still daunting. Chocolate tycoon Petro Poroshenko, who won the 25 May presidential elections by a landslide, will first need restore peace in the eastern regions of Donetsk and Luhansk, which are largely controlled by armed pro-Russian separatists. Poroshenko pledged to seek conciliation in talks with the separatists, but the latest military confrontations to gain control over the Donetsk airport left dozens of separatists dead, which makes a peaceful resolution of the conflict with separatists even less likely than a month ago.
Poroshenko’s foreign policy agenda puts closer ties with the West first, yet he also seems eager to restore relations with Russia. Described by analysts as a pragmatist who served in the governments of pro-western Viktor Yushchenko and pro-Russian Viktor Yanukovych, Poroshenko appears to be able to work with both camps. His first test will be the resolution of the long-running conflict over gas prices and Ukraine’s debt to Russia’s state-owned gas company Gazprom. A deal that the European Union recently brokered resulted in an extension of Ukraine’s deadline to pay off its debt to Russia and suggests that a solution is close. Once Poroshenko tackles the challenges of reuniting the regionally-fractured country and mending relations with Russian gas providers, he will need to restore trust in the country’s institutions, which are generally perceived as dysfunctional and fraught with endemic corruption. FocusEconomics Consensus Forecast panelists have become slightly more upbeat about Ukraine’s growth prospects since the elections and have lifted their GDP forecasts for 2015 by 0.2 percentage points to 1.5%.
Russian Economy Contracts in Q1, Growth Outlook Deteriorates
Russia’s conflict with Ukraine and its subsequent rift with the West have eroded optimism regarding the country’s growth outlook. The Russian economy, which was already on the verge of recession prior to the crisis, contracted on a quarter-on-quarter basis in the first three months of the year and is likely to experience yet another sequential decline in the second quarter. On a positive note, the country’s financial markets have calmed over the last few weeks. Capital outflows that had reached alarming levels in the first quarter slowed notably in April and the ruble stabilized in May, encouraging the Central Bank to adopt a less interventionist exchange rate policy. Furthermore, President Putin scored a major political success by signing a 30-year deal to pipe natural gas from Russia to China. The deal, worth around USD 400 billion, will boost the country’s construction industry over the coming years and promises to reduce Russia’s dependence on European energy markets.
Despite these positive developments, economists remain skeptical about Russia’s growth prospects. FocusEconomics Consensus Forecast panelists cut their GDP growth forecasts for this year and next yet again, this time by 0.2 percentage points respectively. They now expect the Russian economy to grow a paltry 0.7% this year. In 2015, the Russian economy is seen experiencing only a mild recovery, with GDP expected to grow 1.7%.
Inflation Rises in Turkey as Central Bank Struggles to Curtail Price Pressures
Meanwhile, panelists turned more optimistic on Turkey, which lifted the 2014 GDP growth forecast a notch to 2.3%. Political uncertainty that has weighed on the economy since the Gezi Park protests began a year ago finally ceded after Prime Minister Recep Tayyip Erdogan scored a conclusive victory in the March elections. The restored political stability pushed business confidence to the highest level in two years in May, which promises a pick-up in business spending. However, inflation continues to rise and the Central Bank’s efforts to curb price pressures are severely undermined by Erdogan’s demands for steeper rate cuts. In May, the Central Bank cautiously embarked on signaling an easing bias by cutting the one-week repo rate from 10.0% to 9.5%. Erdogan classified the moderate rate cut as a “mockery” and urged the Central Bank to adopt more aggressive rate cuts. This puts monetary authorities in a difficult position, as any additional rate cuts over the next months may signal markets that the Bank heeds to political pressure and erode its reputation as an independent policy maker.
Regional Inflation Jumps on Price Increases in Russia, Turkey and Ukraine
Inflation continues to rise in Eastern Europe. Regional inflation jumped from 4.9% in April to 5.3% in May amid faster price increases in Russia, Turkey and Ukraine. Despite mounting inflation, Turkey’s Central Bank cut interest rates—a decision that took the markets by surprise. Hungary’s Central Bank also lowered its policy rate, marking the 22nd consecutive rate cut. All other central banks in the region stayed put last month. While inflation forecasts for 10 of the 14 countries surveyed are declining, the average forecast for the region is rising as it is being driven up by higher inflation projections for Russia, Turkey and Ukraine. On balance, the inflation projection for Eastern Europe moved to 5.2%, up from the 5.0% expected last month. In 2015, inflation is seen falling back to 4.5%.
Note: This is an excerpt from the FocusEconomics Consensus Forecast Eastern Europe – June 2014. Published June 3, 2014. The full report (161 pages, covering 14 major economies in Central and Eastern Europe is available for immediate download at the FocusEconomics Online Store). For more information and a free sample of the report please visit our website.