Outlook for Eastern Europe Stabilizes amid Improving Prospects for Turkey

Growth forecasts for Eastern Europe remained unchanged this month thus ending the string of seven consecutive downward revisions. The stability reflects a strong lift to Turkey’s growth forecast, which was sufficient to offset further cuts to the growth projections for Russia and Ukraine. On balance, the growth forecast for the region remained at the 1.4% that was expected last month. Along with Turkey, 6 more countries of the 14 surveyed experienced upward revisions. The outlook for one country remained unchanged and the forecasts for six economies, including Russia and Ukraine, deteriorated. Economists are less upbeat about the prospects for 2015 and reduced the regional GDP growth forecast by 0.1 percentage points over last month to 2.4%. This was the eighth cut in a row and mainly reflected deteriorating sentiment for Russia, for which the projections were reduced to less than half the 3.5% that was expected in July of last year.

Growth Forecasts for Turkey Pick Up Following Robust First Quarter

In Turkey, news that Prime Minister Erdogan will run in the presidential elections scheduled for 10 August dominated media headlines. Economists, however, were more focused on the fact that the economy weathered the adverse global setting slightly better than expected and grew by 4.3% annually in the first quarter. The robust reading reflected a stronger contribution from the external sector, which compensated for weaker domestic demand. Developments in the external balances also surprised positively. The current account deficit continued to narrow in April, suggesting that one of the economy’s weak spots is improving. However, the conflict in Iraq, one of Turkey’s most important trade partners, may bring a sudden end to the improving trend in the country’s external balances. Nevertheless, backed by performance that was better than expected in the first quarter, FocusEconomics Consensus Forecast panelists are notably more optimistic regarding Turkey’s growth prospects and lifted their 2014 GDP forecast from the 2.3% that was expected last month to 2.9%. The panel’s GDP growth forecast for 2015 remained unchanged at 3.6%.

Russian Economy Slowing Down as West Threatens to Impose New Sanctions

The improving outlook for Turkey was contrasted by the ongoing crisis in Russia and Ukraine, which is increasingly seen as having a severe downside effect on both countries’ economies. In Russia, the economy contracted 0.4% over the previous quarter in Q1, but still grew 0.9% on a year-on-year basis. The brunt of the crisis’ downside effect on Russia’s economy will not be evident until after the first quarter as the crisis escalated in late February and the West imposed its sanctions in March. That said, the Russian economy seems to have weathered the adverse setting quite well so far: Industrial output expanded 2.8% in May, which was up from the 2.4% recorded in April, and fixed investment, the most important factor behind the weak first quarter GDP showing, also gained traction.

The Ukraine crisis, however, has shown no signs of abating and the threat of additional and potentially more damaging sanctions from the West continues to overshadow the outlook for the Russian economy. Consequently, FocusEconomics Consensus Forecast panelists have continued to trim their growth forecasts for Russia and now see the economy growing a paltry 0.4% in 2014. Moreover, although President Putin signed a USD 400 billion natural gas deal with China in May that promises to spur investment in the year ahead, panelists cut their GDP growth forecast for 2015 by a notch and now expect the Russian economy to expand 1.6% next year.

Ukraine Signs Free Trade Agreement with EU, but Economic Outlook Remains Challenging…

In Ukraine, some positive news emerged in the past month as President Poroshenko signed the free trade agreement with the European Union on 27 June. Former President Yanukovich’s rejection of this deal in November 2013 had triggered violent protests that culminated in his ousting and marked the start of the ongoing standoff with Russia. The treaty will gradually grant Ukrainian exports free access to the EU market, which should help support the economic recovery in the years ahead. For now, however, Ukraine faces a challenging situation. In the first quarter, GDP contracted a relatively modest 1.1% over the same period last year. The government expects the economy to shrink even further in the second quarter as fighting in the country’s eastern parts continues. In the third quarter, the austerity measures—a prerequisite to garner IMF support—will begin adding to the woes and will send the country into an even deeper recession.

… as Fighting in the Eastern Regions Continues

Recent political developments in Ukraine are cause for even more concern than the economic recession. The country is still hovering on the brink of disintegration despite numerous diplomatic efforts and months of negotiations. Heavy fighting resumed in the eastern part of the country after a ten-day ceasefire ended on 1 July. The Ukrainian military regained control of the pro-Russian rebel stronghold of Slovyansk in early July, but the pro-Russian rebels still hold large parts of the Donbas region, Ukraine’s industrial heartland, and are concentrated in Donetsk, the region’s largest city. With no end to the crisis in sight, FocusEconomics Consensus Forecast panelists again cut their GDP growth forecasts for 2014 and now expect the Ukrainian economy to contract 4.9% this year. In 2015, the Ukrainian economy is expected to rebound with a 1.4% expansion.

Inflation Forecasts are Rising amid Rapidly Increasing Price Pressures in Russia and Ukraine

Inflation continues to rise in Eastern Europe. Regional inflation rose from 5.4% in April to 5.6% in May amid faster price increases in Russia, Turkey and Ukraine. In Turkey, price pressures abated in June and inflation dropped notably as pass-through effects from the weaker Turkish lira subsided. Lower inflation and a more benign global liquidity situation prompted Turkey’s Central Bank to cut interest rates yet again. Following a 50 basis point cut in May, the Bank cut its benchmark rate by another 75 basis points in June, which surprised economists who had expected a more moderate 50 basis-point cut. Hungary’s Central Bank also lowered its policy rate, marking the 23rd consecutive rate cut. All of the other central banks in the region stayed put last month. While inflation forecasts are declining for 11 of the 14 countries surveyed, the average forecast for the region is rising as higher inflation projections for Russia and Ukraine are driving it up. On balance, the inflation projection for Eastern Europe reached 5.3%, which was up from the 5.2% expected last month. In 2015, inflation is expected to fall back to 4.6%, which is a tad higher than last month’s projection.

Note: This is an excerpt from the FocusEconomics Consensus Forecast Eastern Europe – July 2014. Published July 8th, 2014. The full report (165 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.

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