Outlook for Eastern Europe Improves amid Upbeat Forecasts for Turkey, but Russia and Ukraine Remain a Drag on the Region’s Prospects

Growth forecasts for Eastern Europe improved this month. The upward revision marks the first improvement in over a year and mostly reflects a lift to Turkey’s growth forecast, which was more than sufficient to offset further cuts to the growth projections for Ukraine. Thus, the growth forecast for the region inched up from the 1.4% expected last month to 1.5% this month. Along with Turkey, three additional countries out of the fourteen surveyed experienced upward revisions. The outlook for six countries, including Russia, remained unchanged, and the forecasts for four economies deteriorated. The growth prospects for 2015 stabilized at 2.4%, thus ending the streak of eight consecutive downward revisions.

US. and EU Step Up Sanctions on Russia to Include Energy Sector

Pressure on Russia mounted significantly when the West imposed a new round of sanctions at the end of July. The new sanctions that for the first time include Russia’s energy sector, will exert additional pressure on the Russian economy, which is already in the doldrums. EU leaders had long been reluctant to heed calls from the U.S. for stronger sanctions, fearing that Russian retaliation would derail the fragile economic recovery underway in Europe. However, following the downing of Malaysian Airlines flight MH17 that was allegedly carried out by pro-Russian separatists in mid-July, European leaders were under pressure to step up measures that would oblige Moscow to end its support for the separatists.

The new sanctions target Russia’s financial, energy and defense sectors and represent a major step up in European pressure on Moscow, but they do not include exports to the Russian gas industry since many European countries are dependent on Russian gas. Nevertheless, the new measures mark a sea change in European policy as they depart from the largely symbolic measures that followed Russia’s annexation of the Crimean Peninsula and show that European leaders are willing to accept the potential cost to their own economies.

Putin Reluctant to Give In to Western Pressure, Approval Rating at Record High

The duration of the current—and possibly additional—sanctions largely depends on Moscow’s reaction. Russian Foreign Minister Sergei Lavrov claimed that his country would not impose tit-for-tat measures, but at the same time he said that the sanctions would, “inevitably lead to an increase in prices on the European energy market.” Moreover, while officially unrelated to the Western sanctions, Russian authorities banned the import of almost all fruit and vegetables from Poland and indicated that these restrictions could soon be extended to the rest of the EU.

So far President Putin seems reluctant to yield to Western pressure and withdraw his support for the separatists. In fact, Putin’s previous support of separatist movements and the annexation of Crimea seem to have bolstered his popularity at home. According to a mid-July Gallup poll, Putin’s approval rating rose to 83%, 30 percentage points higher than two years ago and a record high for Putin. Public opinion, which broadly supports the separatists in eastern Ukraine, also makes any concessions to Western demands difficult. Therefore, a quick resolution of the Ukraine crisis is highly unlikely and the geopolitical uncertainty that has characterized the region for more than half a year is likely to persist. Nevertheless, the outlook for Russia stabilized this month as the latest data suggest that domestic economic activity held up well against the headwinds. Following continuous downward adjustments to Russia’s outlook in the previous months, FocusEconomics Consensus Forecast panelists have not applied new cuts to the growth forecasts for 2014 and continue to see GDP growing a moderate but positive 0.4% this year. The growth forecast for 2015 also remained unchanged over the previous month at 1.6%.

Ukraine Averts Political Crisis, but Economic Situation Remains Grim

In Ukraine, the frail political stability was tested again this month when Prime Minister Arseniy Yatseniuk presented his resignation to the parliament on 24 July. Yatseniuk tendered his resignation after two parties left the governing coalition and parliament failed to pass laws to fund Ukraine’s war against pro-Russian separatists. However, backed by support from President Petro Poroshenko, parliament finally passed Yatseniuk’s bills, which are also vital to fulfilling Ukraine’s obligations with the International Monetary Fund. Subsequently, the parliament voted not to accept the resignation of Yatseniuk, who will thus remain prime minister.

While the country avoided a protracted political crisis, the economic situation remains dire. In the second quarter, the economy contracted by 4.7% over the same period last year, according to preliminary estimates from Ukraine’s statistical office. Moreover, as long as the military conflict continues in the east of the country, it is unlikely that economic activity will pick up again. Therefore, FocusEconomics Consensus Forecast panelists cut their GDP forecasts for 2014 again and now see the economy contracting 5.1%, which is down 0.2 percentage points over the previous month’s estimate. In 2015, the Ukrainian economy is expected to expand 1.5%.

Consensus Forecast Panelists Optimistic about Turkey, Lift Growth Forecast Again

Meanwhile, panelists are growing even more optimistic about Turkey. They lifted the 2014 GDP growth forecast another notch to 3.0%, following larger upward revisions in the previous two months. While the latest economic data paint a rather bleak picture of the Turkish economy, the stronger-than-expected activity in the first quarter prompted panelists to raise their GDP growth forecasts for the full year. For 2015, the panel sees the Turkish economy growing 3.5%, which is down a tad compared to last month’s estimate. Over the coming weeks, the presidential elections will dominate the news in Turkey. The latest polls show Prime Minister Recep Tayyip Erdogan winning the 10 August elections by a landslide, thereby avoiding a second round.

Russia and Ukraine Tighten Monetary Policies on Inflation Concerns

Inflation has continued to rise in Eastern Europe. Regional inflation inched up from 5.6% in May to 5.7% in June as faster price increases in Russia and Ukraine offset declining inflation in Turkey. In July, price pressures mounted again in Turkey. Nevertheless, at its 17 July meeting, the Turkish Central Bank decided to cut interest rates yet again, which represents the third rate cut since May. Hungary’s Central Bank also lowered its policy rate, marking the 24th consecutive rate cut. Romania’s monetary authorities followed suit on 4 August, cutting the policy rate by 25 basis points to 3.25%. Russia and Ukraine, in contrast, both tightened their policies. In an attempt to rein in soaring inflation, the National Bank of Ukraine raised its discount rate by 300 basis points to the highest level in more than a decade on 17 July. A week later, on 25 July, Russia’s Central Bank unexpectedly raised its main interest rate by 50 basis points, citing the increase in geopolitical tensions and concerns about high inflation.

Regional Inflation Outlook Ticks Up Again on Higher Forecasts for Turkey and Ukraine

Driven by higher inflation forecasts for Turkey and Ukraine, the average forecast for the region has risen, even though most countries see inflation projections either declining or remaining stable. On balance, the inflation projection for Eastern Europe reached 5.4% this month, which was up from the 5.3% that was expected last month. In 2015, inflation is expected to fall back to 4.5%, which is a tad lower than last month’s projection.

Note: This is an excerpt from the FocusEconomics Consensus Forecast Eastern Europe – August 2014. Published August 5th, 2014. The full report (163 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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