wiiw Summer Forecast 2022: Growth slows down in CEE

Economic growth in the region of Central, Eastern and Southeastern Europe (CESEE) is slowing down due to the Russia’s war in Ukraine, the related increase in inflation and supply chain problems. These are the findings of the 2022 summer forecast published by the Vienna Institute for International Economic Studies (wiiw):

Most countries will still be able to avoid a recession. In 2022, a slump is expected only for Ukraine (-38%), Belarus (-4.5%), Moldova (-1%) and Russia (-7%). According to the forecast, Slovenia (4.5%), Poland (4.2%), Serbia and Montenegro (3.6% each) will experience the strongest growth this year. Especially in some EU member states of the region, growth forecasts have been revised upwards compared to the spring, as they proved to be more resilient than expected in the first quarter owing to the pent-up consumer demand after the Corona crisis. They are growing by 3.3% on average. Economic growth in the six Western Balkan states could increase by 2.9% on average in 2022, but less than in the previous year.

In 2023, the vast majority of countries are expected to record stronger growth than in 2022, with Poland, Hungary, Serbia and Slovenia being the exceptions. Ukraine could also grow again by 5% in 2023. Altogether, the outlook for 2023 has been revised downwards compared to the spring forecast.

Lower growth will mean slowing down of the convergence process of CEE toward Western Europe.

Inflation

According to the wiiw forecast, inflation will be in double digits in almost all countries in 2022 and has been revised upwards significantly compared to the spring forecast. Only Albania, Croatia, Kosovo, and Slovenia will remain in single digits this year. Turkey stands out with inflation of 67.7%, Moldova follows with 25%. For 2023, inflation is estimated to remain elevated, though mostly no longer in double digits (EU members: 3.5-8%; Western Balkans: 3.5-6%). In 2024, inflation could fall below 5%.

The fact that core inflation (excluding food and energy) is also rising in the region is currently a cause for concern. This suggests that inflation is not only driven by supply shortages and supply chain problems. In macroeconomic terms, the increasingly high inflation reduces the region's growth prospects because it reduces the real incomes of the population. If oil and gas must be rationed in winter, Eastern Europe could slide into recession.

Monetary policy

Central banks are tightening monetary policy in response to high inflation. However, real interest rates remain negative despite a partial rise in interest rates. According to wiiw, monetary policy is not too tight now because the central banks want to keep some room for manoeuvre for autumn and winter.

Ukraine

In Ukraine, the consequences of the severe destruction caused by the Russian attack are massive: more than $100 billion in damage to infrastructure and housing - around 60% of the pre-war GDP of 2021, 14 million displaced persons, thousands of civilian victims. The reconstruction is monumental in scale. One of the biggest problems is the blockade of the Black Sea ports as important transit hubs for (grain) exports.

A ray of hope, according to wiiw, is the large financial support from Western partner countries and the stronger EU integration, which can serve as an important cornerstone for reforms. Western investments could also bring about technological improvements and productivity increases, especially in the IT and agricultural sectors.

Risks

The biggest risks at the moment are the uncertain outcome and duration of the war in Ukraine and the persistently high inflation, which could lead to stagflation. Many countries could also be hit by a sudden gas supply stop by Russia; besides Slovakia and Hungary, Austria would also be strongly affected due to its dependence on Russian gas. In addition, there is an indirect dependence on oil from Kazakhstan (about 40% of Austria's oil imports), because it is transported via Russia. It could not be ruled out that Russia will use energy as a weapon again.

Medium-term trends

In the medium term, wiiw expects that the EU member states in Central and Eastern Europe will continue to detach from Russia and increase defence spending. At the same time, investors in countries that are also threatened by Russia are becoming more concerned. However, an acceleration of the "green transition" is becoming apparent due to the current energy crisis.

For the countries of the Western Balkans, on the other hand, there are in part stronger ties with Russia, which make the decoupling more painful, also because there are no shock absorbers through high EU transfers. There is hope, however, that the process to EU memberships may now be accelerated for some countries.

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