Subdued regional growth trends in Central and Eastern Europe

Scope Ratings GmbH says the CEE 11 region’s relative economic resilience so far to a slowdown in Western Europe reflects: i) gradually diminishing dependence on export sectors and greater reliance on domestic demand, supported by tight labor markets and rising wages; ii) loose fiscal and monetary policies; and iii) robust public investment supported by EU fund absorption.

“Looking ahead, however, sluggish Western European economies – and crucially the slowdown in Germany’s manufacturing sector due to the cyclical downturn in the car industry – will be a significant drag on CEE-11 growth,” Giacomo Barisone, managing director of sovereign ratings at Scope, says.

The car industry is key for many CEE-11 economies, accounting for 14% of GDP in Slovakia and Romania and almost 10% of GDP in the Czech Republic, Hungary and Slovenia. Thus, the health of the German auto and broader industrial sector is critical with Germany being the destination for 25% of total CEE-11 goods exports in 2018. Scope expects only 1% growth in Germany in 2020 after an estimated 0.5% in 2019.

CEE-11 governments will have to press ahead with structural reforms to sustain future growth. “Resolution of labor market shortages, stronger governance standards and investments into research & development as well as energy and digital infrastructure are key elements for raising economic growth in the region,” Barisone says.

Scope expects that the CEE 11 will continue to attract foreign direct investment next year. These economies remain cost competitive compared with their Western European neighbors, even though there are disparities in institutional strengths, which have weakened in some regional cases.

More subdued growth in the CEE 11 will contrast with the performance of the two large economies on the region’s eastern flank: Russia is set for 1.5% growth in 2020, modestly higher from an estimated 1.0% in 2019, while Turkey can expect 3% growth next year, after 0.2% in 2019.

“Expectations for a moderate recovery in Russian growth in 2020 reflect at least in part an easing of fiscal policy to address domestic challenges via ‘National Projects’ investments over 2019-24,” Barisone notes. “While sanctions-related risks and a lack of FDI remain further challenges, we believe Russia’s external resilience has improved.”

“We expect that Turkey’s economic recovery will extend into 2020 after the recovery started this year, but structural and institutional challenges remain largely unaddressed amid persistent geopolitical risks. They underscore our cautious outlook for Turkey,” Barisone says.

In both Russia and Turkey, governance and institutional limitations remain key ratings constraints.

A common priority in 2020 for CEE-11 governments will be negotiations over the EU’s next long-term budget for 2021-27. Scope expects an upward adjustment in funding for CEE-11 countries compared with the current European Commission draft proposal foreseeing significant reductions in allocations to the region.

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