Central and Eastern Europe

Central and Eastern Europe

Economic update - May 2020

Sharp economic decline knocking on CEE doors

The COVID-19 pandemic, which originated in China at the turn of the year, soon spilled over into Western Europe. With just a couple of weeks delay it reached the CEE region. This short ‘delay’ was important. It helped the governments and the population in the region to not underestimate the disease. Consequently, authorities were able to take a series of timely measures to prevent an explosive spread of the virus, which could have led to the collapse of the health system.

The drastic epidemiological measures, centered around social distancing, have been very successful in flattening the number of infected people and in reducing the number of victims of the disease. But the price paid to save lives was a sharp slowdown in the economy, with negative consequences in the form of rising unemployment and corporate bankruptcies.

At the beginning of May, there is still little “hard” data available to reliably quantify the losses caused so far by the coronavirus. However, already available data signal that like elsewhere, in the CEE region the economic downturn is painful. Regionally important car production has stalled for a number of weeks and industrial production as a whole dropped significantly in some countries (e.g. -10 % year-on-year in the Czech Republic). Electricity consumption noticeably decreased too. Many services, in particular in tourism and hospitality sectors, have been hit hard by government restrictions from the outset. While in the absence of much ‘hard’ data it is difficult to predict overall losses in the economy, it is clear that the process of recovery will be lengthy and difficult in these sectors.

In most countries of the region, we already saw an increase in the season-adjusted unemployment rate in March. In Romania and Bulgaria, the unemployment rate increased by around half a percentage point (Figure CEE1), despite the fact that the workforce usually includes a proportion of workers whose dismissal does not have an impact on the rise in unemployment. The number of unemployed people can be expected to continue to grow in the future, as the financial situation of a number of businesses exposed to input constraints and weak sales deteriorates. They suffer from the disruption of production chains and a strained return to previous demand levels.

Governments are attempting to mitigate the negative economic consequences with a series of fiscal and monetary measures. But, e.g., support for maintaining employment (Kurzarbeit) is clearly not enough to stabilize the unemployment rate. At the same time, measures to maintain corporate liquidity and access to credit cannot prevent the closure of many of businesses. Resources dedicated by government assistance programs to affected people or businesses have often been distributed too slowly or in a low-targeted way. For health or economic reasons, consumers may remain more restrained than they were before the crisis, even after the loosening of government restrictions and bans. On the part of many companies, the risk remains that even in the case of a relative normalization of domestic circumstances, they may not be able to prosper due to the disruption of the global production chains of which they are part. All this complicates the current economic situation and the prospects for rapid recovery. Sentiment indicators illustrate the fact that both companies and consumers in the region are well aware of the depths of current problems and future risks (figure CEE2).

 

In the meantime, it has become clear that for a number of economic and non-economic reasons, the “freezing” of the economy - albeit epidemiologically effective - is unsustainable in the long run. Hence, government restrictions are beginning to loosen in the CEE region to varying degrees and structure (see box CEE1). The role of blanket social distancing should be gradually replaced by more sophisticated ways of controlling the pandemic development, namely massive testing and ‘smart quarantine’ measures until a reliable, widely available medicine or vaccine is available.

Box CEE1 - Central and Eastern European economies are reopening

Since mid-March, the CEE governments have imposed restrictions on the free movement of people. This included a ban on international travel and large public gatherings, and the closure of schools and non-essential business. Strict and early lockdowns are paying off across the CEE countries. As of May 11, the daily number of new coronavirus cases remains contained in the Czech Republic, Slovakia, Hungary, Poland and Bulgaria. Only Romania is somewhat struggling to slow the spread of the virus.

So, following a more restrictive approach at the beginning of the outbreak of the virus, the CEE countries are now among the first to tentatively start relaxing the social distancing rules. Most countries have already unveiled plans for a phased reopening of businesses and an easing of individual mobility restrictions. By doing so, they are trying to balance the risk of a second wave of the epidemic with the need to restart economic activity, which has been severely hit by the lockdown.

The Czech Republic has been on the forefront of reopening its economy with a five-stage plan effective already since 20 April. The plan was recently brought forward by two weeks due to the favourable epidemiological situation. While it is still mandatory to wear face masks in public, the country has gradually eased the restrictions on retail, services, culture and leisure. Importantly, automakers and other production facilities have also resumed work. Elsewhere in the region, governments are taking similar steps, effectively easing the stringency of containment measures (Figure BCEE1). The one notable exception is Romania, the hardest-hit country in terms of confirmed cases per capita in the region. So far, this country has opted for a more cautious approach, starting to lift the restrictions only gradually since May 15.

 

Over the next few quarters, the economic activity in the CEE region will depend on the global development of the coronavirus pandemic and the success of the local, smart quarantine measures. If infected individuals are quickly and deliberately identified and isolated, and if the virus does not return repeatedly in an even more dangerous form, the prospects for a relatively rapid economic recovery over the next year are well-imaginable. Otherwise, due, inter alia, to the fact that the potential for fiscal and monetary assistance to companies and individuals is already largely depleted in most countries, we would have to prepare for a significantly less optimistic scenario.

Box CEE2 – Bulgaria has formally applied for ERM II membership

Bulgaria’s plans to adopt the euro has seen yet another U-turn. Following the outbreak of the coronavirus pandemic, the Bulgarian authorities, both the government and the central bank, indicated that the corona crisis would delay further progress in the euro area accession. Nonetheless, in early April, Prime Minister Borisov surprisingly announced that the process of entering the Exchange Rate Mechanism II, the so-called euro area waiting room, is back on track. On April 30, 2020, Bulgaria formally applied for the ERM II membership.

At the moment, Bulgaria meets four nominal convergence criteria relating to the budget balance, general government debt, inflation and long-term interest rates. Additionally, its currency has been pegged to the euro already since 1999. However, the European Central Bank found capital shortfalls at two locally owned banks. Provided capital buffers are adequately rebuilt, we expect that Bulgaria should receive a formal invitation to join the Exchange Rate Mechanism II and the banking union in July 2020.

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