Central and Eastern Europe

Central and Eastern Europe

CEE currencies

EUR/HUF (light blue):

1 April 2018: President Orban is re-elected. Political uncertainty launches an upward trend in EUR/HUF. The pair leaves the 305/315 sideways trading band.

2 The currencies of both the Czech Republic and Hungary often show inverse correlation with the US dollar. The strong performance of the USD since April/May leads to a weakening of the krona and forint.

3 Markets doubts economic sustainability of Turkey and massively sell the Turkish lira. Hungarian forint (and Czech koruna) suffers collateral damage.

4 Despite strong economic data, Hungarian forint slips because of pressure on emerging countries (Turkey, Russia, etc.).

5 The European Union activates the sanctions procedure (the infamous Article 7) against Hungary, which may ultimately end in the deprivation of voting rights. The effective implementation is highly uncertain because every EU member has a veto. The forint hardly reacts.

6 18/12: Hungarian central bank suggests faster than expected policy normalisation

EUR/CZK (dark blue):

1 Months-long rally of the Czech koruna bottoms out after the Czech Central Bank (CNB) signalled a pause in the tightening of its monetary policy.

2 Unfortunate combination of pressure on the emerging countries, temporarily reduced liquidity in the run-up to a few holidays and the news regarding a possible reduction in European funding for some Central European countries affects the Czech koruna in the middle of the year.

3 A tough confrontation between Italy's brand new populist government (Lega, 5SM) and Europe seems inevitable. The negative risk climate leads to a collapse of Italian assets and drags along central European currencies, including the krona (and the forint).

4 The currencies of both the Czech Republic and Hungary often show inverse correlation with the US dollar. The strong performance of the USD since April/May leads to a weakening of the krona and forint.

5 ‘Buy the rumor, sell the news': In September, the Czech koruna strongly anticipated more central bank interest rate hikes. The central bank put its money where its mouth is, but the krona no longer benefited from it.

6 Despite multiple rate hikes, the Czech koruna remains under pressure as growth slowed down more than anticipated. Political uncertainty (vote of no confidence) keeps the currency in the defensive also. Meanwhile, prime minister Andres Babis’ government survived the vote.

Latest updates on economic growth in the region

Central and Eastern European economies experienced another year of a robust economic growth. While the final growth figures for Q4 are yet to be published, the economic momentum was likely sustained, thus confirming the positive picture so far. Above all, the performances of Poland and Hungary stand out as both economies are on track to register their highest annual GDP growth in a decade. Also, the Slovak Republic continued to catch-up with the rest of the region. The continued strong growth performance throughout 2018 signals that the Central and Eastern European economies have been particularly resilient to the growth slowdown in the Western and Southern European economies. Notably the German growth slowdown has so far not much affected the eastern neighbours. This is no surprise as the German growth decline, in particular in Q3, was related to temporary production issues in the automotive industry rather than due to lower extra-EU exports due to the trade war. Undoubtedly the latter would have affected the Central and Eastern European economies too.

While 2019 should see GDP growth moderate across the region, growth is set to remain strong and above potential. The main reason behind the slowdown is a less favourable external environment as the growth in major economies, i.e. the euro area and the US, is expected to decelerate. Moreover, negative risks associated with Brexit, the US-China trade conflict and generally increased volatility on financial markets might weigh on sentiment. On the other hand, the slower pace of growth will ease the fears of overheating, which are most pronounced in some regional labour markets, e.g. the Czech Republic or Hungary. Overall, the continued strong economic performance should help the Central and Eastern European economies to remain on a convergence path to other EU member states.

Worries about Romania

Nonetheless, the positive regional picture sketched above does not hold for all countries in the region. Most worrisome seems the economic situation in Romania, which stands out as an economy with rapidly deteriorating fundamentals. After the exceptionally high GDP growth of 6.9% in 2017, which was driven by surging private demand, the Romanian economy is set to substantially slow, with GDP growth of 4.1% in 2018 and 3.5% this year as fiscal stimulus fades.

Still, as a result of the Social Democrat-led government’s fiscal expansion, i.e. an unprecedented hike in public sector salaries and pensions, the economy shows signs of overheating. While Romania’s unemployment rate plunged to historical lows of 3.3% in November, a double-digit wage increase (underpinned by a 25% rise in public sector salaries) led to a build-up of inflationary pressures. The National Bank of Romania (NBR) was therefore forced to implement a relatively aggressive frontloaded tightening with three interest rate hikes in 2018. This brought the key rate to 2.50% and inflation back within the NBR’s target band (2.5±1ppt) to 3.4% in December from 5.4% in June. Moreover, fiscal stimulus resulted in a growing twin deficit. The current account deficit continues to widen, reaching 4.0% of GDP as of October (weakening pressure on the Leu has been so far contained by the NBR’s FX interventions), while fiscal deficit is expected to overstep the 3.0% Maastricht rule in 2018. This could trigger the opening of an excessive deficit procedure by the European Commission.

Fiscal policy remains one of Romania’s main economic weaknesses and is a risk to macroeconomic stability. To address a budget shortfall and keep Romania within the EU budget rules, the government announced a surprise corporate tax hike on banks (a progressive tax implemented if the money market rate, i.e. ROBOR, exceeds 2.0%), as well as on energy and telecommunications companies at the end of December. However, these ad hoc fiscal policy manoeuvres are not only inadequate to achieve necessary fiscal consolidation, but also, and no less importantly, bear a risk of negative repercussions for the business environment and could possibly even trigger capital outflows. In addition, the NBR criticises the intention to tie bank taxes to interbank rates, which would constrain the efficiency and flexibility of the central bank´s monetary policy.

Finally, the risk of further fiscal slippage seems more worrying on the back of the upcoming presidential elections scheduled for November 2019, which might intensify political fights and increase political risks in the coming months. Moreover, proposed changes to judiciary and criminal codes threaten to trigger both widening social unrest and squabbles with the European Commission, which has been criticising Romania for allegedly undermining the rule of law. All in all, weak political institutions and poor quality of governance is the key factor weighing on economic growth and the corresponding catching-up process in Romania.

Latest updates on economic growth in individual countries

Hungary - Economic update January 2019

201901 Hungary - Economic update

Czech Republic - Economic update January 2019

201901 Czech Republic - Economic update

Slovakia - Economic update January 2019

201901 Slovakia - Economic update

Bulgaria - Economic update January 2019

201901 Bulgaria - Economic update

Forecasts for the Central and Eastern European countries in numbers:

In-depth credit reviews

In depth review: Slovakia

MR20181218 In depth review: Slovakia

Most recent publications on Central and Eastern Europe:

EU funding for Central and Eastern European regions remains essential

EU-fondsen voor Centraal- en Oost-Europese regio’s blijven noodzakelijk

Diversity in European income trends...but education pays off everywhere

Geen eenheid maar diversiteit in Europese inkomenstrends