Eastern European                 Export-driven growth gains                                 strength as domestic demandOut...
Economic ResearchEastern European Outlook is produced twice a year. This report was published on March 23, 2011.It was wri...
Summary            Economic conditions in Eastern Europe will strengthen in 2011-2012, although fiscal poli-            ci...
The international economyGlobal growth will stabilise a bit above trendƒ   Marginal slowing due to disasters in Japan     ...
Theme: Impact of the global commodity price shockon inflation            Underlying inflation pressures are calm          ...
Theme: Impact of the global commodity price shock on inflationMeanwhile underlying price increases in Eastern Europe      ...
Estonia                The export boom continues            ƒ    Labour market stronger than expected                     ...
Estoniaing to 5.4 per cent of GDP. Part of the outflows had to                                      (up by 16 per cent in ...
Latvia            Exports support shaky domestic recovery            ƒ        Households still under pressure             ...
LatviaThe internal devaluation process is thus over. Competi-                                Budget consolidation continue...
Lithuania            Stronger upturn − labour shortage a hindrance            ƒ        Domestic demand starting to grow   ...
Lithuania2010, possibly due to decreasing inactivity and higher                         duties required by the EU. In 2010...
Poland            Continued good growth despite imbalances            ƒ     Budget deficits and inflation worrisome       ...
Polandmeasure) to nearly 10 per cent in early 2010 and has                                      government has launched a ...
SEB-report: Consumption, exports boost eastern European economies
SEB-report: Consumption, exports boost eastern European economies
SEB-report: Consumption, exports boost eastern European economies
SEB-report: Consumption, exports boost eastern European economies
SEB-report: Consumption, exports boost eastern European economies
SEB-report: Consumption, exports boost eastern European economies
SEB-report: Consumption, exports boost eastern European economies
SEB-report: Consumption, exports boost eastern European economies
SEB-report: Consumption, exports boost eastern European economies
SEB-report: Consumption, exports boost eastern European economies
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SEB-report: Consumption, exports boost eastern European economies


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Eastern European economies will strengthen in 2011 on the back of greater household purchasing power and competitive exports, states SEB's Eastern European Outlook released Wednesday. Overall, economic conditions will strengthen across the region over the next two years, with exports driving growth this year.

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SEB-report: Consumption, exports boost eastern European economies

  1. 1. Eastern European Export-driven growth gains strength as domestic demandOutlook awakens Theme: Impact of the globalEconomic Research – March 2011 commodity price shock on inflation
  2. 2. Economic ResearchEastern European Outlook is produced twice a year. This report was published on March 23, 2011.It was written by Mikael Johansson (Chief Editor), Daniel Bergvall, Dainis Gaspuitis, AndreasJohnson, Hardo Pajula and Vilija Tauraite.Robert Bergqvist Håkan FrisénChief Economist Head of Economic Research+ 46 8 506 230 16 + 46 8 763 80 67Daniel Bergvall Mattias BruérEconomist Economist+46 8 763 85 94 + 46 8 763 85 06Ann Enshagen Lavebrink Mikael JohanssonEditorial Assistant Economist+ 46 8 763 80 77 + 46 8 763 80 93Andreas Johnson Tomas LindströmEconomist Economist+46 8 763 80 32 + 46 8 763 80 28Gunilla Nyström Ingela HemmingGlobal Head of Personal Finance Research Global Head of Small Business Research+ 46 8 763 65 81 + 46 8 763 82 97Susanne Eliasson Johanna WahlstenPersonal Finance Analyst Small Business Analyst+ 46 8 763 65 88 + 46 8 763 80 72SEB Economic Research, K-A3, SE-106 40 StockholmHardo Pajula Dainis GaspuitisEconomist, SEB in Tallinn Economist, SEB in Rigahardo.pajula@enskilda.ee dainis.gaspuitis@seb.lv+372 6655173 +371 67779994Gitanas Nauseda Vilija TauraiteChief Economist, SEB in Vilnius Economist, SEB in Vilniusgitanas.nauseda@seb.lt vilija.tauraite@seb.se+370 5 2682517 +370 5 2682521 Eastern European Outlook – March 2011 | 3
  3. 3. Summary Economic conditions in Eastern Europe will strengthen in 2011-2012, although fiscal poli- cies will be tightened moderately in many countries and global growth will level out. Strong, competitive exports will remain a key driving force this year. Meanwhile con- sumption and capital spending are awakening from their crisis-period hibernation and will help sustain good GDP growth. Eastern Europe was the region of the world hardest hit by the global credit crisis, mainly due to relatively large borrowing in foreign currencies. The first sign of recovery in private consumption came in 2010, alongside a rebound in real wage growth, stabilising labour markets and some thawing in frozen credit condi- tions. Looking ahead, continued decline in unemployment, faster wage and salary hikes and gradual normalisation in the credit situation will contribute to growing consumption. Rapidly accelerating inflation due to sharply higher global energy and food prices will partly undermine household purchasing power this year. Underlying inflation pressure is low but is gradually increasing. Looking ahead, the commodity price upturn will moder- ate. The increase in broad inflation measures will culminate this year, except that in Estonia and Lithuania inflation will continue to accelerate in 2012. Large public budget deficits in the wake of the crisis will shrink to more moderate levels in most countries. Estonia’s deficit will rise slightly from a low level. Public sector debts will continue to grow somewhat; they are low or moderate, compared to many Western countries. SEB’s GDP forecasts for 2011-2012 will remain somewhat above consensus, except in Ukraine: ƒ Russia’s GDP will increase by 5.6 and 5.2 per cent, respectively, in 2011-2012, sus- tained by high commodity prices. SEB is now raising its Brent oil price forecast for 2011 to USD 102/barrel from USD 80 in Eastern European Outlook, October 2010, and more recently USD 96/barrel. This will provide an extra growth impulse and room for a continued expansionary fiscal policy, although in the short term there is increased uncertainty about consumption due to rapidly rising inflation. The central bank will continue to tighten monetary policy, and the rouble will appreciate further. ƒ Poland’s growth will become more investment-driven and rise to 4.5 and 4.6 per cent. Further fiscal tightening will be needed after the autumn parliamentary elec- tion in order to meet nationally established debt limits. The key interest rate will continue to be raised, and the zloty will appreciate. ƒ Ukraine’s growth will improve slightly to 4.7 per cent this year. Favourable world market prices for steel and agricultural products, two major export industries, will provide support but austerity requirements imposed by Ukraine’s lender, the IMF, will restrain growth. ƒ Estonia’s GDP increase will accelerate to 5.0 and 4.5 per cent, respectively, in 2011- 2012. The export boom is continuing, while domestic demand is gradually picking up. An unexpectedly rapid labour market improvement will help fuel consumption. Austerity policies have eased. ƒ Lithuania’s growth will surge to 4.0 and 4.5 per cent in 2011 and 2012. Exports will continue to drive growth, which will nevertheless become more broad-based as fiscal tightening softens this year. Emigration and growing labour shortages will hamper the upturn. ƒ Latvia, which is lagging behind Estonia and Lithuania, will see GDP growth pick up to 4.0 per cent in 2011 and 4.5 per cent next year, but the domestic economic recovery will be shaky. This is partly because public budget consolidation is continuing. 4 | Eastern European Outlook – March 2011
  4. 4. The international economyGlobal growth will stabilise a bit above trendƒ Marginal slowing due to disasters in Japan autumn to USD 116. We now forecast average oil prices of USD 102 this year and USD 90 in 2012.ƒ More synchronised growth as US improves Crisis policies have begun to be replaced by exit poli-ƒ German strength helping Eastern Europe cies. We expect OECD fiscal policies to tighten margin- ally in 2011 and by the equivalent of 1.5 per cent ofIn the past six months, the global economic outlook GDP in 2012. Due to rising inflation expectations andhas brightened. Slower growth once seemed likely in high CPI inflation, the European Central Bank and the2011-2012, but it now appears as if growth in both Bank of England will begin hiking key interest rates thisthe OECD countries and the world will slow marginally spring. The ECB will raise its refi rate from 1.00 to 2.00compared to 2010 and will stabilise at decent levels, per cent in 2011, then to 3.00 per cent in 2012. Wesomewhat above trend. The main reason is much higher expect the US Federal Reserve to hold off on rate hikesexpectations in the US, but also stronger forecasts for until January 2012.Germany, which continues to prop up the euro zone. In the short term, the EUR/USD rate will be governedGlobal manufacturing indices have also provided upside largely by monetary policy expectations. The euro willsurprises. The US and global recovery is becoming more climb further to about USD 1.45 this autumn, with a riskself-sustaining. This is clear from the optimism of major of even faster appreciation; by year-end the dollar willcompanies and the rebound in Western capital spending begin a weak recovery.over the past 6-12 months. The American purchasingmanagers’ index in manufacturing reached 61.4, a level Global economic highlightslast achieved in May 2004, which in turn was the highest GDP, year-on-year percentage changesince 1983. Germany’s IFO business climate index wasat its highest since measurements began in 1991. 2009 2010 2011 2012 United States -2.6 2.8 3.6 4.0Meanwhile the world economy still faces challenges and Euro zone -4.0 1.7 1.9 1.8risks. Government debts continue to grow. Fiscal crises The world -0.6 5.0 4.4 4.7in various euro countries remain unresolved − Portugal Oil, USD/barrel 61.9 79.8 102.0 90.0may be forced to apply for bail-out loans − though the EUR/USD, Dec 1.43 1.34 1.40 1.38creation of the European Financial Stability Facility andthe Euro Pact have bolstered confidence in the euro. Source: SEBIn the short term, Japanese natural disasters and the Eastern European exports and growth will continue toLibyan war will generate worries that temporarily be sustained by solid demand in Germany, with GDPrisk dampening global optimism. We believe that the growth of 3 per cent in 2011 and 2.5 per cent in 2012.damage and energy disruptions will push down Japan’s This year the recovery will broaden from exports to do-already slow growth expectations by nearly 1 percent- mestic demand. Germany weighs heavily in the foreignage point this year but that the positive impact of trade of many countries in the region. For example,reconstruction in 2012 will exceed 1 percentage point 20-30 per cent of Polish, Hungarian and Czech exportsin 2012. We previously forecasted 1.6 per cent annual are sold there. Germany is also a relatively importantGDP growth. Globally, the impact will be marginal. Our market for exports from the Baltic countries, but lessprojections are partly based on historical experience so for Russia and Ukraine. The latter two countries areafter natural disasters and assume that Japan’s energy benefiting from higher commodity prices.problems will not be long-lasting. As in the West, many Eastern European countries haveYet that world economic recovery has gained a foot- launched belt-tightening programmes to combat largehold. The focus of financial markets and economic budget deficits; the Baltics have already implementedpolicy is shifting towards more traditional variables much of these programmes. Eastern Europe is fortunatesuch as growth, the labour market and inflation. We to have low or moderate public sector debts, even afterbelieve that the euro zone’s output gap will close in the increases of recent years. Instead, the main prob-2011-2012, while this process will take longer in the lem in many parts of the region before the 2007-2008US. We expect underlying inflation to rise moderately, global credit crisis was large current account deficitsdespite the sharp upturn in energy and food prices. The and relatively high foreign currency debts.price of Brent crude has risen from USD 80/barrel last Eastern European Outlook – March 2011 | 5
  5. 5. Theme: Impact of the global commodity price shockon inflation Underlying inflation pressures are calm ƒ Food, energy big factors in Eastern Europe on broad inflation measures has been stronger than in the West. We have studied the trend in the EU countries ƒ …but inflation patterns similar to the West of Eastern (including Central) Europe. For example in ƒ Small secondary effects from commodities Poland, Harmonised Index of Consumer Prices (HICP) inflation rose from 1.9 per cent year-on-year in August 2010 to 3.3 per cent in February. In the Baltics, Estonia Global energy and food prices have climbed rapidly and moved from deflation a year ago to a 5.5 per cent rate almost uninterruptedly since mid-2010. The Hamburg in February, Latvia’s inflation reached 3.8 per cent and Institute of International Economics (HWWI) world in Lithuania the rate was 3.0 per cent. However, this energy price index rose over 50 per cent in USD, and its dramatic surge was also due to sizeable base effects food price index climbed just as fast. Before this, food (strongly depressed 12-month comparative figures) plus price hikes were much calmer, though energy-related recent tax hikes and administrative price increases that commodities also rose dramatically in 2009 and early are part of fiscal belt-tightening packages. 2010. The pattern of faster price increases in Eastern Europe In the past six months higher commodity prices, mainly than in the West is largely due to the relatively heavier for energy and food, have been instrumental in driv- weighting of energy and food in the region’s consumer ing up broad Consumer Price Index inflation around baskets. Meanwhile appreciating currencies have eased the world, albeit moderately. In the euro zone, for such external price impulses to some extent. example, the CPI rate was around 1.5 per cent last summer but rose to 2.4 per cent in February, exceed- Role of energy and food in CPI ing the European Central Bank’s target of just below 2 Per cent (food includes alcoholic beverages and tobacco) per cent. Yet core inflation − adjusted for energy, food, alcoholic beverages and tobacco − has remained stable Energy Food Energy Food at close to 1 per cent. The same is true of most Western Estonia 13 29 Poland 13 30 countries, though at different levels; secondary effects Latvia 14 31 Czech Rep. 13 27 on other consumer prices have so far been limited. Lithuania 14 34 Euro zone 10 19 Global energy and food prices, OECD inflation Index 100 = Jan 1, 1996, year-on-year percentage change Source: Eurostat 175 6 5 In most parts of Eastern Europe, core inflation has only 150 4 risen slowly since year-end 2010. One exception is Es- 125 3 tonia, where the rate has climbed from 0.7 per cent in 100 2 August to 2 per cent. As elsewhere in the Baltics, base 75 effects are part of the picture following the earlier 1 50 0 downward price squeeze. Estonia’s inflation trend may 25 -1 also diverge from Latvia and Lithuania since its eco- 0 -2 nomic recovery has been somewhat stronger. Price hikes 00 01 02 03 04 05 06 07 08 09 10 11 when Estonia joined the euro zone on January 1, 2011 Energy-related commodities (LHS) may also have contributed to some extent. Food (LHS) OECD consumer prices (RHS) Looking ahead 1-2 years, we expect broad inflation Source: Reuters EcoWin measures in many Eastern European countries to fall In our assessment, CPI inflation in the OECD countries somewhat. This assumes a slower commodity price will fall slightly in the coming year as the commodity upturn, milder base effects and continued currency rally slows. Meanwhile low underlying price pressure appreciation. But inflation is unlikely to cool much, will start rising, though sedately. This pressure is still especially this year, since various tax hikes and admin- weak and will presumably climb slowly, since there istrative price increases will push up inflation figures. are still a lot of idle post-crisis resources. The inflation Inflation will continue climbing somewhat in Estonia risk seems larger in Western Europe than in the US, and Lithuania as they utilise more and more resources because the former region’s output gap is smaller. In following their deep economic crisis. Eastern Europe, the impact of rising commodity prices 6 | Eastern European Outlook – March 2011
  6. 6. Theme: Impact of the global commodity price shock on inflationMeanwhile underlying price increases in Eastern Europe recession — The Baltic countries noted some of thewill gradually move upward from today’s low levels. world’s steepest GDP declines. The exception is Poland,Faster pay hikes and accelerating economic activity will which weathered the crisis with no GDP downturn, andexert some upward pressure on consumer prices. where the output gap will start closing in 2012. Eastern Europe was the region hardest hit by the global creditOur main conclusion is thus similar to that for the West: crisis and recession, partly due to its relatively highno Eastern Europe inflation surge is imminent. The main pre-crisis borrowing in foreign currencies.reason is that there are lots of idle resources after the Estonia: Inflation Lithuania: Inflation Year-on-year percentage change Year-on-year percentage change15.0 15.0 15.0 15.012.5 12.5 12.5 12.510.0 10.0 10.0 10.0 7.5 7.5 7.5 7.5 5.0 5.0 5.0 5.0 2.5 2.5 2.5 2.5 0.0 0.0 0.0 0.0 -2.5 -2.5 -2.5 -2.5 -5.0 -5.0 -5.0 -5.0 05 06 07 08 09 10 05 06 07 08 09 10 HICP HICP HICP excl food, energy, alcohol and tobacco HICP excl food, energy, alcohol and tobacco Source: Eurostat Source: Eurostat Latvia: Inflation Czech Republic: Inflation Year-on-year percentage change Year-on-year percentage change20.0 20.0 8 817.5 17.5 7 715.0 15.0 6 612.5 12.510.0 10.0 5 5 7.5 7.5 4 4 5.0 5.0 3 3 2.5 2.5 2 2 0.0 0.0 1 1-2.5 -2.5-5.0 -5.0 0 0-7.5 -7.5 -1 -1 05 06 07 08 09 10 05 06 07 08 09 10 11 HICP HICP HICP excl food, energy, alcohol and tobacco HICP excl food, energy, alcohol and tobacco Source: Eurostat Source: Eurostat Poland: Inflation Euro zone: Inflation Year-on-year percentage change Year-on-year percentage change 5.0 5.0 5.0 5.0 4.5 4.5 4.5 4.5 4.0 4.0 4.0 4.0 3.5 3.5 3.5 3.5 3.0 3.0 3.0 3.0 2.5 2.5 2.5 2.5 2.0 2.0 2.0 2.0 1.5 1.5 1.5 1.5 1.0 1.0 1.0 1.0 0.5 0.5 0.5 0.5 0.0 0.0 0.0 0.0-0.5 -0.5 -0.5 -0.5-1.0 -1.0 -1.0 -1.0 05 06 07 08 09 10 11 05 06 07 08 09 10 HICP HICP HICP excl food, energy, alcohol and tobacco HICP excl food, energy, alcohol and tobacco Source: Eurostat Source: Eurostat Eastern European Outlook – March 2011 | 7
  7. 7. Estonia The export boom continues ƒ Labour market stronger than expected GDP, employment and unemployment 15 20 ƒ Weak upturn in consumption due to infla- tion and deleveraging 10 15 5 10 ƒ Austerity policy is over 0 5 -5 0 Estonia is in the midst of an export boom, with an- -10 -5 nual growth rates beating one record after another. In January, nominal exports were up by 57 per cent year -15 -10 on year. The performance of non-oil exports — from -20 -15 which the effects of Russian fuel transit have been 00 01 02 03 04 05 06 07 08 09 10 eliminated — was even more staggering; they rose by GDP, year-on-year percentage change (LHS) 84 per cent in December. Total merchandise exports for Unemployment, per cent (RHS) Employment, year-on-year percentage change (RHS) 2010 amounted to EUR 8.7 billion, slightly higher than Source: Statistics Estonia the pre-crisis peak of EUR 8.5 billion in 2008. The trade One of our central theses in the October EEO was a deficit of roughly EUR 0.5 billion was the lowest since slow, drawn-out labour market recovery. The 5 per- 1995 even in absolute terms, let alone in relation to centage point fall in the unemployment rate during GDP (3.4 per cent). the third and fourth quarters was surprisingly large. Together with a smooth transition to the euro, this Joblessness was 13.6 per cent at the end of 2010. The has lifted spirits. A broad-based sentiment index has average 2010 rate was 16.9 per cent. The impact of shown one of the sharpest upswings in the EU. Given export-led recovery in 2010 made unemployment drop the strong correlation between exports and GDP since faster than expected. Employment was up by 2.1 per the second half of 2008, it is evident that the future cent in the fourth quarter, with the manufacturing outlook will remain dependent on trade performance. sector employing 13 per cent more people than a year ago. That said, even though the total number of jobs is Industry still growth-engine up by 7 per cent since last spring, it is still more than In the fourth quarter, GDP grew by 6.7 per cent year- 10 per cent below its summer 2007 peak. Supply-side on-year. This brought the 2010 growth rate to 3.1 per adjustments have been relatively modest. Compared to cent. In the second and third quarters growth was the peak late in 2008, the size of the labour force has driven mainly by stockbuilding, but in the fourth quar- stayed more or less the same. Unemployment will fall ter net exports were once again the largest contributor. further from its fourth quarter level, coming in at 12 More tellingly, the growth contribution of fixed invest- per cent in 2011 and 11 per cent in 2012. ments turned positive (2.5 percentage points) for the Stronger employment gains and associated increases in first time since mid-2007. Manufacturing remains the nominal wages, which have risen since the second quar- primary engine of recovery; in 2010 it contributed 2.6 ter of 2010, will provide improved support for domes- percentage points to GDP growth. tic demand. The impact is, however, being held back Exports are benefiting from a combination of improved by a gradual erosion in purchasing power. Real wages competitiveness, internal devaluation in recent years have declined since end-2008 and there is continued and a favourable trend in major markets, especially deleveraging in the household sector; outstanding loans Sweden, which since autumn 2010 has been Estonia’s have shrunk by 6 per cent since peaking at the end of largest export market. We expect the weighted average 2008. The growth contribution of private demand has growth rate of Estonia’s nine largest trade partners to now been negative for three years in a row. In 2011 we be 3.9 per cent in 2011, an upward revision compared expect a positive increase and a contribution of 1–2 to the October 2010 issue of Eastern European Outlook percentage points. (EEO). Together with a much sharper than anticipated drop in unemployment, this contributes to the upward Domestic liquidity contracting revision of our 2011 GDP forecast to 5.0 per cent. In In 2010 Estonia saw its largest liquidity outflow on 2012 we expect GDP to grow by 4.5 per cent. record, with a total balance of payments deficit (the sum of current, capital and financial accounts) amount- 8 | Eastern European Outlook – March 2011
  8. 8. Estoniaing to 5.4 per cent of GDP. Part of the outflows had to (up by 16 per cent in February). Looking ahead, wedo with the sharp decline in reserve requirements and expect somewhat weaker price pressure in the comingthe associated repatriation of surplus funds from the quarters. First, there is the downward trend in moneylocal banking sector. As a result, domestic monetary supply and second, inflation expectations seem to haveand credit aggregates have temporary been contract- stabilised in recent months. Finally, high unemploy-ing. The year-on-year growth rate in domestic credit ment will exert a disciplining effect on excessive wagewas down to minus 8 per cent in January, while broad demands. These factors must be weighed against highermoney (M2) growth turned negative last summer. commodity prices and wage rises in the tighter corners Money, HICP and credit of Estonia’s increasingly fragmented labour market. All Year-on-year percentage change in all, we expect inflation to moderate in the second 50 50 half and to average 4 per cent in 2011. Due to contin- ued recovery and monetary aggregates, including 40 40 credits, inflation will probably be a bit higher in 2012. 30 30 Tough austerity packages have kept the general govern- 20 20 ment deficit below the Maastricht ceiling, 3 per cent of GDP. The 2010 deficit is expected to come in at 1.0 per 10 10 cent of GDP, increasing according to the government to 0 0 1.6 per cent in 2011 and 2.3 per cent 2012. The gov- ernment forecasts are, however, based on rather more-10 -10 00 01 02 03 04 05 06 07 08 09 10 restrained assumptions on nominal GDP growth rates; 5.6 per cent in 2011 and 6.6 per cent in 2012. Although M2 HICP Credit Source: Statistics Estonia, Bank of Estonia our nominal growth outlook is more optimistic, we ex- pect approximately the same deficit levels as theHence, current account surpluses are increasingly insuf- government does: 1.5 per cent of GDP in 2011 and 2.5ficient to cover financial account deficits, with adverse per cent in 2012. The main reason is that we expecteffects on domestic liquidity. Last year’s current ac- somewhat laxer fiscal policy in the years ahead (seecount surplus was around 4 per cent of GDP. We expect box). These deficit figures bring public debt to 12 perit to come down to 2 per cent of GDP in 2011 and 1 per cent and 16 per cent of GDP in 2011 and 2012, respec-cent in 2012 as domestic demand picks up. Downward tively. An easing of fiscal policy at the same time aspressure on domestic liquidity is likely to intensify. the ECB’s monetary policy is gradually tightening but still expansionary may prove risky. It is important toThe financial account of the balance of payments has keep inflation from getting stuck at 4-5 per cent, highermajor influence on the miniscule Estonian real economy than in most other EU countries and far higher than theand inflation, since it determines the level of liquidity ECB’s 2 per cent target. Otherwise, there is a risk thatin the system. Estonia’s recently regained competitiveness may againInflation is still rising, with the year-on-year rate at 5.7 be lost.per cent in February, primarily due to higher food prices Government wins new term despite austerity The two-party coalition looks likely to stay in office That said, we envisage a somewhat weaker fiscal for another four years. Prime Minister Andrus Ansip’s stance over the next four years. First, the smaller Reform party won a widely predicted victory on March coalition partner IRL campaigned this time on an 6. Despite its recent austerity packages, the govern- overtly populist ticket. While the Reform party will try ment was thus re-elected. With the Reform party its best to persuade IRL to drop the costliest items, gaining two seats and its coalition partner IRL adding some of them will probably be enacted, particularly four, the two now have a comfortable parliamentary if, as rumoured, IRL will be given the finance minister majority: 56 votes out of 101. portfolio. Second, it is more difficult to argue for fur- ther consolidation now that the country is already in A net gain of 6 seats compared to the previous elec- the euro zone. Third, part of what looked like aggres- tion means that voters largely endorsed pro-European, sive cuts in 2008 and 2009 will turn out to be deferred responsible policymaking at the heavy cost of a fiscal spending in 2011-2015. consolidation package with an overall impact of over 8 per cent on GDP. We thus expect no major changes in policy agenda or style. Eastern European Outlook – March 2011 | 9
  9. 9. Latvia Exports support shaky domestic recovery ƒ Households still under pressure were up by one fourth. Despite continued robust export growth this year, we expect the trade deficit to widen ƒ Continued fiscal tightening again after shrinking dramatically since mid- 2007. The ƒ High but falling unemployment reason is growing imports, driven by manufacturing and a weak recovery in domestic demand. The current account surplus, which narrowed to 3.6 per cent of GDP Last year, Latvia’s economy stabilised after its depres- last year, will shrink further and may turn into a deficit sion-like 21.4 per cent GDP decline during 2008-2009. In as early as the second half of 2011. The surpluses of re- 2010, GDP fell by a further 0.3 per cent but returned to cent years are largely due to losses incurred by foreign growth in year-on-year terms during the third quarter. investment companies, mostly related to the banking In the fourth quarter, growth had reached 3.6 per cent. sector, but lately also reflect a pickup in tourism and The recovery is mainly export driven, though late in the transit trade. However, we do not foresee any 2010 private consumption became livelier and helped build-up of large current account imbalances, which to sustain growth. The performance of the construction was one of the main pre-crisis problems. and financial sectors was weak. Forward-looking indica- GDP and current account tors continued to strengthen last year from low levels, 15 15 with manufacturing taking the lead but with construc- SEB forecast 10 10 tion and consumer confidence remaining historically 5 5 low. 0 0 Leading indicators Net balance -5 -5 20 20 -10 -10 10 10 -15 -15 0 0 -10 -10 -20 -20 -20 -20 -25 -25 -30 -30 00 01 02 03 04 05 06 07 08 09 10 11 12 -40 -40 -50 -50 GDP, year-on-year percentage change Current account, per cent of GDP -60 -60 Source: Central Statistical Bureau, Latvia, SEB -70 -70 -80 -80 After peaking at 20.7 per cent in the first quarter of 94 96 98 00 02 04 06 08 10 2010, unemployment shrank to 17.2 per cent in the Manufacturing sector Consumer confidence fourth quarter. As a consequence of the crisis, there is a Construction sector growing number of long-term unemployed. According to Source: DG Ecfin statistics, nine out of ten job seekers were previously Our assessment is that the turnaround is now on firmer employed. There is a risk that they will lose qualifica- ground, but that the economy, especially this year, is tions in an environment where economic growth is not characterised by duality. Exports continue to perform sufficiently strong to generate enough jobs. This might well, supported by renewed competitiveness and good also sustain emigration. The government can mitigate sales in old as well as new markets. On the other hand, this through training programmes and tax policy, which domestic demand is improving only slowly. Households the IMF has also suggested in its lending agreement. We are under pressure due to continued fiscal tightening, expect unemployment to decline, partly due to supply albeit not as significant as in previous years. Wages are effects, and to average 14.7 per cent in 2012. rising, but purchasing power is being eroded by higher inflation. Unemployment is gradually declining, but After declining for six straight quarters, wages and structural labour market problems and emigration pose salaries rose by 3.4 per cent year-on-year in the fourth risks to the economy and constitute political challeng- quarter of 2010. The biggest increase was in the public es. We expect GDP to grow by 4.0 per cent in 2011 sector, up 5.1 per cent, while in the private sector it and 4.5 per cent in 2012. was only 2.1 per cent. We foresee slowly rising nominal gross wages, but net and real wage growth will be held Strong export growth led to a historically low trade back by tax hikes and higher inflation in 2011. deficit in 2010. Exports rose by one third, while imports 10 | Eastern European Outlook – March 2011
  10. 10. LatviaThe internal devaluation process is thus over. Competi- Budget consolidation continuestiveness has improved, with wages and salaries falling A preliminary estimate shows that the governmentalmost 20 per cent − the largest overall pay cut in the budget deficit in 2010 was 8.2 per cent of GDP. TheBaltic countries. budget for 2011 includes fiscal consolidation of LVL Improved competitiveness 290.7 million, but a further LVL 50 million in belt- 35 135 tightening was presented early this year due to IMF 30 130 demands. These consolidation measures include com- 25 125 bating the shadow economy, levying a tax on non-bank 20 120 credit institutions, trimming salaries and jobs in the 15 115 public administration and raising the gambling tax. 10 110 They also include higher excise taxes on fuel (petrol), 5 105 cigarettes and alcoholic beverages. The reduction in 0 100 the VAT rate on natural gas will be cancelled, which -5 95 may push up electricity charges.-10 90-15 85 The latest addition to the consolidation plan was mainly 00 01 02 03 04 05 06 07 08 09 10 revenue-oriented. Raising taxes might play into the Wages, year-on-year percentage change (LHS) hands of the grey economy. Increased taxes on fuel will Real effective exchange rate, CPI based, index 100 = 2005 (RHS) Source: BIS, Statistics Latvia adversely affect the economy by increasing inflation. International creditors will have to be persuaded ofDeflationary pressure ended last autumn, and inflation the rationality of the plan. They will probably disagreeagain turned positive. In February 2011 it reached 4 per about some parts. The IMF and the EU have alreadycent. Soaring fuel and food prices in global markets and hinted that more should be done on the expenditurechanges in value-added, excise and real estate taxes side. Our assessment is that there will be an agree-are the main inflation drivers. Expected increases in ment in the near term (the IMF/EU-led loan packageelectricity charges in April and taxes in June will add to lasts from December 2008-2011 and will probably beinflation. The inflation rate may thus reach 5 per cent replaced by a traditional stand-by-agreement).in the coming months. Furthermore, inflation expecta-tions have risen. We have lifted this year’s forecast to Where to find the millions for continued budget con-3.3 per cent. For next year we foresee inflation of 2.4 solidation in 2012 remains to be answered. There willper cent. probably be cuts in the social welfare field. Meanwhile, such decisions will be achieved by political compro-In recent months there have been initial signs of recov- mise. Continued tax increases that fuel inflation mightery in the retail trade, after a 34 per cent drop be- threaten Latvia’s ability to meet the Maastricht infla-tween 2007 and 2010. January’s small monthly increase tion criterion and its ambition to join the euro zone inof 0.1 per cent was largely due to a sharp drop in fuel 2014.sales; excluding this, retail sales increased by 4.8 percent. High energy prices partly explain the drop, but In the past year, Latvia’s disciplined budget consolida-it may also be partly due to an increased grey fuel tion, economic recovery and internal devaluation havemarket. helped it to regain the trust of financial markets. There is now solid confidence in the currency peg against theHousehold income will gradually improve, leading to a euro, and there has been no contagion from recentweak upturn in private consumption in the years ahead. euro zone crises. One sign of a more positive view ofThe duality between people with and without jobs, Latvia’s economic situation is that rating agencies havecombined with rising food and energy prices, may af- started to improve their outlook. For example, late lastfect consumption patterns ahead. year Standard & Poor’s raised the country’s sovereignThe banking sector is continuing to recover from the credit rating to BB+. In March S&P revised its outlooklosses incurred during the crisis. The total loss last on Latvia’s ratings from stable to positive. During theyear was 360.7 million lats. In January the banking first half of 2011, when we believe that the latest con-sector reported a profit of LVL 10.9 million. The situa- solidation measures will be approved by internationaltion improved due to a reduction in provisions and the lenders, Latvia may see yet another upgrading of itsrecovery of assets that had been written off, as well sovereign credit rating.as higher net interest income. The banks continued toincrease their share capital. The aggregate bank loanportfolio shrank further. Deleveraging will continue butmay slow by the end of the year. Eastern European Outlook – March 2011 | 11
  11. 11. Lithuania Stronger upturn − labour shortage a hindrance ƒ Domestic demand starting to grow exports of oil products and increased re-exports of used passenger cars. ƒ Some relaxation of fiscal tightening Capital spending was still lamentable last year, after a ƒ Inflation risks are rising 40 per cent drop in 2009. It remained flat throughout the year compared to 2009. Looking ahead, continued Last year, the Lithuanian economy started to recover relatively low capacity utilisation makes only a gradual after its record decline in 2009 and grew by 1.3 per continued upturn in fixed investments likely. The con- cent. First and foremost, the recovery took off thanks struction sector grew by 7 per cent in the second half to stronger external demand. This year we expect a of 2010, mainly due to investments in infrastructure, more balanced picture. Domestic demand shows signs while residential construction stalled. The number of gradual improvement, and exports are continu- of flats built in 2010 was down 61 per cent compared ing to rise due to improved competitiveness and good to 2009. On the other hand, low activity has laid the growth in major export markets. In addition, the most groundwork for recovery in the housing sector, since severe fiscal measures are in the past. We forecast GDP the supply of new residential property has shrunk to a growth of 4 per cent this year and 4.5 per cent in minimum. Some companies are returning to the market 2012. after a break of 2-3 years with the intention of devel- oping large new housing projects. However, there are The beginning of 2010 was quite gloomy, as GDP small positive movements only in Vilnius, the capital, decreased by 2.0 per cent in the first quarter year-on- whereas the market in other cities remains sleepy. year. However, growth picked up to 4.8 per cent in the Housing prices in the five largest cities have remained fourth quarter. The early birds in the business cycle unchanged since touching bottom in June 2010. We were manufacturing and the transport sector, both expect them to rise by 5 per cent this year. closely related to export activity. Meanwhile the retail trade and construction did not show positive results un- Private consumption finally sent encouraging signals at til the third quarter of 2010. Agriculture suffered from the end of 2010. After eight consecutive quarters of unfavourable weather conditions in the summer and, as decline, household consumptions increased by 3.3 per a consequence, a 30 per cent lower cereal harvest. cent year-on-year in the fourth quarter. GDP, retail sales and exports Recent labour market trends add up to favourable Year-on-year percentage change signs in the domestic market. The unemployment rate 30 30 declined to 17.1 per cent in the fourth quarter of 2010 20 20 from its peak of 18.3 per cent two quarters before. The 10 10 number of unemployment benefit claims fell signifi- cantly. On the other hand, the percentage of long-term 0 0 unemployed and young unemployed people is very high. -10 -10 The two latter groups are highly inclined to emigrate, -20 -20 and this is likely to further intensify the outflow of labour. -30 -30 -40 -40 As pointed out in the previous Eastern European Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Outlook, emigration markedly increased in 2010 to 07 08 09 10 GDP Exports Retail sales 40-50,000. The flow barely eased early in 2011, with Source: Statistics Lithuania almost 9,000 emigration declarations in January and Export growth remains impressive, albeit slower, sup- February. What is more, Germany and Austria will open ported by strong demand among major trading part- their labour markets to Lithuanians in May and Switzer- ners and soaring commodity prices. In January, both land in June, while Malta and the UK will ease existing merchandise exports and imports grew by 60 per cent restrictions starting in May. We estimate that 10 per year-on-year in nominal terms. The poor harvest in cent of the labour force has left the country over the Russia and Poland has provided a favourable basis for past decade. However, according to the Labour Force food exports. Furthermore, we expect continued strong Survey, the labour force actually expanded over 2009- 12 | Eastern European Outlook – March 2011
  12. 12. Lithuania2010, possibly due to decreasing inactivity and higher duties required by the EU. In 2010, budget revenueretirement ages. exceeded plan by 9 per cent. Early in 2011, revenue collection fell slightly short of the ambitious target forDespite high unemployment, the labour shortage will the period. In 2011, the government aims to reduce thebecome increasingly acute and will hamper recovery, public sector deficit to 5.8 per cent of GDP, helped byparticularly in transportation, IT, shipbuilding, textiles more buoyant economic growth and lower demand forand food processing. On the other hand, remittances unemployment benefits. We think this target is realis-from emigrants continue to play an increasing role in tic. In 2012, the possibility of more relaxed fiscal disci-household finances. In 2010, official remittances in- pline before the October parliamentary election cannotcreased by 43 per cent. This made up as much as 24 per be ruled out. This threatens the government’s ambitioncent of total wages and salaries in Lithuania. to keep the deficit within the Maastricht maximum (3 Wages and unemployment per cent of GDP), which is necessary ahead of planned 25 25 euro zone membership in 2014. Overly high inflation 20 20 may also threaten this timetable. 15 15 General government consolidated debt has been at a 10 10 relatively low level in international terms, increasing to 38.7 per cent of GDP at the end of 2010. This debt will 5 5 increase, albeit at a much slower pace than in recent 0 0 years. It will reach 41 per cent of GDP at the end of -5 -5 2011, below Maastricht’s 60 per cent limit.-10 -10 Public deficit and debt Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Percentage of GDP 07 08 09 10 50 SEB 0 Wages (year-on-year percentage change) 45 forecast -1 Unemployment (per cent) Source: Statistics Lithuania 40 -2 35 -3Consolidation of wages and salaries has already come to 30 -4an end, as we projected in the last EEO. In the fourth 25 -5 -6quarter of 2010 wages and salaries grew by 0.2 per 20 15 -7cent on an annual basis, for the first time in almost two 10 -8years. Public sector pay in 2011 was frozen according -9 5to the government’s decision. Nevertheless wages and 0 -10salaries will continue to grow this year, primarily in 00 01 02 03 04 05 06 07 08 09 10 11 12exporting industries. We forecast that pay increases in General government consolidated debt (LHS)nominal terms will total 3.5 per cent at the end of 2011 Public sector deficit (RHS) Source: Eurostat, SEBand 5.0 per cent at the end of 2012. Despite its low popularity in opinion polls after mak-Due to increasing inflation, real household income will ing painful fiscal decisions, the ruling coalition man-continue to rise very slowly or even shrink in 2011. aged to score rather good results in the February 2011The risk of a wage-price spiral is increasing and would local elections. Prime Minister Andrius Kubilius’ party,be very harmful to the consumption recovery in the the Homeland Union-Lithuanian Christian Democratscurrent cyclical phase. Despite meagre income growth, got 16 per cent of the total seats in municipal councilswe expect consumption to grow by 3 per cent in 2011. throughout the country. This represented second placeIncreased confidence will lead to lower savings among after their main rival, the Lithuanian Social Democratichouseholds. Credit growth is only expected to return Party, which won 22 per cent of the total seats. Thegradually. election results eased some of the political pressure on the ruling coalition. Nonetheless, there is still aAfter a brief deflationary period early in 2010, inflation way to go until the parliamentary election. We expectpicked up last autumn due to higher global food and more opposition parties to become increasingly active,energy prices. In 2010, the average annual HICP infla- especially when budget discussions start in the autumntion rate stood at 1.2 per cent. We expect it to increase of 2011. Despite the possibility of increased clashes into an average of 3.5 per cent in 2011 and 4.0 per cent parliament, our main scenario is that the current rulingin 2012. coalition will remain in power until the election.Fiscal tightening in 2011 has softened a bit compared to2009-2010. The expenditure side remains under strictcontrol, including a pay freeze for public servants anda backup plan for additional cuts if the budget outcomeis worse than planned. However, there were no bigchanges in taxation, except increases in some excise Eastern European Outlook – March 2011 | 13
  13. 13. Poland Continued good growth despite imbalances ƒ Budget deficits and inflation worrisome closely. Poland seems to lack underlying problems of deteriorating competitiveness. Although imports have ƒ New austernity after election also recovered, net exports will contribute positively to ƒ Higher key interest rate, stronger zloty GDP growth over the next couple of years. The current account − negative for a decade − reached about -5 per cent of GDP before the crisis. Since imports fell more Poland, the only EU country to show positive growth all than exports during the crisis, the balance improved through the crisis, will continue to perform well. Last sharply, but rising commodity prices and other factors year ended strongly, with annual GDP growth of nearly will push the deficit back above 4 per cent in 2012. 4.5 per cent in the fourth quarter. We expect contin- ued good growth. GDP will rise 4.5 per cent in 2011 Zlotyn gaining strength Index 100 = 2005 and EUR/PLN and 4.6 per cent in 2012. Although small declines to 5.00 80 regain, the economy will grow rapidly. Several factors 4.75 85 support a positive trend ahead. Confidence indicators 90 4.50 are at good levels, and capital spending is expected 95 4.25 to take off. Exports are rising even though the zloty 100 4.00 has strengthened. Household consumption will keep 105 3.75 growing, though more slowly than before the crisis. The 110 main sources of worry are inflation and large public sec- 3.50 115 tor deficits. Deficits widened because of fiscal stimulus 3.25 120 during the crisis; further tightening is expected after 3.00 125 00 01 02 03 04 05 06 07 08 09 10 this autumn’s parliamentary election. In recent months, inflation has exceeded the central bank’s upper limit. EUR/PLN (LHS) Real effective exchange rate, inverted (RHS) Source: Reuters EcoWin, BIS Economic growth expectations levelled out last year, according to the European Commission’s survey. Other To maintain good growth, it is important for capital indicators show continued improvement. Although the spending to take off. After two years of decline, invest- purchasing managers’ index for manufacturing fell to ments are now expected to rise, supported by several 53.8 in February from 55.6 in January, manufacturing, factors. Capacity utilisation remains below pre-crisis construction and service companies remain optimistic. levels, but not far below historical averages. In addi- tion, real interest remains low, capital spending, as a EU sentiment survey supports higher growth percentage of GDP, is historically and internationally Index 100 = historical average, percentage change 120 8 low and the credit stock, as a percentage of GDP, is at 115 7 a relatively modest level. In spite of public deficits, 6 110 public investments will be sustained by EU funds and by 105 5 100 4 preparations for the European football championship, 95 3 which Poland and Ukraine are co-organising in 2012. 2 90 1 85 0 Household consumption was kept going throughout the 80 -1 crisis. The rate of pay increases admittedly slowed, but 75 -2 70 -3 Poland did not undergo the same real wage squeeze as 65 -4 many other countries in the region. A low debt level Q4 Q2 Q4 Q2 Q4 Q2 Q4 Q2 made public sector stimulus possible. In recent months, 06 07 08 09 10 Euro zone (LHS) GDP, Poland (RHS) wage and salary growth has accelerated, although Poland (LHS) we expect a more moderate pace ahead, due among Source: DG Ecfin, Statistics Poland other things to a public sector pay freeze. The savings Industrial production is showing pre-crisis growth rates, ratio has fallen, which is a source of some concern and with indicators signalling continued expansion. Ex- household borrowing is expected to increase slower ports benefited from the weak zloty but appear set to than pre-crisis. continue performing well even though the currency has regained about half its decline. Real effective exchange During the crisis, unemployment rose from a low of 6.9 rate and the EUR/PLN rate are tracking each other per cent late in 2008 (according to the harmonised EU 14 | Eastern European Outlook – March 2011
  14. 14. Polandmeasure) to nearly 10 per cent in early 2010 and has government has launched a moderate four-year belt-remained relatively unchanged since then. We expect tightening programme based on a VAT increase, slightlyjoblessness to fall slowly to 9.4 per cent in 2011 and 8.9 lower spending (a public sector pay freeze and ceil-per cent in 2012 as annual averages. The rate will be ings on spending increases) and changes in the pensionaffected more than normally by developments in West- system. One concern is the absence of major spendingern Europe; poor growth in countries where Poles have adjustments; the changes in the pension system arepreviously sought work, such as the UK and Ireland, is also based on accounting technicalities; different typescausing more people to return home. This will boost the of provisions have different effects on net lending ac-labour supply and slow the decline in unemployment. cording to EU rules. Smaller provisions will be made to the non-public part of the system and more will remainHICP inflation, rose unexpectedly fast to 3.5 per cent in in the public sector. This change will improve public fi-January. The national CPI measure rose to 3.8 per cent, nances in the short term but instead increase long-termabove the central bank target of 2.5 ± 1 per cent. This government pension expenditures.increase is largely due to rising food and energy pricesand a 1 per cent VAT hike. Core HICP in January was 1.1per cent and is expected to increase this year and next Poland’s debt ceilingto 2 per cent. Inflation expectations have turned out Fiscal rules specify the imposition of certain limitsto follow the CPI relatively well, and the rate of pay when government debt exceeds 50, 55 and 60 perincreases rose late in 2010. Although we expect infla- cent of GDP, the latter is written into the constitu-tion to start falling during this year, we are revising our tion; Poland’s debt measure diverges slightly from theinflation forecast to 3.7 per cent in 2011 and 2.8 per Maastricht definition and is about a percentage pointcent 2012. lower. When debt reaches 50 per cent of GDP, the gov- ernment must budget for a lower deficit in the second Rising prices Year-on-year percentage change year after this occurs. When debt surpasses 55 per6 6 cent, the government must present a plan for achiev- ing lower debt in the second year after this occurs.5 5 Finally, if debt exceeds 60 per cent, the government4 4 must balance the budget the year after this level was3 3 reached; if this is achieved, the debt ratio will fall as long as nominal GDP increases.2 21 1 Keeping growth up during the crisis slowed the increase in the debt ratio. Continued good growth is necessary0 0 02 03 04 05 06 07 08 09 10 11 to prevent government debt from exceeding further debt limits. Our assessment is that the government HICP Core HICP needs to implement further belt-tightening to reach Inflation expectations, next 12 months a deficit below 3 per cent of GDP by 2012. This would Source: Eurostat, Central Statistics Office, Poland enable Poland to join the euro zone as early as 2014.Inflation will stay above the central bank’s target this The government seems to be aiming at 2015, but ityear and then fall to 2.5-3.0 per cent when food prices might be delayed further. Because of the October 2011are normalised, the effect of the VAT hike disappears parliamentary election, the government (Civic Platformand due to effects of interest hikes and the stronger and Peasants’ Party) is unlikely to implement furtherzloty. Further tightening of fiscal policy may make it measures before then. Our assessment is that theeasier for the central bank to keep inflation down. It reform agenda will be speeded up after the electionwill hike its key rate gradually to 4.50 per cent by the though. Meanwhile we do not believe that Poland risksend of 2011 and to 5.25 per cent by the end of 2012. borrowing problems, despite 10-year bond yields aboveThe zloty has regained half of its decline during the 6 per cent. Public debt is relatively low, the country hascrisis and should strengthen further; we remain positive an IMF credit facility and much of its debt is domesti-towards the zloty in the long term. Because of good cally financed. Overall, we expect the deficit to fall ineconomic growth over the next couple of years and key the next couple of years, with debt stabilising at aroundrate hikes, although structural reforms are conspicu- 55 per cent of GDP due to solid growth and further pri-ously absent and public financial problems are being vatisations. Short term strategies to reduce the deficittackled in short-sighted ways, there is room for further (pension reform) makes us believe that further short-currency appreciation ahead. term measures will be taken if the 55 per cent level is further threatened, such as redefining debt limits in theAn expansionary fiscal policy sustained demand during debt-rule.the crisis; the aftermath is that the public deficit hasrisen sharply to nearly 8 per cent of GDP in 2010. Thegovernment debt ratio came in just below the 55 percent limit according to national debt rules (see box).To avoid breaching further levels under these rules, the Eastern European Outlook – March 2011 | 15