CEE growth under pressure, COVID impact uneven so far...
Government lockdowns have started to weigh on the regional economies in Central and Eastern Europe (CEE). In the first quarter of 2020, real GDP growth turned negative in several countries. The Slovakian and Czech economies were the most severely hit (figure CEE1). Compared to the last quarter of 2019, real GDP was 5.5% lower in the first quarter of 2020 in Slovakia and 3.3% lower in the Czech Republic. This contrasts with the relatively mild hit to the Hungarian and Polish economies (both -0.4% qoq). But the contrast with Bulgaria and Romania was even bigger, as in these countries the economy continued to grow in the first quarter.
We believe that a large part of the difference was driven by the timing of the more drastic lockdown measures, which in particular in the Czech Republic came very early. The country was fast in closing the borders, restaurants and shops and in ultimately deciding on a universal quarantine. This resulted in a more significant hit to business and consumer spending in the first quarter. It was most visible in investments. Czech investments “fell off the cliff” (by almost 10% qoq in the first quarter of 2020), while Polish and Hungarian investments declined only marginally (less than 1% qoq). Czech foreign trade also suffered more due to the earlier border closures and its more significant exposure to European markets (especially compared to Poland). As a result, both the decline in real imports and exports was faster relative to Poland and Hungary.
Looking ahead, there are not many reasons why the Czech economy should significantly underperform the region in the second quarter. The earlier adoption of lockdown measures in Czech Republic also led to an earlier relaxation. Besides that, the usual argument that the most vulnerable economies are the small and open economies (such as the Czech Republic), does not seem so evident this time, at least not during the first phase of the economic crisis driven by the lockdowns. As our input-output simulations show, the Covid-19 lockdowns have the most dramatic impact on several service sectors, such as trade, accommodation, food services, real estate or transport. The direct hit to industry or construction should be smaller, at least in the first phase of the economic crisis. As a result of that and of the earlier easing of the lockdown measures, we believe the Czech economy could slightly outperform the region in the second quarter of 2020. Nevertheless, this call must be confirmed by the monthly data.
For now, the available industrial data for April point to misery across the region, with industrial production in April down from March between 13% (Bulgaria) to around 33% (Hungary, Slovakia and Romania) (figure CEE2). Furthermore, we are afraid that open industrial economies can face a more problematic recovery than bigger economies, such as Poland. Indeed, after the easing of the lockdown measures, second-round negative shocks to demand may weigh on the European economy. Open economies, such as the Czech Republic and Slovakia, might be more vulnerable to this. Additionally, the negative outlook for the car industry may be a more significant burden for both economies. As a result, the ultimate GDP loss over the years 2020 and 2021 is expected to be higher in the Czech Republic and Slovakia than in the rest of region.
Regional food-price inflation has probably peaked
Inflation figures for May showed that inflation pressures in Central European countries have been easing. If we discount an unexpected increase of tobacco prices in the Czech Republic, regional headline inflation actually fell across the board last month despite a significant depreciation of all CEE currencies. This confirms our view that the negative demand shock of the Covid-19 crisis will outweigh the supply shock, while exchange rate volatility will not be reflected in upcoming inflation figures. In this respect, monetary policies of regional central banks have been relaxed in a correct way.
For future inflation developments in Central Europe, the behaviour of food prices will be a key factor. In recent years food prices have had a strong pro-inflationary influence (figure CEE3). In the past, food price inflation has been supported by several positive factors. These factors might start to fade away now. One was clearly strong regional wage growth, which will definitely be more muted in the future. Second, there has been strong food-price pressures coming from a regional price-setter, Germany. This trend will probably change in the second half of the year, especially if we take into account Germany’s planned VAT rate cut. Last but not least, the whole CE region had been experiencing a severe drought up to April. This has also changed since May (there were even floods in the Czech Republic), which might imply a better-than-expected crop which will translate into lower prices for some food items.
Box CEE1: Exposure to tourism in the CEE region
While the adverse impact of Covid-19 is felt in almost all sectors, international tourism is hit particularly hard as a result of lockdown measures, widespread travel restrictions and shutdowns of airports and national borders. According to the United Nations World Tourism Organisation (UNWTO), tourist arrivals in Europe collapsed by 60% yoy in March (latest available data). On top of that, the scope for recovery remains relatively limited compared to other sectors. This is due to the ongoing social-distancing policies, lingering Covid-19 fears and the drop in disposable income. Hence, even in the most optimistic scenario, the UNWTO assumes a decline of 58% to 78% yoy in international tourist arrivals globally in 2020.
Exposure to tourism varies greatly across Central and Eastern Europe. The share of the tourism sector in GDP is the highest in Bulgaria where it accounts for 12%, followed by Hungary with 7%. Other regional economies are significantly less dependent on tourist arrivals; in the Czech Republic and Romania, tourism makes up 3% of GDP, while in Slovakia and Poland, the contribution is only 2% and 1% of GDP, respectively. The share of tourism in total employment follows the same pattern. Moreover, the sector is characterized by a relatively high prevalence of temporary contracts and small and medium-sized enterprises, both reinforcing vulnerabilities to the coronavirus-shock. Overall, these factors risk undermining the economic recovery, which is the case particularly in Bulgaria and to a lesser extent also in Hungary.
Since tourism is highly seasonal, most Central and Eastern European economies are making a substantial effort to revive the sector with the start of the summer season. Following the gradual easing of containment measures, governments are now focusing on boosting domestic tourism. For instance, both the Czech Republic and Hungary are discussing government-subsidised vouchers to encourage domestic travel. Still, such measures are unlikely to fully compensate for the loss of foreign visitors, which will leave some regional economies, in particular Bulgaria, with considerable excess of capacity (Figure BCEE1).