A historic collapse of economic activity in the CEE region in Q2 2020…
Following a broader trend in the European Union, the Central and Eastern European region saw a sharp contraction in economic activity in the second quarter of 2020. There are two ways of looking at the fresh regional GDP readings. The more pessimistic one is to emphasise the size of the economic contraction, which was historic and, in many countries, so far unseen. Owing to unprecedented lockdown policies due to the Covid-19 pandemic, the consequential loss of real GDP in the second quarter has pushed economies across the region back several years. The most pronounced fall-back was in the case of Slovakia, with GDP now at its Q3 2014 level, while Poland appears more resilient, with GDP falling back to the Q3 2017 level.
The more optimistic way of looking at the new figures is that the worst – in terms of the steep fall in real GDP – is behind us. Across the region, sentiment indicators as well as high-frequency data, such as industrial production and retails sales, suggest a rebound in economic activity starting as early as May and progressing further in the following months. Still, the recovery is subject to numerous risks and its trajectory remains highly uncertain, in particular, due to the resurgence of the virus. This is particularly the case for Czechia and Hungary, which have both seen a flare-up in the number of new Covid-19 cases over the summer months.
A synchronised, yet heterogenous plunge in activity across the region
While the collapse in real GDP was broad-based in the region, there was notable heterogeneity related to the size of the economic contractions. Hungary, traditionally a regional growth champion, has come out as a surprising underperformer, seeing real GDP shrink by 14.5% qoq in Q2 2020 (figure CEE1).
Part of the explanation is the timing; the Hungarian economy held up relatively well in the first quarter as the major shock was concentrated in the second quarter. Still, this is hardly the full story, since by looking at the cumulative H1 2020 real GDP loss, Hungary is indeed still underperforming, lagging well behind its regional peers (Figure CEE2).
Looking at the breakdown of the Q2 real GDP figure, the major driver behind the unparalleled economic downturn in Hungary was the external performance, while household consumption held up surprisingly well, supported by strong pent-up demand. A positive contribution to growth came from government spending amid robust fiscal stimulus. Meanwhile, the explanation for plummeting exports is twofold. First, the Hungarian economy has been exposed to the sudden stop in tourism, accounting for some 7% of GDP, triggering a collapse in foreign arrivals in the second quarter. Second, the deeper-than-expected recession is attributed to a sharp fall in industrial output, specifically manufacturing, which suffered from factory shutdowns and supply chain disruptions. Importantly, Hungary has also seen a more gradual recovery in manufacturing compared to other CEE economies.
The plunge in manufacturing, in particular in the automotive sector, was also a prominent factor behind the real GDP prints in Czechia and Slovakia, which posted declines of 8.7% qoq and 8.3% qoq, respectively. Following real GDP contractions in the first quarter, Czechia saw its largest fall in activity since its establishment in 1993, while for Slovakia it was the largest quarterly fall since 2009. Like in Hungary, the external performance was a major drag on growth, but a rapid downswing was also seen across the demand components, i.e. private consumption and investments. The important exception was again government spending that partly mitigated the size of the economic dip. This was due to the easing of fiscal policy, and most importantly short-term working schemes that have so far limited the major negative spill-over effects of the pandemic to the labour market.
To further add to the cross-country differences in the CEE region, Poland and Bulgaria both experienced the least pronounced cumulative contractions in H1 2020, outperforming their regional peers. In the second quarter alone, the Polish economy declined by 8.9% qoq, while the Bulgarian economy shrank by 10% qoq. The stringent lockdown measures in Poland had a major negative impact on household consumption which was even more severe than monthly retail trade data suggested. Luckily, the pent-up demand materialised somewhat already in May and June, partly compensating for the April shock. Importantly, the substantial fiscal stimulus (supported by NBP’s massive government bond purchases), in particular focusing on the stabilisation of the labour market, led to a ramp-up in government spending. Finally, a large internal market and generally less exposure to foreign trade helped insulate the Polish economy from broader weakness abroad, eliminating the negative contribution to growth from the external sector. Somewhat surprisingly, the trade balance and the current account have both even reached all-time high surpluses in June.
While Bulgaria’s economic decline came marginally short of its largest drop in real GDP on record (which was during the currency crisis of 1997), in the European as well as the specific CEE context, the economy fared relatively well. The composition of second-quarter real GDP indicates a fall across all demand components, with the most pronounced drop experienced by the external sector. The sector was adversely influenced by both supply chain disruptions and an unparalleled plunge in international arrivals. Still, acknowledging that Bulgaria is the most exposed to international tourism (accounting for some 12% of GDP) in the CEE region, the weak summer season is yet to fully weigh on growth in the third quarter.
… was followed by rapid industrial recovery this summer…
After a massive slump in March and April, industry in the CEE region began to stabilize rather quickly. Since May, production has been steadily growing, step by step approaching the February (pre-corona) level. The latest figures clearly confirm the trend. In July, industrial output remained only three percentage points below the starting level in Poland, while the gap was only marginally higher (four percentage points) in Czechia. Slovak and Hungarian industry, in contrast, still stayed about a tenth below its February level.
The automotive sector, which plays a particularly important role in Czechia, Slovakia and Hungary, assisted significantly to the restart of industrial production in the CEE region. The end of factory shutdowns allowed car manufacturers to raise production by completion of old orders even though demand for passenger cars remains subdued worldwide. At the same time, though, persistent weak demand for cars along with negative investment outlook constitute risk factors that will adversely affect future performance of regional engineering.
In the upcoming months, though, mainly positive news should come from the industrial sector. Except for Bulgaria and Poland, a recent DG ECFIN survey signalled another significant increase in regional new orders. It is true, however, that while rising orders tend to improve overall industrial sentiment, they may not necessarily change the currently prudent attitude of industrial companies toward employment. Although companies´ readiness to fire employees appears to be much weaker now than it was at the peak of the recession, it is still significantly higher than it was before the coronavirus crisis.
… but sentiment data suggest heterogenous recovery in the autumn
The latest sentiment data from the CEE region reveal that optimism is highest among retail traders, which contrasts to a distinctly pessimistic outlook of consumers. The construction sector belongs among those with the largest share of skeptical responses. A less pronounced but also negative outlook dominates among respondents in industry and services. All in all, the CEE sentiment figures suggest that despite the recent recovery, CEE economies still haven’t made it out of the woods.
As for industry, Poland was the most pessimistic among the compared countries with the difference between negative and positive verdicts exceeding 20 percentage points in August. In Slovakia, on the opposite side, the share of negative and positive responses nearly matched.
In construction, the balance of confidence remains below that measured in industry in all countries compared. Slovakia appears to be the most pessimistic country (40 points difference), but even in the most optimistic country, Czechia, the share of negative responses outnumbers the share of positive outlooks by more than 10 points.
The Czech managers are least pessimistic in the service sector, too, with the share of positive answers very close to the share of negative responses. All other countries, except for Slovakia, show the difference between negative and positive answers at 20 percentage points or more, which may indicate a complicated recovery of the service sector in large parts of the CEE region.
Not surprisingly, retail trade prospects look better than the outlook for services. The country balances oscillate between -11 points in Poland and +15 points in Czechia. Massive government support obviously helped stabilize household revenues and spending.
Slower wage growth and weaker state assistance, though, may pull retailers´ expectations down relatively soon. This worry seems to be supported by distinctly less optimistic consumer confidence surveys. In Slovakia, the gap between the outcome of the retail survey and the consumer survey amounts to nearly 35 percentage points. In Czechia, Bulgaria and Romania, the gap is about 25 points. Only in Poland do the share of (prevailing) negative responses of retailers matches that of consumers.
Economic Outlook: gradual recovery, but continued regional differences
Taking into account the latest Q2 GDP growth figures for the region, we maintain our GDP growth forecasts for the region (see table at the end of the publication). Our forecasts reflect a recovery path generally similar to the one we expect in the euro area. Hence substantially negative annual GDP growth in 2020 will be partly compensated by high growth in 2021. However, in line with recent economic developments, we expect this year’s contraction and next year’s recovery to be heterogeneous across the region. At the same time, it remains likely that this outlook needs to be updated, in particular as various governments may increase their fiscal stimulus to cope with this unprecedented crisis. Uncertainty will therefore remain and important facet of the regional outlook.