The Vienna Institute for International Economic Studies (wiiw) has for third time in a row this year has raised its growth forecast for 2021 in the EEC as the region continues to rebounding from the COVID-19 pandemic.

In his fall forecast, the wiiw has raised its growth forecast for 2021 in the 23 countries of the central, southern and eastern European region by 1.2 percentage points from its July forecast to 5.4%.

This means that in 2021, the CESEE region is expected to grow significantly faster than the euro area (of which it forecasts 4.8% growth). In addition, for two-thirds of CEECs, the pre-crisis level of 2019 was already exceeded in the second quarter.

“We are seeing a much stronger and better recovery than we expected,” Richard Grievesen, deputy manager, said on a webcast to announce the forecast on Oct. 20.

Grievesen said 2022 would be a “much more mixed picture” with a “slight slowdown in growth” to an average of 3.7%, caused by base effects, monetary tightening and larger external headwinds.

In 2023, growth is expected to slow further to 3.5%. Convergence with Western Europe, which has slowed since the global financial crisis, will continue “but at a slower pace,” Grievesen said.

However, the wiiw also pointed out that downside risks have increased, highlighting a severe worsening of the COVID-19 pandemic, hasty fiscal consolidation and an upcoming slowdown in US monetary policy.

Grievesen said the main reason for the upgrade was that in Central and Eastern Europe, “governments have given up on trying to curb the pandemic,” and restrictions are now much looser than in Western Europe, where the The hard-hit service sector is a bigger part of the economy anyway. As the fourth wave of the pandemic sweeps through the region, Latvia is to date the only country to have re-established containment.

The strongest growth in 2021 is expected in Turkey (9.1%), Montenegro (8.4%) and Moldova (8%), with the weakest in Belarus affected by the crisis at 2.5%. The most significant revisions concerned Estonian (up 3.6 pp) and Turkish (up 3.3 pp) growth. The only degradations concern Macedonia (-0.6 pp to 3.5%) and Ukraine (0.5 pp to 3.8%).

In 2022, the strongest growth is forecast for Croatia (5%) and Poland (4.9%), as well as Montenegro and Kosovo (4.8%).

For Russia, after growing 4% this year, Wiiw forecasts 3% in 2022 and 2.8% in 2023. Grieveson was bearish on Russia’s long-term growth, which he attributes to the poor business environment and the government’s restrictive fiscal policy, which was motivated by the desire not to go into debt to Western creditors.

“Stability takes precedence over growth, “he said.” Over the past five years, Russia has been more or less the slowest growing economy in the region, “he noted.” He will come back to this weak performance in the next years. “

Looking at the whole region, the wiiw says the main driver of growth is private consumption. With an average growth of 14.5%, it developed massively in the second quarter. Investment has also increased by almost 18%, on average, during this period. Exports are also recovering sharply thanks to the global recovery and the tourism recovery.

On the downside, industrial production suffers from shortages of materials (for example semiconductors in the automotive industry), as well as rising commodity and energy prices, much of which is currently absorbed by businesses and not passed on to consumers.

Employment is once again approaching pre-crisis levels in many countries, and Croatia, Latvia, Hungary, Poland and Slovenia have already reached or exceeded this level.

However, according to the wiiw report, the coronavirus (COVID-19) crisis has left scars on labor markets, with higher underemployment than before the pandemic, and unemployment remains a problem in many countries, especially in the Western Balkans.

At the same time, there are labor shortages in some countries, notably EU member states in the region, but also in Montenegro, Serbia and Russia.

“Labor shortages are back,” Grievesen said, stressing that the Czech Republic once again had the worst problems in this regard. “We were surprised at how quickly the subject of labor shortages returned,” he said, noting that the fundamental problems of low birth rates and labor migration work towards Western Europe because of the income gaps are still present. “These labor market problems will persist.

For the future, the wiiw predicts that the transfers of the EU recovery and resilience facility (RRF) will be an important engine of growth. The EU RRF will be particularly important, for example in Romania, where program transfers – worth a total of around € 29 billion – could in theory generate additional annual growth of up to 3.1 percentage points through 2026.

“In reality, however, the economic effect of the reconstruction fund will be significantly weaker,” predicts Vasily Astrov, senior economist. “On the one hand, because the region’s economies cannot fully absorb the money, and on the other hand, because EU transfers will partly replace the financing of investment projects from national budgets. .

Rising inflation is already becoming a challenge for policymakers, with inflation rates 3 to 4 percentage points higher than at the start of the year, but wiiw argues that it will be probably a transient phenomenon.

His views contrast with those of Capital Economics in the UK, which published a research note last week affirming that Central and Eastern Europe is one of the regions of the world where the risk of persistently higher inflation over the next few years is greatest. “The combination of a cyclical recovery in demand for labor and structural labor shortages will contribute to stronger wage growth and keep inflation above central bank targets,” said Capital Economics.

Faced with rising inflation, many central banks have already responded by raising interest rates, and further interest rate measures are expected to follow. This has already led governments to criticize central banks, especially in Czechia and Hungary. Nonetheless, real interest rates continue to fall, given the rise in inflation.

“Central banks are following the Fed / ECB narrative that this is a transitional situation very closely,” Grievesen said, adding that there was “not much evidence of overheating at the aggregate level. , except in the real estate markets “.

In the Czech Republic and Lithuania, real estate prices have increased by 16% and 15% respectively since the start of the pandemic, and still show an upward trend.

‘This [central bank tightening] The overheated, predominantly credit-financed real estate markets are also expected to cool in many places, some of which are showing signs of bubble formation, ”says Astrov.

However, there is a risk that a further tightening of monetary policy in export-dependent Central European countries, such as the Czech Republic, could increase the value of currencies and weaken the competitiveness of exports against the euro area. , especially since the ECB’s monetary policy is likely to remain ultra-expansive, Astrov said.

Grievesen said shortages of key components and rising commodity prices, along with labor shortages and a potential deterioration in U.S.-China trade relations, could drive inflation up. . “This could lead to inflation which leads to monetary tightening which kills the recovery and causes financial instability,” he warned.

He also warned of premature fiscal tightening. The fiscal response to the COVID-19 pandemic had been “pretty good,” he argued, although budget deficits across the region swelled to an average of 6.3 percent of GDP in 2020 and around 4.5% this year. A premature cut in public spending could jeopardize the recovery in a number of countries, in particular in the Western Balkans and the successor states of the Soviet Union.

Another risk was that weakening monetary policy in the United States could dampen the recovery, making dollar financing more expensive. Grievesen said Turkey was most at risk of a hard landing here, followed by Romania. Turkey, the second largest economy covered by Wiiw, is already expected to grow from 9.1% growth this year to 3.8% in 2022 and 2023.

“But the region during this time will feel the impact [of Fed rate rises], mainly in terms of borrowing costs, ”he said.