Emerging Europe economic outlook: Growth to stay well ahead of EU average

Macro-economic analysis by Stefan Stoyanov, Head of Global M&A Database, EMIS

The countries in emerging Europe have enjoyed some of the highest GDP growth rates in Europe throughout 2018 and 2019. Despite macro-economic indicators being less impressive in 2020 and afterwards, the markets in the region are likely to remain the growth leaders on the continent.

Short-term outlook of key indicators

The gloomy sentiment among manufacturing companies in the eurozone has spilled over to emerging Europe, as the region is highly dependent on demand from its western trading partners, especially Germany. Manufacturing is suffering due to trade tensions and growing protectionism, and further factors such as strict new EU emission regulations and high levels of car market saturation. On the other hand, healthy domestic demand, underpinned by a strong labour market with rising wages, has continued to support growth. Further resilience can be seen in the services sector, especially finance and IT, as well as in e-commerce.

In its latest economic forecast published in November 2019, the European Commission points out that while the EU and the eurozone will grow by a mere 1.4% and 1.2% respectively each year from 2019 to 2021 (Table 1), Hungary will impress with a GDP growth rate of 4.6% in 2019. Romania and Poland would grow by 4.1% each in 2019 and will be the only countries in the CEE CEE includes Poland, Hungary, the Czech Republic, Slovakia, Slovenia, Romania, Bulgaria, Croatia, Lithuania, Latvia, and Estonia. maintaining a growth rate above 3% until 2021. Indeed, from 2020 onwards a visible slowdown is expected in the region, which will grow by 2.7% on average in 2020 and 2021 according to the European Commission’s forecasts. The lowest growth rate is expected in the Czech Republic (2.2% in 2020 and 2.1% in 2021).

Focus Economics, a provider of global economic analysis and forecasts, points to global uncertainties, the slowdown in the Euro Area, and growing supply constraints as the main reasons for a slow-down in the region. Further, moderating construction activity and EU funding inflows will likely put a brake on fixed investment growth.

The labour market in emerging Europe remains stable with the unemployment rate seen maintaining its slightly improving trend and eventually reaching 4.7% in 2021 from 5.3% in 2018 (Table 2). Although ticking up by a basis point each year from 2019 onwards, the Czech Republic remains the country with the lowest unemployment forecast at 2.3% in 2021. At the other end of the spectrum are Euro Area members like Slovakia and the Baltic countries, where the unemployment rate will remain higher at 5-6% and above in the next three years. Wage increases support household disposable income. For example, in Poland further positive factors are certain tax and benefit measures, which contribute to increased private consumption. However, most economies in the region already face labour shortages and are set to compete for cheap labour particularly against Ukraine.
In terms of inflation, the expected developments are subdued, with consumer price growth slowing to 2.3% in 2020 and 2021 each from 2.5% in 2019. The highest inflation rates are expected in Hungary and Poland, with both figures above 3.0%.

Long-term GDP growth forecast for the larger economies

With Poland among the largest markets in the region, it has proved quite resilient in facing international headwinds. Further, because the country is less dependent on foreign trade, it is better suited to absorb potential trade shocks. Focus Economics forecasts a long-term average annual growth rate in Poland of 2.8% between 2022 and 2024.

Hungary stands out as another resilient CEE economy, especially regarding the manufacturing sector. The long-term GDP growth rate forecast is set at 2.5% during 2022–2024 in line with the expected regional easing due to weakness in key trading partners, reduced absorption of EU funds, and slower job creation.
Another larger market is Romania, which will grow at levels similar to Hungary in 2022–2024, that is 2.8% average annual growth rate according to Focus Economics. While the EU Commission expects recovery in investments and robust growth in 2020, Romanian net exports are projected to weigh on growth and the current account deficit will likely widen.

The Czech Republic is set to follow the same slow-down pattern as its regional peers. However, given its relatively low debt-to-GDP ratio (32.6%) and relatively high interest rate (2%), it might be better positioned to cope with a potential crisis, as the authorities have room to lower rates and provide significant fiscal support. According to Focus Economics, the long-term average annual growth rate of the Czech Republic will be 2.3% during 2022–2024. Brexit and the uncertainties around the process are probably going to hamper investment decisions regarding markets in the CEE region. In addition, shifts in the trading relationships between the UK and CEE countries should be expected, as the UK used to be a major trading partner. For example, the UK has traditionally been Poland’s second-biggest trading partner, but recently the Czech Republic has taken that spot. Overall, Brexit means that a net contributor to the EU budget is leaving, which would happen at the expense of CEE countries which are generally net recipients.

Economic development and M&A activity

A slowdown in economic growth will not necessarily result in a depressed M&A deal flow; in fact, the lowering of valuations and the increase in distressed situations may lead to new opportunities for investors. As the region will outperform its trading partners in western Europe in terms of economic growth and will experience a growing consumer demand as a result of increased salaries, companies with strong domestic brands and quality products will remain targets of interest for both strategic and financial investors.

Table 1: European Commission’s Real GDP Growth Rate Forecasts, %

Table 2: European Commission’s Unemployment Rate Forecasts, %