150629 emerging europe quarterly

Group Economics Emerging Markets

Emerging Europe outlook

Peter de Bruin +31 20 343 5619 peter.de.bruin@nl.abnamro.com

As divergent as ever

29 June 2015 

Regional growth contracted in first quarter of the year, but this masks strong differences within the region



Although Russia and Ukraine are in a deep recession, Eastern European economies are booming



Meanwhile, in Turkey, growth has eased due to uncertainty surrounding the elections and tight monetary policy

First contraction since the global financial crisis…

The economies in emerging Europe as a whole shrank by 0.6% yoy in the first quarter of this year, according to our estimates. This marked the first contraction since the global financial crisis. However, it is important to note that this rather dire economic backdrop masks significant differences within the region. Not surprisingly, Russia and Ukraine are on one side of the spectrum. In Russia, significantly higher inflation has dented household and firms’ purchasing power. This is the result of the past fall in the ruble that in turn was sparked by the sharp drop in oil prices at the end of last year. As a result, GDP declined by 2.2% yoy in Q1, following a modest expansion of 0.4% in the final quarter of last year. What is more, incoming data are suggesting that the recession deepened, and a contraction of around 6% yoy in Q2 seems to be on the cards. More positively, timelier data show that inflation has started to come down, which together with ongoing easing by the central bank, should help the recession to abate in the second half of the year. In Ukraine, the situation is even more dire due to the ongoing conflict in the East of the country. Consequently, the economy has fallen off a cliff, and shrank by a staggeringly high 17.2% yoy in Q1

Emerging Europa contracts for first time since crisis

upswing in the eurozone, CE3 countries’ main trading partners, is providing a strong lift to trade. Moreover, domestic demand in these economies is also strengthening. As a result, first quarter GDP releases were upbeat. In Poland, strong domestic demand helped GDP to grow by 1.0% qoq/ 3.6% yoy, while in Hungary firm external demand was behind the 0.8% qoq/3.5% yoy rise. And then the Czech Republic. Here, GDP surged by 4.2% yoy and by 3.1% qoq in Q1. While special factors were at play, this was the highest number on record. Although growth in the region should moderate somewhat, showing payback for the stellar performance in Q1, the economies in central Europe are clearly in good health. …while growth in Turkey has moderated Meanwhile, growth in Turkey has continued to moderate. It fell from 2.6% yoy in Q4 to 2.3% in Q1, a level that is clearly below Turkey’s potential growth rate given the country’s rising population. The softening of growth is attributable to the uncertainty surrounding the elections and due to the relatively tight policy of the central bank. However, industrial production growth, which tends to move in tandem with GDP growth, has recently picked up somewhat. This suggests that the economy has gained more momentum going into Q2, though growth is expected to remain modest.

Weighted GDP, %yoy

More rate cuts to come in Russia 6

CBR, policy rate, %

5

18

4 3

16

2

14

1

12

0 10

-1 11

12

13

14

15

8 6

Source: Thomson Reuters Datastream

…but sun shines in Central Europe…

However, on the other and sunnier side of the spectrum are countries in Central Europe, such as Poland, Czech Republic and Hungary (CE3). Broadly speaking, two trends are at play here. Firstly, CE3 countries are benefitting from rising exports.

With trade exposures to Russia and Ukraine being limited, the

4 04

05

06

07

08

09

10

11

12

13

14

15

Source: Thomson Reuters Datastream

Russia’s central bank will continue to ease…

Central bank policy is equally divergent within the region.

Russia’s central bank (CBR) has continued to loosen policy.

The CBR had been forced to hike rates all the way to 17% in

2

Emerging Eu urope Outlook, As divergent as a ever – 29 Ju une 2015

ord der to defend th he ruble when the t country wa as in the midst o of a financial crisis a at the end of last year. But is has started to s has returned loosen policy as ccalmness in financial markets d inflation has p peaked. Since the start of the e year, it has cu ut and its policy rate by a cumulative 55 50bps. We thin nk that this ocess has further to go and se ee the CBR’s policy p rate at 9% % pro at the t end of this year.

kely to come in the second haalf of 2016. Meanwhile, the lik Cz zech central ba ank’s policy haas also remaine ed unchanged with w the central bank (CNB) keepingg its policy rate e close to zero an nd its currency low by mainta ining the peg to the euro at EU UR/CZK 27. Th he central bankk has signalled d that it intends to ke eep the peg in place until at leeast 2016H2, and a we think th hat we e have to wait for the first ratee hike even lon nger.

while Turkey’s s central bank k is likely to tig ghten …w How wever, Turkey’’s central bankk is likely to tigh hten its policy furtther. Although the CBRT left its policy rates on hold during g its June J meeting, it struck a slightly more hawk kish tone. Whil e the e statement wass mostly uncha anged compare ed to previous mo onth, it left out tthe phrase thatt “cautious mon netary policy along with pruden nt fiscal and ma acroprudential policies are ving a favourab ble impact on in nflation”. This is because hav inflation has been n on a renewed d upward trend. Granted, food d ce inflation is ccoming down, helped h by bette er agricultural pric con nditions, but the e weakening of o the lira that we w have seen since the end of la ast year will co ontinue to unde erpin consumerr ces. While the CBRT has alre eady pushed in nterbank rates tto pric the e upper bound o of its interest ra ate corridor, we e think that it ultimately must hiike its key ratess. Indeed, besiides stubbornlyy weak lira and po ossible market unrest as the high inflation, a w d starts to tightten policy are all a factors that argue a for a Fed tigh hter policy stan nce. As such, we w expect the CBRT C to raise iits key y rates by 50bp ps in the remainder of the yea ar.

…though … central bank of Hun ngary will eas se a bit more Allthough inflation, as in the Czzech Republic, has turned po ositive in Hungary as well, Huungary’s centra al bank (MNB) has co ontinued its eas sing cycle with baby steps. During D its latest meeting, it cut its s benchmark raate by another 15bps to 1.50%, wh hile signalling that t the inflatioon outlook points to ‘further sliight ea asing’. As such h, the central baank should cutt rates one or tw wo more times by 15bp in coming months. But th hey are likely to o re emain on hold once o the Fed sstarts its tighten ning cycle.

Ho owever, if we were w to take a sstep back from m all this, the bigger picture is more or less thhe same as in Poland and the Cz zech Republic.. The economyy will slowly sta art to generate inflationary press sures and the M MNB will most likely move to a tig ghtening stance e in 2016H2.

CE E3 economies moving outt of deflation % yoy

Economic E gro owth % yoy

14Q3

14Q Q4

15Q1

201 14

2015

201 16

Cz zech Republic

2.2

1.44

4.2

2.0

3.5

3.0

Hu ungary

3.3

3.33

3.5

3.6

3.0

2.5

Po oland

3.3

3.33

3.6

3.4 4

3.5

4.0

Ro omania

3.0

2.77

4.3

2.8

3.0

3.5

Ru ussia

0.9

0.44

-2.2

0.6

-4.0

0.5

4

Tu urkey

1.9

2.66

2.3

2.9

3.0

3.5

3

Uk kraine

-5.4

-144.8

-17.2

-6..8

-10.0

1.5

2

Re egional average

1.3

0.77

-0.6

1.3

-1.0

1.9

So ource: ABN AMRO O, EIU, Thomson R Reuters Datastrea am

1 0 -1 -2 J 2013 Jan

Jull 2013

Jan 20 014

Czeech Republic

Jul 2014 4

Hungary

Jan 2015 Poland

Sou urce: Thomson Re euters Datastream m

sing cycle in E Eastern Europ pe mostly ove er…

Eas Me eanwhile, the ea asing cycle in Eastern E Europe ean countries see ems to have mo ostly ended. This reflects that as a result off the e strong econom mic performancce, these countries are slowlyy mo oving out of defflation. As a ressult, in the beginning of June,, the e Polish central bank (NBP) ke ept its key rate e on hold, at 1.5 5%, for the third d time in a row.. The NBP sign nalled that defflation risks were abating as inflation has be ecome less neg gative. Given th he strengthenin ng of the econo omy, we think tha at inflation will ccontinue to firm m. Ultimately, th his should prom mpt the e NBP to shift to o a tightening stance s with the e first rate hike

Th hree broad tre ends in emerg ging European n currencies In thinking abou ut what this alll means for em merging Europ pean cu urrencies three e broad trends appear. We expect the Russian ru uble to strength hen in line withh slightly highe er oil prices in the re emainder of thiis year and neext year. We should s also se ee a strengthening in the Polish Zlot oty and, after th he peg is removved, in the Czech Ko oruna. This is because both the NBP and the CNB are likely to begin their ttightening cycle es earlier than the EC CB. We are, ho owever, more ccautious on the e Hungarian fo orint.

De espite a strong g improvementt in the country y’s current acco ount su urplus, the go overnment’s uunorthodox po olicies make the co ountry vulnerab ble to potential capital outflow ws. Fed tighten ning, du ue to Turkey’s vast currennt account de eficit, should also a ne egatively affec ct the lira, whhich we expect to continue e to we eaken against the dollar.

Em merging Europe should staart to growing again in 2016 6 Th he good news is that afteer contracting by 1% in 20 015, em merging Europ pe as a whole should start to o grow again next n

3

Emerging Eu urope Outlook, As divergent as a ever – 29 Ju une 2015

yea ar. This reflectts that growth in both Ukrain ne and Russia a is sett to return. Gra anted, develop pments in Ukra aine make it ve ery diffficult if not im mpossible to fo orecast what will happen, b but Russia’s econom mic prospects are easier to predict. W With ontinue to deccline as the im mpact of the pa inflation set to co ast op in the ruble ffalls out of the annual compa arison, the burd den dro of higher pricess on househo olds will conttinue to reced de. elp gether with o ongoing monettary easing, this t should he Tog con nsumption to fiind some footiing. In turn, this should prom mpt elf, com mpanies to take e some of their investment plans off the she helping the economy to stabilisse, and eventu ually to return to odest growth in n 2016. A stronger eurozone e recovery and d a mo stre engthening of domestic dem mand should, on o balance, he elp gro owth to step up p a bit in CE3 countries, while a better tra ade outtlook should alsso be beneficia al to Turkey’s economy. e eece, Fed and d geopolitics biggest b risks Gre So what would be e the main riskss to our scenario? Although o our se case remain ns that Greece e will remain in the eurozone, its bas pro oblems and the e threat of a euro exit have clearly increassed

ov ver the past days. d A Grexxit and the re esulting unrestt on fin nancial marketts would almoost certainly lead to a slo ower eu urozone recovery, and theree would be co ontagion effects to Ea astern Europe e, implying thhat economic prospects of the re egion will be les ss favourable. Still, if Greece e were to leave e the eu urozone, we th hink that, due to intervention n by policymakkers, ca alm will be restored relativelyy quickly. If tha at is the case, the eu urozone economy should eveentually regain its footing. A final f ris sk relates to the Fed’s tightenning cycle. Wh hile markets slo owly se eem to get used to the idea thhat the Fed’s tightening cycle e will ad dvance later this year, theere remains a particularly big difference betwe een the amounnt of rate hikes s that we thinkk will ventually materialize and whhat markets are e currently priccing ev in. This could be worrisome ffor Turkey as the country’s vast v urrent accountt deficit continnue to make it dependentt on cu foreign capital in nflows. While not our base case, these co ould re everse quickly in the case off market unres st, as seen du uring the tapering tanttrum in 2013.

Ma ain economic in ndicators/fore casts GD DP growth (%) Em merging Asia Em merging Europe Lattin America Mid ddle East/North Africa A Em merging marketts total

2013 2 6.5 1.8 2.4 1.5 4.6

2014 6.4 1.3 1.0 3.0 4.4

2015e 6.3 -1.0 0.3 2.9 3.9

2016e 2 6.4 1.9 2.0 4.1 4.8

-0.4 2.2 3.2

0.9 2.4 3.3

1.8 2.7 3.2

2.3 3.1 3.8

2013 2 -2.5 -1.5 -3.0 0.5

2014 -2.5 -1.5 -4.5 -2.0

2015e -2.5 -3.0 -5.5 -7.0

2016e 2 -2.5 -2.0 -4.0 -4.0

Eurozone -2.9 -2.4 S US -4.1 -2.8 Source: EIU, ABN AMRO Group E Economics

-2.3 -2.5

-2.0 -2.2

Eurozone S US Wo orld Bu udget balance (% ( GDP) Em merging Asia Em merging Europe Lattin America Mid ddle East/North Africa A

Inflattion (%) Emerrging Asia Emerrging Europe Latin America Middle East/North Affrica Eme rging markets total zone Euroz US d World Currrent account (% % GDP) Emerrging Asia Emerrging Europe Latin America Middle East/North Affrica Euroz zone US

2013 4 4.7 5 5.3 8 8.9 13 3.5 6 6.5

2014 3.5 6.3 12.6 7.4 5.8

2015e 2.7 11.2 13.5 7.1 6.1

2016e 3.2 5.3 1 11.5 6.8 5.2

1.3 1 1 1.5 4 4.3

0.5 1.6 3.9

0.4 0.4 3.7

1.7 2.4 3.8

2013 1 1.0 -1 1.5 -3 3.0 8 8.5

2014 2.0 0.0 -3.0 5.5

2015e 2.5 1.0 -3.5 -1.0

2016e 2.0 0.0 -3.0 1.0

3.2 3.1 2 2.6 2.9 -2.3 -2 2.4 -2.3 -2.4 * figures Emerrging Markets re egions are round ded

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