Analysis

Growth in CEE is expected to rebound but with considerable divergence

A stuttering recovery in the Euro Area and slowing growth in the Russian Federation have posed headwinds to developing Europe and Central Asia, says the World Bank’s Global Economic Prospects report.

The conflict between Russia and Ukraine has taken a severe toll on Ukraine’s economy, with output estimated to have contracted an estimated 8.2 per cent in 2014.

An 85 per cent depreciation of the currency against the U.S. dollar in 2014 and a sharp import compression led to a significant current account adjustment. The fiscal deficit remains high amid weakness in revenue collection and increased security related spending. High debt refinancing needs weigh on the balance of payments. Although an EU-brokered ceasefire agreement was reached in October, disputes with Russia over natural gas supplies, prices, and debts, as well as over pipeline transit, have heightened uncertainties.

Growth in Central and Eastern Europe (CEE) was broadly steady at an estimated 2.6 per cent, reflecting close trade ties to struggling core Euro Area countries. In addition, the escalating economic sanctions between Russia and other high-income countries reduced confidence and slowed FDI inflows. Investment was further damped by sluggish bank lending, and by rising real interest rates as inflation approached zero or even turned negative.

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Many CEE countries are in or near deflation, because of negative output gaps, significant cuts in regulated energy prices (in Bulgaria, Croatia, Czech Republic, Hungary, and FYR Macedonia), and declining food and fuel prices. Falling food prices reflected bumper harvests (especially in Bulgaria and Romania), as well as weaker demand because of the Russian ban on food imports. Several central banks cut interest rates to historic lows to support weak economies in the second half of 2014. However, the high share of foreign currency denominated lending and nonresident debt holdings has constrained central banks’ ability to support growth, because of the risk that interest rate cuts might lead to large depreciations, and thereby impair balance sheets.

After a sharp deceleration in 2014, growth in the region is projected to recover moderately, with growth in developing countries in the region averaging 3.5 per cent in 2015–17, but with considerable divergence across countries. In the baseline scenario, the expected contraction in Russia in 2015 and gradually tightening global financial conditions are expected to be offset to some extent by a modest recovery in Euro Area demand, diminishing political tensions, and the benefits of lower international energy prices on net importers.

Ukraine’s economy faces a highly uncertain outlook. In the baseline scenario, which assumes no further escalation of tensions, activity is expected to bottom out in 2015 and to recover in 2016–17.