Nowhere in the world have expectations for growth changed so rapidly and positively as in central and eastern Europe.
The consensus forecast for economic growth in the region this year is now 2.5 per cent — 0.3 per cent points higher than four months ago. Expectations for 2018 are even brighter at 2.6 per cent, 0.1 percentage points higher than forecast at the start of the year.
“The recent strong run of economic data — particularly the stronger-than-expected Q1 GDP — has prompted analysts to revise up their forecasts,” says Liam Carson, Emerging Europe economist at Capital Economics. Romania, for example, grew at an annual rate of 5.6 per cent — the highest rate in the EU — while the consensus pointed to a more subdued 4.4 per cent.
The consensus improvement for the region would be even stronger if Russia — where growth of 1.2 per cent is forecast this year — were excluded from the figures.
What is behind the improving picture? Stronger-than-expected demand elsewhere, a tighter labour market, an attractive environment for foreign investment, government stimulus measures, easy financing conditions and the revival of EU structural funds are all supporting stronger growth in the region.
The strength of external demand is the result of brightening economic circumstances in western Europe. Economic growth in the eurozone was twice as fast than in the US in the first quarter of 2017. Germany expanded at a strong quarterly rate of 0.6 per cent. This is important to eastern Europe: almost two-thirds of the value of its exports goes to the EU. Germany is the top market.
FocusEconomics forecasts that exports in the region will grow nearly six per cent this year, more than double the rate last year.
Strong labour markets support growth in the region
Unemployment rates in Poland, Czech Republic and Romania are all below the European average and at their all-time low. This is largely the result of growth in economic activity but also of emigration and a limited number of young people entering the labour force.
Companies are increasingly reporting labour shortages, with rising numbers of unfilled job vacancies — making wage rises possible and in turn supporting domestic demand.
Romania registered the highest annual increases in hourly labour costs in the EU in 2016: 12 per cent. It is not an isolated case: labour costs rose by more than 8 per cent in Lithuania, Latvia and Bulgaria. In Hungary the minimum wage rose by an impressive 15 per cent. Conversely, in the EU hourly labour costs increased by a mere 1.6 per cent.
Yet eastern European countries remain largely competitive in terms of wage costs, making it an attractive destination for foreign direct investment.
The region attracted nearly half of Europe’s FDI industrial projects, according to the latest Ernst & Young European FDI Attractiveness Survey. Poland is the second destination for FDI in Europe by jobs created, after the UK and ahead of Germany.
The region has become a favourite among European carmakers but the EY report also notes that investors are broadening into IT, software development and R&D capabilities. Investors noted rising wages, but rather than leaving the region, they are expanding into second or third-tier cities or non-EU member states including Serbia.
EU structural funds boosted investment
Eastern Europe has long benefited from EU “structural funds”, designed to help the region’s economic convergence with the rest of the bloc. Although these structural fund inflows fell markedly in 2016, they stabilised at the start of this year resulting in stronger construction growth and a recovery in fixed investment. “The size of the boost to growth stemming from a recovery in EU fund inflows probably took some analysts by surprise” says Mr Carson. “We expect EU structural fund inflows to continue to pick up over the course of this year across the region.”
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