Countries in the EU’s east have higher and more persistent inflation than their western neighbors. Current efforts in the region to boost growth with higher spending run the risk of fueling inflation.
The countries of the Central and Eastern European region have “probably already digested” the majority of economic shocks caused by the was in Ukraine, the Vienna Institute for International Economic Studies noted recently. Growth in the region is expected to pick up somewhat and inflation to come down at the end of 2023, the institute said in a report published January 30.
In the course of 2023, however, the four CEE countries — comprising Poland, Hungary, the Czech Republic and Slovakia — face a series of tough choices, and a complex and uncertain global and regional situation.
Central banks in the region have put their interest rate hike cycles on hold as a feared acceleration in inflation appears to have abated at the start of 2023. But the economic fate of the region is heavily tied into how its EU partners to the west cope with rising prices and high interest rates.
With around 80% of their trade done with the rest of the EU, all four CEE countries are as likely as ever to catch a cold if Germany and others sneeze.
UK-based economic consultancy Capital Economics thinks CEE headline inflation could rise from around 15% now to 20% in the second or third quarters of 2023.
How well CEE governments and central banks navigate the tricky course between the dual and often contradictory needs of avoiding recession while dampening inflation will determine how well the CEE countries perform in 2023 and beyond.
Poland in an election year
Poland’s gross domestic product (GDP) rose 4.9% in 2022, easing from 6.8% in 2021 — the year of the post-pandemic rebound. Excellent figures, experts say, when compared to Western Europe, but for 2023 growth forecasts differ widely and are far lower.
Dutch bank ING sees GDP expanding just 1%, while the International Monetary Fund (IMF) has lowered its growth forecasts to 0.3%. The World Bank sits in between, forecasting GDP to rise by 0.7% in 2023.
The key reasons for the slowdown in Poland are weaker growth in the eurozone and lower domestic demand largely due to inflation outstripping wage growth, thus reducing purchasing power.
Capital Economics said in a note to clients that Poland’s economy “seems to be holding up much better” than in Hungary and the Czech Republic. But the impact of high inflation, the lagged impact of higher interest rates and subdued global demand are still likely to impede growth.
Meanwhile, ING expects Poland’s consumer price inflation to rise to 18.1% in January from 16% at the end of 2022, before dropping to about 10% in December.
Poland has managed to slash its dependence on Russian gas and oil since the invasion of Ukraine last February, but global energy prices remain a key factor and depend on events in Ukraine and how fast China ends its COVID-19 lockdowns.
The EU decision to withhold funds over doubts about Poland’s commitment to winding back on controversial judicial reforms also leaves a hole in the coffers that will need to be filled by added borrowing or higher taxes, neither of which will go down well with voters as parliamentary elections beckon in the autumn.
The role of monetary policy will then be crucial and closely watched. The expected slowdown in 2023 means that the National Bank of Poland is faced with an awkward choice between monetary tightening to rein in inflation and loosening to boost growth after almost a year of rate hikes.
Czech Republic faces anemic growth
The Czech economy entered recession in the second half of 2022. Economists say this was mainly due to a reduction in consumer spending, following rate rises and higher borrowing costs. As a result the central bank lowered its GDP growth forecast in November from 2.3% to 2.2% for this year.
Meanwhile, consumer price inflation rose to 16.2% at the end of 2022 after the government unveiled plans to cap energy price rises, thus boosting spending and borrowing and in turn reducing the space for spending to stimulate growth. It is expected to stay high in 2023, before falling in 2024.
Czech National Bank expects inflation to remain strong due mainly to supply-side effects, including higher imported energy and food prices, which should fade over the year. The economy, it said in a recent report, depended heavily on energy imports from Russia before Moscow’s attack, leaving Prague desperately seeking alternative suppliers.
On the monetary policy side, ING expects the central bank to keep interest rates on hold in February.
Hungary the outlier
Strong growth in Hungary in 2022 was driven by domestic demand and a tight labor market. But the economy is expected to slow in 2023, as domestic and external demand fall away.
ING revised its 2023 GDP growth forecast to 0.7%, but said any growth poses an inflationary risk due to preexisting structural economic imbalances, aggravated further by a series of shocks, including the war in Ukraine, which have driven up inflation, now among the highest in Europe at 24.5%.
ING sees headline inflation peaking just below 26% in the two months of January and February and a 18.5% average rate in 2023.
Slovakia caught in the crosshairs
Slovakia’s economy has stuttered since Russia’s invasion of Ukraine, even though it “pleasantly surprised in the third quarter,” as Lubomir Korsnak, chief economist at UniCredit Bank in Bratislava, told news website Euractive recently. However, a “short recession” is likely to follow, he added, as indicated by the stagnation in the job market.
The European Commission forecasts growth of 0.5% in 2023, and is much more upbeat than the National Bank of Slovakia, which sees activity even declining 1% this year.
Being a member of the euro area, Slovakia has fewer means at its disposal to fight inflation, expected to average 13.9% in 2023. It cannot raise the exchange rate of its own currency to mitigate higher consumer prices or set its own policy rate.
But, like its CEE neighbors, the crucial decisions rest in balancing spending to boost growth while combating persistent inflation. For small, open economies caught between richer neighbors to the west and a vicious war to the east, the only viable approach is one of vigilance and flexibility.
Edited by: Uwe Hessler
Author: Jo Harper