WIIW The Vienna Institute for International Economic Studies - Wiener Institut für Internationale Wirtschaftsvergleiche

External determinants: Two key factors currently affect the economic prospects of CESEE: the crisis in the euro area and movements in the commodity prices. For Russia, Kazakhstan and Ukraine declining world market prices of energy carriers, steel and other basic commodities are vital. For most of the countries in Central and Southeast Europe, the strength of external demand for their manufacturing exports and their competitiveness are much more important. The European Union constitutes a natural external environment not only through mutual trade, capital and labour flows, but also through ‘intangible links’: regulations/directives enacted ‘in Brussels’. The economic crisis in the euro area is perceived as being primarily about possible insolvencies of peripheral euro area countries. The range of possibilities opened up by sovereign insolvencies is vast. However, a muddling-through scenario still seems the most realistic prospect. Insistence that the ‘problematic’ euro area countries – but possibly also others in the EU (including the new member states) – should enact the austerity measures in order to reduce public debt levels continues to set the tone throughout Europe, as epitomized by the Fiscal Compact. But, were the Fiscal Compact to be actually obeyed, the euro area – and the EU as a whole, including the new member states – would plunge into an era of permanent stagnation with high and rising unemployment.

Euro area enters recession, CESEE to follow? Given the prevailing fiscal consolidation policy mix it is not surprising that while the world economy recovers, the euro area returns to recession. Consolidation fever has spread to the new member states – including those that formally refused to subscribe to the Fiscal Compact such as the Czech Republic. Given the trend towards fiscal consolidation, it is natural to expect that the new member states will also slow down in 2012. Chances of faster growth in 2013 remain uncertain – both in the new and old member states. The EU Spring forecast is cautiously optimistic. Our forecasts for the new member states in 2013 and afterwards are also cautiously optimistic. That optimism, however, is based on the assumption that the fiscal consolidation fever will abate – both within the euro area and outside. After the deep recession that beset almost all CESEE countries in 2009, most of them recorded a moderate recovery in 2010. However, on a quarterly basis, growth has been generally slowing down since the third quarter of 2011. In a number of countries (e.g. Croatia, Czech Republic, Hungary, Serbia, Slovenia) the most recent quarterly GDP growth rates are already negative. The recent output contractions do not appear to be exceptions, but point to the possibility of more protracted periods of recession occurring in the CESEE region. Among the star-performers of 2011 (Turkey, the three Baltic countries and Kazakhstan), growth will also slow down. Poland, Slovakia, Ukraine and Russia, all of which displayed steady growth in the biennium 2010-2011, are gradually losing steam as well.

External rebalancing is proving temporary: Merchandise exports are expected to rise in 2012. This view reflects an assumption of a shallow and short-lived recession in the euro area. In the Baltic countries, as well as in Romania, Bulgaria, Bosnia and Herzegovina and Ukraine, even with relatively slow growth in domestic demand, foreign trade will not be in a position to support overall GDP growth in 2012. The frailty of a proper industrial base capable of supplying higher value-added exports may be one reason for this. Furthermore, those countries’ real exchange rates have also started moving in the wrong direction once again, adding to the deterioration in cost competitiveness. The return of a rise in trade deficits in the Baltic countries (and some other countries) indicates that the ‘rebalancing’ of 2009 may have been a temporary phenomenon.

Household consumption and investment: steady on the ‘fringes’, sagging in the ‘core’: Investment growth in 2012 is expected to remain quite sluggish throughout the ‘core’ countries (even declining in some of them). Only in the period 2013-2014 is investment growth expected to recover across the new EU member states and in the Balkans. Investment is forecast to remain steady throughout 2012-2014 in Kazakhstan, Russia and Ukraine. In 2012, consumption growth will sag still more in most new EU member states and across the Balkans. Even in the Baltic countries, consumption growth is expected to slow down.

Threats and opportunities: At present, the major and most realistic danger facing the majority of CESEE countries is that they will stick to their commitment to fiscal consolidation, even if investment, consumption and exports continue to weaken. For that threat to materialize, neither the euro area nor the EU as whole need necessarily plunge into some dramatic crisis. For that danger to become reality, it is sufficient for Europe to continue slowing down, while fiscal consolidation is still being demanded of its old, new or prospective members. Of course, some spectacular collapse of the euro area/EU (as we know it) could perhaps have truly devastating effects on most CESEE countries – via trade, capital flows, transfers and migration. Chaotic developments would then follow in its wake, with repercussions for the global economy at large. However, we may be unqualified to predict events, should chaos erupt. A scenario more optimistic than that possible under ‘muddling through’ may still be beyond the horizon. Muddling through is unlikely to yield satisfactory results, but desirable changes may still eventually come about. But those changes would have to start in ‘high places’ in the leading EU countries and leading European institutions. Should the political and economic elites of Europe start acknowledging the negative consequences of fiscal austerity and efficiently work for an overhaul of EU institutions (including the ECB), things might start looking more promising for Europe as a whole – and hence for the CESEE countries as well.