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

By Andreas Knapp

image credit: unsplash.com/Valentyn Chernetskyi

• Growth in 2022 will be 2.5 percentage points lower than in 2021 (estimated at 5.7%)
• The slowdown is due to the weakness of Russia and Turkey, and the withdrawal of pandemic aid and base effects
• Risks are strongly to the downside, and include higher-than-expected inflation, strong sanctions on Russia, and the continued COVID-19 pandemic
• The Russian economy is partly sanctions proof due to large FX reserves and limited external debt, but will still be negatively impacted

The Vienna Institute for International Economic Studies (wiiw) expects growth in 2022 of 3.2% for the 23 countries of Central, Eastern and Southeastern Europe (CESEE). Compared to last year’s figure of 5.7%, that is a marked slowdown of 2.5 percentage points. The main reason is the poorer growth prospects facing Russia (2%) and Turkey (3.5%), the two largest economies of the region.

The Visegrád countries of Poland, Czechia, Slovakia and Hungary should continue to grow strongly, at an average of 4.6% in 2022 and 4.4% in 2023. The economic impact of the pandemic should remain manageable, even though the number of COVID-19 infections in many Eastern European countries remains alarming. Low vaccination rates and a relatively elderly population pose a risk to economic recovery, despite the Omicron variant proving milder.

‘In the case of Russia, the new economic sanctions by the EU and the US, which are to be expected in the event of armed conflict in Ukraine, cloud the outlook,’ says Richard Grieveson, Deputy Director of wiiw and lead author of the winter forecast, ‘as do Russia’s long-standing structural weaknesses.’ In the case of Turkey, the economic boom of previous years collapsed along with its currency. Soaring inflation will limit that country’s growth prospects.

Compared to last autumn, wiiw has revised its forecast for the CESEE region only slightly for both 2022 and 2023. For 2022, we now view the growth prospects of Bulgaria (3.8%), Czechia (4.0%), Serbia (4.9%) and North Macedonia (3.5%) in a somewhat more positive light. Meanwhile, Russia (2.0%), Belarus (1.0%), Bosnia and Herzegovina (2.5%) and Slovakia (3.9%) have experienced a downward revision.

Russia is partially cushioned against new economic sanctions

In Russia, growth is likely to come to a virtual standstill in 2023, with an expected growth rate of just 1.5%. The consequences of a possible conflict over Ukraine are already factored into this forecast, but not those of a major invasion. ‘In our forecast, we assume an escalation of tension between Russia and the West, with the imposition of further mutual economic sanctions,’ says Grieveson. ‘These will affect both sides, but should not bring the overall economic recovery in Eastern Europe to a standstill.’

Ever since 2014, Russia has taken steps to partially immunise its economy against fresh sanctions, and it should be able to cope with most of them. ‘The scope for forcing Russia to change its behaviour over Ukraine using economic sanctions is limited,’ points out Grieveson. Conservative monetary and fiscal policies have enabled it to build up substantial foreign exchange reserves, totalling USD 630 bn. Gross foreign exchange reserves, including gold, accounted for about 40% of Russia’s GDP in November 2021. External debt is low, and there has also been a reduction in exposure to the US dollar in government bonds.

Inflation is the main risk

A showdown with Russia could hit the EU harder, says Grieveson. ‘If an armed conflict does occur, the already high prices of natural gas and oil will skyrocket and further boost inflation.’

High inflation is the biggest risk to economic recovery in the CESEE region – ranking ahead of both the conflict with Russia and the COVID-19 pandemic. While inflation in Western Europe is higher than it has been for many years, this is not the case in much of CESEE. Nevertheless, inflation is also becoming entrenched in Eastern Europe, where spending on energy and food accounts for a much higher share of total spending than it does in Western Europe. As a consequence, the governments of Hungary, Serbia and North Macedonia have already introduced price controls on food, not least for reasons of domestic political stability. Meanwhile, Poland and Romania are discussing a similar move.

After 8.7% inflation last year, we expect a weighted average of 10.3% in CESEE this year – and in Turkey as much as 26.2%. However, the inflation rate in the Visgrád countries of Poland, Czechia, Slovakia and Hungary should average 5.2%. Inflation will remain high for at least several more months. The most important question is whether it will lead to a sustained increase in wages. ‘If it does, we are in for a protracted period of inflation that will be significantly higher than most states in Eastern Europe have experienced since 2008,’ says Grieveson.

The most likely scenario, however, is that price increases will level off by the middle of the year. On the one hand, this is because the worst distortions on the supply side – the problems with international supply chains – should have eased by then; and on the other hand, the high energy prices are also unlikely to persist. However, these forecasts are subject to an unusually high degree of uncertainty.

About the wiiw Forecast Report for CESEE

The report analyses the economies of 23 countries in Central, Eastern and Southeastern Europe (CESEE) and provides a detailed forecast of the macroeconomic indicators of the following countries: Albania, Belarus, Bosnia and Herzegovina, Bulgaria, Croatia, Czechia, Estonia, Hungary, Kazakhstan, Kosovo, Latvia, Lithuania, Moldova, Montenegro, Northern Macedonia, Poland, Romania, Russia, Serbia, Slovakia, Slovenia, Turkey and Ukraine.