Southeast Europe

Southeast Europe Macroeconomic Outlook:

1. Overview:
SEE economies have been severely impacted by the global economic crisis due to the deterioration of their export performance, decreased FDI inflows and lower remittances. Estimated economic growth in the region for 2008 was 6.6%, whereas real GDP for 2009 is forecast to decrease by 3.2% (EBRD). Credit and deposit growth have slowed in all SEE countries, while in BiH and Montenegro annual deposit growth turned negative in January. Lower economic activity has impacted fiscal revenues, with 2009 national budgets based on overly optimistic economic assumptions; the first economic reports for 2009 indicate budget gaps in Serbia and Montenegro. IMF has already provided finance to Serbia and BiH, with Montenegro and Macedonia are currently negotiating similar agreements. Despite massive macroeconomic imbalances, the Balkan countries are coping better than the Central European and Baltic countries due to their relatively underdeveloped capital markets. Furthermore, the economic slowdown poses significant political burdens to national governments, as they have to cope with the decrease of the public sector workforce, the freezing of wages and the cut of social welfare benefits.

2. Growth Performance:
EBRD forecasts that a gradual recovery will commence in the second half of 2010, in accordance to global economic conditions. SEE is particularly affected by the crisis through the trade channel and currently experiences a collapse of external demand, due to the near-recession conditions in EU markets (the prime export markets for the region’s economies). In addition to the decrease of demand for SEE exports, a major problem for the region is the access to external finance; as most countries face significant current-account deficits, the slowing of FDI inflows along with the ongoing intra-bank lending freeze is projected to significantly impact regional growth in the near future. Furthermore, most SEE countries are expected to face a decline of private capital inflows of 10% to 20% in 2009 (EUI), with some of SEE economies depending heavily on these remittance inflows.

3. Balance of Payments:
FDI flows to SEE countries accounted for an average of 65% of their economies’ C/A deficits during 2003-07. Forecasts indicate that net private capital flows to Eastern Europe are projected to fall from an estimated $254b in 2008 to $30b in 2009 (IIF). Current-account deficits, to some extent, have been regarded as a necessary procedure towards the convergence of the region’s economies with the EMU; the high C/A deficits of recent years, though, - particularly of Bulgaria and Romania – have prompted fears of severe macroeconomic imbalances. Although current account deficits are narrowing across the region, tightened credit conditions indicate that the financing of these deficits could be a challenge.

4. Fiscal Policy:
Policymakers across Eastern Europe will likely resort to monetary policy, not fiscal policy, to cushion the downturn. There are concerns whether some countries in the region have no room to ease fiscal policy, as budget deficits widened in 2008, especially in the case of Romania. Fiscal loosening could further undermine investor confidence in the region. Additionally the impact of these financial stimulus packages is questionable; sharply slowing growth in the region is related to unwinding economic imbalances, tightening credit, and slowing growth in Western Europe.

5. Foreign Exchange:
The widespread foreign currency lending in the region raises concerns regarding any F/X interventions; most notably in Romania, 55% of household loans are FX denominated. An exchange rate devaluation as an attempt to deal with the excessive C/A deficits will entail significant risks. In such cases, private parties will not be able to finance these F/X denominated loans, causing wider financial instability to the country’s economy. Additionally, as a consequence of the increased number of non-performing loans, financial institutions are projected to apply stricter lending conditions, therefore raising the cost of lending.