By Gunter Deuber, RBI Vienna, Dorota Strauch, RBI in Poland, Zoltan Török, Head of Research at Raiffeisen Bank in Hungary and Zrinka Zivkovic Matijevic, Head of Research at Raiffeisen Bank in Croatia |
The COVID-19 crisis is certainly a watershed event. After the deep 2020 economic slump, it could take until 2021 or 2022 for the CE/SEE region to return to pre-crisis GDP levels. In order to flank the recovery some growth prerequisites are certainly necessary. However, we want to stress that the region is not so badly positioned to emerge well from the crisis.
First, this time the local banking sectors are very sound and can contribute to shock absorption. This has to do with sound business policies in the past (including limited foreign currency lending and solid local refinancing, see also a recent Discover CEE Blogpost). Second, public debt levels in most CE/SEE countries are at levels that appear to be sustainable from a longer-term perspective. This holds true from a level perspective with public debt-to-GDP ratios mostly in the 40-60% range (excl. Croatia, Hungary / Albania). Moreover, when looking at expected GDP and inflation developments going forward, we see public debt sustainability less of an uphill battle than in Western Europe. Fiscal sustainability shall be especially secured in EU member countries from CE/SEE where substantial EU funds (grants, loans, EU budget funds) are on the horizon for the years to come. It is especially this funding that shall add to a recovery that will be shaped by solid investment dynamics. Moreover, the potential for co-financing and market financing is also there. The CE/SEE countries were able to place record amounts of international bonds in 2020 – a reasonable move not to overburden local absorption capacities in the banking sector. But in order to use EU funds properly, significant improvements in local absorption conditions on an administrative level are certainly necessary. Moreover, it should not be risked falling under the EU’s strengthened rule of law mechanism or even to get into such discussions which could be short-term investor negative. Thirdly, the conditions for the digital and ESG transformation in CE/SEE should not be underestimated. Here, too, banks can play an important role, as the increasingly high degree of digital penetration in the CE/SEE banking markets shows. This trend should be further strengthened by the pandemic. In addition, the digital transformation can also create qualified jobs locally – thus, parts of the brain drain could also be eliminated. Furthermore, we see great potential in the Green Transformation and ESG space in the region. On the one hand, it is important to show and/or finance progress in transformation. And here there is more potential for progress in CEE than in Western Europe. In addition, the country ratings of the CE/SEE region are relatively good or high in the ESG sector. This can be explained by many factors (e.g. good education and health or social systems from a broader country rating perspective). Moreover, we see potential for sustainable (intra-European) tourism and not mass tourism in a lot of CE/SEE countries. In this respect, the starting conditions for a new leg of convergence after the crisis – possibly greener and more digital – should certainly not be underestimated.
The COVID-19 crises hit the Hungarian economy exactly at the point when the partially politically driven and overheated economic growth registered in previous years was losing steam. This delivers a mixed bag with both positive and negative outcomes. On the one hand it magnified the recession, particularly in Q2 when GDP contracted by 14.5% over the previous quarter. On the other hand, the economy is much more resilient to a crisis than it was during the Great Financial Crisis in 2008-2009. This holds especially true with regards to public finances, the labor market or the banking sector. Let us first concentrate on the last of the list: while in the previous episode, the banking sector was a main contributor to the severe crisis due to the promotion of FX lending and its inapt risk policies, this time the banking sector is part of the solution due to its intermediary function that makes efficient use out of the plentiful central bank and government sponsored loan schemes targeting (mainly) SMEs, and on behalf of the sector’s partnership vis-a-vis the loan repayment moratoria. As far as the public finances are concerned, Hungary is significantly less vulnerable this time than a decade ago. If in the previous years, economic policy would have concentrated less on growth and more on reducing the public debt, the fiscal space would be even broader now. Last, but not least, take the labor market: the COVID-19 crisis brought about the end of the painful lack of labor that became the most problematic bottleneck in the Hungarian economy over the previous years. The crisis brought forward and speeded up digitalization in a wide range of activities. The combo of a developed broadband internet infrastructure and skilled labor contributes to the mitigation of the crisis impact and provides good prospects for the post-pandemic era.
Overall, the Polish economy was able to recover quite fast from the downturn in Q2 as its structure limited the hit during lockdown: a relatively low share of tourism compared to some other CE/SEE countries, a high degree of diversification with a large share of manufacturing in value added or expanding sectors resilient to the shift to remote work, like the business services sector. However, despite this resilience, in view of the ongoing second wave of the pandemic and its likely return in 2021, it may prove hard to survive for some businesses especially for smaller firms in the services sector. This may lead to some longer-term structural changes which may clash with changes on the labour market as digitalisation gathers pace (and it already has during the pandemic). It remains to be seen whether there are more negative effects (intensifying skills mismatch) or maybe if the pandemic accelerates structural changes on the labour market. Looking at the whole economy the digital transition will surely support inevitable long-term changes leading to an increase in potential output, which is especially important in the face of the weakening of the economy by the pandemic. However, especially among smaller firms there is still limited attention put to the transition while firms lag significantly compared to the rest of the EU in terms of the integration of business technology as indicated by the DESI Index (Poland is ranked 25th in the EU in terms of business digitisation). In view of this fact it is important that the digital and environmental transitions are directly connected to the new EU funds available via the Next Generation EU (NGEU) instrument in the form of minimal spending limits (20% and 37% respectively for the digital and ecological transition). Moreover, NGEU funds are likely to impact growth already in 2022 which is crucial as it will not only add fuel to the post pandemic recovery but also smooth the inflow of EU funds as the impact from previous budget wanes. Finally, the pandemic has shown that decisions can be made fast both at national and international level which should also be a factor accelerating strategic reforms. However, the old, well-known potential bottlenecks to this change will remain, which in the case of Poland may be regulations, inefficiencies in implementation of reforms and politics as well as still unresolved issues with the EU (rule of law in particular).
Croatia welcomed the year 2020 and the sudden onset of the COVID-19 crisis well prepared, with a considerably lower vulnerability and debt level, compared to the great recession that lasted for nearly half a decade in the case of Croatia. The debt level of all sectors diminished. In addition, by reining in rise in the expenditure side of the budget supported by lavish inflows into the budget even without any major (although needed) reforms, the fiscal policy managed to create some fiscal space. This, paired with the EU membership, proved to be pivotal in the current struggle of repairing the economic consequences of the pandemic. As in the year 2008, the banking system remained well capitalized and resilient, and therefore it comes as a nice approval here that Croatia could enter the EU Banking Union and euro area waiting room (ERM2) in 2020. However, no crisis so far, much like the relative stagnation of the Croatian economy (reflected in the relative stagnation of purchasing power parity and emigration of the work force) managed to yield the necessary structural changes. Inefficient (suboptimal) allocation of resources and overreliance on tourism and renting proved itself also in this crisis as an inadequate and high-risk growth model. With the weak industry, in the sense of declining share in GDP and low participation of high-technology products, it is already now evidently clear that Croatia will be one of the hardest hit EU countries in 2020 and beyond. Some hope comes from the available European funds, but their withdrawal depends, first, on the project capacity of the Croatian administration, which cannot praise its past achievements. During Q1 2021 the government will present its own draft of the RRF (Recovery and Resilience Facility) milestones in order to utilise the generous allocation (EUR 9.4 bn) from NGEU. The focus will probably be on the health system, provision of liquidity to SMEs and self-employed, enhancing investments on the green and digital transition, in particular on environmental infrastructure, sustainable urban and rail transport, clean and efficient production and use of energy and high-speed broadband. Naturally, these are just some of the areas that could support growth. There are opportunities and funds, they just need to be used and properly directed because otherwise there will be no sustainable recovery.
Some of the key views offered here were also presented and discussed at the 17th Vienna Economic Forum – Vienna Future Dialogue 2020, on 16 November 2020, where RBI presented its key views on the regional economic outlook and recovery prospects represented by Mr. Peter Lennkh, Board Member Corporate Banking at RBI and Mr. Gunter Deuber, Head of Economics Researchat RBI and designated Head of Raiffeisen Research