By Gunter Deuber, Casper Engelen and Andreas Schwabe, RBI |
Spread of the pandemic
Overall, nearly all countries in Central and Eastern Europe (CEE) seem to be still in the very early stages of local Coronavirus outbreaks, but events are emerging rapidly. Thankfully, the amount of reported infections is still on a relatively low level compared to Western Europe, with the CEE average lying at around 400 confirmed cases per country (about 5 per 100,000), while the Austrian number of infections lies at 4,767 (53.3 per 100,000) as of 24 March. Some CE countries such as Czechia or Poland seem to show a more rapid development than some other neighbouring CE or SEE countries, more like the start of COVID-19 outbreaks in Western Europe. As can be seen in the graph, the Czech Republic, with about 1,500 cases as of 24 March, already schows a relatively high level of confirmed cases, as do Poland and Russia – although it should be noted that in Poland and Russia the development of confirmed cases per 100,000 inhabitants is still less explosive compared to COVID-19 outbreaks in the West. In the case of the Czech Republic, several factors are at play that could contribute to these high levels compared to other CEE countries. The most important factor is the number of tests conducted per capita. Some countries, such as the Czech Republic, Slovenia, Russia and Belarus, test relatively many people, therefore the number of confirmed cases is likely closer to the true number of corona cases than in other countries. In some countries, such as Serbia, Bosnia and Hercegovina and Croatia, there is a relatively small number of tests, which may only be performed in cases of strong suspicion. It is paramount to test many people in order to reduce the amount of undetected cases and to identify the true scope of the pandemic locally. However, there are also several problems regarding the reported numbers/cases: Some countries, such as Russia, allegedly report unlikely low confirmed cases and a very high number of tests. Others, such as Bulgaria do not report the number of tests that were conducted up to now.
Overall, the SEE region might be somewhat more vulnerable to a possible largescale epidemic due to the relatively high levels of self-employed and the importance of tourism for their economies. Russia and Ukraine might lack the infrastructure necessary for establishing the possibility for working remotely for large parts of their working population outside of the capital cities. The CE countries might be subject to a faster spreading of the virus due to their high level of connectedness and exchange with heavily affected Western countries through their manufacturing industries and trade openness. Those economic interlinkages imply a substantial day-to-day flow in terms of people and goods. That said, the CEE countries were quick to adopt measures that are aimed at containing and mitigating the economic effects of the pandemic (for more on these measures see CEE Covid-19 Responses). Our current baseline scenario, for now, is that the good testing practices in some CEE countries and the measures taken can contribute to containing the spread of the disease to manageable levels. This holds especially true for Russia.
Macroeconomic contagion – almost everywhere higher than during the global financial crisis
Regarding the economic impact of the Coronavirus outbreak in China on the CEE region, we initially focused on the direct trading links with China (possibly also via Germany) and the degree of integration into global supply chains with Asia. In this respect, the CEE region appeared less exposed, except for some electronic supplies and stronger links between China and Russia/Ukraine compared to those in CE/SEE. In a second step, when the pandemic spread to Western Europe, we quickly understood that CEE can no longer stand on the sidelines of the unfolding crisis/events. We identified several transmission channels to the essential economic supply shock – unseen in peace-time – from its Western neighbors to the CEE economies: the strong openness to trade and integration in pan-European supply chains (especially with Italy and Germany), the dependence of several countries on tourism (like Croatia, Albania, Bulgaria and partially Bosnia) and finally the substantial amount of remittances from labor migrants out of several CEE countries (mainly in Italy, Spain, Germany and France for CE/SEE plus Poland and other CE countries for Ukraine). Therefore, when it became visible that the harsh restrictive measures taken in Western Europe will substantially decrease economic activity, we knew that also the CEE region will be very heavily affected. Finally, the CEE countries themselves have begun to implement similarly harsh containment measures to reduce the contact between citizens and slow down the pandemic in their countries in recent days and weeks. That said, we see a significant risk that containment measures will be even tightened in several CEE countries going forward.
We now project that GDP in the euro area will decrease by at least 4% in 2020, i.e. Europe will enter a deep recession in H1 2020. This is already supported by first data points, as the Purchasing Manager Index for the euro area in March fell by 20 points to a shocking all-time low of 31 points, and the services subcomponent even lower to 28 points, which already hints to a shocking GDP drop unfolding. We expect economic sentiment indicators to deteriorate in at least a similar dimension in CE/SEE going forward. On a positive note, for the time being we expect the recession to be short-lived with the main slump concentrated in Q2 both in the euro area and CE/SEE. We assume that, harsh restrictive measures are possibly somewhat softened in late spring when the coronavirus pandemic is hopefully brought under control. Moreover, policymakers may also shift their current policy focus from punitive containment measures at all costs into the direction of a more balanced approach – once the unfolding deep recession is visible in hard economic data. Moreover, bold monetary and fiscal stimuli in Europe and worldwide can only unfold once supply-side restrictions are partially lifted. Not to forget that all the rescue packages are only fanciable on a sustainable basis when we get a recovery going into the year 2021.
Given both the external shock from depressed euro area business activity and domestic containment measures, we project nearly all CEE economies to be hit similarly to the euro area mainly in late Q1 and in Q2 – during an expected lockdown phase of 2-3 months. Given the different exposure to external shocks, fiscal and monetary policy space locally, the scope of restrictive measures and the sectoral structure of the economy the depth of the expected recessions in CEE differ between the countires. Our baseline scenario entails growth rates between -2% in Poland and -6% in highly trade-open Slovakia; similarly, in SEE we penciled in a -2.5% GDP drop in Romania and a deeper slump of -4.8% in tourism-dependent Croatia. We think that Russia is still better positioned this time compared to 2008/2009 and 2014/2015 to cope with the double whammy of oil price shock and Coronavirus pandemic, given its strong fiscal and FX reserves and automatic stabilizers of a flexible exchange rate and the budget rule. Moreover, we currently do not expect full lockdown measures in Russia as seen in the West. Furthermore, and compared to the West, we see countries like Russia and Belarus to be better positioned to quickly implement decisive China-style containment measures. Not to forget that Russia’s ability to export commodities might be harmed less, even in case of a stronger COVID-19 outbreak and more restrictive measures, as operations and workers in the resources sector in remote places may be more resilient and could be quarantined more easily. Ukraine and Belarus are structurally weaker and especially Ukraine can only sustain economic and financial stability, if the country receives bold IMF support. In our baseline scenario, we project a return to growth of CEE markets in H2 and a strong economic rebound in 2021.
However, even our sobering scenario for the CEE region is still susceptible to substantive downside risks:
- The lockdown in the euro area and/or CEE markets could take longer than the 2-3 months we currently assume. If the period of economic shutdown becomes more protracted the recession will be deeper and longer (with GDP drops of -10% as a more realistic outcome, then)
- Moroever, there is the risk that after a sensible lifting of restrictions a “second wave” of infections once again requires the phase-in of restrictive measures to be (partly) reinstated later
- If there are not enough international (fiscal) support measures, especially less wealthy countries with limited fiscal maneuvering space would not be able to support their companies and citizens, which could result in a large number of bankruptcies and permanent harm in the respective economies.
- In Russia, we currently assume only limited lockdown measures and moderate economic effects from the coronavirus and a moderate recovery of the oil price in H2 2020. If one or both assumptions would not realize, Russia would also plunge into a deeper recession. Moreover, there are already rumors, that official statistics might underreport the number of corona cases in Russia.
Banking sectors in CEE – Corona-stress hits stronger credit institutions
For the banking sectors in CEE, hypothetical stress scenarios are currently becoming reality. In the EBA stress tests of recent years, adverse macro scenarios for the CEE countries showed GDP declines of -1 to -3% per year. The cumulative GDP losses over two years then often result in slightly higher negative values. Now, unfortunately, such values are becoming reality as sketched in the macro section beforehand. Due to the still strong year 2019 in CEE, we will see one-year GDP hits of at least -5 to -8.5 percentage points – which is also close to macro shock assumptions in bank stress tests. Moreover, currently, risks to the downside for such assumptions are higher than risks to the upside.
Despite such stress scenarios, however, almost all banking sectors in CEE are currently in a much better fundamental position than they were prior to the global financial crisis (GFC). This applies to several dimensions. Firstly, credit growth has been moderate in recent years and risk taking has therefore been disciplined. Hence, the upcoming NPL trend should be less brutal. Second, foreign currency credit risks are significantly lower than before the GFC. Third, the capital buffers are much higher nowadays (incl. additional capital buffer build-up in faster growing markets). In addition, local (re)financing has been significantly strengthened in recent years and there has been no external cross-border funding leverage as before the GFC. It is also important that we therefore see less fundamental external rebalancing need (e.g. current account reversals). Therefore, from a fundamental perspective – also against the background of the banking sector conditions outlined above – there should be less currency-related downside risks. In conclusion, the major lenders active in the region should now be able to act as a stabilizing element. This presupposes, however, that sensible nationally and internationally coordinated solutions are found here – within the EU and in the non-EU countries in CE/SEE where Western European banks are key systemic players. Here, we are thinking about sensible solutions with regards to special bank taxes, additional capital buffers or moratoria for the coming months.
Looking forward, we may also see the current crisis as an opportunity for a better-balanced relationship between politics and banks than in recent years. Banks will now have to play a key role in arresting insolvencies and in the much-needed macro stabilization in the coming months. Moreover, in the current situation, it is also important to remember “lessons learned” from the last crisis and the Vienna Initiative. Much has been achieved here through effective cooperation between the private sector and public authorities (incl. IMF and EU financial support). In this respect, less public funds were probably spent on stabilization at the time than in a scenario without such cooperation. In addition, the risk concentration in the CEE banking sectors (in terms of home countries of the leading banks in the region) has turned into a positive factor here. It is therefore all the more important that these experiences are taken into account in the current fast deteriorating environment (see also a contribution by US expert Rachel Epstein and RBI Head of Economics Research Gunter Deuber “Forward-looking implications of the Vienna Initiative: why did Western banks enter the Central, Eastern and Southeastern Europe region, what went wrong and what did we learn?” in EIB: Ten years of the Vienna Initiative 2009-2019, pp. 345-362)
Gunter Deuber is Head of Economics, Fixed Income and FX Research Department at Raiffeisen Bank International in Vienna.
Casper Engelen is a Junior Economist in the Economics Research Department at Raiffeisen Bank International in Vienna.
Andreas Schwabe, CFA, MBA, is Senior Economist for Central and Eastern Europe in the Economics Department at Raiffeisen Bank International in Vienna.
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