Focus on European Economic Integration Q2/20

Call for applications: Klaus Liebscher ­ Economic Research Scholarship

The Oesterreichische Nationalbank (OeNB) invites applications for the Klaus ­Liebscher Economic Research Scholarship. This scholarship program gives outstanding researchers the opportunity to contribute their expertise to the research activities of the OeNB’s Economic Analysis and Research Department. This ­contribution will take the form of remunerated consultancy services.

The scholarship program targets Austrian and international experts with a ­proven research record in economics and finance, and postdoctoral research experience. Applicants need to be in active employment and should be interested in broadening their research experience and expanding their personal research networks. Given the OeNB’s strategic research focus on Central, Eastern and South­eastern Europe, the analysis of economic developments in this region will be a key field of research in this context.

The OeNB offers a stimulating and professional research environment in close proximity to the policymaking process. The selected scholarship recipients will be expected to collaborate with the OeNB’s research staff on a prespecified topic and are invited to participate actively in the department’s internal seminars and other research activities. Their research output may be published in one of the department’s publication outlets or as an OeNB Working Paper. As a rule, the consultancy services under the scholarship will be provided over a period of two to three months. As far as possible, an adequate accommodation for the stay in Vienna will be provided. 1

Applicants must provide the following documents and information:

  • a letter of motivation, including an indication of the time period envisaged for the consultancy
  • a detailed consultancy proposal
  • a description of current research topics and activities
  • an academic curriculum vitae
  • an up-to-date list of publications (or an extract therefrom)
  • the names of two references that the OeNB may contact to obtain further information about the applicant
  • evidence of basic income during the term of the scholarship (employment contract with the applicant’s home institution)
  • written confirmation by the home institution that the provision of consultancy services by the applicant is not in violation of the applicant’s employment ­contract with the home institution

Please e-mail applications to scholarship@oenb.at by the end of October 2020.

Applicants will be notified of the jury’s decision by end-November.

1 We assume that the coronavirus crisis will have abated by next year. We are also exploring alternative formats to continue research cooperation under the KLERS program for as long as we cannot resume visits due to the ­pandemic situation.

Developments in selected CESEE countries

Coronavirus overruns the region 2 , 3 , 4

1 Regional overview

The spread of the coronavirus pandemic to Central, Eastern and Southeastern ­Europe (CESEE) has led to restrictions on economic life that seemed difficult to anticipate just a few weeks ago, bringing about some of the most severe social and economic disruptions since the revolutions of 1989. The coronavirus crisis is ­primarily a public health crisis and constitutes an external and symmetric macroeconomic shock to all countries, with containment measures adversely affecting both the supply and demand side, though with different implications across ­countries. This macroeconomic shock will without any doubt fundamentally change the state of affairs in CESEE and send the region into deep recession.

This report gives an overview of the economic situation prior to the corona­virus pandemic and sheds light on macroeconomic strengths and weaknesses and the associated policy space for the CESEE region. It then sketches the development of the coronavirus crisis in CESEE and the policy measures implemented so far.

Pre-coronavirus: moderating though still broadly robust economic growth amid often slowly rising price pressures

Moderating growth amid decelerating international ­momentum in the second half of 2019

High-frequency activity indicators weakened in the second half of 2019 and in early 2020 in most CESEE countries. The weakening was most pronounced in the (very strongly export-oriented) industrial production sector, which basically stagnated in the CESEE EU Member States and decelerated notably in Russia. This reflected the deteriorating international environment and a pronounced decline in world trade that was strongly influenced by the U.S.-China trade war. Somewhat ­stronger dynamics were reported for construction output and retail sales, underlining the continuing strength of domestic demand. A clear pickup among all activity ­indicators was only observed in Turkey as the country recovered from recession in late 2018.

GDP figures for the second half of 2019 were broadly in line with the trends outlined above (see table 1). Real GDP growth in Turkey accelerated to 1.9% (quarter on quarter) in the fourth quarter of 2019 – by far the strongest reading in the CESEE region. Decelerating economic momentum was reported for the ­CESEE EU Member States, where average GDP growth came in at 0.7% (quarter on quarter) in the final quarter of 2019. This was a rather weak reading compared to the dynamism of the past three years. GDP growth in Russia amounted to 0.6% (quarter on quarter) in the fourth quarter of 2019 and was broadly in line with CESEE EU Member States’ figures.

Table 1: Real GDP growth
2017 2018 2019 Q3 2018 Q4 2018 Q1 2019 Q2 2019 Q3 2019 Q4 2019
Period-on-period change in %
Slovakia 3.0 4.0 2.3 1.0 0.4 0.6 0.3 0.4 0.6
Slovenia 4.8 4.1 2.4 1.0 0.8 0.5 0.0 0.8 0.4
Bulgaria 3.5 3.1 3.4 1.0 0.8 1.0 0.7 0.7 0.8
Croatia 3.1 2.7 2.9 0.2 0.4 1.1 0.6 0.6 0.3
Czech Republic 4.4 2.8 2.6 0.6 0.9 0.6 0.5 0.4 0.5
Hungary 4.3 5.1 4.9 1.5 1.2 1.4 1.0 1.1 1.0
Poland 4.9 5.1 4.1 1.3 0.7 1.4 0.7 1.2 0.3
Romania 7.1 4.4 4.1 1.7 0.6 1.1 0.9 0.6 1.5
Turkey 7.5 2.8 0.9 –1.1 –2.4 1.3 1.2 0.4 1.9
Russia 1.8 2.5 1.3 0.4 0.4 –0.1 0.6 0.5 0.6
CESEE average1 4.0 3.2 2.0 0.3 –0.2 0.6 0.8 0.6 0.9
Euro area 2.5 1.9 1.2 0.2 0.4 0.5 0.1 0.3 0.1
Source: Eurostat, national statistical offices.
1 Average weighted with GDP at PPP.

Domestic demand remained the backbone of growth in the second half of 2019 as exports flagged

Growth remained firmly rooted in domestic demand. Private consumption made the strongest contribution to GDP growth in seven of the ten countries ­under observation. It continued to benefit from benign labor market conditions and swift wage growth. Furthermore, consumer sentiment was robust until most recently and consumer credit expanded swiftly.

Unemployment rates have been falling consistently in recent years, from an average level of around 10% in early 2013 to 3.4% in February 2020. This ­represents the lowest reading since the start of transition. Furthermore, employment kept expanding throughout most of the region up to the outbreak of the pandemic, ­contributing to a convergence of employment rates toward euro area levels.

Investment also supported growth throughout most of CESEE in the second half of 2019. Capital spending was bolstered by high capacity utilization, favorable financing conditions, robust construction activity and the availability of EU ­funding in many countries. In some countries, however, poor export prospects already led companies to postpone or scale down investment. This was especially the case in Slovenia, where growth in capital formation dipped into the red. A notable ­deceleration of investment growth was also observed in Croatia, Hungary and ­Poland, coming down from very high levels, however.

Export growth continued to soften in the review period, mirroring declining world trade amid lower international demand. Given the high import content of CESEE’s export production, import growth was also somewhat lower. On ­balance, the external sector often contributed negatively to GDP dynamics, especially in Russia and Turkey.

Inflation reflected strong domestic price pressures

Despite somewhat lower growth rates, means of production – especially labor – continued to be utilized in full in the second half of 2019. High GDP growth, ­emigration and a lack of skilled workers had led to labor shortages in the past years. This translated into high wage growth rates that reached up to 12% annually. The situation has relaxed in recent months and both wage growth and labor shortages came down somewhat (e.g. annual nominal hourly wage growth declined to around 9% by the end of 2019). Nevertheless, the region’s economies mostly ran above full potential. The positive output gap for the CESEE EU Member States in 2019 was estimated at an average 2% of GDP by the European Commission.

This translated into higher inflation rates. Average HICP inflation came in at 3.7% in January and 3.6% in February 2020 in the CESEE EU Member States, the highest level since late 2012. While this in part reflects higher energy prices up until February, core inflation was on the rise, too. In February 2020, it reached an average of 3.3%. Several central banks (e.g. in the Czech Republic, Hungary, ­Poland and Romania) have missed their inflation targets in recent months (at least temporarily).

In Turkey, inflation came down from around 25% in late 2018 to a three-year low of 8.6% in October 2019. However, price growth subsequently reaccelerated to 12.4% in February 2020, owing in part to unfavorable base effects. Among the HICP components, it was especially industrial goods prices that fueled the ­increase.

Russia was the only country with a clear downward trend in inflation in recent months. In February 2020, price growth declined to 2.3% (from 4% in September 2019), well below the central bank’s target of 4%. The most important building block for this development was a base effect from a value-added tax increase in January 2019. Other disinflationary factors included a decline in prices of food products and non-food goods.

Czech central bank tightens monetary policy while key rates in Russia and Turkey decline further

Regional central banks reacted to inflation developments. The Czech central bank increased its policy rate by 25 basis points to 2.25% in February 2020 after having missed its inflation target for three months in a row.

The Turkish central bank decreased its policy rate in four steps, from 16.5% in early October 2019 to 10.75% in late February 2020, reversing most of its ­crisis-induced rate hikes carried out after the turbulences in mid-2018. It argued that the improvement in macroeconomic indicators supported the fall in the ­country’s risk premium. The exchange rate of the Turkish lira vis-à-vis the euro remained broadly stable from October 2019 until the end of February 2020.

The Russian central bank cut its key rate in three steps, from 7% in early ­October 2019 to 6% in late February 2020, citing disinflationary pressures and – in its February move – rising risks of a substantial global economic slowdown.

Coronavirus crisis: macroeconomic strengths and weaknesses and policy space for the CESEE region

The CESEE region entered the current slump from a state of moderating, though still broadly robust economic growth amid often slowly rising price pressures. Compared to 2008, general macrofinancial risks remain broadly contained at the onset of the downturn. The upcoming section provides an overview of important indicators on the external, the general government and the banking sectors in the CESEE region and outlines specific strengths and weaknesses.

External sector: current accounts mostly in surplus and rising external debt buffered by an even larger increase in reserves

The period before the great financial crisis was characterized by twin deficits in the external and public sector accounts in many countries of the CESEE region. At the outbreak of the coronavirus crisis, the region reported a combined current and capital account surplus of 2.2% of GDP (end-2019). Among the individual ­CESEE countries, only Romania recorded a notable current account deficit in 2019 (see chart 1). The external adjustment of the region was driven predominantly by better outcomes in the goods and services balances. The momentum in the trade balance initially rested on strongly reduced domestic demand at the height of the global financial crisis that led to a substantial decline of imports. Trade in goods, however, also benefited from the close integration of the CESEE (EU) region in international supply chains as the associated rise in competitiveness bolstered ­export growth after the acute crisis years. In recent quarters, pronounced (­productivity-adjusted) wage increases in the manufacturing sector have already shaved off some of the competitive edge of the region, however.

Chart 1 is a column chart that shows the combined current and capital account and its components in % of GDP for the countries of Central, Eastern and Southeastern Europe in the years 2008 and 2019. Combined current and capital account balances improved strongly in most countries. In 2008, they ranged between minus 21.2% of GDP in Bulgaria and 6.1% of GDP in Russia. In 2019, they ranged between minus 3.3% of GDP in Romania and 6.2% of GDP in Slovenia. Source: Eurostat, ECB, national central banks.
Chart 2 is a column chart that shows backward participation in global value chains for the countries of Central, Eastern and Southeastern Europe as well as Austria and the OECD on average. It is measured as the foreign value added content of exports in % of a country’s total exports. Values range between 7.9% for the OECD average and 44.8% in Slovakia. Source: OECD.

Yet, some CESEE countries belong to the world’s most tightly integrated in terms of global value chains (see chart 2), which implies a high vulnerability in the current crisis. All countries under observation are more strongly integrated than the OECD average, and the degree of integration in countries like the Czech ­Republic, Hungary and Slovakia is even five to six times as high. Global production networks could be an important transmission mechanism for shocks throughout the global economy and have already been disrupted at an early stage by the ­stoppage of production in China. Furthermore, global value chains not only ­transmit shocks in supply, they also transmit shocks in demand. As an example, the automobile industry in CESEE will not only be impaired by a lack of Chinese ­inputs into domestic production, but also by a decline in Chinese auto demand via falling sales of international (especially German) car producers that usually obtain inputs from CESEE.

International trade also acts as a transmission mechanism for coronavirus-­related shocks. Chart 3 shows that the degree of openness has mostly increased since the global financial crisis and is especially high in the Central European EU Member States (up to three times as high as in the EU-15). Even though the ­geographical distribution of CESEE countries’ trade remains very much centered on the EU-15, the weight of China and the U.S.A. as the largest and second-largest global economies (in terms of purchasing power parity) in final demand for CESEE products must not be ignored given the strong integration in international value chains.

Further, tourism will be one of the sectors most strongly affected by the ­coronavirus recession; this warrants a closer look at the importance of this sector for CESEE (see chart 4). In terms of dependence on tourism, the CESEE countries can be broken down into roughly three groups. The first group includes Poland, Russia, Romania, Slovakia, the Czech Republic and Hungary. These countries ­reported a share of tourism in total GDP of between 5% to 8%. The second group includes Bulgaria, Turkey and Slovenia, with a share of tourism of around 11% to 12% in total GDP. Finally, Croatia is in a league of its own, with a share of tourism in GDP and employment of around 25%, making it the country most dependent on tourism in the whole region (and in fact also throughout much of Europe).

Chart 3 is a column chart that shows trade openness for the countries of Central, Eastern and Southeastern Europe and the EU-15 for the years 2008 and 2018. Trade openness is measured as the sum of exports and imports in % of GDP. In 2008, it ranged from 43.3% in Turkey to 149.2% in Slovakia. In 2018, it ranged between 41.3% in Russia and 177.6% in Slovakia. Source: The Vienna Institute for International Economic Studies.

Finally, we take a look at foreign capital flows and external debt to get an idea of the sustainability of the external position of the CESEE region. For the region as a whole, external liabilities in the international investment position (IIP) ­increased by some 20 percentage points of GDP between 2008 and 2019 (see chart 5), mostly on account of FDI inflows (+16.3 percentage points of GDP) but also on account of higher portfolio liabilities (+10.7 percentage points of GDP). Other ­investments were the only component of IIP liabilities that posted a notable decline (–6.4 percentage points of GDP). The latter mainly reflected two things: The ­deleveraging of international banking groups in the region and the change in the refinancing structure of CESEE banking sectors away from external liabilities to domestic deposits. The outlined dynamics in IIP liabilities translated into a somewhat higher gross external debt of the CESEE region (+4.9 percentage points of GDP, reaching 48.7% of GDP in 2019; see chart 6). At the same time – supported by current account surpluses – reserves (including gold) also trended higher (+7.4 percentage points of GDP) and covered more than 50% of total external debt by the end of 2019.

Chart 4 is a column chart that shows the importance of tourism for Central, Eastern and Southeastern Europe in 2018. This importance is measured as the share of employment in tourism in total employment and as the share of tourism in total GDP. In 2018, employment in tourism as a share of total employment ranged between 4.5% in Poland and 23.4% in Croatia. The share of tourism in GDP ranged between 4.5% in Poland and 25.1% in Croatia. Source: World Bank.

Developments at the country level were heterogeneous, however. Between 2008 and 2019, a large degree of external deleveraging was observed for Hungary and Bulgaria (and to a lesser extent also for Croatia). In all three countries, the ­decline in IIP liabilities was almost exclusively driven by other investments, leading to a corresponding decline in gross external debt. The Czech Republic and ­Slovakia, by contrast, reported an increase in their external liabilities of more than 50 percentage points of GDP. Strongly rising portfolio and other investment ­liabilities – amid an also substantial upward trend in FDI – pushed up external debt in the two countries. In Turkey and Poland, the increase in IIP liabilities amounted to some 25 percentage points of GDP in the past decade. While, in the case of ­Poland, the increase rested on FDI and portfolio flows only, all IIP components contributed to the rise in Turkey. Hence, external debt in Turkey also posted a relatively large increase. Comparatively little change could be observed in ­Slovenia, Romania and Russia, where increases in FDI and decreases in other investments broadly leveled out.

Chart 5 is a column chart that shows international investment position liabilities and their components in % of GDP for the countries of Central, Eastern and Southeastern Europe in the years 2008 and 2019. In 2008, international investment position liabilities ranged from 47.9% of GDP in Russia to 176.6% of GDP in Hungary. In 2019, they ranged between 55.7% of GDP in Russia and 161.3% of GDP in Slovakia. Source: National central banks.
Chart 6 is a column chart that shows gross external debt and gross official reserves (excluding gold) in % of GDP for the countries of Central, Eastern and Southeastern Europe in the years 2008 and 2019. In 2008, external debt ranged between 30.3% of GDP in the Czech Republic and 114.5% of GDP in Hungary. Reserves ranged between 1.6% of GDP in Slovenia and 32.5% of GDP in Bulgaria. In 2019, external debt ranged between 29.2% of GDP in Russia and 111.9% of GDP in Slovakia. Reserves ranged between 1.6% of GDP in Slovenia and 60.4% of GDP in the Czech Republic. Source: National central banks.

Summing up, the region entered the current downturn with its external ­accounts in broadly solid shape. Combined current and capital accounts were mostly in surplus and an increase in external debt was buffered by an even larger increase in reserves. On the country level, Romania was the only country to ­report a notable current account deficit in 2019. Most of the shortfall, however, was ­covered by capital (mostly FDI) inflows. Given the high degree of openness and the strong integration in global value chains, Central European countries (especially Hungary, the Czech Republic and Slovakia) will most likely be more affected by a slowdown in global demand. The sudden stop in international mobility will particularly dampen the Croatian economy, as the country is highly dependent on tourism. Finally, Turkey experienced a rather large increase in external debt amid broadly unchanged international reserves, leaving the coverage of external debt by foreign exchange reserves among the lowest of the region. Furthermore, exchange rate risks are high given the Turkish lira’s strong volatility in recent years and the country is also rather susceptible to the effects of a sudden stop in tourism.

General government sector: lower budgetary shortfalls than in 2008 despite a lack of consolidation in recent years; debt levels generally higher with partly unfavorable financing structures

A central question on the eve of the recession is whether fiscal policy has enough room for maneuver to weather the fallout from the coronavirus crisis. ­Ideally, policymakers would want to rely on automatic fiscal stabilizers, discretionary fiscal stimuli and favorable financing conditions to shield companies, workers and households from the most severe consequences of the coronavirus-induced economic slump. The ability to do so crucially depends on a country’s fiscal space.

A look at general government net lending in the region reveals that most ­CESEE countries managed to substantially bring down headline deficits as well as ­cyclically adjusted budget deficits from the heights after the global financial crisis (see chart 7). Measures to improve revenue collection combined with strong economic growth in recent years have underpinned a notable improvement in public finances. In fact, most countries reported notably lower deficits in 2019 than they did before the outbreak of the global financial crisis in 2008.

The reform momentum, however, stalled somewhat in 2019. Six of the ten countries under observation reported higher headline deficits (lower surpluses) than in 2018, despite continuing robust economic momentum. An expansionary fiscal stance was also documented by the deterioration in the (projected) cyclically adjusted deficits of most CESEE EU Member States.

In Romania, the headline deficit increased to 4.3% of GDP, 1.3 percentage points of GDP above the Maastricht threshold. Romania has been in a significant deviation procedure (SDP) since 2017. In November 2019, the European ­Commission commented that the Romanian authorities do not intend to act upon the recommendations issued within the SDP and that the new pension law poses a significant upward risk to the public deficit in 2020 and beyond. Against this background, an excessive deficit procedure (EDP) was launched in spring 2020. ­Hungary – the second country subject to an SDP – was on a better trajectory ­before the coronavirus hit the region. In its November 2019 report, the European Commission noted that the Hungarian economy was experiencing good times, with an improvement in the overall fiscal situation.

After the start of transition, CESEE public sectors had been known for their low indebtedness for a long time. The global financial crisis thoroughly altered this situation, however (see chart 8). Discretionary fiscal spending and large-scale banking sector support in several countries drove up general government debt to more “normal” European levels after 2008. Strong economic dynamics in recent years reversed some of these increases, but debt levels mostly remain substantially higher than ten years ago. In Turkey, government debt even displayed a clear ­upward trend in the past two years as the country went through a recession. Russia reports the by far lowest public debt and the country’s National Welfare Fund holds about USD 150 billion in liquid assets (9% of GDP).

Chart 7 is a column chart that shows headline deficits and cyclically adjusted general government deficits in % of GDP for the countries of Central, Eastern and Southeastern Europe in the years 2008 and 2019. In 2008, headline deficits ranged between minus 5.4% of GDP in Romania and 4.9% of GDP in Russia. Cyclically adjusted deficits ranged from minus 7.9% of GDP in Romania and 0.3% of GDP in Bulgaria (no figures available for Turkey and Russia). In 2019, headline deficits ranged between minus 4.3% of GDP in Romania and 2.1% of GDP in Bulgaria. Cyclically adjusted deficits ranged between minus 3.7% of GDP in Romania and 1% of GDP in Bulgaria (no figures available for Turkey and Russia). Source: European Commission.

For fiscal sustainability, it is not only the level of debt that matters but also its composition. With respect to the creditor structure, a large share of foreign ­investors can drive up risk premiums and impede access to market funding and favorable financing conditions in turbulent times. Domestic investors (such as ­pension funds), by contrast, are usually more long-term oriented and less prone to swings in sentiment. The share of domestic investors is relatively low in CESEE, partly because comparatively shallow capital markets make it hard to issue ­sufficient portions of sovereign debt domestically. Chart 9 shows that nonresidents on ­average held close to 50% of total debt in CESEE in 2019. In Slovakia and Slovenia, the shares reached close to 70% and displayed a notable upward trend.

If we look at the currency denomination of public debt, we find that the share of foreign currency-denominated debt in total debt is rather high in many CESEE countries given the strong presence of nonresident investors (see chart 10). ­Exchange rate risks, however, are mitigated by two factors: The euro is the most important foreign currency in the CESEE EU Member States, given their close trade, financial and business cycle linkages with the euro area and the associated hedging possibilities. Second, the stock of euro-denominated debt is ­especially high in those countries that have pegged their currencies to the euro or whose ­exchange rate policy is strongly focused on the euro (Bulgaria, Romania, Croatia). Among the non-EU countries, a high share of (mostly U.S. dollar-­denominated) foreign currency debt can be observed in Turkey. In Russia, the share of foreign currency-­denominated government debt has decreased notably in recent years as sanctions have made tapping international markets increasingly ­difficult for the country.

Chart 8 is a column chart that shows general government debt levels in % of GDP for the countries of Central, Eastern and Southeastern Europe in the years 2008 and 2019. In 2008, debt ranged between 5.7% of GDP in Russia and 71.8% of GDP in Hungary. In 2019, debt ranged between 12.4% of GDP in Russia and 73.2% of GDP in Croatia. Source: European Commission.
Chart 9 is a column chart that shows general government debt owed to nonresidents in % of total government debt for the countries of Central, Eastern and Southeastern Europe in 2008 and the third quarter of 2019. In 2008, it ranged between 25.6% in the Czech Republic and 62.6% in Romania. In the third quarter of 2019, it ranged between 24.1% in Russia and 69.3% in Slovenia. Source: Eurostat, IMF, national central banks.
Chart 10 is a column chart that shows general government debt denominated in foreign currency in % of total debt for the countries of Central, Eastern and Southeastern Europe in the years 2009 and 2019. In 2009, it ranged between 19.8% in Turkey and 69.4% in Bulgaria (no figures available for Slovakia and Slovenia). In 2019, it ranged between 4.6% in Slovenia and 77.8% in Bulgaria. Source: Bloomberg, Oesterreichische Nationalbank.

Regarding the ratings for long-term foreign currency sovereign debt, Slovakia, Slovenia, the Czech Republic and Poland currently show the strongest ratings (see chart 11). Bulgarian, Hungarian, Romanian and Russian government bonds are assessed as moderately risky. While Standard & Poor’s applies the moderate risk category also to Croatia, Moody’s sees a substantial credit risk for the country. Turkey is the lowest-rated country in the CESEE region, with credit risk being deemed high by both rating agencies. Comparing 2008 and today, current ratings by Moody’s are often somewhat weaker than before the global financial crisis, while no major changes can be observed in the country risk assessments released by ­Standard & Poor’s.

Chart 12 is a column chart that shows general government debt maturing within one year in % of total debt for the countries of Central, Eastern and Southeastern Europe in the years 2009 and 2019. In 2009, the share ranged between 7.4% in Bulgaria and 44.7% in Hungary. In 2019, it ranged between 5.4% in Bulgaria and 25.3% in Hungary. Source: Bloomberg, Oesterreichische Nationalbank.

Short-term debt issuance is usually associated with lower funding costs but – at the same time – it is also associated with higher interest and rollover risks ­especially in times of turbulence. Since the global financial crisis, the share of short-term debt in total debt has fallen substantially in all CESEE countries except Russia (see chart 12). In some cases, it has reached long-term lows. This development was ­related to favorable market conditions in an environment of prolonged monetary accommodation that favored the issuance of long-term debt.

Chart 11 is a column chart that shows the latest available ratings of long-term foreign currency sovereign debt as released by Moody’s and Standard & Poor’s for the countries of Central, Eastern and Southeastern Europe. Moody’s assigned the weakest rating to Turkey and the strongest rating to the Czech Republic. Standard & Poor’s assigned the weakest rating to Turkey and the strongest rating to Slovenia. Source: Moody’s, Standard & Poor’s.

Summing up, despite some recent deterioration, CESEE countries’ budget deficits are generally lower than in 2008, and three countries even reported ­surpluses in 2019. However, public debt levels have increased substantially throughout most of the region. The structure of public debt remains skewed toward nonresident investors and – at least in some countries – foreign currency-denominated debt. On a positive note, refinancing risks have been reduced considerably due to a lengthening of debt maturities. Therefore, the recent increase in government bond spreads (see below) does not pose an immediate threat.

On the country level, Romania and Turkey seem to be exposed most strongly to public finance risks. Romania’s public finances have deteriorated throughout the past years and the country is currently subject to an excessive deficit procedure (the only ongoing EDP in the EU). Its debt level has nearly tripled since 2008. ­Furthermore, it scores relatively high in terms of the share of nonresident investors and foreign currency public debt. Turkey has by far the weakest country rating in the CESEE region and reports a relatively large (and rising) share of U.S. dollar-­denominated debt amid pronounced exchange rate volatility in recent years.

A more stable ­refinancing ­structure, improving asset quality and rising capitalization mostly contain banking ­sector risks

In recent years, credit growth accelerated in an environment of strong GDP growth, ample liquidity and low interest rates in most CESEE countries. Some credit segments already displayed first signs of overheating. This applies in particular to housing loans, which grew swiftly given strong housing demand and ­ever-increasing housing prices. Several CESEE countries (especially EU Member States) have introduced macroprudential measures and/or recommendations to put a brake on this development. Furthermore, countercyclical capital buffers were activated in Bulgaria, the Czech Republic and Slovakia.

Chart 13 is a column chart that shows foreign currency-denominated loans to the private sector in % of total loans to the private sector for the countries of Central, Eastern and Southeastern Europe in the years 2008 and 2019. In 2008, the share ranged between 7.6% in Slovenia and 65.5% in Hungary. In 2019, it ranged between 0.1% in Slovakia and 51.5% in Croatia. Source: ECB, national central banks.
Chart 14 is a column chart that shows nonperforming loans in % of total loans for the countries of Central, Eastern and Southeastern Europe in the years 2008 and 2019. In 2008, they ranged between 2.8% in the Czech Republic and 13.5% in Russia. In 2019, they ranged between 1.1% in Slovenia and 17.1% in Russia. Source: IMF, national central banks, Oesterreichische Nationalbank.

Compared to 2008, banking sector risks in CESEE have moderated. For ­instance, the share of foreign currency-denominated loans in total loans to the ­private sector has declined throughout most of the region (see chart 13). This downward trend is particularly pronounced in loans to households, which is ­especially welcome as the sector is usually unhedged against exchange rate changes. At end-2019, the foreign currency share in loans to households was virtually zero in ­Slovakia, Slovenia, the Czech Republic, Hungary and Russia (in Turkey, foreign currency loans to households have been legally banned). Several countries (most prominently Hungary and Croatia) introduced conversion schemes for foreign ­currency loans to households into local currency loans that fueled this downward trend. It needs to be noted, however, that the foreign currency share in corporate loans remains notably higher. Such loans have received more policy attention ­recently. The IMF has intensified its warnings on high levels of corporate debt in emerging markets, and the sharp depreciation of the nominal effective exchange rate of the Turkish lira in 2018 as well as the recent pandemic-­induced ­depreciation of some of the region’s currencies has illustrated potential risks.

The decline in foreign currency loans has contributed to a higher quality of banking sector assets, as has the decline in nonperforming loans (NPLs). A ­comparison of the shares of nonperforming assets in total assets for 2008 and 2019 does not yield a clear-cut regional trend (see chart 14). Compared to 2013, ­however, when the global financial crisis and crisis legacies pushed NPL ratios to 15% or more in several countries, NPL ratios have come down substantially. This positive momentum can be attributed to favorable lending developments as well as to the strong general economic momentum. Furthermore, active portfolio ­cleansing measures – including writing off bad debt, selling NPL portfolios as well as restructuring and forbearance agreements and the transfer of NPLs to bad banks – also positively impacted the stock of nonperforming assets. In Russia, NPLs also decreased somewhat in the past two years after the 2014 recession and the banking sector turbulences in late 2017 (which led to the nationalization of three ­medium-sized credit institutions together accounting for about 7% to 8% of banking assets). Turkey was the only CESEE country to report higher NPLs in the past few years. The increase in Turkish NPLs reflected the financial difficulties ­associated with the 2018 financial turbulences faced by indebted companies – ­particularly those with debts in foreign currency.

Another positive development was observed in CESEE banking sectors’ ­refinancing structure. Over the past years, the refinancing structure has shifted from external liabilities to local deposits. This makes CESEE banks less vulnerable to swings in international sentiment and the possible (and in a worst case synchronized) withdrawal of foreign capital. At end-2019, seven of the ten countries under observation reported a (partly substantial) overhang of private sector deposits ­relative to domestic banking sector claims (see chart 15). Banking sectors in Slovakia and Turkey reported a moderate funding gap (on a notable declining trend in the case of Turkey), while only Russia recorded a persistently high funding gap of around 10% of GDP.

Chart 15 is a column chart that shows domestic banking sector claims to the private sector less private sector deposits in % of GDP for the countries of Central, Eastern and Southeastern Europe in the years 2008 and 2019. In 2008, it ranged between minus 11.3% of GDP in Turkey and 35.1% of GDP in Slovenia. In 2019, it ranged between minus 18.1% of GDP in Croatia and 11.2% of GDP in Russia. Source: ECB, Eurostat, national central banks, national statistical offices.
Chart 16 is a column chart that shows the capital adequacy ratio in % of risk-weighted assets for the countries of Central, Eastern and Southeastern Europe in the years 2008 and 2019. In 2008, it ranged between 11.1% in Slovakia and 16.8% in Russia. In 2019, it ranged between 12.3% in Russia and 23.2% in Croatia. Source: National central banks.

On top of that, the risk-bearing capacity of CESEE banking sectors has ­improved. Capital adequacy ratios have increased throughout the region, in most countries substantially so (see chart 16). Capitalization is not only higher than in 2008, it is also high compared to other European countries. The by far weakest capital base was reported for Russia.

Summing up, risks emanating from the banking sector – a main transmission channel in the global financial crisis – currently seems to be relatively contained. Credit growth is swift (in certain segments probably too swift) but credit is stably funded by local deposits. Asset quality has improved, and banking sector portfolios today are generally less risky than a decade ago. Among the individual countries, Russia and Turkey are exposed to the highest risks. In Russia, domestic claims are notably higher than domestic deposits, capitalization is weak and the NPL ratio is the highest in the region (accompanied by a coverage ratio of only somewhat above 50%, which is the lowest level in CESEE). At the same time, credit growth ­remains high and strongly driven by uncollateralized consumer loans. Turkey was the only country to report negative dynamics in nonperforming assets. While consumers are banned from foreign currency borrowing, the stock of foreign currency-­denominated lending in corporate credit remains stubbornly high. This exposes corporations to exchange rate risks amid large (short-term) negative foreign ­currency positions. Finally, the Turkish banking sector still reports a positive – though declining – funding gap.

Spread of coronavirus: CESEE was affected later and to date less strongly than other regions

Table 2: Key indicators regarding COVID-19 spread in CESEE (mid-April)
Current number of ­official cases Infections per million inhabitants Daily increase of cumulative cases (average of last 5 days, %) Days since first reported case Cumulative ­deaths Deaths per ­million inhabitants
SK 835 152 4 40 2 0
SI 1,220 581 2 42 56 27
BG 713 103 3 39 35 5
HR 1,704 416 4 50 31 8
CZ 6,141 574 2 45 161 15
HU 1,579 164 6 42 134 14
PL 7,202 191 5 43 263 7
RO 6,879 358 6 49 344 18
TR 65,111 806 9 35 1,403 17
RU 21,102 145 16 75 170 1
CN 83,293 60 0 >110 3,344 2
AT 14,234 1,582 1 50 384 43
IT 162,488 2,708 2 76 21,069 351
Source: European Centre for Disease Prevention and Control, OeNB calculations.

Coronavirus reached CESEE somewhat later than Western European countries. On average, the first COVID-19 cases in CESEE were reported thirty days later than in Italy (and five days later than in Austria). At the current stage, the number of reported infections is still comparatively small in CESEE (see table 2). Russia and Turkey are the only clear outliers. Infections per million inhabitants, however, remain relatively low also in these two countries.

The Global Health Security Index (developed by the Johns Hopkins Center for Health Security, the Nuclear Threat Initiative and The Economist Intelligence Unit) provides a rough estimate of the health security capabilities in CESEE. The subcomponents of the index that are related to responding to and mitigating the spread of an epidemic and to the quality, coverage, resilience and robustness of the health sector are especially relevant in the current situation. In both categories, CESEE countries do not score notably worse than Austria or Italy. Some countries even outperform Western European peers, e.g. Slovenia, Poland and Turkey. Rather low capabilities of dealing with pandemics, however, are reported for ­Romania, Slovakia and especially Bulgaria.

While the Global Health Security Index suggests that health-related risks from the coronavirus pandemic are generally in line with other European countries, two factors should be noted: (1) The median age of the population in CESEE is rather high and the age distribution of the population skewed toward older age cohorts (this does not apply to Turkey, though). This implies a rather large high-risk group for serious COVID-19 infections. (2) Furthermore, studies 5 suggest that case-­fatality rates are strongly positively related to a country’s share of working-age families living with their parents (multigeneration households). Such living ­arrangements increase intergenerational contacts and enable the virus to spread more quickly to high-risk older strata of the population. Multigeneration households are especially widespread in several CESEE countries (e.g. in Slovenia, ­Bulgaria, Croatia and Poland).

Government responses to the spread of coronavirus: fast, comprehensive and associated with high economic costs

Chart 17 is a line chart that shows the COVID-19 Government Response Stringency Index plotted against the number of confirmed COVID-19 cases for the countries of Central, Eastern and Southeastern Europe. Most countries implemented stringent containment measures even when the number of confirmed COVID-19 cases was still relatively low. Source: Oxford COVID-19 Government Response Tracker, Blavatnik School of Government.

Government responses to the spread of coronavirus have taken various forms, ranging from contact tracing and testing up to general curfews. The Oxford COVID-19 Government Response Tracker aims to track and compare government responses to the coronavirus outbreak and makes it possible to compare CESEE countries’ stance compared to other European peers. Chart 17 and 18 plot the Stringency Index 6 against the number of confirmed COVID-19 cases and shows that CESEE countries responded quickly and started to implement measures soon after the first coronavirus cases were reported. Government responses at the time of writing were stringent and far reaching in all CESEE countries (in some cases even more stringent than in Italy or Austria).

Chart 18 is a line chart that shows the COVID-19 Government Response Stringency Index plotted against the number of confirmed COVID-19 cases for Austria and Italy. Compared to the countries of Central, Eastern and Southeastern Europe, Austria and Italy tightened containment measures only after a comparatively larger number of confirmed COVID-19 cases. Source: Oxford COVID-19 Government Response Tracker, Blavatnik School of Government.
Chart 19 is a column chart that shows percentage change in Google mobility trends figures for the countries of Central, Eastern and Southeastern Europe on April 11, compared to a baseline. In the category retail and recreation, mobility trends decreased by between 51% in Hungary and 92% in Turkey. In the category transit stations, mobility trends decreased by between 37% in the Czech Republic and 90% in Turkey. Source: Google COVID-19 Community Mobility Report.

Government measures will, without any doubt, lead to large economic costs. The extent of these costs, however, is still very hard to gauge as no hard data on production and sales for the period in question is available at the time of writing (for our current forecast for GDP growth in CESEE, see the Outlook for selected CESEE countries in this issue). However, some indicators suggest that public life has temporarily come to a standstill and that economic activity has declined ­notably. Chart 19 shows mobility trends published by Google, which are based on visits and the length of stays at different places. For example, mobility observed at transit stations (e.g. public transport hubs such as subway, bus and train stations) declined by more than 50% on average in the CESEE region in mid-April ­compared to early February 2020. The reduction was even more pronounced in the area of retail and recreation (e.g. at restaurants, cafés, shopping centers, theme parks, ­museums, libraries and movie theaters), where mobility declined by 70% on ­average (up to 90% in the case of Turkey). The same is true for international ­mobility. Flight departures from international capital airports had basically come to a standstill by mid-April (see chart 20).

Chart 20 is a column chart that shows flight departures from international airports for the countries of Central, Eastern and Southeastern Europe. In the period between March 15 and March 17, departures ranged between 0 in Slovakia and 384 in Turkey. In the period between April 11 and April 13, departures ranged between 0 in Slovakia and 43 in Russia. Source: flightradar24.com.
Chart 21 is a line chart that shows the development of the Economic Sentiment Indicator for the countries of Central, Eastern and Southeastern Europe and the Purchasing Managers Index for Turkey and Russia between January 2018 and April 2020. Both indicators nosedived in March and April 2020 and reached historically low levels. Source: European Commission, Markit.
Table 3: Selected financial market indicators
Exchange rate versus
Equity index Euro-denominated1 ­government bond yield spread versus euro area Sovereign credit default swap premium (5-year)
% Basis points Basis points
CZ –6.2 –26.0 59 20
HU –6.0 –29.0 69 42
PL –6.6 –22.8 54 29
SK n.a. –6.6 n.a. 11
SI n.a. –14.5 n.a. n.a.
HR –2.3 –21.8 155 28
BG Currency board –20.2 74 21
RO –1.1 –13.6 156 40
RU –16.1 –18.0 146 50
TR –12.3 –16.2 365 326
Source: Macrobond.
Note: Year-to-date changes observed on April 14, 2020. A negative value in the first column indicates depreciation.
1 RU: EMBIG (USD-denominated eurobonds) used instead of Euro-EMBIG (EUR-denominated eurobonds).

Mirroring these figures, sentiment in CESEE has plummeted (see chart 21). In April 2020, the European Commission’s Economic Sentiment Indicator (ESI) for the CESEE EU Member States dropped by nearly 40 points and declined to its lowest level in history. A similar development was observed in the Purchasing Managers’ Index (PMI) for Russia and for Turkey. Both indexes descended into free fall in April 2020 and reported values of only 31.3 and 33.4 points, respectively, far below the 50-point threshold indicating an economic expansion.

The impact of the coronavirus crisis on financial market indicators was immediate and substantial. A deterioration was observed in all financial market segments and in all countries. The strongest impact was reported for equity prices, which declined by up to 29% against the start of the year in Hungary. Euro-­denominated eurobond spreads also increased strongly in all countries against the backdrop of increasing sovereign credit default risk and a notable depreciation of national currencies against the euro. The countries most affected by the sell-off were Turkey, Russia, Romania and Croatia, not least because of higher macro­financial vulnerabilities (as outlined above).

Governments throughout CESEE have taken extensive measures to alleviate the fallout from the ensuing greater economic crisis (for a more detailed overview see country chapters). Fiscal support measures have included, among others, ­deferring tax and social security contributions for affected enterprises, taking over part of the salary payments to employees and extending paid sick leave. Some countries have increased the pay for key sectors, including the salaries of medical professionals. Governments in many countries have also taken measures to avoid liquidity shortages in the real sector, often jointly with commercial banks and development banks; in some cases, these measures include state guarantees. Moratoria for debt repayments have also widely been recommended and implemented.

CESEE central banks have also been quite active and made use of their full tool kit. Following the onset of the pandemic, key policy rates were cut in the Czech Republic (by 125 basis points to 1%), Poland (100 basis points to 0.5%), Romania (50 basis points to 2%) and Turkey (100 basis points to 9.75%). The Croatian ­central bank also inter­vened on the foreign currency markets to contain ­depreciation pressures. Liquidity provision measures for banks including ­longer-term refinancing operations and additional foreign currency swap auctions were launched in several countries, and some central banks also started buying bonds of their respective governments (e.g. in Croatia, Hungary, Poland, ­Romania). In mid-April, the Croatian and the Bulgarian central bank announced swap lines with the ECB. Easing measures regarding the regulatory frame­work have also been announced. They include, among others, a revision of (planned) countercyclical capital buffer rates (e.g. in Bulgaria and the Czech Republic).

Ukraine: coronavirus pandemic hits economy after successes in macroeconomic stabilization

The Ukrainian economy continued to grow gradually in the second half of 2019, bringing full-year GDP growth to 3.2%. Yet, inventory destocking weighed on the growth rate, particularly in the final quarter. Supported by strong wage growth, private consumption remained the main growth driver, while gross fixed capital formation also showed positive developments. Exports performed well despite a strengthening hryvnia, as agricultural exports were expanding particularly briskly. Import growth stood slightly below export growth, but due to the higher starting base of imports the contribution of net exports remained marginally negative.

Benefiting from rising real exports and improving terms of trade, the current account ­deficit narrowed to 2.7% of GDP in 2019 (excluding the one-off compensation payment the Ukrainian state-owned energy company Naftogaz received from Gazprom in the amount of about 2% of GDP). Income from gas transit will remain an important component of the current account in the next few years, but its role will decline. Under the new gas transit contract that was concluded at end-2019, Ukraine will earn about USD 7 billion over the next five years, which is about half of the amount Ukraine would have received under the expired contract. As regards the financial account, the high interest rate level increasingly attracted portfolio investments on the government bond market in 2019, while net FDI inflows stayed moderate.

Consumer price inflation fell to 4.1% at end-2019 and thus reached the inflation target range of 5% ± 1 percentage point defined by the National Bank of Ukraine (NBU). Inflation declined further to 2.3% in March 2020. Lower energy prices and declining core inflation ­ (supported by the appreciation of the hryvnia) brought down headline inflation rates. Against the background of disinflationary developments, the NBU cut the key police rate in six steps from 17.5% in mid-2019 to 10% in March 2020.

When making its latest interest rate decision public in mid-March, the NBU cited risks related to the spread of coronavirus for the global and the Ukrainian economy. In the same week, the NBU sold foreign currency on the foreign currency market to ease depreciation pressures on the hryvnia in an environment of global financial market turbulences. Net foreign currency interventions totaling about USD 2.2 billion mainly caused official reserves to decline by about 8% in March to USD 24.9 billion. Hence, they fell slightly below their end-2019 level (equal to 3.7 months of imports) after a continued rise in 2019. NBU measures taken in the context of the spread of coronavirus also include delaying the introduction of capital buffers, introducing long-term refinancing loans and encouraging banks to introduce a special grace period for loan repayments by individuals and companies. In parallel, the Ukrainian authorities implemented several measures to contain the spread of coronavirus, ranging from the closure of schools to movement restrictions. Moreover, the budget for 2020 was amended to incorporate a deficit of 7.5% of GDP compared to a deficit of 2.1% in 2019. The budget revision took into account support measures (increases in medical, social and pension expenses) and projected negative GDP growth of 4.8%.

Following a staff-level agreement on a new three-year IMF Extended Fund Facility (EFF) reached in early December 2019, the arrangement has not come into effect so far. Efforts to fulfill the conditions for IMF Executive Board approval intensified more recently, as the land reform was approved by the parliament and a crucial banking law that prevents former owners of banks that have been declared insolvent from regaining their assets passed parliament in the first reading. However, a group of Ukrainian lawmakers proposed thousands of amendments to the law that could lead to a noticeable delay until final parliamentary approval of the law. If the EFF is approved by the IMF Executive Board, total available disbursements would be larger than envisaged in December (reportedly USD 8 billion instead of USD 5.5 billion).

Western Balkans 7 : strongly affected by the coronavirus crisis

The coronavirus crisis strongly impacted on the Western Balkan economies since the first lockdown measures were enacted toward mid- or end-March 2020. The far-reaching shutdown of the economies to combat the spreading of the virus have shaken all areas of life in the region with tremendous economic consequences. Overall, the Western Balkan region seems to be more vulnerable to a fast spreading of the virus and its consequences owing to generally poorer health systems and less preparedness to face a pandemic than most EU countries (chart 1).

Chart 1 is a column chart that shows the subcomponent of the Global Health Security Index capturing the quality of public health care systems for the EU Member States and the Western Balkan countries for the year 2019. Values range from 37.3 in Malta to 75.6 in the Netherlands (with a possible maximum score of 100). Source: Global Health Security Index.

In most Western Balkan countries, economic growth already lost some momentum in the final quarter of 2019 compared to previous quarters, with strongly diverging growth patterns (chart 2). Growth declined particularly sharply in Albania, from 4.2% in the third to –0.2% in the fourth quarter of 2019, as a devastating earthquake hit the country in November 2019, and in Bosnia and Herzegovina, from 3.1% in the third to 1.6% in fourth quarter of 2019, driven by almost stagnating private consumption. By contrast, growth in Serbia accelerated to 6.2% in the fourth quarter on the back of strong gross fixed capital formation, which lifted full-year growth to above 4%.

Overall, private consumption continued to be an important growth contributor in the second half of 2019. Swift credit expansion, higher wages and remittances and, moreover, positive developments on the labor markets were supportive factors. According to labor force surveys, the Western Balkan economies managed to bring down their unemployment rates (toward the end of 2019) compared to a year earlier. In Kosovo, the unemployment rate declined by almost 4 percentage points compared to one year earlier to (still high) 25.7% at the end of 2019, and by 3.5% in North Macedonia to 17.5%. At end-2019, Serbia had the lowest unemployment rate with below 11%. It should be noted that these positive trends are also owed to a strong brain drain in the region.

The rather volatile patterns of investment are often the result of big public investments (mainly infrastructure or energy projects) throughout the Western Balkans. It is worth noting that, in Albania, investment growth decelerated sharply in the second half of 2019 due to the finalization of large infrastructure projects. Furthermore, political uncertainty and the earthquake left their marks as well. In Serbia, by contrast, investment growth accelerated by more than 20% in the second half of 2019. Here, a huge energy project was key but FDI inflows also contributed positively to investment growth.