CEE Outlook 2021: Vaccination & pro-cyclical policies, positive impact in H2

In Central and Eastern Europe (CEE), the year 2020 has been dominated by the COVID-19 pandemic. The first pandemic wave in March/April 2020 has been managed well by many CEE states with swift and strong lockdowns, but the second wave is harder to control and still raging in parts of the region. The economic costs of the lockdowns in 2020 were high: Croatia, depending on summer tourism was hit hardest in CEE, with GDP declining by 9% in Q1-Q3 compared to the previous year, more than the euro area average of 7.4% yoy. In Czechia, Hungary and Slovakia, as well as in Romania, GDP declined by around 5-6% in Q1-Q3, similar to Germany. The Russian economy shrank only by 3.4% in the first three quarters of 2020 compared to the previous year — less than we anticipated .

Chart 2 - Economic decline during 2020 (%)

Refinitiv, RBI/Raiffeisen Research

Output bounced back strongly in Q3 2020 when restrictive measures were largely removed. However, policies were possibly relaxed too much over the summer and the CE region became a global focal point of the pandemic in autumn when Czechia temporarily led the global infection ranking. Notable is a dichotomy in the structure of the latest shock (see CEE Watch: Economic Sentiment (ESI) — "two-speed economy" continues). While industrial production slumped by over 20% yearly during the first wave in April 2020, in November industrial output merely stagnated. On the other hand, retail sales are again strongly affected in countries with renewed lockdowns like Czechia, Poland and Austria and will likely remain depressed in early 2021.

Looking forward to this year’s economic development, theavailability ofvaccines and thepace of rollout of the vaccinationwill be key for CEE in 2021. Depending on vaccination levels, governments will be willing and able to remove restrictions. As of now, many CEE countries have prolonged or reinforced their restrictive measures at least until the end of January. The second wave of the pandemic is seemingly under control in most countries. However, with the recent arrival of more contagious mutation(s), it can be easily imagined that a substantial easing of restrictions will happen only by the end of Q1 or even later. Vaccination in CEE, as in Western Europe, has just started and some countries have even yet to start. As of mid-January, just around 1-2% of the CEE population received COVID-19 vaccinations, with the SEE regions lagging particularly.

Regarding the procurement of vaccines, there are three groups in CEE:

• The first ones are EU member states, who will mainly receive their vaccines via the common EU buying and distribution scheme. The EU ordered around 2 bn doses from six different vaccine producers, however, only two of them have been approved so far and have already started being deployed. It will still take several months — likely until late spring or summer — until enough vaccines are available.

• The second group is Russia and neighbor Belarus. Russia quickly developed its vaccine called “Sputnik V”, which reportedly is less effective compared to the products to be deployed by the EU. However, the vaccination rate in Russia is similarly low, indicating that the country could not fully convert the advantage of an own vaccine into a high vaccination rate – at least for now.

• The last group are non-EU member states like Ukraine, and several Western Balkan countries. They rely on bilateral deals with vaccine producers or the global GAVI COVAX program co-led by the WHO, which secures some access to vaccines to poorer countries. However, the programme only covers vaccination of around 20% of the populationand these countries are still awaiting their first shipments as, possibly due in April at the earliest. Still, the EU may distribute a part of its superfluous vaccines to disadvantaged neighbours. However, this is unlikely to happen before the needs of EU states are fulfilled, i.e. possibly only late this year or next year.

All these programmes will not be enough to vaccinate the entire population even until H2 2021, but should suffice in protecting the most vulnerable groups, which in term helps in reducing the impact of the pandemic and the extent of necessary restrictions. Still, there are many uncertainties, as there is yet no information for how long the vaccination protects the vaccinated person and how fast and effective the vaccination programmes can contain the pandemic.

For CEE economies, our scenario implies a weak economic start into 2021, but with vaccinations progressing and restrictive measures being removed in Q2, pent-up demand will support consumption especially in the second half of the year. The pace of recovery or revival will differ from country to country, given possible flare-ups of COVID-19, the pace of vaccination and differences in state support measures. For CE, the development of Germany also plays a crucial role. We may observe a certain lag in parts of South-Eastern Europe or Eastern Europe to the overall European trend. An additional positive factor could be starting disbursements of means from the EU’s recovery fund later during 2021. We project GDP growth rates for CEE ranging from 2.5% to 5% in 2021, compared to the 4.3% projected for the euro area.

For the more challenging months ahead it should also bode well for the CE/SEE region that in most countries the level of consumption and services (in relation to GDP) is lower than in Western European countries (with the possible exception of Croatia and Bulgaria). Moreover, the close links of a lot of CE/SEE countries to the German industry cluster are currently once again an advantage. The German economy is currently strongly profiting from the fast rebound in global trade (much faster than in the aftermath of the Global Financial Crisis), which is based on a (much) better economic performance of China and the US compared to Europe.

Downside risks to our scenario are a longer second pandemic wave in spring 2021, slower progress in vaccination than anticipated, and another wave of the pandemic in autumn 2021 or during winter 2021/22, causing new restrictions. Moreover, the destruction done to the economies by prolonged restrictive measures to the economies, especially to the services sector and SME, is still hard to assess, hence a negative surprise cannot be excluded. Changes in global supply chains, triggered by the pandemic, may begin to be implemented by companies, though we do not expect a sizeable economic impact from this factor in 2021.

Chart 3 - CEE more stringent in first wave

Oxford Covid-19 Government Response Tracker, Blavatnik School of Government, RBI/Raiffeisen Research

CE: Avg. of CZ, SK, HU, PL; SEE: Avg. of BA, AL, HR, RS, RO, BG; EE: Avg of UA, RU; EA5: Avg. of DE, FR, IT, ES, NL

CEE central banks reacted by lowering the interest rates given the economic challenges during 2020. The equally-weighted average key interest rate almost halved over the year 2020 from around 5% to 2.7%, falling from a maximum key rate of 13.5% in early 2020 in Ukraine to the highest regional rate of 7.75% in Belarus at the end of the year. Some CEE central banks such as in Hungary, Poland or Croatia even made forays into the realm of quantitative easing (QE) via government bonds, i.e. a policy so far predominantly observed at developed market central banks. This turn of events wasn’t a foretold story. In earlier crises, CEE reacted with monetary tightening, the classic reaction by emerging markets during times of financial stress. This time, monetary easing was globally synchronized, allowing countries like Ukraine to cut rates without endangering exchange rate stability. Moreover, some CEE central banks were even tolerating a certain FX weakness in order to support the economic recovery.

In 2021 monetary policy is set to remain expansionary. Interest rate cuts are largely done. There is, a possibility that the Bank of Russia will still cut by 25 bp in Q2 from currently 4.25%, as soon as inflation recedes and that the Romanian Central Bank may add another cut by 25bp to 1% after its surprise move last week. At the turn of the year, inflation in CE/SEE dropped (see on Poland, Romania, Serbia, Czechia and Croatia). This year, inflation is seen to increase slightly, as the effect of lower energy prices will no longer be present, and demand is set to increase during the year. Nevertheless, inflation is still expected to remain in moderate territory this year and next year. While developed market central banks are expected to keep rates low for several years ahead, we see a chance for first interest rate hikes in CE/SEE already in the year 2022. Especially more orthodox institutions like the Czech National Bank could tighten policy earlier amidst a moderately rising inflation and the current pro-cyclical policy mix. Still, the extent of these early rate hikes would be rather limited for CE/SEE central banks, between 25-50bp in 2022.

After a relatively short period at the beginning of the crisis, when financial markets closed, CEE sovereigns were able to finance their increasing budget deficits. With economies sent into lockdowns, fiscal deficits ballooned by an average of 7% in the CEE region (most in CE and SEE, less in EE), as many countries launched huge programmes in support of their economies and populations. Thus, public debt relative to GDP also shot up by estimated 12pp in CE, 10pp in SEE and 7pp in EE in 2020. In 2021, budget deficits should be already on the declining path consolidating by ~4 percentage points in CE/SEE, partially given the economic improvements this year. We expect the public debt ratio still to increase this year by 2-3 percentage point and to stabilize or slightly decline in 2022.

Chart 4 - General budget deficits to decline in 2021, but still elevated level (% of GDP)

National sources, RBI/Raiffeisen Research

For Russia, while we do not expect immediate or harsh US-led Western sanctions, the Biden administration could push the sanction topic, and US action in this field could again be more coordinated with European partners. In Ukraine, we have seen signs of backsliding on reforms in 2020 and more tense relations with the IMF. In Belarus, the political situation is still difficult given the continuing protests (though on a smaller scale) after the contested Presidential elections of last August. Compromise with the opposition looks unlikely and Russia could play an important role due to the strong financial dependence of Belarus on Russia. In Bulgaria, there have been protests in 2020, while in Romania political uncertainty and fiscal populism remained issues, which are unlikely to disappear. In Albania, an agreement on the EU accession in 2020 has been brought closer due to the country’s determination to key reforms. Yet it must be remarked that given the slow nature of the process, any rapid accession is not a likely scenario. Croatia and Bulgaria have been admitted to the ERM II mechanism in mid-2020, the “waiting room” ahead of euro accession, and their progress will be closely monitored.

The election calendar for CEE in 2021 includes: Parliamentary and Presidential elections in Bulgaria (Parliamentary: Mar, Presidential: Oct), Parliamentary elections in Albania in April, Kosovo (Presidential: Apr; Parliamentary: possible snap election necessary in 2021 due to court ruling), Russian Duma elections in September, Czech parliamentary elections in October and not in CEE but possibly also relevant on the European level are German parliamentary elections (scheduled for September).

This overview is partly based on our biweekly updated presentation / slide deck with the latest measures and developments in CEE in relation to the pandemic: Covid-19 and Economic Update CEE: Vaccine rollout starts, recovery pending.