An obstacle course for the old EU

This is the sixth edition of the report. In this year’s edition, among various topics, it delves into an analysis of the economic conditions spanning from 2004 to 2022 in eleven Central and Eastern European countries. A team of numerous experts hailing from the Warsaw School of Economics scrutinises various aspects including inflation, the repercussions of the Ukraine conflict on Poland and other CEE nations’ economies, the mounting burden of public debt, challenges to food security, energy security, labour market dynamics, sustainable development, and a many other critical issues pertinent to the region.

– “The report’s primary objective is to empower business leaders, government officials at all levels, and non-governmental organisations to make more informed decisions amidst significant social and economic challenges. These challenges encompass factors such as the ongoing Ukraine conflict, surging inflation, waves of migration, the evolution of artificial intelligence, and the imperative to address climate protection”, write the report’s authors.

Accession to the European Union

The experts allocate substantial attention to the repercussions of the accession of the eleven Central and Eastern European countries into the European Union. Particularly, they highlight that this accession transpired with a notably wide economic development gap as compared to the countries constituting the EU’s “core”, except for Slovenia and the Czech Republic.

In 2004, the GDP per capita within the CEE-11 countries averaged only 53% of the EU average. By contrast, between 1980 and 1986, when Southern European nations were admitted to the Union, this figure stood at 72%, varying from 60% (Portugal) to 76–80% (Spain and Greece). Following their EU membership, the CEE-11 countries, distinct from the Mediterranean nations, underwent a rapid process of income convergence. This convergence resulted in a reduction of the development gap with the Union by 24 percentage points after 15 years of membership. Concurrently, as a collective group, they have surpassed Greece and Portugal in terms of GDP per capita, thereby constituting the majority of the development gap with the Mediterranean countries.

Pandemic and war

This shift was heavily influenced, initially, by the COVID-19 pandemic and, subsequently, by Russia’s invasion of Ukraine. The authors of the report observe that in 2020, the favourable economic trends in the CEE-11 region were reversed. Due to the COVID-19 pandemic and the significant reduction in economic activity, largely stemming from administrative restrictions like lockdowns and a sharp decline in demand, all countries in this group experienced a recession.

However, the extent of the GDP decline varied, with the most pronounced drop occurring in Croatia, primarily due to the crucial role of the tourism sector in its economy. Conversely, Lithuania, Estonia, and Poland saw the smallest declines. In 2021, there was a swift recovery, albeit influenced by the base effect, as the percentage change in GDP in 2021 was calculated relative to the reduced pandemic levels. Nevertheless, in most of the CEE-11 countries, GDP by the end of 2021 had surpassed the levels seen in December 2019. Croatia, Slovenia, Estonia, and Hungary notably exhibited strong growth rates.

The year 2022 brought forth a continuation of these positive trends in the analysed countries, with all of them (except Estonia) maintaining a positive economic growth rate. However, an examination of the growth dynamics reveals a significant deceleration, primarily attributable to Russia’s invasion of Ukraine and the rapid tightening of monetary policy in response to rising inflation across the entire region, which is partly a consequence of this conflict.

Consequently, all economies examined (excluding Estonia, where GDP declined by 1.1%) experienced a slowdown in growth, ranging from 3.8 percentage points in Croatia to 3.1 in Lithuania, and as low as 0.4 in Bulgaria and 0.6 in Poland. The war in Ukraine particularly strained economic growth dynamics in the Baltic States, where Latvia, for example, saw a 2.5 percentage point decline in GDP growth in 2022 compared to the previous period, given the heightened political risks associated with the conflict’s expansion.

Nonetheless, the report authors emphasise that despite the recession in 2020 and the growth slowdown in 2022, the CEE-11 countries, on average, achieved faster growth rates than the EU average between 2020 and 2022, thereby narrowing the development gap with the EU-28. The exceptions were the Czech Republic and Slovakia, where the development gap widened over the three years by 2 and 4 percentage points, respectively, relative to the EU-28 average. The direct consequences of the pandemic, as well as the indirect impacts of the armed conflict in Ukraine, have destabilised the economic situation in CEE-11 countries.

In all these nations, inflation rates increased significantly as compared to 2021, with most of them reaching double-digit levels. Estonia, for instance, surpassed the 20% inflation threshold in 2022. Lithuania, Latvia, and the Czech Republic reported inflation rates ranging from 16% to 18% during the same period. The authors of the report note that while none of the surveyed countries had double-digit inflation rates in 2021, in the following year, only Slovenia and Croatia recorded single-digit inflation, specifically 8.9% and 9.8%, respectively.

The report suggests that the inflation experienced in the CEE-11 in 2022 resulted from a combination of supply and demand factors. The authors believe that the most critical factors contributing to the high price dynamics during this period included deferred demand from the pandemic, a substantial easing of fiscal and monetary policies to mitigate the recession’s impact in 2020 and the first half of 2021, disruptions in global supply chains stemming from China’s restrictive pandemic control measures, and a sharp, cumulative rise in energy prices in the short term.

The latter was initially triggered by Russia’s destabilising policies in the European energy market and subsequently exacerbated by sanctions imposed on Russia, a significant energy resource supplier to many post-socialist countries. The first two factors were demand-driven, while the latter two were primarily supply-driven. Additionally, in countries that maintained their own currencies (such as Poland, the Czech Republic, and Hungary), there was a sharp depreciation of exchange rates when the conflict began, further fuelling inflation. In 2022, inflation rates in the CEE-11 countries were more than double those in the older EU member states.

– “According to the established perspective in economic theory, addressing inflation stemming from an adverse supply shock is exceedingly challenging and often involves significant short-term social costs. The determinants of economic policy priorities and preferences in terms of the disinflation trajectory play a pivotal role in this regard”, write the experts of the Warsaw School of Economics (SGH).

They contend that, fortunately, the probability of further inflation escalations or the emergence of hyperinflation in certain nations should be considered extremely low. Nevertheless, even when factoring in the declines in gas and oil prices witnessed on global markets in the first and second quarters of 2023, the specter of a worsening energy crisis still looms.

Debt servicing costs

The report’s authors also highlight the escalating expenses associated with servicing public debt. They estimate that a 1 percentage point increase in government bond yields leads to an additional quarterly financial burden for the public sector, equivalent to approximately 0.11% to 0.12% of annual GDP in the Czech Republic, Poland, and Romania, around 0.15% of annual GDP in Slovakia, approximately 0.18% of GDP in Hungary, and about 0.45% of GDP in Greece. In an exceptional scenario, in October 2022, bond yields reached remarkable levels: Slovak bonds at 3.6%, Greek bonds at 4.4%, Czech bonds at 5.5%, Polish bonds at 7.8%, Romanian bonds at 9.1%, and Hungarian bonds at 10.3%.

According to the experts from the Warsaw School of Economics (SGH), if these observed yield levels persist over an extended period, annual public sector expenditures in relation to GDP, as compared to the levels in the second half of 2020 and the first half of 2021, would rise significantly, i.e., 1.7% in the Czech Republic, 2.1% in Romania and Slovakia, 2.8% in Poland, 4.6% in Hungary, and 6.4% in Greece.

– “For the latter two countries in particular, this could put the sustainability of public finances at risk”, the report says.