2019 Outlook for Central and Eastern Europe
Geopolitical tensions threaten business stability and overall growth in the region.
Russia is often painted as a villain in the news cycle these days, but the business environment there—and throughout Central and Eastern Europe—is more complex, and more promising, than it may appear to casual outside observers.
The region experienced strong growth in 2018, thanks to domestic demand fueled by tightening labor markets, high wage growth, and low borrowing costs, among other factors. As we head into 2019, conditions look favorable for that demand to remain high. Moreover, the business environment in Central and Eastern Europe is largely positive—for now. Strong institutions and a proximity to Western European markets, which enables easy integration with the supply chains of major companies in the West, combine to support an optimistic outlook.
Still, clouds are gathering on the region’s horizon as a result of geopolitical uncertainty and the related issue of unorthodox policymaking. Europe is already split in an east-west divide along Cold War lines. Some populist governments in the east have recently driven up political and social tensions by launching policies that undermine democratic institutions and threaten to derail long-term growth. In Russia and Turkey, in particular, leaders who are demonstrating authoritarian tendencies and stoking geopolitical tensions are undermining the confidence of the business community and increasing economic uncertainty.
A Primer on Russia
Since Russia is so much larger than the other countries in Central and Eastern Europe, changes to its business environment are likely to affect its neighbors. Atradius analysts predict that Russia’s gross domestic product (GDP) will grow modestly in 2019, as a result of increased oil prices, relatively low inflation, and business and consumer confidence. However, the projected 1.5 percent growth is slightly lower than last year’s 1.8 percent. This downshift reflects Russia’s plan to increase its value-added tax (VAT) from 18 percent to 20 percent and a prediction that inflation will continue to rise gradually.
An ongoing escalation of tensions between Russia and the West would likely slow the economy further. If President Trump were to withdraw from the nuclear arms treaty—as he has threatened to do—security risks would rise. Actual military conflict is not likely, but any loss of confidence in the Russian economy or increase in organizations’ perception of the risk of doing business in the country could have long-term negative effects.
For most American businesses trading with Russian firms, the biggest cause of worry at the moment is the threat of further sanctions, which could destabilize the Russian economy and exert downward pressure on the ruble. The United States first imposed sanctions when Russia annexed Crimea in 2014. They were ratcheted up after Russia’s alleged meddling in the 2016 presidential election, followed by additional sanctions after Russia’s alleged attack on former intelligence officer Sergei Skripal and his daughter. Analysts expect to see new sanctions again in 2019.
This is bad news for the Russian currency. Sanctions are contributing to a weakening of the ruble, which has fallen about 5 percent against the U.S. dollar over just the past six months. Fixed investment has also taken a hit: Russia saw only 1.2 percent growth in foreign investment in 2018, a sharp decline from the 4.3 percent growth of 2017.
Turkey: Trouble Ahead
Turkey may be the least stable country in the region. This fall, the Turkish economy finally boiled over as a result of a slow response to surging inflation and recent policy mistakes, including the removal of former constitutional checks and balances, the increase of government leverage on formally independent institutions such as the Central Bank, and the detention of journalists and human rights activists with EU citizenship.
The Turkish government has taken some steps to correct its mistakes, but the damage is done, at least for the short term. Real GDP growth slowed from 7.4 percent in 2017 to around 3.9 percent in 2018. The initial forecast for 2019 predicts a recession, with a decline in GDP of 1.7 percent. This comes on top of a major currency crisis—year to date, the Turkish lira is down nearly 30 percent. Inflation is extremely high, and interest rates are soaring at around 24 percent. Together, all these factors are having a devastating effect on productivity and consumer confidence. Turkey is currently experiencing a high level of corporate insolvencies, which are expected to increase another 15 percent in 2019, to the highest level in five years.
What’s more, some of Turkey’s attempts to turn these trends around by micromanaging the economy could backfire and spook foreign investors again. The Turkish government has recently instituted a requirement for exporters to convert a large share of their foreign currency back to lira and has tightened restrictions on the use of foreign currency in domestic transactions. Such questionable market interventions are likely to make foreign companies think twice before investing in Turkey, which would undermine hopes of an economic recovery.
Times Are Uncertain, but Opportunities Remain
Other Central and Eastern European countries are facing similar challenges as a result of political decisions or social turmoil. In Hungary, economic uncertainty is on the rise, as the European Union (EU) recently imposed Article 7, opening the door for potential sanctions designed to deter antidemocratic policies. The EU action was a response to the Hungarian government’s efforts to silence the country’s media, target nongovernmental organizations (NGOs), and remove independent judges from the bench. Poland was hit with the same ruling earlier in 2018 for undermining the independence of its judiciary.
Atradius expects these types of tensions to arise in other countries in the region throughout 2019. If this assessment is correct, the trend might further dampen investor interest in the region, despite the relative attractiveness of Central and Eastern Europe due to low labor costs, geographical proximity to Western European markets, and flexible exchange rates.
If governments in Central and Eastern Europe take blatantly antidemocratic actions in the next year, those policy mistakes could have medium- to long-term consequences for the economies of the region. Continued convergence with the rest of the EU is going to require ongoing investment in public infrastructure and organizational productivity. EU resources are vital for this, but the EU is considering reducing the structural funding available in its 2021–2027 budgets for countries with unacceptable policies affecting the stability of democratic institutions, the rule of law, and immigration.
Nevertheless, Central and Eastern European economies are still strongly pro-business, for the most part, and will likely continue to be for some time to come. The Czech Republic stands out as particularly stable. Although the Czech government has adopted populist rhetoric recently, particularly surrounding immigration, the same leaders’ policies remain business-friendly and pro-EU. They continue to encourage foreign capital inflows and have developed a financial buffer against the predicted global downturn. This buffer comes from a strong track record of fiscal prudence and debt servicing, contributing to the country’s low public debt levels, which will help protect the Czech Republic from slower regional or global growth.
As always, leaders of companies with interests in foreign jurisdictions need to stay abreast of global geopolitical risks, as well as the economic and political developments within individual countries. Working with a trade credit insurer is one way to keep informed of the economic health of individual countries and sectors.