Southeast Europe faces some economically difficult months ahead with the renewed spread of coronavirus after the region’s economies rebounded mid-year from the initial pandemic shock. In line with economic developments in western Europe, the SEE economies benefitted from the lifting of lockdowns and travel restrictions, which released significant pent-up demand for businesses such as restaurants, bars and retail stores in the summer. The strength of the rebound is now being tested by rising daily coronavirus cases and deaths, running above the peaks recorded earlier in the year in the cases of Bulgaria, Romania and Albania. Governments’ reimposition of restrictions on people’s day-to-day lives is slowing the recovery down, if not placing recoveries in reverse. SEE economic recoveries should regain momentum, however, by the early spring of 2021 with the passing of the acute phase of new Covid-19 cases over the winter and as societies growingly adapt to co-existence with the coronavirus, helped by better medical treatment and more efficient coronavirus-containment measures. The speed and scale of the recovery hinges on several factors: how quickly governments address pandemic-related disruptions, the structures and industry concentrations of individual economies, the size and effectiveness of domestic and EU stimulus, the speed of the recovery among SEE’s western European trading partners, and investor sentiment.
Scope Ratings currently covers and rates the four EU member states of SEE: Bulgaria, Romania, Croatia and Slovenia. The recession these four countries face this year will be somewhat less severe than we anticipated three months ago, even recognising the loss of economic momentum this quarter. We revised up 2020 GDP forecasts for the four economies on milder second-
quarter economic contractions and better-than-expected third-quarter turnarounds. In the rest of SEE, recessions will vary in severity this year. We expect a fairly shallow contraction in Serbia but larger ones in Montenegro, Kosovo and Albania. Looking further ahead, economic output in SEE on average will return to 2019 levels only by the first half of 2022, despite sturdy rebounds across the region in 2021. Lingering uncertainty over the duration and severity of the pandemic and its economic impact in SEE and in the rest of Europe are downside risks to the growth outlook in the fourth quarter and beyond. However, the recently agreed 2021-27 EU budget, including the recovery fund of 750 billion euro, represents a significant opportunity for all EU member states to undertake much-needed infrastructure investment and enhance economic growth in the medium term.
EU recovery funds – significant opportunity to raise much-needed investment in SEE
SEE’s EU member states are some of the largest beneficiaries of EU structural and investment funds relative to their economic size. Financial allocations through these funds represent about 2.5% of yearly GDP on average under the existing 2014-20 budget. These funds are an important positive credit rating driver for the four SEE EU countries under Scope’s coverage.
The ability of SEE countries to deploy EU funding, including the Next Generation EU recovery fund, over the 2021-27 multiannual financial period will prove critical for mediumrun growth and investment, notably to narrow the infrastructure gap with western Europe, advance green infrastructure to achieve long-run economic competitiveness, as well as enhance spending on research & development. Current R&D spending is well below EU averages in the cases of Romania, Croatia and Bulgaria. EU recovery funding will help bolster the economic recovery in member states and ensure further economic convergence with western Europe.
One proviso is the region’s capacity to improve its absorption of EU funds. Taking the 2014-20 period, SEE absorption rates of EU funds ranged from less than 40% in Romania and Croatia to 46% in Bulgaria and less than 50% in Slovenia as of October this year. The variations reflect disparity in the co-financing capacities of central governments and other institutional factors. Further strengthening the quality of governance and long-term planning, better control of corruption and tighter public procurement procedures would improve SEE countries’ productive deployment of EU funds and underpin more durable longterm growth.
Bulgaria: joining ERM II and Banking Union supports economic integration, recovery
We have upgraded our 2020 output forecast for Bulgaria from -7% to a still significant contraction of -5%. The economy should rebound by 4.5% in 2021, before gradual reversion toward Bulgaria’s medium-run underlying yearly growth rate of 2.5% thereafter. Under a stressed scenario in which Bulgaria reimposes a state of emergency and economic restrictions similar to those of the spring, the economy would contract by 7.5% this year.
The entry of Bulgaria and Croatia in July to the Exchange Rate Mechanism II (ERM II) and EU Banking Union represented historic steps in their economic and financial integration with the euro area, helping to further reduce financial, external-sector and foreignexchange-related risks. For Bulgaria, strengthening central bank independence, tackling corruption, addressing judicial weaknesses, and enhancing legislative compatibility are important for sustained economic and institutional convergence with the euro area. Amid long-running demonstrations this year against corruption and violations of the rule of law, opposition parties have called for the resignation of the centre-right government of Prime Minister Boyko Borissov and the country’s chief prosecutor.
Scope rates Bulgaria’s long-term bonds at an investment grade of BBB+ – above the ratings assigned to Bulgaria from several peer rating agencies – which recognises the government’s strong commitment to fiscal discipline and maintenance of pre-crisis balanced budgets. The impact of the pandemic has pushed public debt higher to around 26% of GDP in 2020 from 20% in 2019, but the ratio remains quite low, providing the government with room for gradual fiscal consolidation in the future.
Croatia: elevated debt, low underlying growth potential are obstacles to robust recovery
Real economic output will contract by around 8.9% in Croatia this year, a relatively steep drop compared with those of other EU member states of the region, reflecting the country’s dependence on the severely hit travel and tourism services sectors, which account for around a quarter of GDP (including indirect impacts on associated industries). The budget deficit will widen to 7.5% of GDP in 2020, with general government debt rising by nearly 15pps to 87.5% of GDP. In 2021, we expect recovery in GDP of 5.9%. Joining ERM II will reinforce credit-positive prudence in government and central bank policies, supportive of Croatia’s investment-grade ratings of BBB-.
However, Croatia’s economy labours under several structural weaknesses that limit the prospects of a vibrant recovery. First, Croatia’s pre-pandemic public debt of 73% of GDP in 2019 – up from 39% in 2008 – remained elevated compared with other SEE countries’ despite falling in recent years. Gross government financing needs stood at a considerable 10% of GDP in 2019 and will increase in the medium term. Croatia has improved its fiscal framework in accordance with EU and IMF recommendations but has more work to do.
Secondly, Croatia’s growth potential, estimated at around 2-2.3% over the medium run, is weak compared with those of other economies in southeast Europe. Low productivity growth, labour shortages and adverse demographic trends are impediments to faster growth.
Romania: deteriorating public finances limit room for further economic stimulus
We marginally revised upward our 2020 GDP forecast on Romania (rated BBB-/Negative Outlook) from -6.3% to -5.5%, followed by 4.8% growth next year. However, the government has relatively limited fiscal space to support the recovery.
Deteriorating public finances after years of expansionary budget policies, including a 40% increase in state pensions approved in Parliament in September, risk triggering higher borrowing rates, which may impede economic recovery. We expect a general government deficit of 8.7% of GDP in 2020, pushing up debt by around 10pps to 45% of GDP.
Ahead of parliamentary elections on 6 December, recent polls suggest a tight race between the ruling centrist Liberals and the opposition Social Democrats, including the possibility of another hung parliament, which would make forming a new government subject to possibly protracted negotiation.
The National Bank of Romania has used monetary policy to support capital markets – 100bps of rate cuts and government bond purchases – while protecting the value of the leu. Significant further monetary easing to upport the recovery is unlikely given the risk that additional interest rate cuts could pose with respect to downward pressure on the exchange rate. The leu’s value against major currencies is an important concern due to the relatively high share of private and public sector debt denominated in foreign currency. The National Bank of Romania’s foreign exchange reserves covered 79.5% of short-term external debt in August 2020.
Slovenia: prudent fiscal stance might slow recovery, supports credit ratings
The Slovenian economy will contract by around 6-7% this year, with additional downside risk for the fourth quarter following the announcement of fresh containment measures after a rise in coronavirus infections. The economy should turn around sharply next year with growth of around 7% helped by extra fiscal stimulus next year focused on infrastructure and protecting jobs.
Significant fiscal stimulus alongside the decline in tax revenues will push up public debt to around 80% of GDP in 2020 from 66% in 2019. The government will likely stick to its prudent fiscal rules but allow the budget deficit to remain wide at 6.6% of GDP in 2021 and 4.6% in 2022 before gradual consolidation thereafter.
Slovenia (rated A/Stable Outlook)’s growth model is coming under pressure, particularly with the health crisis, given the country’s ageing population and dependence of its external sector on mature European markets. Mediumterm economic potential hinges upon improvements in productivity, especially in the information & communications technology sector, but also on raising private-sector investment in R&D to fill gaps in productivity in the corporate sector.
Recessions vary in severity in rest of SEE this year; solid growth expected in 2021
Among other SEE economies, Serbia should prove its relative economic resilience, with GDP set to fall around 3% this year, the lowest of the region. By contrast, Montenegro and Albania face severe recessions, with output down by 10% and 7% respectively, reflecting their reliance on tourism and travel, which together account for about a quarter of each country’s GDP. In Bosnia & Herzegovina, North Macedonia and Moldova, output will contract by 5-6%, somewhat less than in Kosovo (7-8%). Next year, growth should pick up strongly across the region, running at 5-6%, assuming gradual recoveries in domestic demand and improving external conditions. Unemployment remains elevated across many SEE economies. Governments need to address structural bottlenecks in labour markets to help sustain economic recovery even if pandemic-related jobs support should prevent jobless rates from rising sharply.