1Q - CEE Quarterly - UniCredit Research

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                    A path to recovery

January 2021                    January 2021    CEE Macro & Strategy Research
                                                             CEE Quarterly

                     “Your Leading Banking Partner in

                     Central and Eastern Europe

UniCredit Research                  page 2                  See last pages for disclaimer.
January 2021                                                   January 2021                                CEE Macro & Strategy Research
                                                                                                                              CEE Quarterly

                                 4   A path to recovery
                                14   CEE strategy: Solid risk appetite and yield in demand
                                65   Acronyms and abbreviations used in the CEE Quarterly

                                21   Bulgaria: Difficult start to recovery but strong medium-term outlook
                                25   Croatia: Rough journey to the light at the end of the tunnel
                                29   Czechia: Getting ready for a fiscal deluge
                                33   Hungary: Reassessing growth drivers
                                37   Poland: A swift recovery after the crisis
                                41   Romania: Looking for normality
                                45   Slovakia: More-resilient manufacturing to mitigate COVID-19 recession
                                47   Slovenia: Recovery amid COVID-19 uncertainty

                                     EU CANDITATES AND OTHER COUNTRIES
                                49   Bosnia and Herzegovina: Smaller contraction in 2020 but slower recovery in 2021
                                51   North Macedonia: Slow recovery amid pandemic risk
                                53   Russia: Gradual recovery from shallow recession
                                57   Serbia: Recovery amid high uncertainty and risks
                                61   Turkey: A better policy mix

                                      Erik F. Nielsen, Group Chief Economist (UniCredit Bank, London)
                                      +44 207 826-1765, erik.nielsen@unicredit.eu
                                      Dan Bucşa, Chief CEE Economist (UniCredit Bank, London)
                                      +44 207 826-7954, dan.bucsa@unicredit.eu
                                      Artem Arkhipov, Head of Macroeconomic Analysis and Research Russia (UniCredit Russia)
                                      +7 495 258-7258 ext. -7558, artem.arkhipov@unicredit.ru
                                      Gökçe Çelik, Senior CEE Economist (UniCredit Bank, London)
                                      + 44 207 826-6077, gokce.celik@unicredit.eu
                                      Ariel Chernyy, Economist, Macroeconomic Analysis and Research Russia (UniCredit Russia)
                                      +7 495 258-7258 ext. 7562; ariel.chernyy@unicredit.ru
                                      Hrvoje Dolenec, Chief Economist (Zagrebačka banka)
 Published on 13 January 2021         +385 1 6006-678, hrvoje.dolenec@unicreditgroup.zaba.hr
                                      Dr. Ágnes Halász, Chief Economist, Head of Economics and Strategic Analysis Hungary (UniCredit Hungary)
                                      +36 1 301-1907, agnes.halasz@unicreditgroup.hu
 Erik F. Nielsen                      Ľubomír Koršňák, Chief Economist (UniCredit Bank Czech Republic and Slovakia)
 Group Chief Economist                +42 12 4950-2427, lubomir.korsnak@unicreditgroup.sk
 (UniCredit Bank, London)
 120 London Wall                      Elia Lattuga, Co-Head of Strategy Research, Cross Asset Strategist (UniCredit Bank, London)
 UK-London                            +44 207 826-1642, elia.lattuga@unicredit.eu
                                      Mauro Giorgio Marrano, Senior CEE Economist (UniCredit Bank, Vienna)
                                      +43 50505-82712, mauro.giorgiomarrano@unicredit.de
 Imprint:                             Anca Maria Negrescu, Senior Economist Romania (UniCredit Bank Romania)
 UniCredit Bank AG                    +40 21 200-1377, anca.negrescu@unicredit.ro
 UniCredit Research
 Am Eisbach 4                         Kristofor Pavlov, Chief Economist (UniCredit Bulbank)
 D-80538 Munich                       +359 2 923-2192, kristofor.pavlov@unicreditgroup.bg
 Supplier identification:             Pavel Sobíšek, Chief Economist (UniCredit Bank Czech Republic and Slovakia)
 www.unicreditresearch.eu             +420 955 960-716, pavel.sobisek@unicreditgroup.cz

UniCredit Research                                                   page 3                                                  See last pages for disclaimer.
January 2021                                                             January 2021                                 CEE Macro & Strategy Research
                                                                                                                                         CEE Quarterly

                                             A path to recovery
Dan Bucsa                                    ■   We expect economies in EU-CEE1 and in the western Balkans, to grow by around 3.3% in 2021
Chief CEE Economist
(UniCredit Bank, London)                         after slumping by close to 5% in 2020. A weak start to 2021, lower fiscal support, looser labor-
+44 207 826-7954                                 market conditions, delayed investment and external risks could result in an incomplete recovery.
                                             ■   GDP in EU-CEE and the western Balkans could return to pre-COVID-19 levels in 2022,
                                                 when growth could accelerate to more than 4%. Interest rates could be increased in
                                                 Czechia at the end of 2021 and in Poland and Romania in 2022.
                                             ■   EU support in the form of the European instrument for temporary Support to mitigate
                                                 Unemployment Risks in an Emergency (SURE), Next Generation EU (NGEU) and the
                                                 2021-27 EU budget could support the recovery in EU-CEE in 2022 and beyond.
                                             ■   IN EU-CEE, only the NBR is expected to cut rates in 2021. The CNB could be the first
                                                 central bank to increase rates in 2H21, followed by the NBP and the NBR in 2H22. Central
                                                 banks could purchase more bonds if state funding needs rise above current plans.
                                             ■   In Turkey, economic growth could accelerate from around 1.2% in 2020, to 2.9% in 2021 and
                                                 4% in 2022. Without structural reforms, most of the monetary tightening implemented in 2020
                                                 could be reversed in 2021 to spur lending and growth. This strategy is not sustainable, and
                                                 may only serve to put pressure back on the current account, the currency and rates.
                                             ■   After declining by almost 4% in 2020, the Russian economy could grow by 2.2-2.3% in
                                                 2021 and 2022. The central bank could keep the policy rate at 4.25% in 2021-22 if inflation
                                                 remains below the 4% target.
                                             ■   The COVID-19 pandemic will continue to affect CEE countries in 2021, with herd immunity
                                                 reached this year only if vaccination accelerates significantly. However, restrictions and
                                                 their negative economic impact could be much milder next winter than they are currently.
                                             ■   In 2021, government anti-pandemic support will decline compared to 2020 in all CEE
                                                 countries but Bulgaria. Indirect support could be less efficient than last year, unless
                                                 governments focus on grants, rather than loans to SMEs. Labor-market support may be
                                                 needed to avoid a large second wave of layoffs. Support could be withdrawn starting in 2H21.
                                             ■   Political noise will be a risk in Bulgaria and Czechia, where parliamentary elections will be
                                                 held in 2021.
                                             ■   Democracy in CEE would benefit if the US administration returns to multilateralism.
                                             ■   In the next two years, EU fund disbursements are unlikely to be tied to observing the rule of law.

2020 recession…                              In 2020, GDP fell in all CEE countries but Turkey, where the economy grew by around 1.2%,
                                             around 3pp below potential. In the rest of the region, the contraction probably ranged between
                                             1.1% in Serbia to almost 4% in Russia and around 5% in EU-CEE and the western Balkans
                                             (Chart 1). The health crisis caused by the COVID-19 pandemic led to a deeper slump in 2Q20
                                             than that which occurred during the global financial crisis. Economies that are more reliant on
                                             domestic demand and that benefitted from timely government support were more resilient than
                                             the small, open economies in central Europe. The recovery in 3Q20 was proportional to the
                                             2Q20 slump but incomplete. In 4Q20, GDP probably fell again in most CEE countries due to
                                             lockdowns imposed in response to the second wave of the COVID-19 pandemic, both
                                             domestically and by the CEE’s largest European economic partners. Yet, the tightness of
                                             restrictions and compliance with rules varied widely across countries. Thus, Croatia, Czechia,
                                             Slovenia, Slovakia, Hungary and Poland probably suffered more than Romania, Russia and
                                             Serbia. Turkey’s sharp credit adjustment, made as the country attempts to tackle yet another
                                             balance-of-payments crisis, might have led to a GDP slump in 4Q20, despite anti-pandemic
                                             restrictions having not been tightened as much as in central Europe.
    EU-CEE refers to CEE countries that are members of the EU: Bulgaria, Croatia, Czechia, Hungary, Poland, Romania, Slovakia and Slovenia.

UniCredit Research                                                            page 4                                                    See last pages for disclaimer.
January 2021                                        January 2021                          CEE Macro & Strategy Research
                                                                                                           CEE Quarterly

                             The 2021 recovery is likely to be incomplete in all CEE countries but Poland, Serbia and
…followed by an incomplete   Turkey. In Poland, quick and targeted support prevented a deeper slump in 2020. Serbia will
recovery in 2021             continue to benefit from large public spending and Turkey from its region-topping potential
                             growth. That said, all three countries could end 2021 with negative or zero output gaps. At the
                             other extreme, the Croatian economy is unlikely to return to its pre-pandemic level of activity
                             before 2023, as the tourism sector could take longer to recover. In 2021, EU-CEE could grow
                             by around 3.3%, in line with the western Balkans, with both the Russian and the Turkish
                             economies recovering by close to 2.5% (Chart 2). We see five main reasons why a full
                             recovery from the 2020 slump will be postponed to 2022 or later in most CEE countries:

                             1.   A weak start to 2021: After small or negative carryover into 2021, economic activity could
                                  remain subdued in 1Q21 if restrictions are maintained throughout the winter. Countries
                                  whose governments reacted indecisively in 4Q20 (Bulgaria, Romania, Russia and Serbia)
                                  could eventually tighten restrictions in 1Q21, leading to a GDP drop during the winter.

                             2.   Lower fiscal and monetary support than in 2020: We expect budget deficits to decline
                                  in all CEE countries but Bulgaria, where anti-crisis support might increase in 2021
                                  compared to last year. Budget shortfalls could narrow less than in official forecasts, even
                                  after governments revised them at the end of 2020. In our opinion, most CEE authorities
                                  are underestimating economic risks from the current pandemic wave. Some of the most
                                  successful support schemes introduced in 2020 might be extended, such as those
                                  backing furlough and part-time work, as well as loan repayment moratoriums. Deferred
                                  taxes could be collected only partially and with a delay. Government guarantees will
                                  remain available for corporate borrowers.

                             3.   Weaker labor-market conditions and their negative impact on consumer spending:
                                  Lengthy restrictions are likely to continue to affect employment, especially in leisure
                                  services and manufacturing. In addition, wage bargaining will mostly occur in 1Q21, when
                                  restrictions and weak foreign demand could lead to much lower wage growth than in
                                  previous years. The first official announcements from car companies in EU-CEE suggest
                                  that wages and bonuses will rise in single digits in 2021 and 2022, compared to 15-25%
                                  annual growth rates in past years. Car manufacturing is a bellwether for at least half of
                                  manufacturing wages in EU-CEE. There has already been a marked reduction in
                                  household plans to make large purchases. We expect a recovery in household investment
                                  in 2H21, at the earliest.

                             4.   Postponed corporate investment: Companies may postpone investment as well, despite
                                  sizeable credit and tax support from governments. While large companies could explore
                                  opportunities to expand their market share or increase productivity, SMEs are less capable
                                  of spending. They started the COVID-19 crisis in a significantly weaker position than their
                                  eurozone counterparts, and preferential loans granted in 2020 increased their leverage to a
                                  point where additional borrowing would be difficult to sustain. Several CEE governments
                                  will hand out grants to SMEs, partly co-financed with EU money, to help them weather a
                                  protracted reduction in demand. However, many SMEs may use grants to repay some of
                                  their debt before venturing into new investment. Besides productive investment,
                                  construction is also likely to suffer from a lack of orders at least until mid-2021. The most
                                  affected will be housing and offices.

                             5. External demand outlook unclear: The outlook for external demand remains uncertain,
                                  especially when it comes to car exports, tourism and Brexit. The high import content of
                                  exports and muted domestic demand could offset a weak contribution from exports to
                                  GDP in 1H21. Starting in 2H21, exports could rise throughout CEE if growth rebounds in
                                  the eurozone and globally.

UniCredit Research                                       page 5                                           See last pages for disclaimer.
January 2021                                                                                  January 2021                                      CEE Macro & Strategy Research
                                                                                                                                                                            CEE Quarterly

CHART 1:                                                                                               CHART 2:
RECESSION IN ALL CEE COUNTRIES BUT TURKEY IN 2020…                                                     …FOLLOWED BY INCOMPLETE RECOVERY IN 2021

      yoy (%),            Private consumption    Public consumption        Fixed investment                 yoy (%),          Private consumption     Public consumption         Fixed investment
      pp                  Net exports            Inventories, error        GDP                              pp                Net exports             Inventories, error         GDP
           Croatia                                                                                                Croatia
            Serbia                                                                                                 Serbia
          Hungary                                                                                                Hungary
         Romania                                                                                                Romania
           Poland                                                                                                 Poland
          Slovenia                                                                                               Slovenia
          Bulgaria                                                                                               Bulgaria
          Slovakia                                                                                               Slovakia
                      -15.0       -10.0         -5.0           0.0           5.0          10.0
                                                                                                                            -4.0        -2.0          0.0           2.0             4.0           6.0

                                                                                                                            Source: Eurostat, national statistical offices, UniCredit Research

Financial support from the EU                           The bright spot in the EU-CEE economic outlook for 2021 is EU support in the form of several
is expected to fuel recovery
in EU-CEE…                                              programs disbursing loans and grants (Chart 3). The first of these loan disbursements has
                                                        already arrived from SURE2, with funding already approved for all EU-CEE countries.
                                                        Together with NGEU loans, they are expected to replace at least 25% of external issuance in
                                                        2021, with grants starting to arrive towards the end of 2021. Together with late disbursements
                                                        from the EU’s 2014-20 multiannual financial framework (MFF), these transfers and loans
                                                        should smooth the transition to disbursements from the 2021-27 EU budget by ensuring that
                                                        public investment does not plummet in 2021-22. We expect EU funding to add 0.1-0.7pp to
                                                        GDP growth in 2021, with its smallest contribution in Czechia and its largest in the Balkans3.

…and accelerate growth to
                                                        Disbursements from NGEU and the MFF will rise gradually in the coming years. This should
above 4% in 2022                                        set the stage for a further recovery in 2022, when GDP growth could exceed 4% (Chart 4). If
                                                        the negative effects of the pandemic are contained, the private sector could increase
                                                        spending, while exports may recover as the eurozone and global economies rebound as well.
                                                        This would allow labor-market conditions to tighten again, eliminating most scarring effects by
                                                        the end of 2022.

CHART 3: LARGE TRANSFERS FROM THE EU…                                                                  CHART 4: …WILL BOOST THE RECOVERY IN 2022 AND BEYOND

      % of avg. GDP for 2021-27           SURE                        NGEU loans                            yoy (%),          Private consumption     Public consumption         Fixed investment
                                          NGEU grants                 EU budget 2021-27                     pp                Net exports             Inventories, error         GDP
     Bulgaria                                                                                                      Serbia

     Hungary                                                                                                     Hungary
     Slovakia                                                                                                     Poland
    Romania                                                                                                      Slovenia
      Poland                                                                                                      Turkey
                0.0           10.0           20.0           30.0            40.0          50.0
                                                                                                                            -4.0     -2.0       0.0          2.0           4.0         6.0        8.0

                                                                                                           Source: national statistical offices, European Commission, UniCredit Research

    The European instrument for temporary Support to mitigate Unemployment Risks in an Emergency
    We are less optimistic than the European Commission in our assessment of the potential impact of EU funding on growth in 2021.

UniCredit Research                                                                                page 6                                                                   See last pages for disclaimer.
January 2021                                                               January 2021                                                                        CEE Macro & Strategy Research
                                                                                                                                                                                       CEE Quarterly

The negative impact of COVID-                   We expect the COVID-19 pandemic to further affect CEE economies in 2021. While
19 could last throughout 2021
                                                vaccination has started in EU-CEE and Russia (Chart 5) and is picking up, countries need to
                                                accelerate immunization. At the current pace, no CEE country will come close to vaccinating
                                                70% of its population in 2021. Significantly more efforts would be needed in Poland and
                                                Romania, and especially in Bulgaria, Czechia and Russia to make sure that a large-enough
                                                percent of the population receives the vaccine before the end of 2022.
                                                Even if herd immunity is reached earlier due to rising infections, it is likely that the epidemic
                                                will continue to affect lives and economic activity throughout 2021. The best hope for CEE
                                                countries is that restrictions are significantly milder next winter compared to the current one.
                                                Until then, CEE countries face several problems in the second wave of the pandemic4, such
                                                as poor official communication, the lack of test-trace-isolate frameworks, low compliance with
The second wave of the                          restrictions, high usage of intensive care units and a shortage of health care workers5. In
pandemic could require tighter
                                                addition, most CEE countries continue to test insufficiently and, as a result, the official
restrictions in 1Q21
                                                assessment of the viral spread is inadequate. Daily case estimates from Imperial College
                                                London (ICL) are 2-8 times higher than officially communicated daily cases. The ICL
                                                estimates correlate strongly with the number of deaths (Chart 6) and are a better predictor of
                                                fatalities than officially published infection numbers.
                                                While most CEE governments plan to remove restrictions in February, new viral strains could
                                                delay the exit from lockdowns and even require tighter restrictions before the spring. These, in
                                                turn, would further weigh on economic growth, employment and wage growth.


     SARS-CoV-2 vaccination rates               Latest                                                                data as of 25 December 2020 (ICL) and 5 January 2021 (deaths)
     (vaccines per 100 inhabitants)             World average                                                         18.0
                                                                                                                          16.0                                                                  SI
                                                                                         Deaths per million inhabitants

    1.0                                                                                                                   14.0
                                                                                                                                                                                 CZ                          HR
    0.8                                                                                                                                                                          BG            HU
    0.6                                                                                                                    8.0
    0.4                                                                                                                                                      RO
    0.2                                                                                                                    2.0
    0.0                                                                                                                          0.0         0.5         1.0            1.5         2.0          2.5          3.0
          BG      HR     CZ     HU    PL   RO     RU     RS     SK   SI   TR
                                                                                                                                       Baseline ICL estimate for daily infections per thousand inhabitants

                                                                          Source: CEE governments, Oxford University, Imperial College London, UniCredit Research

Governments are expected to                     The risk of further restrictions and economic disruption require CEE governments to maintain
maintain some anti-crisis
support in 2021                                 some support measures in 2021. While the size will not match what was spent in 2020
                                                (Tables 1 and 2), the implementation of last year’s fiscal and financial packages carry
                                                valuable lessons for authorities.
                                                The most important lesson is that timeliness may be more important than size. Poland is the
Timeliness of disbursements
could improve further                           most relevant example. The government’s decision to dole out most financial support through
                                                the state-owned sovereign investment fund (PFR) and development bank (BGK) helped the
                                                Polish economy weather the downturn better than its central European peers. At the other
                                                extreme, Czechia pledged the largest indirect support package in the region, but managed to
                                                implement only 7% of it. The good news is that most CEE countries have improved the
                                                channeling of funding to the private sector, be it directly or via the banking sector, and
                                                disbursements could become more efficient still in 2021.

  While some prefer to call it the third wave, we believe that the second wave never ended in CEE and the decline in the number of cases was mostly due to fewer
tests conducted before Christmas and during the winter holidays. The exception is Czechia, where a tight lockdown reduced the number of infections in 4Q20.
However, the number of cases rose rapidly once restrictions were eased.
  For details, please see the EEMEA Country Note – Long COVID risk in CEE from policy inaction, 10 December.

UniCredit Research                                                              page 7                                                                                                See last pages for disclaimer.
January 2021                                                  January 2021                         CEE Macro & Strategy Research
                                                                                                                      CEE Quarterly

Labor-market support is                The second lesson is that labor-market support may have the farthest reaching effects of all
needed throughout the second
pandemic wave                          support measures. Prompt support for furlough and part time work blunted the rise in
                                       unemployment, but could not prevent employment from falling in 3Q20 even in sectors such
                                       as industry that rebounded strongly. Yet both employment and consumer expectations fell
                                       much less than during the global financial crisis, probably helped by public safety nets.
                                       Maintaining labor-market support in 2021 could be paramount for the recovery, especially if a
                                       protracted second wave of the pandemic leads to another round of layoffs this winter.

SMEs better targeted with              The third lesson is that SMEs have limited room to further increase leverage. The take-up of
grants than loans                      subsidized and/or guaranteed loans slowed towards the end of 2020 in most CEE countries.
                                       For small companies saddled with debt and facing an uncertain future, grants may be a better
                                       option than more loans. EU funding from NGEU and SURE could supplement national
                                       resources in supporting hard-hit sectors (especially services) but also companies in sectors
                                       prioritized by the European Commission, such as IT, environment and energy transition.

2021 support packages are too          Taking these lessons into account, 2021 pandemic support packages seem too heavy on
heavy on new lending                   lending incentives and guarantees. This is especially true in Hungary, where SMEs were
                                       more leveraged than their regional peers even before the pandemic started. More subsidized
                                       lending may achieve little in reducing corporate borrowing costs or spurring growth. The other
                                       EU-CEE countries could use a mix of loans and grants, with Poland and Romania probably
                                       favoring the latter. Russia and Turkey pledged the least indirect support in CEE. The CBR is
                                       already subsidizing funding for banks and appetite for borrowing is very healthy in an
                                       economy that missed out on the CEE credit boom of the mid-2010s. On the other hand, the
                                       CBR is looking to slow credit growth, fearing that current growth rates could threaten financial
                                       stability. The CBRT has also moved to cool down the credit boom it fueled in 2020. The
                                       adjustment will continue at least in 1H21, leading to a negative credit impulse.

Direct support could increase if       With the exception of Bulgaria, direct support will be smaller than in 2020, in some cases
the second wave has                    significantly so. In a repeat of 2020, many governments probably underestimate the negative
significant economic costs
                                       impact the pandemic will have on their economies. Others plan to reduce their budget deficits
                                       and cap public debt before sovereign ratings are threatened. Either way, we expect all EU
                                       countries to ramp up direct support in case of need, with the funding coming partly from the
                                       EU (in EU-CEE and the western Balkans), government reserves (in Russia) and central bank
                                       purchases (in Turkey). If economies start to recover in 2Q21, we expect government support
                                       to be withdrawn in the second half of the year.


                            Direct s      Indirect         Total                                  Direct         Indirect                Total
  (% of GDP)                 upport       support        support             (% of GDP)         support          support               support
  Bulgaria                      3.2            0.2            3.4            Bulgaria                4.0              2.0                    6.0
  Croatia                       5.1            2.4            7.5            Croatia                 1.1              2.3                    3.4
  Czechia                       3.9            1.2            5.1            Czechia                 2.0              0.0                    2.0
  Hungary                       4.4            1.0            5.4            Hungary                 0.1              3.7                    3.7
  Poland                        2.4            4.8            7.2            Poland                  1.0              1.4                    2.4
  Romania                       1.8            3.7            5.5            Romania                 1.5              1.6                    3.1
  Russia                        2.0            1.0            3.0            Russia                  0.7              0.2                    0.9
  Slovakia                      1.8            0.7            2.5            Slovakia                1.1              1.0                    2.1
  Slovenia                      4.6            0.4            5.1            Slovenia                3.0              1.8                    4.8
  Serbia                        7.5            3.2           10.7            Serbia                  0.0              0.5                    0.5
  N. Macedonia                                                               N. Macedonia            0.1              0.9                    1.0
  Turkey                        4.9            5.5           10.4            Turkey                  0.4              0.1                    0.5

                                                                                                 Source: CEE governments, UniCredit Research

UniCredit Research                                                  page 8                                           See last pages for disclaimer.
January 2021                                                                           January 2021                                          CEE Macro & Strategy Research
                                                                                                                                                             CEE Quarterly

Inflation is expected to be                          In 2021, low imported inflation, little scope for currency depreciation and weak domestic demand
inside target ranges in 2021-22
                                                     could keep inflation safely inside target ranges in EU-CEE, Russia and Serbia
                                                     (Chart 7). Inflation is expected to rebound in 2022, without leaving target ranges in any of the
                                                     aforementioned countries. In EU-CEE, only the National Bank of Romania is expected to deliver
                                                     limited rate cuts from here on, while the Czech National Bank is contemplating rate hikes in
                                                     2021 if fiscal spending fuels inflationary pressure. By 2H22, the Polish, Romanian and Russian
Rate hikes are possible in                           central banks might consider increasing interest rates without giving up on negative real interest
Czechia in 2H21 and in Poland,                       rates. However, the CBR could leave the policy rate at 4.25% for longer if inflation remains
Romania and Russia in 2H22
                                                     below the 4% target and economic growth does not accelerate above potential.

                                                     Turkey’s permanent target miss could extend to the coming years. We expect the CBRT to
                                                     reverse most of its rate hikes from 2020 in the second half of 2021, once disinflation resumes. In
Turkey is likely to reverse                          the absence of structural reforms, the authorities may revert to the credit-driven growth model
monetary tightening in 2021
                                                     that has led to several balance-of-payments crises – combined with TRY depreciation and sharp
                                                     swings in GDP dynamics – in the past decade. Such growth spurts are shorter, and the effect of
                                                     credit booms increasingly smaller, due to high leverage in the private sector. As a result, the
                                                     Turkish economy could grow below potential in 2021-22, which would revive the specter of
                                                     higher unemployment and populist spending ahead of 2023 parliamentary elections.

CHART 7: INFLATION INSIDE TARGET RANGES IN ALL                                                  CHART 8: 2020 BOND PURCHASES GIVE AN INDICATION OF
COUNTRIES BUT TURKEY                                                                            THE SCOPE FOR CENTRAL BANK PURCHASES IN 2021

   annual inflation (eop, %)        2020E        2021F   2022F     Inflation target                     bond purchases since the start of          Other bonds
  14                                                                                                    the crisis, % of GDP                       Government bonds

  10                                                                                                5

   8                                                                                                4


   0                                                                                                1

  -2                                                                                                0
         SI    SK      PL      HR   RS      CZ     BG    BH   RO    RU      HU        TR                     CNB*           NBP             NBH    NBS           CBRT        NBR

*CNB stands for the Croatian National Bank.                                                   Source: statistical offices, central banks, ministries of finance, UniCredit Research

CEE central banks could                              Some CEE central banks could continue bond purchases in 2021 due to high budget deficits.
purchase more bonds in 2021
                                                     We believe that purchases in 2020 (Chart 8) are a good indicator of how active central banks
                                                     may be in 2021. Besides the NBH, which still has around HUF 1.1tn in bonds to buy before
                                                     reaching its self-imposed limit, the Croatian and Serbian central banks are the likeliest to buy
                                                     bonds, followed by the NBP. However, actual purchases could be smaller than they were in
                                                     2020 as budget deficits decline. They could also target the longer end of the yield curve more
                                                     than they did in 2020, which is what the NBH is doing.

Elections could trigger fiscal                       Elections will add to noise in other CEE countries, with Bulgaria and Czechia holding
populism in Bulgaria and
Czechia                                              parliamentary elections in 2021. While populist fiscal spending may rise ahead of these polls,
                                                     both countries start from a very strong fiscal position. Strong institutions in Czechia and the
                                                     process of euro adoption in Bulgaria could deter legislation that would affect the rule of law.

The return of multilateralism is                     The election of Democratic candidate and former Vice President Joe Biden as the next US
good news for democracy
in CEE                                               president could lead to more-targeted US involvement in the region if Mr. Biden follows in
                                                     Barack Obama’s footsteps. That said, we do not expect crippling sanctions to be placed on
                                                     Russia, while Turkish authorities could try to appease concerns in Washington to avoid conflict
                                                     with the incoming US administration.

UniCredit Research                                                                         page 9                                                          See last pages for disclaimer.
January 2021                                               January 2021                          CEE Macro & Strategy Research
                                                                                                                  CEE Quarterly

                                    For EU-CEE, a return to multilateralism may strengthen democratic values while dampening the
                                    prospects of those politicians who have tried to escape the process of further European
                                    integration. None of the small, open economies in EU-CEE can afford to leave the EU, a reality
                                    that could be made all the more clear by the effects of Brexit.

EU fund disbursements may           The deal struck by EU governments to adopt the NGEU and the 2021-27 EU budget gave some
not be tied to the rule of law in
the next couple of years            respite to Hungarian and Polish governments in their attempt to avoid linking EU fund
                                    disbursements to observing the rule of law. However, this respite might be temporary and will
                                    depend on how quickly European authorities define the rule of law and the European Court of
                                    Justice (ECJ) rules whether the link between financial transfers and rule-of-law conditionality is
                                    in agreement with European treaties. It might be much easier to back such conditionality for
                                    NGEU than for the EU budget. Thus, the ruling could depend on whether the ECJ decides to
                                    treat the two financing frameworks together. Thus, Hungary and Poland may have bought
                                    themselves up to two years and a resolution could be issued close to the Hungarian
                                    parliamentary elections expected in spring 2022.

                                    In the medium term, additional reforms to take decisions in the European Council by a qualified
                                    majority, rather than unanimously, and for European authorities to have a bigger say in national
                                    legislative processes may be unavoidable if the EU does not choose the path of multi-speed
                                    European integration.

UniCredit Research                                              page 10                                          See last pages for disclaimer.
January 2021                                                                                January 2021                                                 CEE Macro & Strategy Research
                                                                                                                                                                             CEE Quarterly


                             GDP growth, %                             CPI (Avg), %                     Policy interest rate**              10Y bond yield (EoP),%        Exchange rate (LC vs. US)
                      2020E      2021F           2022F            2020E       2021F       2022F         2020        2021F       2022F        2020       2021F    2022F      2020      2021F      2022F
 Eurozone                -7.4           3.0          4.5            0.3             0.7     1.6         -0.50       -0.50       -0.50        -0.26       0.00     0.20       1.22       1.28        1.32
  Germany               -4.8*       3.3*             4.2*           0.4             0.9     1.7                                              -0.57      -0.30    -0.10
  France                 -9.5           3.2          5.1            0.5             0.5     1.5
  Italy                  -9.2           2.8          4.4            -0.1            0.1     0.8                                              0.55        0.85     1.40
 UK                    -11.2            4.3          6.3            0.9             1.4     1.9         0.10         0.10        0.10                                        1.37       1.36        1.40
 USA                     -3.8           1.8          3.5            1.2             1.9     2.1         0.25         0.25        0.25        0.91        1.30     1.75
 Oil price, USD/bbl                                                                                                                                                            43         41          50

*Non-wda figures. Adjusted for working days: -5.2% (2020), 3.3% (2021) and 4.2% (2022); **Deposit rate for ECB                                                            Source: UniCredit Research


 Real GDP                                                             CPI (EoP)                                                                C/A balance
 (% change)           2019 2020E          2021F       2022F           (% change)             2019        2020E        2021F       2022F        (% GDP)            2019      2020E      2021F       2022F
 EU-CEE                3.8       -4.9          3.3          4.1       EU-CEE                  3.4           2.1         2.3          2.9       EU-CEE              -0.4        1.1        0.6         0.4
  Bulgaria             3.7       -5.5          2.7          4.5            Bulgaria           3.8           0.7         2.5          2.6         Bulgaria           3.0        2.7        3.2         3.4
  Czechia              2.2       -6.4          2.0          4.9            Czechia            3.2           2.3         2.3          2.7         Czechia           -0.3        3.6        2.7         1.2
  Hungary              4.6       -5.6          4.1          4.3            Hungary            4.0           2.6         3.6          3.7         Hungary           -0.2        0.0        -0.1        1.1
  Poland               4.6       -3.0          3.5          3.1            Poland             3.4           2.3         1.9          3.2         Poland             0.5        3.0        1.5         1.4
  Romania              4.2       -5.5          3.7          5.0            Romania            4.0           2.2         2.9          2.6         Romania           -4.7       -4.9        -4.7       -4.8
  Croatia              2.9       -9.1          4.6          4.8            Croatia            1.4           0.3         2.0          2.0         Croatia            2.7       -2.9        0.7         0.5
 Russia                2.0       -3.9          2.3          2.2       Russia                  3.0           4.9         3.5          3.5       Russia               3.9        2.5        1.0         1.8
 Serbia                4.2       -1.1          4.2          4.2       Serbia                  1.8           1.3         2.1          2.4       Serbia              -6.9       -5.7        -5.5       -5.5
 Turkey                0.9       1.2           2.9          4.0       Turkey                 11.8          14.6        10.8         11.5       Turkey               0.9       -5.3        -3.0       -2.8

 Extended basic
 balance (%                                                           External debt                                                            General gov’t
 GDP)                 2019 2020E         2021F        2022F           (% GDP)                2019        2020E        2021F       2022F        balance (% GDP)    2019      2020E      2021F       2022F
 EU-CEE                 2.5      4.1           3.7          3.7       EU-CEE                 66.6          72.5        69.4        66.4        EU-CEE              -1.1       -7.4        -5.9       -3.9
  Bulgaria              5.5      6.3           7.3          8.7            Bulgaria          58.0          66.1        65.2        63.2          Bulgaria           2.1       -3.7        -5.6       -2.8
  Czechia               1.3      4.5           4.2          2.8            Czechia           76.2          82.4        80.7        81.4          Czechia            0.3       -7.0        -7.8       -6.0
  Hungary               1.3      3.8           4.4          3.6            Hungary           91.0         111.5       104.5        97.6          Hungary           -2.0       -9.2        -6.0       -2.7
  Poland                4.1      6.9           4.8          5.1            Poland            59.7          58.0        52.0        47.1          Poland            -0.7       -6.0        -4.6       -3.2
  Romania              -1.5     -2.4          -1.2      -1.0               Romania           33.3          42.9        46.5        46.9          Romania           -4.3       -9.8        -7.0       -4.0
  Croatia               6.7      2.5           5.8          5.7            Croatia           75.3          88.1        82.8        79.2          Croatia            0.4       -8.0        -3.5       -2.6
 Russia                 4.5      1.5           0.4          1.1       Russia                 28.5          31.1        28.7        28.4        Russia               1.8       -5.0        -3.4       -1.8
 Serbia                 0.8     -0.8           0.3          0.3       Serbia                 61.5          64.4        66.7        63.2        Serbia              -0.2       -8.0        -3.5       -2.0
 Turkey                 1.7     -5.1          -2.3      -1.9          Turkey                 57.1          62.0        59.4        58.3        Turkey              -5.3       -5.6        -5.4       -5.1

 Gov’t debt                                                           Policy rate                                                              FX vs. EUR
 (% GDP)              2019 2020E         2021F        2022F           (%)                    2019         2020        2021F       2022F        (EoP)              2019       2020      2021F       2022F
 EU-CEE                44.1     56.8          58.7      58.9          EU-CEE                                                                   EU-CEE
  Bulgaria             19.9     25.0          28.3      29.1               Bulgaria               -             -           -           -        Bulgaria          1.96      1.96        1.96        1.96
  Czechia              30.2     38.1          44.4      47.3               Czechia           2.00          0.25        0.50        0.75          Czechia           25.4      26.2        25.6        25.0
  Hungary              63.7     84.6          85.4      83.4               Hungary           0.90          0.60        0.60        0.60          Hungary           331      365.1         353        360
  Poland               45.4     58.7          58.5      58.2               Poland            1.50          0.10        0.10        1.00          Poland            4.26      4.61        4.45        4.45
  Romania              35.3     46.8          49.4      49.9               Romania           2.50          1.50        1.00        1.00          Romania           4.78      4.87        4.95        5.05
  Croatia              72.8     89.6          87.9      84.9               Croatia                -             -           -           -        Croatia           7.44      7.53        7.53        7.53
 Russia                12.5     18.3          19.4      20.8          Russia                 6.25          4.25        4.25        4.50        Russia              69.3      90.7        90.2        95.0
 Serbia                52.9     59.0          59.4      58.2          Serbia                 2.25          1.00        1.00        1.00        Serbia             117.6     117.6       117.9      118.3
 Turkey                32.6     40.0          40.7      41.4          Turkey                12.00         17.00       12.00       12.00        Turkey              6.67      9.08       10.11      11.67

                                                                                                                      Source: National statistical agencies, central banks, UniCredit Research

UniCredit Research                                                                                    page 11                                                               See last pages for disclaimer.
January 2021                                                                   CEE Macro & Strategy Research
                                                                                                                                                                                                 CEE Quarterly


                                                BG       CZ      HR     HU     PL    RO       RS        RU      SK      TR        UA        MX         BR         CL       SA         ID         IN         CN          AG
External Liquidity
Current account (% of GDP)                       0.7     2.4    -1.5   -0.9    2.8   -4.7    -5.4       2.3    -1.3    -4.2       4.2       1.4       -0.8         0       0.8      -1.3        1.3         1.5          1.6
Extended Basic Balance (% of GDP)                3.2     4.0     3.1    1.8    6.6   -2.3     0.2       1.3     0.6    -3.6       4.6       3.1        1.1        0.6      0.2      -0.2        3.0         2.0          1.9
FX Reserves coverage (months of imports)         9.8     9.1     8.9    2.9    5.2    5.0     6.8      14.8       -     2.2       4.7       5.5      18.9         6.5      6.9       8.9       10.1       16.3           7.9
External Debt (excl.ICL, % of GDP)*            36.8     75.2    67.6   54.3   40.6   38.0    65.0      20.7    92.1    59.3      79.8      44.7      69.7       83.0      51.0      37.9       21.4       16.1         57.8
Short-term debt (% of GDP)                     12.3     41.1    26.4   10.8    8.2    6.5     4.2       4.0    43.9    18.3      10.8       4.0        5.2        7.9      9.1       4.1        7.8         9.1          8.1
REER (Index, 2010=100)                        106.8     99.4   101.2   83.5   91.2   98.3   126.2      72.3       -    51.6      91.2      80.5     144.1       83.9      90.3      90.8      107.8      123.3              -

Domestic Finances
Corporate debt (% of GDP)                      47.3     52.3    65.3   56.3   44.6   38.8    46.2      58.8    54.4    77.6      60.5      42.3      45.2       94.8      58.6      38.8       47.3      162.5         15.2
Household Debt (% of GDP)                      23.7     39.3    39.0   22.6   35.2   21.1    20.5      19.1    45.6    17.8       5.7      17.1      31.4       37.6      35.6      16.6       13.5       59.1           5.0
Nonresident holdings of gov.debt (% total)       1.0    33.9       -   28.9   17.0   19.5    26.1      25.6    48.1     5.2         -      22.2      11.3           -     29.7      30.0           -        9.5             -

Banking System
Credit Impulse (% of GDP)                       -0.7    -0.1     3.1    0.6   -2.1   -1.0     1.9       4.3     3.9    12.7       9.7      -0.6        2.4       -1.4      -2.1     -3.2        1.2         8.5          1.5
Loans/deposit ratio (%)                        70.7     63.7    79.1   66.6   82.5   68.9    88.1      89.8   102.8   104.2     143.4      92.3     101.9      111.4      99.1      90.6      111.2       75.5        130.8
NPL (% of total loans)                           8.6     2.4     7.6    2.8    3.8    3.9     3.4       6.1     2.8     4.0      45.6       2.0        2.2        1.6      4.0       3.2        8.4         1.9          4.8
Domestic Banks CAR (%)                         22.9     21.5    25.0   17.9   17.9   22.8    22.4      12.8    19.7    19.4      21.9      17.2      16.3       14.3      15.9      23.8       14.5       14.5         22.0
Domestic Banks RoE (%)                           6.9     8.6     5.5    3.8    7.0   10.5     7.7      16.7     3.6    11.3      26.2      13.4      14.7         7.3     16.6      10.4        0.1       12.1              -

*External debt incl ICL for CZ, RS, TR, MX, CL and SA                                                                  Source: Haver, Bloomberg, National Statistics Offices, Central Banks, IMF, BIS, UniCredit Research

Low vulnerability
Moderate vulnerability
Significant vulnerability
High vulnerability

UniCredit Research                                                                                  page 12                                                                                     See last pages for disclaimer.
January 2021                                                                        CEE Macro & Strategy Research
                                                                                                                                                                                                                      CEE Quarterly


                                               BG         CZ         HR           HU       PL      RO        RS          RU        SK       TR        UA         MX        BR         CL        SA          ID        IN         CN          AG
Policy Rate, nominal (%)                          -      0.25          -      0.60        0.10    1.50      1.00        4.25        0     17.00      6.00       4.25      2.00       0.50      3.50       3.75      4.00       4.35        38.00
Real policy rate (%)                              -      -2.3          -          -2.0    -2.8    -0.7       -0.5       -0.7      -1.5      2.1       2.1        0.9       -2.2      -2.2       0.3        2.1       -2.8        0.6          1.6
Real Money market rate (%)                        -      -2.2       -1.8          -1.9    -2.8    -0.3       -0.7             0   -2.0      2.9       1.7        1.0       -3.7      -3.3       0.1        2.4       -3.1        4.5         -3.8
Headline inflation (% yoy)                     0.4        2.7       -0.2          2.7      3.0     2.1       1.7         4.9       1.5     14.6       3.8        3.3       4.3        2.7       3.2        1.6       7.0        -0.6        35.8
Core Inflation (% yoy)                         0.6        2.4        0.8          3.9      4.3     3.4       1.9         3.9       1.4     14.3       3.9        3.7       2.0        2.3       3.3        1.8       5.7         0.4        37.8
GG Fiscal balance (% of GDP)                   -2.3      -4.0       -3.1          -4.6    -5.5    -8.5       -7.5       -5.1      -4.7     -3.9       -8.5      -2.5      -13.7      -7.5      -10.7      -5.0       -6.3       -5.5         -8.9
GG Primary balance (% of GDP)                  -1.8      -3.2       -1.0          -2.3    -2.6    -7.1       -5.6       -4.1      -3.4     -1.2          -       0.7       -8.9      -6.6       -6.2      -3.0       -2.9       n.a.             -
Government Debt (% of GDP)                    24.6       38.4       85.3      74.3        51.6    44.0      57.6        18.3      60.2     42.6      79.8       48.2      80.8       49.6      75.2       60.2      56.2       63.0         70.4

External Debt Spread (10Y, bp)**              57.7       20.0     105.4       92.2        47.7   181.5     153.9      126.3       43.2    454.0     504.2      110.0     210.5       53.5     298.6      150.3     105.0        -6.9             -
Local Currency Curve (5Y, %)***                0.2        0.8        0.4          1.5      0.4     2.6       2.6         5.4      -0.6     13.4       4.9        4.8       5.1        1.6       8.0        5.2       5.4         2.9        52.0
Local currency bond spread (2s10s)****        62.6      115.2       44.9     117.3       117.0    68.5     139.7      150.0       13.9   -142.0     285.7      141.0     261.5      397.0     283.0      192.7     151.9       56.6       -270.2
CDS (10Y, bp)                                   61         44       122            87      89     117        149        140        71      328        384       140        225         85       300       116        128          30       1400
FX 3m implied volatility (%)                      -       5.6        4.0          7.2      6.4     2.3          -       15.4         -     16.9          -      15.0      20.3       13.8      17.2       10.2       5.9         5.8        15.0

IBRD Doing Business                             61         41        51            52      40       55        44         28        45        33        64         60       124         59        84         73        63          31         126
WEF Competitiveness Ranking                     49         32        63            47      37       51        72         43        42        61        85         48        71         33        60         50        68          28          83
Unemployment (%)                               4.9        2.9        6.7          4.4      3.4     5.1       9.5         6.3       7.2     12.7       9.3        4.4      14.3       10.8      30.8        7.1       6.5         5.2        11.9

** Spread between 10Y EUR government bond yields and the corresponding German government bond yields for BG, HR, HU, PL, RO. For CZ, the spread refers to the 5Y yield. For the other countries, the spread is computed with respect to US
government bond yields
*** Data for UA refer to the generic USD bond. Data for HR refer to the 4Y bond
**** Data for UA refer to the generic USD bond. Data for CL refer SA to the spread between 8Y and 2Y bond and 9Y and 2Y bond respectively. Data for HU refer to spread between 10Y and 3Y bond.
*****IBRD and WEF indicators for 2018
                                                                                                                                            Source: Haver, Bloomberg, National Statistics Offices, Central Banks, IMF, BIS, UniCredit Research

Low vulnerability
Moderate vulnerability
Significant vulnerability
High vulnerability

UniCredit Research                                                                                                  page 13                                                                                          See last pages for disclaimer.
January 2021                                                      CEE Macro & Strategy Research
                                                                                                                                                                       CEE Quarterly

                                               CEE strategy: Solid risk appetite and yield in demand
Elia Lattuga                                   ■   As markets shift focus towards economic recovery, and while monetary policy at key central
Co- Head of Strategy Research,
Cross Asset Strategist                             banks remains accommodative, financing conditions on global markets should help fuel the
(UniCredit Bank, London)                           performance of risky assets and keep yield hunting alive. Developments pertaining to the
+44 207 826-1642
                                                   pandemic and to long-term US yields are key sources of risk that should be monitored.
                                               ■   CEE assets are set to benefit from negative net supply in the eurozone, the yield hunting
                                                   environment and positive developments in bond supply. Higher-yielding exposure might be
                                                   preferred, but portfolio flows might also sustain higher-rated issuers.

Asset performance in 2020                      With large swings in asset performance and unprecedented stimulus by fiscal and monetary
                                               authorities, 2020 has been an extremely volatile year for global markets. At the end of the year,
                                               the MSCI World Index was 14% higher than it was a year earlier after posting a staggering 68%
                                               rally from March lows. In spite of some upward pressure at the long end of the curve, 10Y UST
                                               yields are still 80bp below their YE 2019 levels. Credit spreads across both US and European
                                               markets have been tightening steadily in recent months, and broad indices have returned to
                                               levels that prevailed a year ago. A return of implied volatility on US equities in the 20 points area
                                               and the weakening of the USD, which lost over 10% (DXY) from March peaks, also supported a
                                               general easing of financial conditions. EM bonds benefited from such improvement and posted
                                               a sharp tightening in credit spreads. However, this was not enough to fully recover from earlier
                                               widening, leaving spreads in broad indices a tad wider than they were a year ago. In total-return
                                               terms, however, EM bonds managed to close 2020 with a positive performance. Across several
                                               segments of the market, total returns exceeded 5%, a very good performance when one
                                               considers the extent of 1Q20 losses. LatAm and lower-rated buckets across EM bond indices
                                               underperformed, displaying, in some cases, sharp losses that were heavily affected by the large
                                               drop recorded in 1Q. A selective approach paid off during volatile times. EMEA did well,
                                               especially across hard-currency indices.

Investors focus on economic                    2021 started on a positive note for risky assets, after a very strong performance in the latter part
recovery over the medium term
                                               of 2020. Uncertainty surrounding short-term development in contagion curves is still high, and a
                                               number of countries have stepped up restrictions in recent weeks and this bodes ill for GDP
                                               growth over 1Q, but risk appetite has remained solid. Markets are taking a constructive stance
                                               with respect to the effectiveness and rapid distribution of COVID-19 vaccines and treatments,
                                               which should limit the need for additional lockdowns down the road and pave the way for a
                                               sustainable recovery in 2021.

CHART 1: TOTAL RETURNS (USD)                                                                       CHART 2: FINANCING CONDITIONS

                        4Q20            3Q20       2Q20            1Q20                                                  8
 40%                                                                                                                               10Y USD RY      DXY        VIX      US HY
                        2019            2018       2020                                                                  7
 30%                                                                                                                     6
 20%                                                                                                                     5
                                                                                                   Standardized levels

 10%                                                                                                                     4

-20%                                                                                                                     0
-30%                                                                                                                     -1

-40%                                                                                                                     -2
         LatAm Asia EMEA LatAm Asia EMEA       A   Baa      Ba      B     Caa   1-3    7-10
                                                                                Year   Year                              -3
                                                                                                                          Jan 17     Oct 17     Jul 18       Apr 19     Jan 20          Oct 20
               LC              HC-USD                     HC-USD                 HC-USD

                                                                                                                                                         Source: Bloomberg, UniCredit Research

UniCredit Research                                                                       page 14                                                                      See last pages for disclaimer.
January 2021                                                                                                               CEE Macro & Strategy Research
                                                                                                                                                                                                                                                                                     CEE Quarterly

                                                               Moreover, lingering support by central banks and the hunt for yield should contribute to limiting
                                                               the impact of negative growth news in the short term while keeping investors focused on
                                                               economic recovery over the medium term. Indeed, central banks ended 2020 by conveying a
                                                               clear message of support for financial markets and will act to avoid that a tightening in financial
                                                               conditions might derail progress before an economic recovery gains pace and inflation outlooks
                                                               improve (which might still be several quarters off). Both the Fed and the ECB are expected to
                                                               leave their official rates at their currently low levels for several years, while net asset purchases
                                                               (and thus balance-sheet expansion) continues into 2021. This will help markets digest lower, but
                                                               still high, borrowing needs as fiscal policy remains accommodative.
Strategy view for 2021                                         In this scenario, we think that risky assets are well-positioned to outperform. We expect to see
                                                               equity indices delivering returns in the 10% area in 2021. We believe that credit-spread
                                                               tightening has more room to run as yield hunting pushes investors to move into riskier
                                                               segments of the market, while interest-rate levels remain subdued. Indeed, we forecast a
                                                               gradual adjustment towards higher yield levels and steeper USD-denominated and
                                                               EUR-denominated government-bond curves. More specifically, we expect that the 10Y UST
                                                               yield will increase to 1.30% by the end of next year and to 1.75% by the end of 2022, while we
                                                               project that 10Y Bund yields will close 2021 at -0.30% and 2022 at -0.10%, representing a
                                                               moderate drag on total returns in the IG space. In spite of some widening in the transatlantic
                                                               spread at the long end, we believe that EUR-USD will continue to move north and close 2021
                                                               at 1.28, as the correlation between equity prices and the US dollar remains negative. In a
                                                               nutshell, moderately higher risk-free rates, tighter credit spreads and a weaker dollar should
                                                               keep financing conditions for EM paper attractive, while investors struggle to find yield.
The main risks to our call                                     Our positive call with regard to risky assets is very much dependent on an assumption that
for 2021
                                                               vaccine distribution will allow a broader and more-solid recovery in global growth in 2021.
                                                               Hence, that recovery expectations could be jeopardized by negative news regarding vaccine
                                                               distribution, or more in general, regarding health conditions might weigh on appetite for risk at a
                                                               time when equities reflect earnings growth in the 20-30% range for this year and the next.
                                                               Moreover, after Democratic Senate candidates won run-off elections in the US state of Georgia,
                                                               thereby avoiding a split Congress, 10Y UST yields rose above 1% for the first time since March,
                                                               and reflation expectations and bear steepening are regaining popularity. We think that inflation
                                                               breakevens have limited upside. However, as the US economy recovers and as GDP begins to
                                                               return to pre-crisis levels, markets might start to react in anticipation of some tapering and
                                                               possibly to a halting of net asset purchases by the Fed. In such a scenario, a sharp repricing of
                                                               US rates could spillover on credit markets, given narrow spreads and high leverage – and
                                                               possibly on equity valuations and on the US dollar. This is a key risk to monitor in our view.

CHART 3: VOLATILITY AND CENTRAL BANK LIQUIDITY                                                                        CHART 4: NON-RESIDENT BOND PORTFOLIO MONTHLY FLOW

                             VIX   G10 FX     EM FX      ECB, Fed, SNB, BoJ, PBoC assets (rs)                                  80                                                 EM EU                      EM Asia                         LatAm                      Africa-ME
                        80                                                                      25
                                                                                                20                             40
1M implied volatilitu

                                                                                                                      USD bn
                                                                                                     Assets, USD tn


                        40                                                                                                      0

                                                                                                10                             -20

                        20                                                                                                     -40
                        10                                                                                                     -60
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                                                                                                                                                                                                                                                                   Jul 18
                                                                                                                                                                                                                                                                            Oct 18
                                                                                                                                                                                                                                                                                     Jan 19

                                                                                                                                                                                                                                                                                                       Jul 19
                                                                                                                                                                                                                                                                                                                Oct 19
                                                                                                                                                                                                                                                                                                                         Jan 20

                                                                                                                                                                                                                                                                                                                                           Jul 20

                        0                                                                    0
                        Jan-10       Sep-12           Jun-15          Mar-18           Dec-20

                                                                                                                                                                                                                       Source: IIF, Bloomberg, UniCredit Research

UniCredit Research                                                                                   page 15                                                                                                                                                                    See last pages for disclaimer.
January 2021                                              CEE Macro & Strategy Research
                                                                                                                                                                                    CEE Quarterly

Currency volatility                                                         Central-bank action has also eased implied volatility across a number of assets. The Chicago
                                                                            Board Options Exchange Volatility Index (VIX) has begun approaching the 20-point level
                                                                            again. This is at the low end of the VIX range that has prevailed since March. FX volatility has
                                                                            been following a similar path, but EM currency volatility remains high compared to G7
                                                                            currency volatility. As the growth outlook improves and the recovery broadens, and with major
                                                                            central banks remaining committed to providing liquidity, we expect markets to become
                                                                            calmer over the coming months, albeit with risks of short-lived spikes. Lower FX volatility
                                                                            would contribute to channeling more funds towards EM markets from crossover investors.

Portfolio reallocation                                                      CEE bond markets are well-positioned in this respect to attract inflows as EUR-denominated
benefiting CEE
                                                                            bond markets will be bid and increasingly owned by the Eurosystem. With governments
                                                                            funding their fiscal expansions and corporates transforming their short-term liquidity sources
                                                                            into capital-market borrowing, 2020 has been characterized by very intense supply pressure
                                                                            on global markets. The very large gross and net supply has been digested smoothly, thanks
                                                                            to the support of central banks’ asset-purchasing programs and strong demand from private
                                                                            investors. In the euro area, PEPP and APP flows have led to a massive increase in demand
                                                                            for bonds. This has taken gross supply net of redemptions and central-bank purchases to
                                                                            negative levels in spite of large funding needs. In the past, sharply negative net supply
                                                                            (including quantitative easing) in the euro area has fueled portfolio reallocations, also
                                                                            benefiting CEE countries. In 2016-17, however, euro-area bond markets offered much better
                                                                            entry levels for those willing to add duration or credit risk. Yield curves were steeper, and
                                                                            spreads were wider and more dispersed. The share of eurozone bonds trading at negative
                                                                            yield levels has increased steadily over the past few months, and scarcity has become a more
                                                                            material issue across several segments of the market. The ECB’s asset purchases will
                                                                            continue over the coming quarters and, according to our calculations, will more than offset net
                                                                            borrowing for both government and non-financial corporate debt over the course of 2021.
                                                                            CEE bonds appear well-positioned to benefit from portfolio reallocation in such an
                                                                            environment. Higher-yielding exposures, such as to Romania or Hungary might be favored,
                                                                            but given their scarcity of yield and higher-rated paper, exposure to Poland and Czech bonds
                                                                            might also be of interest – if volatility on the currency market subsides.

CHART 5: PORTFOLIO INFLOWS INTO CEE DEBT (12M SUM)                                                                                  CHART 6: YIELD CURVES EUR-DENOMINATED BONDS

                                     EA net issuance* (rs, inv.)      CZK        RON        PLN          HUF                                   Romania      Hungary       Poland   Euro Swap
                              25                                                                               -300                    3

   Portfolio inflows USD bn

                                                                                                                   EA issuance

                               5                                                                                                     1.5

                               0                                                                               0                       1
                              -20                                                                                                    -0.5

                              -25                                                                             300
                                Jan-13   Jan-14   Jan-15    Jan-16   Jan-17   Jan-18   Jan-19   Jan-20   Jan-21                         2019   2024      2030     2035      2041   2046        2052     2057

*Euro-area net issuance refers to net government and non-financial corporations’ gross issuance net of redemptions and of ECB APP and PEPP flows, which are
calculated as a three-month rolling sum.
                                                                                                                   Source: Haver, Bloomberg, UniCredit Research

UniCredit Research                                                                                                        page 16                                                  See last pages for disclaimer.
January 2021                         CEE Macro & Strategy Research
                                                                                                      CEE Quarterly

Reduced supply pressure   In 2021, three additional factors will reduce net borrowing needs in CEE, supporting bond
in CEE
                          prices: 1. budget deficits will fall compared to 2020; 2. up to 25% of funding needs could be
                          covered out of the market by borrowing from EU facilities such as SURE and NGEU. This is
                          especially true for higher yielders such as Croatia and Romania, which have a larger incentive
                          to tap funds at a cost below market levels. However, even Bulgaria, Hungary and Poland
                          could decide to tap EU loans to extend debt duration at below-market costs. The availability of
                          such funds will also allow greater flexibility for issuers, reducing further supply risk;
                          3. remaining gross external borrowing needs will either be below redemptions or fall short of
                          the purchases needed to maintain the current allotment by index-trackers (in percent of
                          assets under management).

                          In EU-CEE, we continue to prefer Romanian bonds to their regional peers, both outright and
                          in spreads. We believe that the downgrade premium should be completely priced out in 2021,
                          besides investors having to anchor yield expectations lower due to cheap EU funding. In
                          Russia, a more stable currency could persuade foreign investors to take exposure back to
                          early 2020 levels as the OFZ curve could bull flatten further after 2020’s rate cuts. In Turkey,
                          investors could prefer an outright carry trade in 1Q21 as the CBRT remains hawkish and
                          inflation continues to rise. However, likely rate cuts in 2H21 could see investors pile into
                          TURKGBs for a while. Lower real rates may end the attractiveness of this trade before year-
                          end due to potential currency depreciation.

UniCredit Research                                   page 17                                         See last pages for disclaimer.
January 2021                                                    CEE Macro & Strategy Research
                                                                                                                                                    CEE Quarterly

Updating our REER models

■   The last few weeks have seen some volatility on EUR-PLN
                                                                                                                     Model (rs)   EUR        USD
    but the pair has recently approached the 4.50 handle,                             5.00                                                                               15%

    nearly 2% higher compared to the December lows.
                                                                                      4.50                                                                               10%

                                                                                                                                                                                  REER under/over valuation
    In REER terms, the zloty trades close to the average over
                                                                                      4.00                                                                               5%
    the past six months; according to our model, it is broadly

                                                                            Spot FX
    in line with its fair value.
                                                                                      3.50                                                                               0%

■   The short-term outlook for the currency is positive and we
                                                                                      3.00                                                                               -5%
    see EUR-PLN dropping below 4.45. This level should
    prove as a good anchor for developments during the year.                          2.50                                                                               -10%
    We do not envisage departures from the 4.40-4.50 range
    over the forecast horizon, as the NBP could intervene to                          2.00                                                                             -15%
                                                                                         Mar-07         Dec-09        Sep-12        Jun-15          Mar-18        Dec-20
    keep the pair from falling below 4.40. Levels above 4.50
    offer good selling opportunities, in our view.

■   The CZK closed 2020 on a solid footing, having recovered
                                                                                                                     Model (rs)   EUR        USD
    most of the losses recorded in September and October                              50                                                                                 15%

    against the EUR. Breaking below 26.0 would take the pair                          45
    to its lowest level since March.

                                                                                                                                                                                   REER under/over valuation

■   Our REER model for the CZK displays the currency as                               35

    slightly overvalued, after the last few months’ recovery.
                                                                            Spot FX

                                                                                      30                                                                                 0%
    However, this should not prevent the CZK from gaining
    against the EUR in the medium term.                                               25
■   We think that EUR-CZK might break below 26.0 and                                                                                                                     -10%
    approach 25.5 by the end of 2021. The CNB is more hawkish
    than its peers, supporting CZK appreciation. In the short                         10                                                                                 -15%
                                                                                       Jan-00      Sep-02   Jun-05   Mar-08    Dec-10   Sep-13     Jun-16    Mar-19
    term, the PLN might outperform the CZK.

■   EUR-HUF has displayed large swings in the 355-365 area
                                                                                                                     Model (rs)   EUR        USD
                                                                                        425                                                                                 15%
    over the past four months, with only short-lived deviations
    outside of the range. The pair remains at the upper end of
                                                                                        375                                                                                 10%
    the 2020 range, and also in REER terms the recovery has
                                                                                                                                                                                  REER under/over valuation

    been limited.                                                                       325                                                                                 5%

■   According to our REER model, the HUF remains
                                                                              Spot FX

                                                                                        275                                                                                 0%
    moderately undervalued, having recovered only part of its
    undervaluation compared to the crisis period.                                       225                                                                                 -5%

■   We forecast EUR-HUF within the 355-360 area over the next                           175                                                                                 -10%

    few quarters. While the NBH tried to decouple monetary
                                                                                        125                                                                                 -15%
    policy decisions from HUF fluctuations, the currency remains                          Jan-00        Feb-04        Mar-08        Apr-12          Jun-16         Jul-20
    the favorite short for investors in central Europe.

                                                                                                                        Source: Haver, Bloomberg, UniCredit Research

UniCredit Research                                                page 18                                                                          See last pages for disclaimer.
January 2021                                              CEE Macro & Strategy Research
                                                                                                                                             CEE Quarterly

■   The RUB seems to have stabilized in the 72-75 area
                                                                                                                  Model (rs)   REER
    against the USD. The rise in commodity prices and the                           120                                                                          20%

    overall weakness in the USD over the past few months                            110                                                                          15%
    have been supportive but the currency remains almost

                                                                                                                                                                       REER under/over valuation
    20% weaker than a year ago in REER terms.                                       100
■   Our REER model for the RUB depicts the currency as                               90

    broadly in line with its fair value, after a long streak of                      80
    overvaluations was reined in.
■   We think that the CBR is done with rate cuts for the time

                                                                                     60                                                                          -15%
    being, with a diminishing short-term risk that the inflation
    target will be undershot. This might pave the way to a                           50                                                                          -20%
                                                                                      Dec-00   Sep-03   Jun-06    Mar-09   Dec-11   Sep-14   Jun-17     Mar-20
    return towards the lower end of the 70-75 range for USD-
    RUB over the coming quarters.

■   Monetary tightening and moves by the CBRT to simplify
                                                                                                                  Model (rs)   REER
    the monetary policy framework have contributed to a                             110                                                                          20%

    sharp U-turn on USD-TRY. The pair trades 13% below                              100                                                                          15%
    October peaks, but is still 25% above YE19 levels.

                                                                                                                                                                       REER under/over valuation
■   Such recovery has reduced the undervaluation of the TRY                                                                                                      5%
    in REER terms, which remains above 10%. Recent hikes

    have taken real rates back into positive territory, which                        70
    should support the currency in the short term.
■   The medium-term picture remains more challenging, and                            50                                                                          -15%
    the risk that the USD-TRY will approach the 8.00 area
                                                                                     40                                                                          -20%
    again by YE21 is material, in our view, if disinflation in                        Mar-03   Dec-05    Sep-08      Jun-11    Mar-14   Dec-16        Sep-19
    2H21 is accompanied by a too-quick reversal of recent
    policy actions.

                                                                                                                  Source: Haver, Bloomberg, UniCredit Research

UniCredit Research                                                 page 19                                                               See last pages for disclaimer.
January 2021   CEE Macro & Strategy Research
                                                 CEE Quarterly


UniCredit Research      page 20                 See last pages for disclaimer.
January 2021                                    CEE Macro & Strategy Research
                                                                                                                                                                  CEE Quarterly

Bulgaria                                                                                                               Baa1 stable/BBB stable/BBB stable*

Additional fiscal measures were announced at the end of 2020 to mitigate the damages caused by the second wave of the
COVID-19 pandemic. We expect the early phase of the recovery in Bulgaria to be somewhat weaker than in most CEE
economies for two reasons. First, Bulgaria was among the countries worst hit by the second wave of COVID-19 infections.
Second, Parliamentary elections will lead to a slow start for the NGEU program and to delays in some infrastructure projects
initiated under the previous government. However, economic recovery is likely to gain stronger momentum in 2022 and 2023
once the health crisis ends and Bulgaria’s absorption of NGEU funds shifts to a higher gear.

Sovereign’s funding needs are set to rise this year, as Bulgaria is the only CEE country where budget deficit is expected to
increase. To meet these needs, a combination of new Eurobond issue, domestic bond issuance, and low-cost borrowing
provided under SURE financial assistance instrument will be used. The first tranche of low-cost borrowing from NGEU is
expected in 2022.

Author: Kristofor Pavlov, Chief Economist (UniCredit Bulbank)

                                                                                           MACROECONOMIC DATA AND FORECASTS

KEY DATES/EVENTS                                                                                                                      2018        2019      2020Е       2021F         2022F
■ Mid-Feb: Labor force 4Q20 data                                                           GDP (EUR bn)                                56.1        60.7       58.4         61.1         65.4
                                                                                           Population (mn)                              7.0         7.0        6.9          6.9           6.8
■ Mid-Feb, Early-Mar: GDP data (4Q20 flash estimate and                                    GDP per capita (EUR)                       8,012      8,728       8,458       8,909         9,603
      structure, preliminary data for 2020)
                                                                                           Real economy, change (%)

■ End March or early April: General elections                                              GDP                                          3.1         3.7        -5.5         2.7           4.5
                                                                                           Private consumption                          4.4         5.5        -2.9         1.7           3.3
                                                                                           Fixed investment                             5.4         4.5        -8.4         4.7         13.3
GDP GROWTH FORECAST                                                                        Public consumption                           5.4         2.0        2.5          4.2           4.0
                                                                                           Exports                                      1.7         3.9      -12.5          5.6           7.5
  yoy (%)          Private consumption         Public consumption     Fixed Investments
                                                                                           Imports                                      5.7         5.2        -9.3         5.3           8.5
                   Net exports                 Inventories            GDP, real growth
                                                                                           Monthly wage, nominal (EUR)                  586        651         701          748          806
                                         3.7                                     4.5       Real wage, change (%)                        7.7         8.0        5.9          4.9           5.2
  4                       3.1
                                                                     2.7                   Unemployment rate (%)                        5.2         4.2        5.4          5.6           4.7
                                                                                           Fiscal accounts (% of GDP)
                                                                                           Budget balance                               2.0         2.1        -3.7        -5.6          -2.8
                                                                                           Primary balance                              2.7         2.7        -3.1        -5.0          -2.2
                                                                                           Public debt                                 21.8        19.9       25.0         28.3         29.1
                                                        -5.5                               External accounts
 -8                                                                                                                                     0.6         1.8        1.6          1.9           2.2
            2017         2018            2019          2020E        2021F      2022F       Current account balance (EUR bn)
                                                                                           Current account balance/GDP (%)              1.0         3.0        2.7          3.2           3.4
                                                                                           Extended basic balance/GDP (%)               3.3         5.5        6.3          7.3           8.7
INFLATION FORECAST                                                                         Net FDI (% of GDP)                           1.4         1.4        1.7          1.5           2.1
                                                                                           Gross foreign debt (% of GDP)               60.3        58.0       66.1         65.2         63.2
       yoy (%)
 5                                                                                         FX reserves (EUR bn)                        25.1        24.8       28.9         31.6         34.2
                                                                                           Months of imports, goods & services          8.0         7.6       10.3         10.3           9.9
 4                                                                                         Inflation/monetary/FX
                                                                                           CPI (pavg)                                   2.8         3.1        1.7          1.9           2.5
                                                                                           CPI (eop)                                    2.7         3.8        0.7          2.5           2.6
                                                                                           Central-bank reference rate (eop)          -0.50       -0.61      -0.70        -0.60        -0.56
                                                                                           USD/BGN (eop)                               1.71        1.74       1.66         1.53         1.47
 1                                                                                         EUR/BGN (eop)                               1.96        1.96       1.96         1.96         1.96
                                                                                           USD/BGN (pavg)                              1.66        1.75       1.72         1.59         1.50
 Dec-17             Dec-18        Dec-19              Dec-20        Dec-21        Dec-22   EUR/BGN (pavg)                              1.96        1.96       1.96         1.96         1.96

                                                                                              Source: Bulgarian National Bank, Eurostat, National Statistical Institute, UniCredit Research
            Source: National Statistical Institute, UniCredit Research

*Long-term foreign-currency credit ratings as provided by Moody’s, S&P and Fitch, respectively

UniCredit Research                                                                                   page 21                                                     See last pages for disclaimer.
January 2021                                  CEE Macro & Strategy Research
                                                                                                                                                                                             CEE Quarterly

                                                                     Difficult start to recovery but strong medium-term outlook
The outlook is for a subdued                                         After GDP contracted by around 5.5% in 2020, our baseline scenario envisages only a partial
economic recovery in 2021
                                                                     recovery of 2.7% this year. Recovery will take a stronger hold in 2022 and 2023, when we
                                                                     anticipate GDP growth to accelerate to something between 4% and 5% annually. We expect
                                                                     GDP to return to its pre-crisis level in mid-2022. Getting back to full employment is likely in the
                                                                     end of 2023. Uncertainty over the near-term outlook remains elevated. Risks to our baseline
                                                                     macro scenario are dominated by pandemic dynamics and local politics related factors.
Bulgaria was hit hard by the                                         The economy faces a difficult winter. The main reason is the surge in COVID-19 infections (see
second wave
                                                                     lhs chart) that have led to the adoption of new restrictions in November. The new restrictions are
                                                                     milder than those implemented during the first wave of the pandemic, but are likely to remain in
                                                                     place for longer. We expect the economy to contract in both 4Q20 and 1Q21. The fall in GDP is
                                                                     likely to be more modest compared to the first wave of the pandemic, because some sectors are
                                                                     excluded from the restrictions, including most importantly the manufacturing sector.

                                                                     A genuine relaxation of the restrictions will start in March, when we expect the pandemic
In 2021, economic growth will                                        curve to become more promising. The spring will limit the spreading of the disease, similarly,
depend on path of virus                                              to what we witnessed in 2020. We expect GDP to rebound in 2Q21 and beyond, as the direct
                                                                     impact of the pandemic on the economy eases, and fiscal stimulus provide further support.

Another difficult season for                                         However, consumption in tourism and other sectors most exposed to the pandemic’s impact
summer tourism is expected                                           will remain subdued. This is because the positive impact from vaccination will take time to
                                                                     materialize, thereby causing many people to continue behaving cautiously and maintaining
                                                                     some sort of voluntary physical distancing throughout the summer months of 2021.

Share of vaccinated people to                                        The strength and speed of the recovery will depend on the timing and effectiveness of the roll-out
become the most closely                                              of the vaccines. Opinion poll conducted by Alpha research in December suggests that the share of
watched indicator
                                                                     the population who want to be vaccinated is similar to the rest of Europe (see right chart). We hope
                                                                     that the share of people wishing to be vaccinated will increase, as information about the pros and
                                                                     cons of doing so becomes more widely available and as leaders in politics, business and the arts
                                                                     presumably lead a large-scale campaign to boost vaccination rates.

No need for new restrictions in                                      Rising vaccination levels (closer to the one required to reach collective immunity) will prevent
winter 2021-22                                                       the need for new restrictions in winter 2021-22. We expect spending to rise and consumption
                                                                     patterns to slowly start to normalize, boosting GDP growth in 4Q21 and further into 2022.

Fiscal support likely to                                             The strength of the recovery will depend on the size and efficiency of the fiscal policy
increase in 2021                                                     response. Initially, Bulgaria’s fiscal policy response was more delayed and timid than in the
                                                                     other CEE countries. The scale of the fiscal support was gradually increased thereafter and
                                                                     we expect it to have reached 3.2% of GDP in 2020.

BULGARIA BADLY HIT BY SECOND WAVE OF PANDEMIC                                                                                          WILLINGNESS TO GET COVID -19 VACCINE IS MORE THAN 50%

        10 most badly hit European countries from the second wave:
         New COVID-19 deaths per 1 mn inhabitants
 700                                                                                                                                                                                      15%
                                                                                          Nov-20             Dec-20
 600                                                                                                                                                                                     Want to be
                                                                                                                                         Share of Bulgarians who                         vaccinated
 500                                                                                                                                     say they want/don`t want        45%
                                                                                                                                         to be vaccinate against
 400                                                                                                                                                                 Don't want to be
                                                                                                                                         COVID-19. (Dec'20)
                                                                                                                                                                     vaccinated                       40%

 200                                                                                                                                                                                    Want to be vaccinated,
                                                                                                                                                                                        but will wait to see if
 100                                                                                                                                                                                    the vaccines had
                                                                                                                                                                                        negative effects




                                                     Bosnia and




                                                                                                                                                          Source: Worldometer, Alpha Research, UniCredit Research

UniCredit Research                                                                                                           page 22                                                        See last pages for disclaimer.
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