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March 2021 CEE Quarterly Macro Research Strategy Research Credit Research Stronger recovery requires pandemic control 2Q2021
March 2021 March 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.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly Contents 4 CEE: Stronger recovery requires pandemic control 13 CEE central banks: The tide is turning slower than markets expect 31 CEE Strategy: Rising duration threats 83 Acronyms and abbreviations used in the CEE Quarterly COUNTRIES 39 Bulgaria: Local policy-related factors to come to the fore 43 Croatia: Three main areas to define the recovery 47 Czechia: Worst anti-pandemic record in CEE threatens recovery 51 Hungary: A health crisis that threatens the recovery 55 Poland: Economy takes precedence over the pandemic 59 Romania: Room for improvement 63 Slovakia: Ineffective restrictions and resilient manufacturing 65 Slovenia: Recovery amid higher political uncertainty EU CANDITATES AND OTHER COUNTRIES 67 Bosnia and Herzegovina: A third wave of the pandemic threatens recovery in 2021 69 North Macedonia: Recovery driven by public investment and consumption 71 Russia: Monetary and fiscal tightening pre-empts the recovery 75 Serbia: Focus on recovery and the EU accession process 79 Turkey: Changing priorities Erik F. Nielsen, Group Chief Economist (UniCredit Bank, London) +44 207 826-1765, firstname.lastname@example.org Dan Bucşa, Chief CEE Economist (UniCredit Bank, London) +44 207 826-7954, email@example.com Florin Andrei, PhD, Senior Economist Romania (UniCredit Bank Romania) +40 21 200-1377, firstname.lastname@example.org Artem Arkhipov, Head of Macroeconomic Analysis and Research Russia (UniCredit Russia) +7 495 258-7258 ext. -7558, email@example.com Gökçe Çelik, Senior CEE Economist (UniCredit Bank, London) + 44 207 826-6077, firstname.lastname@example.org Ariel Chernyy, Economist, Macroeconomic Analysis and Research Russia (UniCredit Russia) +7 495 258-7258 ext. 7562; email@example.com Published on 30 March 2021 Hrvoje Dolenec, Chief Economist (Zagrebačka banka) +385 1 6006-678, firstname.lastname@example.org Dr. Ágnes Halász, Chief Economist, Head of Economics and Strategic Analysis Hungary (UniCredit Hungary) Erik F. Nielsen +36 1 301-1907, email@example.com Group Chief Economist (UniCredit Bank, London) Ľubomír Koršňák, Chief Economist (UniCredit Bank Czech Republic and Slovakia) 120 London Wall +42 12 4950-2427, firstname.lastname@example.org UK-London Elia Lattuga, Deputy Head of Strategy Research (UniCredit Bank, London) EC2Y 5ET +44 207 826-1642, email@example.com Mauro Giorgio Marrano, Senior CEE Economist (UniCredit Bank, Vienna) Imprint: +43 50505-82712, firstname.lastname@example.org UniCredit Bank AG Kristofor Pavlov, Chief Economist (UniCredit Bulbank) UniCredit Research +359 2 923-2192, email@example.com Am Eisbach 4 Pavel Sobíšek, Chief Economist (UniCredit Bank Czech Republic and Slovakia) D-80538 Munich +420 955 960-716, firstname.lastname@example.org Supplier identification: Daniel Vernazza, PhD, Chief International Economist (UniCredit Bank, London) www.unicreditresearch.eu +44 207 826-7805, email@example.com UniCredit Research page 3 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly CEE Stronger recovery requires pandemic control Dan Bucsa ■ We expect EU-CEE1 economies to grow by 3.9% in 2021 and 4.5% in 2022. Last year’s Chief CEE Economist (UniCredit Bank, London) economic losses could be recovered this year in Hungary, Poland and Romania and the +44 207 826-7954 next year elsewhere. The western Balkans could outpace EU-CEE. firstname.lastname@example.org ■ Russia could grow by 2.5-3% in 2021-22 and the Turkish economy is likely to grow at 4.7% in 2021 and 2.3% in 2022 after avoiding a contraction in 2020. ■ Failure to control the pandemic could slow the recovery by affecting services and construction. Vaccination is not enough to avoid future lockdowns, with governments having to test, track and trace more than they do at the moment. ■ Households and companies are both in a good position to start spending once restrictions are eased. ■ Government may have to increase economic support if the pandemic is not controlled. With few exceptions, fiscal impulses are likely to be negative in 2021-22. ■ CEE benefits from larger stable capital flows than other EM. EU transfers in EU-CEE and the western Balkans will ensure positive extended basic balances in all countries but Romania. Revenue from commodity exports will boost reserves in Russia. ■ A move to looser monetary policy could widen macroeconomic imbalances in Turkey, forcing an adjustment of the C/A and affecting the exchange rate, inflation and growth. ■ The main economic risks are a slow recovery amid a raging pandemic and, in Turkey, a forced adjustment of the economy. ■ Elections in Bulgaria and Czechia are highly uncertain due to incumbent administrations being unable to control the pandemic. ■ Russia faces limited sanctions related to Nord Stream 2, but more consequential sanctions related to potential interference in US elections. In an extreme scenario, the OFZ market could be affected. ■ We see limited risk of crippling sanctions against Turkey from the EU and the US. Failure to control the pandemic In 2021, CEE economies should recover the ground lost since the start of the COVID-19 is slowing the economic recovery crisis. Yet, after the strong rebound over the summer and autumn of 2020, the recovery started wavering and CEE economies entered 2021 on a weaker footing. The main reason for this was another round of lockdowns as the third, and worst, wave of COVID-19 infections gathered pace around Christmas. The spread accelerated in 1Q21 to the point where it overwhelmed the health-care sectors of several countries. Despite nominally tight restrictions, compliance has fallen steadily during the first quarter, with poor communication exacerbating lockdown fatigue. 1 Bulgaria, Czechia, Croatia, Hungary, Poland, Romania, Slovakia and Slovenia UniCredit Research page 4 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly 1. Lessons not learned There are several lessons that CEE countries need to learn before the likely drop in cases over the summer, but in time for what may be a crippling fourth wave later this year: 1. More tests must be done to better assess and control the spread. Many CEE governments did exactly the opposite and reduced testing just as the third wave was gathering pace. This was done to keep economies as open as possible, especially around the winter holidays. By taking the opposite approach to eurozone governments, CEE governments put their health-care sectors under unprecedented strain in an effort to help drive their economies in 4Q20 and 1Q21. 2. The pandemic cannot be controlled without properly tracing and isolating the infected. No CEE country has managed to achieve this so far. Poor medical records, the misplaced decision to isolate light cases in hospitals and, in some countries, failure to protect the jobs of those required to isolate meant that many cases went unreported and tracing has been partial at best. Slovakia’s attempt to test the entire adult population proved to be a temporary solution because the subsequent spread was not properly traced. As countries that have run more tests and tried to trace the spread have shown, proper tracing is paramount to reducing the spread of the virus. 3. Restrictions must be kept in place for as long as the reasons for imposing them persist. Frequently imposing and removing restrictions leads to lower compliance (Chart 1). Czechia and Slovakia are the best examples of what happens when the government is inconsistent in its decisions. 4. Applying the same restrictions to regions with very different infection rates leads to popular discontent, as happened in Russia’s eastern provinces. Rewarding those who comply over those who do not could increase the incentive to comply with rules. 5. Public trust and compliance with rules cannot be won with normative communication after a year of pandemic-related restrictions. Normative communication worked well during last spring’s first lockdown, when executive orders, rather than explanations, helped lead the population to believe that the authorities were in control2. As restrictions were extended and authorities appeared unable to control the spread, mistrust started to rise and is now at its height. Conflicting communication on restrictions, politicians shunning rules they helped impose and the failure to counteract misinformation are reducing the efficiency of other anti-pandemic measures. 6. The biggest hurdle to vaccinating a large-enough part of the population to achieve herd immunity is the lack of trust in vaccines and authorities, stemming from the reasons mentioned above. CEE faces the risk that vaccine doses will remain unused once supply picks up in late April and especially in May and June. Reaching herd immunity Based on current vaccination rates and assuming that the authorities convince people to be this year is possible… vaccinated, most CEE countries could vaccinate 70% of their population before the end of 2021 (Chart 2). There are, again, caveats. A higher vaccination rate usually means that vulnerable categories were given priority only at the onset of the process or not at all. This is especially the case in Serbia where the number of hospitalizations and severe cases is not …if vulnerable categories are falling, despite the highest vaccination rate in the region. Increasingly, this is also the case in convinced to be vaccinated EU-CEE countries. Voluntary immunization is higher among people of working age, who are more mobile, while older people in the countryside have limited access to vaccines and are more prone to believe conspiracy theories. Besides poor compliance, countries such as Bulgaria and Russia are struggling to make the vaccine available to large parts of their populations. These are the only two countries in our sample where vaccination rates are lower than the global average. It is likely that governments and private companies will have to think of incentives to increase vaccination rates, especially among the old and the young. 2 This is very likely a remnant of communism in CEE and reflects a lingering preference for strong leaders. UniCredit Research page 5 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly CHART 1: WIDENING GAP BETWEEN RESTRICTIONS CHART 2: MOST CEE COUNTRIES COULD REACH HERD AND COMPLIANCE IMMUNITY THIS YEAR Restrictions (100 = tightest) Years to vaccinate 70% of the population, given current speed of rollout Mobility (closer to zero = higher mobility, inverted, rs) Year-end 90.0 -50 2.50 80.0 -45 2.25 70.0 -40 2.00 60.0 -35 -30 1.75 50.0 -25 1.50 40.0 -20 30.0 1.25 -15 20.0 -10 1.00 10.0 -5 0.75 0.0 0 0.50 Jan-21 Jan-21 Jan-21 Jan-21 Jan-21 Jan-21 Jan-21 Jan-21 Jan-21 Jan-21 Jan-21 Mar-21 Mar-21 Feb-21 Mar-21 Feb-21 Feb-21 Mar-21 Feb-21 Mar-21 Feb-21 Mar-21 Feb-21 Mar-21 Feb-21 Mar-21 Feb-21 Mar-21 Feb-21 Mar-21 Feb-21 Mar-21 Feb-21 0.25 0.00 BG CZ HR HU PL RO RS RU SK SI TR HU RS SK CZ PL TR RO SI HR BG RU Source: Oxford University, national health ministries, UniCredit Research 2. Short-term growth: putting the economy ahead of public health Less stringent restrictions and poor compliance helped GDP recover further in 1Q21, CEE grew faster than the eurozone in 4Q20 and 1Q21… although not completely. Of the CEE countries included in the OECD’s GDP trackers, only Russia and Turkey seem to have completely recovered the losses from 1Q20 (Chart 3). Comparing performance just for the first month of the pandemic, March 2020, GDP losses have been recovered only in Russia and Poland, according to the OECD (Chart 4). The region’s most open economies of Slovakia, Czechia and Hungary, are lagging in the recovery, despite a strong recovery in foreign demand. Some countries allowed trade, …due to less stringent catering and tourism outlets to open, with Romania and Russia standing out. Russia is one of restrictions… the few EM countries in which the services PMI showed a stronger recovery than the manufacturing one. In addition, Poland, Romania and Russia are less dependent on foreign tourists and, thus, activity in leisure services was closer to the 1Q20 level than in tourism- dependent countries such as Czechia, Hungary, Slovenia and Slovakia (the latter receiving most of its foreign tourists during the winter season). …that could slow Since economic activity improved at the cost of allowing the pandemic to run unconstrained, the recovery in 2H21 we expect a trade-off between a better-than-expected 1Q21 and a slower-than-expected recovery in 2Q21. The current usage of intensive-care units is highest in Czechia, Bulgaria, Romania and Slovakia. These are therefore the countries with the highest risk of tighter restrictions in 2Q21. CHART 3: CEE ECONOMIES YET TO RECOVER THE LOSSES CHART 4: …AS ECONOMIC ACTIVITY IN MARCH 2021 FROM 1Q20… REMAINED WELL BELOW MARCH 2019 LEVELS Change in real GDP in 1Q21 vs 1Q19 according to the OECD GDP tracker, % Change in GDP vs. corresponding month of 2019, Jan-21 OECD GDP tracker, % Feb-21 2 Mar-21 1 6 0 4 -1 2 -2 0 -2 -3 -4 -4 -6 -5 -8 -6 -10 -7 -12 SK CZ HU RO SI PL BG TR RU SK CZ HU RO TR SI BG PL RU Source: OECD, national statistical offices, central banks, UniCredit Research UniCredit Research page 6 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly Supply-chain blockages could Supply-chain blockages are the biggest risk for industry and exports. The shortage of affect industrial output throughout 2021 semiconductors in car manufacturing is the most prominent, but by no means the only one. Metals are also in short supply for some CEE companies, as are some chemical products. The focus on semiconductors is due to car manufacturing representing up to 25% of industrial production in EU-CEE, the Balkans and Turkey, with Hungary being the most reliant on the industry. The shortage does not affect all countries equally (Slovakia less than Czechia and especially Hungary – Chart 5). The country of origin does not explain these shortages either. While Hungary’s imports of semiconductors from the four large Asian producers (Japan, China, Taiwan and South Korea) fell by a third between October 2020 and January 2021 (seasonally adjusted), in Poland they were very resilient (although total imports fell significantly). Thus, we believe that shortages are mostly due to company-specific planning, making the future evolution difficult to predict. Anecdotal evidence suggests that large car manufacturers favor their factories in western Europe over those in CEE when deciding to allocate limited resources. As a result, supply-chain bottlenecks could affect CEE industrial production and exports more than it does in Germany or France. According to supply managers and academic sources, bullwhip effects could last throughout 2021 in industries where production lines cannot adapt flexibly (as is the case of semiconductors). Although supplier delivery times have increased to all-time highs, in line with those in western Europe (Chart 6), they have not yet affected production expectations. Several CEE manufacturers decided to schedule annual maintenance works earlier than planned as the supply of components slowed. This could affect industrial output in February- April, but will leave companies in a good position to accelerate production once supply chains are running more smoothly. CHART 5: COUNTRIES AFFECTED DIFFERENTLY CHART 6: SUPPLIER DELIVERY TIMES ARE LONGER BY SHORTAGES OF SEMICONDUCTORS THAN EVER BEFORE imports of semiconductors CZ HR HU PL supplier delivery times, standardized, CZ HU PL EUR mn RO SI SK fall = increase in delivery time RU TR 80 3 70 2 60 1 50 0 40 -1 -2 30 -3 20 -4 10 -5 0 -6 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21 Feb-09 Feb-11 Feb-13 Feb-15 Feb-17 Feb-19 Feb-21 Source: Eurostat, HIS Markit, UniCredit Research 3. Thrifty anti-pandemic support At the start of the year, CEE governments were hoping to dole out far less support in 2021 Anti-pandemic support may have to be supplemented if the than they did 2020, in order to begin the adjustment of their budget deficits (Chart 7). This is pandemic is not controlled still likely to be the case, but labor-market support will probably be needed until restrictions loosen, hopefully some time in 2Q21. This is the case especially in services. It is increasingly looking like western European governments will be reluctant to allow their populations to travel unrestricted before a large portion have been vaccinated, both at home and in destination countries. This raises significant risks for countries such as Bulgaria, Croatia, Czechia, Hungary and Turkey. Bulgaria plans to increase the size of support this year compared to 2020, while Hungary extended labor-market support and loan moratoriums to the end of June, adding measures to help leisure services, but also construction. In contrast, Turkey is phasing out most labor-market support by the end of 1Q21. UniCredit Research page 7 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly Different experiences with While most CEE countries continue to offer guaranteed loans to companies, especially indirect support SMEs, demand has fallen due to high leverage, especially at smaller companies. Grants, rather than loans, seem to be the answer. In 2Q20, Poland was the first country to offer loans convertible to grants. The first conversions will start in April for an amount equivalent to 0.6% of GDP and are likely to continue until grants reach 2.4% of GDP. This conversion increased demand for the 2021 part of the support program, with SMEs already having taken most of the funding allotted for the whole year (the equivalent of 0.2% of GDP). In Hungary, the Funding for Growth Scheme “Go!”, aimed at SMEs, had a slow start last year, but net disbursements since June 2020 have exceeded HUF 1.3tn (almost 3% of GDP), despite Hungarian SMEs having the highest leverage in the region before the crisis. The experience of other countries is less impressive. After pledging the largest amount of guaranteed loans in 2020 and seeing meager take-up, the Czech government settled for a very modest amount in 2021. The Romanian government promised a program of grants for small companies that is yet to function properly. Until March, Turkey underwent a tightening in monetary conditions that weakened the credit impulse. Things could change after the replacement of CBRT Governor Naci Agbal 3, although private banks are unlikely to support a rapid loan increase given rising costs of borrowing from abroad. The Central Bank of Russia started a tightening cycle that might not slow credit significantly, but it will increase debt service of the private sector at a time when the economic recovery is ongoing. Negative fiscal impulses ahead In 2021, half-hearted government support will translate to negative fiscal impulses in all CEE countries except Bulgaria, Czechia and Serbia (Chart 8). In 2022, all countries are likely to run negative fiscal impulses to reduce budget deficits further. With most CEE economies recouping COVID-19-related loses already this year, tighter fiscal and monetary conditions could lead to slower economic growth in 2022 than in 2021. CHART 7: ANTI-PANDEMIC SUPPORT TO FALL IN 2021 CHART 8: NEGATIVE FISCAL IMPULSES AHEAD anti-pandemic support fiscal impulse, % of GDP % of GDP 2020E 2021F 2022F 2020E 2021F 12 6 5 10 4 8 3 2 6 1 4 0 -1 2 -2 0 -3 BG HR CZ HU PL RO RU SK SI RS MK TR RU TR HU RO HR RS CZ BG PL SK SI Source: Eurostat, CEE governments, statistical offices, UniCredit Research 4. Complete recovery in 2021 or 2022, at the latest We expect EU-CEE to grow by 3.9% in 2021 and 4.5% in 2022, with economic activity returning We forecast GDP growth in EU-CEE of 3.9% in 2021 to pre-pandemic levels this year in Hungary, Poland and Romania, and next year in the other and 4.5% in 2022… countries (Chart 9 and 10). Poland will lead the recovery based on the strength of its domestic demand, its more efficient pandemic support measures and its lower reliance on exports of leisure services. At the other extreme, Croatia might have to wait until 2023 to see a full recovery of revenue from foreign tourists. Serbia had one of the shallowest recessions in 2020 3 The next article deals with inflation and monetary policy, pages 12-27. UniCredit Research page 8 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly thanks to the government’s large footprint in the economy. Public investment will remain the biggest growth driver in 2021. Turkey is the only CEE country to avoid a recession in 2020, but its growth rate was below potential and could exceed potential only temporarily in 2021. …with services lagging in the We assume that bullwhip effects will die down before year-end, paving the way for industrial recovery… output to accelerate and for employment and wages to recover. Services will lag in the recovery, despite an expected rebound over the summer if the pandemic is brought under control. Demand is not an issue, as CEE households are currently in a better financial position than they were before the COVID-19 pandemic4. …and net exports contributing In both EU-CEE and the western Balkans, we expect foreign demand to recover in 2021 and only in 2021 net exports to contribute to growth. In 2022, imports could outpace exports if domestic demand recovers further and commodity prices remain high. However, extended basic balances will remain positive in all countries but Romania, as inflows from the EU could pick up further5 and FDI is likely to recover. Equity FDI will flow mostly to countries where large investment projects had been planned before the pandemic and/or where governments have made rapid progress in attracting investors involved in the production of electric cars. However, the sharp rise in intercompany lending registered by Hungary shows that some foreign investors may prefer debt over equity when financing their EU-CEE subsidiaries due to preferential tax treatment. Infrastructure spending could lead the investment recovery in 2021, with capex starting to Infrastructure to outpace other investment pick up towards the end of the year. Like households, companies in EU-CEE and the western Balkans have improved their net financial position since March 2020, but would need demand to rebound and idle capacity to be utilized in order to restart productive investment. Russian GDP is expected to The Russian economy is also expected to return to pre-crisis levels of activity before the end grow by 2.5-3% in 2021-22 of the year, with growth expected in the 2.5-3% range in 2021-22. The credit impulse will continue to fuel domestic demand growth at least in 2021, with the increase in corporate and mortgage lending catching up to the CEE loan boom registered in the second half of the last decade. Russia missed that boom because its economy was adjusting after the Crimean crisis. Tighter monetary conditions may have a limited effect on credit growth, as admitted by CBR Governor Elvira Nabiullina. However, household income has been falling in real terms since 2013 and there is limited scope for consumer demand to grow beyond the increase in leverage. Moreover, the rapid increase in mortgage lending is further reducing net disposable income, reining in consumption growth. Fiscal and monetary tightening could prevent economic growth from accelerating in 2022. Investment will rely on public projects, which failed to pick up in the past, despite the National Priority Projects launched in 2005 and revamped in early 2021. We expect net exports to contribute to growth at least in 2021 amid larger volumes of commodity exports. Turkish GDP is expected to Turkey’s economic outlook may be more volatile than that of the rest of CEE. Turkey’s credit- grow by 4.7% in 2021 and dependent growth engine may be revving up ahead of yet another acceleration in lending 2.3% in 2022, below potential after the management change at the central bank. However, the scope for cutting rates is limited and comes at the risk of further depreciation and diminishing access to foreign funding6. Since 2010, credit impulses have increased in amplitude and frequency, but their impact on growth has diminished due to the uncertain outlook. This is unlikely to change in 2021-22 and we expect GDP growth at 4.7% in 2021 and 2.3% in 2022, thus falling back below potential next year. More importantly for the political leadership of the country, unemployment could rise further as Turkey prepares for elections in 2023 or, potentially, 2022. 4 For details, please see the EEMEA Country Note “CEE: Private sector in a good position to restart spending” from 3 March 2021. 5 This is also the case for the western Balkans, as shown in the EEMEA Country Note “Not alone: Financial support of the Western Balkans” from 20 January 2021. 6 Please see pages 26-27 for details. UniCredit Research page 9 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly CHART 9: CEE: RECOVERY STARTING IN 2021… CHART 10: …AND CONTINUING IN 2022 Private consumption Public consumption Private consumption Public consumption yoy (%), yoy (%), pp Fixed investment Net exports Fixed investment Net exports pp Inventories, error GDP Inventories, error GDP Hungary Hungary Romania Romania Turkey Turkey Croatia Croatia Poland Poland Slovenia Slovenia Serbia Serbia Russia Russia Bulgaria Bulgaria Slovakia Slovakia Czechia Czechia -4.0 -2.0 0.0 2.0 4.0 6.0 8.0 -2.0 0.0 2.0 4.0 6.0 8.0 Source: Eurostat, statistical offices, UniCredit Research 5. Capital flows: better than other EM Capital outflows from EM due to rising US Treasury yields again highlight the privileged EU-CEE shielded by flows from the EU position of EU-CEE as the recipient of large net transfers from the EU (Chart 11). Before the end of April, all EU-CEE countries will have to submit their frameworks for spending NGEU funding. Negotiations with the European Commission (EC) could last until the end of June or even longer. In our view, the main points of divergence will be the large share of funding that EU-CEE countries would like to allot to developing their transport infrastructure, which is not a priority for the EC, and the funding of recurring expenditure. The likely compromise will be to transfer part of the planned spending on infrastructure from the NGEU to the 2021-27 EU budget. If spending frameworks are approved before mid-year, the first funds could already start flowing in this year, with a significant pick-up in 2022. However, these are not the only transfers that EU-CEE benefits from. Remaining funding from the 2014-20 EU budget will continue to arrive until 2023, with pre-funding from the new EU budget also expected to start flowing before year-end. While EU-CEE countries are considering borrowing from the NGEU, they will first draw loans from SURE, the facility that supports labor markets, whose funding will be available until 1Q22. While many EU governments speak about re-shoring and the need to shorten supply chains, we see limited interest at European companies to bring manufacturing closer to Europe. Moreover, labor shortages persisted during the COVID-19 crisis in all EU-CEE countries and this could be a deterrent to moving production lines from Asia back to Europe, especially in car manufacturing. The sectors in which EU companies may be more interested in developing further capacity closer to home are pharma and chemicals. In the western Balkans, we expect FDI to cover C/A deficits, with the EU chipping in additional funding. Russia helped by high In Russia, high commodity prices and tighter fiscal policy will help replenish FX reserves. The commodity prices country remains an outlier among large EM, due to its low external debt and diminishing reliance on foreign borrowing. In Turkey, external debt could be rolled over only in part if funding is less available and/or Risk of external deleveraging in Turkey more expensive. This may limit the C/A deficit, since FDI is likely to remain much less than the trade shortfall. Recent inflows into TURKGBs could be reversed, putting additional pressure on FX reserves. We were expecting the CBRT to start amassing FX reserves under the guidance of former governor Naci Agbal. The opposite could happen following his recent dismissal, with net reserves at risk of remaining negative (Chart 12). UniCredit Research page 10 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly CHART 11: CHART 12: LARGE EU GRANTS AND LOANS TO EU-CEE THE CBRT WILL STRUGGLE TO REPLENISH NET FX RESERVES SURE NGEU loans Gross reserves % of avg. GDP for 2021-27 NGEU grants EU budget 2021-27 USD bn Net reserves Croatia Net reserves excluding swaps 0.1 Bulgaria 0.1 Hungary 0.1 0.1 Slovakia 0.1 Romania 0.0 Slovenia 0.0 0.0 Poland 0.0 Czechia 0.0 -0.1 0 10 20 30 40 50 Jan 18 Jul 18 Jan 19 Jul 19 Jan 20 Jul 20 Jan 21 Source: Eurostat, EC, CBRT, UniCredit Research 6. Economic and political risks The main economic risks stem from a slower recovery. If countries fail to control the A delayed recovery due to the pandemic is the main pandemic, the toll on employment, growth and government budgets could be significant. It is economic risk clear that vaccination alone cannot bring a swift end to the COVID-19 crisis. More must be done to control and track the spread, and it is never too late for CEE countries to increase testing and establish rules that make sense and are easier to follow by the population. While risks are probably lower over the summer, when warm weather could help reduce the number of cases (as it did in 2020), the specter of crippling restrictions in 4Q21 and a weak start to 2022 is very real. Turkey risks more financial Among country-specific risks, Turkey’s external financing is the most pressing. The authorities market pain will struggle to cut rates, spur lending and growth, and finance the rise in credit while preventing a TRY sell-off. A domestic-funded credit boom could allow the private sector to delever externally, but may lead to sharp rises in exchange rates and inflation. These, in turn, could trigger a flight from TRY deposits, further aggravating existing imbalances. Ensuring enough foreign funding requires the type of cautious policies that the CBRT tried to implement between November 2020 and March 2021. By rejecting such policies, the Turkish authorities have done nothing to narrow external imbalances and ensure a return to positive net FX reserves. A return to loose policies focused on growth at all costs may land Turkey at the IMF’s door, although the likelihood of an agreement has fallen continuously in recent years. The main political risks in the region are upcoming elections in Bulgaria and Czechia and potential sanctions on Russia and Turkey. Looming elections in Bulgaria Like their CEE counterparts, the Bulgarian and the Czech governments failed to contain the and Czechia have not led to COVID-19 pandemic and this may cost them at the ballot box. Czechia has the highest strain on better policies intensive-care units across CEE, while Bulgaria trails the rest of the region in vaccinating its population. Despite having the most room to spend in EU-CEE, the two governments implemented smaller support packages than their regional peers. That said, these are the only two countries where the size of support measures will increase in 2021 compared to 2020. According to opinion polls, the ruling GERB could win the parliamentary elections scheduled for 4 April in Bulgaria. However, it could struggle to form a coalition in a fragmented parliament. In Czechia, the government led by ANO has been losing ground to the alliance of Pirates and Mayors, with the two groupings running neck in neck. Momentum could move away from ANO if the dramatic pandemic situation does not improve. Czechia had to transfer some of its serious COVID-19 cases abroad as it had exhausted the available beds in intensive-care units. According to opinion polls, the current opposition would clearly win the elections scheduled for 8-9 October, but it remains to be seen whether a new majority will emerge. UniCredit Research page 11 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly Limited risks of wide-reaching With Nord Stream 2 practically completed, potential US sanctions related to the project could sanctions related to Nord Stream 2… only lead to tensions with EU countries, something that the Biden administration might want to avoid. If sanctions are imposed, they are likely to be targeted and narrow in scope. Sanctions related to potential interference in US elections have much broader support in Congress and could be more consequential. From an economic point of view, the toughest sanctions would curb access to OFZ issuance for US funds. This is not a fiscal risk for Russia, as the …more worries related to government can finance its limited needs through the local market. Russian banks hold only accusations of election 6% of their assets in government bonds, compared to 15-25% in most EM countries. Budget interference spending could also be covered out of reserves, which will continue to be replenished at current oil prices. The experience of similar sanctions on FX issuance by the Russian government suggests that such sanctions could lead to a long-term reduction in foreign holdings of OFZ, which would be dominated by private funds from Europe and Asian investors. Limited risks of harsh We believe that there could be an agreement between Turkey and the EU on maritime sanctions against Turkey borders in the Mediterranean. Both Turkey and Greece started out with maximalist positions that leave room for a compromise. The EU has also offered the possibility of a deeper trade union, which should be very beneficial for the Turkish economy. Potential US sanctions on Turkey will have to consider the importance that the Biden administration attaches to NATO. Turkey has the second-largest army in NATO and a strategic position in a region likely to remain in turmoil. This does not exclude potential sanctions, but their reach and effects are more likely to be limited than damaging. UniCredit Research page 12 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly CEE central banks The tide is turning slower than markets expect Dan Bucsa ■ CEE central banks have become more hawkish due to an increase in inflationary risks. Chief CEE Economist (UniCredit Bank London) +44 207 826-7954 ■ In 2Q21, base effects in fuel prices will send inflation higher in all CEE countries but email@example.com Russia and outside target ranges in Hungary and Romania. ■ Bullwhip effects are adding to production costs. The pass-through from producer prices to consumer prices could be the highest in Turkey, Serbia and Poland. ■ Inflation could miss targets this year in Turkey, Hungary and Romania and next year in Turkey, Hungary and Poland. ■ Momentum in real wage growth suggests that core inflation could rebound this year in Czechia and Poland and next year in Hungary. In Romania, demand pressure on prices is undergoing a structural downshift. ■ We expect inflation to lose momentum in Russia and return close to target, although risks remain high. In Turkey, the weaker TRY combined with a higher credit impulse could take inflation to around 18% in 2Q21, falling towards 15% by end-2021 and 13% by end-2022. ■ We expect the CNB to deliver at least 3 rate hikes in the next 12 months, in line with market expectations. As a result, the CZK could outperform its central European peers. ■ The NBH could lift the 1W deposit rate to around 1% in 2Q21. This may not be enough to prevent HUF depreciation amid rising inflation. ■ The NBP may be forced to hike to 1% in 2H22 as domestic demand stages what is projected to be the most impressive recovery in central Europe. ■ The NBR could remain on hold in 2021-22 if fiscal policy tightens, weakening household income growth and pressure on core inflation. ■ The CBR is expected to hike to 5.25% before the end of the year, taking the policy rate in a neutral range of 5-6%. ■ The CBRT could cut to 15% in the coming MPC meetings and to 12-13% by next year. Access to TRY could be curtailed during episodes of depreciation. ■ Expected monetary-policy action supports the CZK and the RUB among CEE currencies, with the TRY being the regional underperformer. Policy dilemma due to higher CEE inflation targeters entered the second year of the COVID-19 pandemic facing a policy inflationary risks, incomplete economic recovery dilemma. On the one hand, economic activity has yet to recover from losses accumulated in 2020. After a better-than-expected end to 2020, a flare-up in the infection count and supply- chain blockages now threaten a smooth recovery. On the other hand, the risk of reflation is rising amid several supply shocks, such as higher oil prices, and higher transport and supply costs for producers. While consumption has yet to rebound, households are in a very good position to restart spending once restrictions are eased7, and that could lead to a demand shock, especially in service prices. Chart 1 shows that inflation is currently inside target ranges for Czechia, Hungary, Poland and Romania (CE4), as well as Serbia. Inflation is above target in Russia and Turkey. With the COVID-19 crisis ravaging economies, inflation was expected to be lower at the start of 2021 than a year ago due to weaker demand and lower core inflation. 7 For more details, please see the EEMEA Country Note – CEE: Private sector in a good position to restart spending from 3 March 2021. UniCredit Research page 13 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly Above-target inflation driven However, Chart 2 shows that this is not the case. Core inflation8 is above headline inflation in by high core inflation in 2020… all countries but Romania and is outside the target range in Poland and Turkey, and outside the central target in Russia. While service-price inflation was expected to slow in 2020 due to restrictions to movement and physical contact, its decline was significant only in Czechia, Hungary and Romania. In fact, service prices might have been overestimated in 2Q20, when cultural venues, hotels and restaurants were closed and flights grounded. Lacking enough data, most statistical offices considered service prices unchanged during lockdowns. Service prices are now rising in line with the target in Serbia and below target in Russia while contributing heavily to inflation in Poland and Turkey. At the same time, goods prices increased in 2020, with demand for durables helped by workers being forced to work from home. Processed-food prices continued to rise at a fast pace in Czechia and Hungary, and they are still accelerating in Turkey. … with supply shocks Thus, most of the contribution to disinflation came from regulated and volatile prices in 2020. taking over in 2021 Fuel prices declined the most on the back of cheaper oil. Currency depreciation mitigated only part of this disinflationary shock. In addition, many regulated prices were mostly kept constant or were even cut in some countries to boost household income. All these negative or mild supply shocks translated into inflationary base effects in 2021. CORE INFLATION IS ABOVE HEADLINE (AND OUTSIDE TARGET RANGE) IN FOUR OUT OF SEVEN CEE COUNTRIES Chart 1: Inflation is inside target ranges in CE4 and Serbia… Chart 2: …but not due to core inflation annual inflation deviation from target (pp) Feb-20 Feb-21 annual inflation excluding energy and unprocessed food (deviation from target, pp) Feb-20 Feb-21 2.5 15.0 2.0 12.0 2.0 12.0 1.5 9.0 1.5 9.0 1.0 6.0 1.0 6.0 0.5 3.0 0.5 3.0 0.0 0.0 0.0 0.0 -0.5 -3.0 -0.5 -3.0 -1.0 -6.0 -1.0 -6.0 -1.5 -9.0 -1.5 -9.0 -2.0 -12.0 -2.0 -12.0 CZ HU PL RO RU RS TR (rs) CZ HU PL RO RU* RS TR** (rs) *Russia: inflation excluding food and gasoline Source: National statistical offices, Eurostat, UniCredit Research **Turkey: core B (inflation excluding unprocessed food, energy, alcohol, tobacco and gold Oil prices are expected to push The most important such base effect will be registered by fuel prices, as the price of Brent inflation higher in 2Q21… crude has risen by more than three quarters since late October 2020. If oil prices remain close to their current levels in 2021-22, 2021 inflation targets could be missed in Hungary, Romania and Turkey (Chart 3). Part of the current inflationary effect is likely to be offset by our expectation of a gradual rise in EUR-USD. If this does not materialize, the target would be missed in Czechia as well. The first countries where inflation could leave the target range are Hungary and Romania. In …and outside the target ranges in Hungary and Romania the former, the question is when rather than if. A large inflationary base effect from last year’s fall in fuel prices will only be amplified by the price for Brent staying close to current levels, which is more than three times higher than its average level from April 2020. In February 2021, the average gasoline price in Hungary was 37.7% higher than it was in April 2020, according to Eurostat, with prices at the pump continuing to rise. In Romania, the large increase in energy prices sent inflation to 3% yoy in January9, and base effects in fuel prices 8 measured by excluding energy and unprocessed food from headline inflation, to improve comparability across countries 9 For details, please see the EEMEA Macro Flash – Romania: Rate cuts off the table with the help of the statistical office from 12 February 2021. UniCredit Research page 14 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly could push it outside the target range by May. However, the target overshoot is likely to be much smaller than in Hungary. In Russia (where oil prices have a much smaller impact on inflation) and Turkey, inflation will stay above target in 1H21. Oil prices could have a If oil prices stabilize or reverse their increase later this year and in 2022, their impact will be disinflationary effect in 2022 disinflationary at the monetary-policy horizon of all seven central banks. OIL PRICES COULD PUSH INFLATION OUTSIDE TARGET RANGES IN CE4 Chart 3: The current price of Brent could push year-end inflation Chart 4: outside target ranges in CE4… …with Hungary and Romania affected first annual inflation, deviation annual inflation (eop, %) 2021F 2022F Upper limit of target interval from target, pp CZ HU PL RO Target range 14 4.0 12 3.0 10 2.0 8 1.0 6 0.0 4 -1.0 2 -2.0 0 -3.0 RS CZ PL RO RU* HU TR Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 Dec-22 *Russia: target, not target range. All forecasts by UniCredit Research Source: National statistical offices, Eurostat, UniCredit Research Bullwhip effects are raising The second inflationary risk comes from disruptions in global supply chains through two production costs… channels: higher input costs and higher transport costs. Supplier delivery times have been rising throughout Europe10. This is already visible in producer prices, which have shot up more in the eurozone than in CEE, as companies in the monetary union are at the top of supply chains and, thus, are affected by all increases in costs. Moreover, expectations for price increases are rising quickly, and they are higher than they were a year ago in all of these countries, aside from Poland and Romania (Chart 5). The pass-through from producer prices to consumer prices has been declining since the start of the millennium. However, Table 1 shows that this pass-through remains significant in Poland, Serbia and Turkey, and most of it happens with a delay of just one month. In Romania, goods prices fully reflect higher producer prices within a year. Throughout CEE, the pass-through from producer prices to consumer prices could increase in the coming months due to an unprecedented squeeze on corporate margins. According to PMIs, margins in manufacturing have been contracting for more than three years, but this narrowing has picked up since the start of the COVID-19 crisis, as detailed in the aforementioned Macro Flash on PMIs. …with the pass-through to Given upward momentum in producer prices and their estimated pass-through to consumer consumer prices largest in prices, the cost-push shock could be the strongest in Turkey, where this could add more than Turkey, Serbia and Poland 0.4pp to monthly headline inflation before the summer and slightly less thereafter. Serbia is facing the second-highest risks, but with inflation significantly below target, higher producer prices may only narrow the gap between headline inflation and the central-bank target. Next is Poland, where the contribution of producer prices to inflation is expected to turn positive in March and contribute, on average, 0.1pp to monthly inflation for the rest of the year. In Romania, higher producer prices could contribute up to 0.5pp to headline inflation in 2021. In Czechia and Hungary, higher producer prices will be mostly reflected in deteriorating terms of trade, with the connected depreciation risk being higher for the HUF. In Russia, food prices and the FX pass-through could be much more important than producer prices in driving inflation. 10 For details, please see the EEMEA Macro Flash – Manufacturing PMIs in CEE: supply disruptions and price shocks from 1 March 2021. UniCredit Research page 15 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly LARGE DIFFERENCE IN PRESSURE FROM PRODUCER PRICES ON CONSUMER PRICES Chart 5: Companies expect prices to rise much faster in the coming Table 1: 11 months than they did a year ago Estimated pass-through of producer prices to consumer prices selling price expectations, normalized, over 0 = above-average increase Feb-20 Feb-21 VAR CPI VAR CPI_g VEC CPI VEC CPI_g 4.0 CZ Pass-thorugh 14% 19% St. dev. 9% 10% 3.5 HU Pass-thorugh 7% 5% 3.0 St. dev. 4% 6% 2.5 PL Pass-thorugh 26% 34% 2.0 St. dev. 5% 7% RO Pass-thorugh 7% 5% 80% 100% 1.5 St. dev. 7% 11% n.a. n.a. 1.0 RU Pass-thorugh 1% 2% 0.5 St. dev. 2% 2% RS Pass-thorugh 33% 13% 0.0 St. dev. 8% 6% -0.5 TR Pass-thorugh 36% 43% RO EZ HU PL TR CZ RS St. dev. 7% 9% Source: National statistical offices, ECB, Eurostat, UniCredit Research In a recent publication12, we showed that households are in a good position to restart spending once restrictions are eased. This means that core inflation could add to supply shocks in pushing inflation higher in 2H22. However, underlying demand pressure on prices is very different across countries. Among the CE4 countries, Chart 6 shows that, in the CE4 countries, inflation (excluding energy, unprocessed food and underlying inflationary tax effects) is below target and declining only in Romania. The reason is wage growth, which pressure is lowest in Romania decelerated sharply in 2020 as minimum wages and public-sector wages increased much less … than they did in the past. The same evolution is expected to be evident in 2021-22. Only Hungary is expected to see a sharper slowdown in public-sector-wage growth in 1H21, before a likely reacceleration occurs in 2H21 and 1H22 due to upcoming parliamentary elections. Meanwhile, private-sector-wage growth depends on how quickly economic activity rebounds, how large labor shortages are and how many workers are employed in sectors with high margins. According to all metrics, Romania ranks last among the CE4 countries, while Czechia ranks first and could see the sharpest rebound in private-sector-wage growth once global trade rebounds. …and is proportional with We expect core inflation to be proportional to wage-growth momentum. Chart 7 shows that wage-growth momentum this momentum will pick up in Turkey, Russia, Poland and Czechia and less so in Romania and especially Serbia. We expect core inflation in 2022 to be higher in the first four countries than in the latter two. In Hungary, pre-election wage growth could push core inflation outside the target range by 1Q22. 11 The pass-through is computed by using shocks in vector autoregressive (VAR) and vector error correction (VEC) models. Numbers in red are not significant at a 10% confidence level. CPI_g refers to the goods part of the CPI basket in each country. Romania is the only country for which there is just one co-integration equation, and the correction coefficient is statistically significant and negative. 12 EEMEA Country Note – CEE: Private sector in a good position to restart spending from 3 March 2021 UniCredit Research page 16 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly CORE INFLATION IS (AND COULD REMAIN) CORRELATED WITH WAGE-GROWTH MOMENTUM Chart 6: Demand pressure on prices is more muted in Romania than Chart 7: in neighboring countries Momentum in real wage growth likely to impact core inflation inflation excluding energy, unprocessed change in average real wage CZ HU PL RO 2020 2021F 2022F food and tax effects (yoy, %) growth, pp 5.0 10 4.5 8 4.0 6 3.5 4 3.0 2 2.5 0 2.0 -2 1.5 -4 1.0 -6 0.5 -8 0.0 -10 Feb-17 Feb-18 Feb-19 Feb-20 Feb-21 CZ HU PL RO RU RS TR Source: National statistical offices, ECB, Eurostat, UniCredit Research Monetary-policy outlook: risk reassessment has begun No rapid change in outlook Since the start of the year, all CEE central banks have reacted to present and potential inflationary and actions, which are risks, at least verbally. Access to local-currency liquidity has been tightening in all countries (Chart conditioned by… 8). However, in central Europe, tougher decisions can be postponed at least until 4Q21 as wage and employment growth will remain subdued this year, putting a break on core inflation. The only exception is the NBH due to inflation likely to leave the target range in 2Q21. Three major factors distinguish monetary-policy outlooks and the timing of potential rate increases: 1. The estimated level of monetary-policy rates needed to meet inflation targets – …rate levels that are consistent with meeting targets… unprecedented easing by the ECB and the Fed has allowed CEE central banks to leave real interest rates below zero. While some of them see this as a temporary feature (CNB, CBR), other central banks (especially the NBH and the NBP) believe it marks a new normal, where inflation can stabilize close to target without positive real interest rates. Chart 9 shows that investors disagree, as they have priced in significant additional tightening since the beginning of the year. 2. The importance given to currencies – the CNB is the only central bank that considers currency …the importance given to currencies… appreciation to be part of the necessary tightening of real monetary conditions. The NBR, the NBS and, more recently, the NBH are trying to limit depreciation through outright and verbal interventions. The NBP is limiting the downside of EUR-PLN through interventions. The CBR and the CBRT have no explicit currency mandates, but both central banks have to purchase FX from the market to meet fiscal rules (the former) and to build up FX reserves (the latter). 3. The assessment of economic recovery and demand pressure on prices – the CBR is more …and the economic recovery upbeat about the economic recovery and sees stronger demand pressure on prices as an important risk. Central European central banks share this upbeat view of an upcoming recovery but not with regard to related inflationary risks. Only the CNB fears that fiscal easing will push inflation higher and require tighter monetary policy. Incoming CBRT Governor Şahap Kavcıoğlu is likely to assess economic conditions less favorably than his predecessor, Naci Ağbal, who thought that demand pressure on prices was strong. Below, we discuss the likelihood of policy action based on these criteria. UniCredit Research page 17 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly FINANCIAL MARKETS ARE PRICING IN SIGNIFICANT TIGHTENING THAT CENTRAL BANKS MIGHT NOT DELIVER Chart 8: Liquidity tightening in CEE since the beginning of the year Chart 9: Financial markets are pricing in significant tightening spread between 1W implied rate and Spread of forward rate agreements Jan-21 Feb-21 Mar-21 CZ HU PL RU 1W interbank rate (monthly average, pp) over 3M interbank interest rates (pp) 0.5 20.0 2.5 0.4 16.0 2.0 0.3 12.0 0.2 8.0 1.5 0.1 4.0 0.0 0.0 1.0 -0.1 -4.0 0.5 -0.2 -8.0 -0.3 -12.0 0.0 -0.4 -16.0 -0.5 -20.0 -0.5 CZ HU PL RO RU TR (rs) 1M 3M 6M 9M 12M 18M 21M Source: National statistical offices, ECB, Eurostat, UniCredit Research The bold Czechia The CNB could deliver at least For the CNB, recent inflationary risks could reinforce its board’s conviction that the time for three hikes in the next 12M,… rate normalization is approaching. The CNB has consistently been the most hawkish central bank in CEE once Czechia’s economy emerged from its first COVID-19-driven lockdown. In its Monetary Policy Report (MPR) published in February, the CNB said that it expects interest rates to increase before the end of this year, mostly due to fiscal easing (Chart 10). Direct spending, higher transfers, higher minimum wages and effective tax cuts on labor income in 2021 are expected to offset the contractionary impact of lower employment and weak wage growth in manufacturing. … fewer than the CNB With the output gap projected to close by the end of next year, and with inflation back to target forecast implies… at the monetary-policy horizon, the CNB’s forecast implies three policy-rate increases of 25bp each this year (taking the key rate to around 1%) and at least two more in 2022. A rise in the policy rate to at least 1.50% is expected to be complemented by currency appreciation to below EUR-CZK 25, a level the central bank considers to be close to fair value. However, in our view, this forecast seems too hawkish according to comments from the CNB’s monetary- policy committee (MPC) members, who do not expect rates to be increased over the summer. …but in line with market There are healthcare and economic reasons for postponing tightening. The pandemic is expectations… taking a heavy toll, with intensive-care units being overwhelmed and the government fiddling with restrictions since the second half of last year. Services are paying the price, with the tourism sector more heavily affected. While there may be an improvement in the spring, restrictions will continue to weigh on activity. At the same time, industry made a full recovery from COVID-19-related losses by 4Q20, but towards the end of last year and at the beginning of 2021, activity was hampered by supply-chain blockages. As a result, the recovery in employment, wages and consumer spending could happen later than the CNB expects. We believe that the market is correctly pricing in three rate increases over the next 12 months and maybe additional hikes later on, but the first hike is likely to come in 4Q21. The CNB’s tightening bias contrasts with the view of all other CE4 central banks and with that … and enough for the CZK to outperform other CE4 of the ECB. However, its forecast for rate increases is in tune with market expectations and is currencies probably behind the CZK’s outperforming its regional peers, despite similarities in terms of trade performance and positive extended basic balances. UniCredit Research page 18 See last pages for disclaimer.
March 2021 March 2021 CEE Macro & Strategy Research CEE Quarterly Russia The CBR’s impressive disinflation record since 2015 is being put to test in 2021. The Higher inflation in Russia… economy has fared better than expected since the start of the COVID-19 crisis, but poor oil demand in 2020 weighed on the RUB and depreciation pushed inflation above the 4% target. Pressure on prices was broad-based at the turn of the year, with core inflation further from target than at any time since January 2017, while both food and non-food price inflation continued to accelerate above target. The CBR reacted by hiking to 4.50% in March and indicating that additional rate increases are in …increases risks of rate hikes this year the pipeline. Chart 9 shows that the market is pricing in at least 1.25pp in hikes in the next 12 months and a whopping 2pp by the spring of 2023. This is excessive, in our view, and we expect the Russian central bank to hike to 5.25% before year-end and keep the policy rate constant next year, at a level consistent with its long-term assessment of the equilibrium rate of 5-6%. Time will tell if the CBR moved too soon. Faster price growth from two rounds of RUB We expect inflation to fall in the coming months depreciation and a rise in international food prices in 2020 will leave the base, especially in 2H21. Moreover, core inflation probably rose due to limited mobility. In 2020, the prices of durable goods increased as demand spiked due to more people working from home. This pattern is unlikely to be repeated in 2021. The substitution of spending on services (especially holidays abroad) with higher demand for goods could persist to some extent in 2021, but this is a supply shock that is likely to diminish in time. Finally, pressure from producer prices on consumer prices might be more muted in Russia than in other CEE countries, as Table 1 shows. Service-price inflation is mostly driven by regulated prices, such as those for gas and electricity, rail transport, housing and utilities. These prices are usually increased twice a year, in January and July, and most are expected to rise by no more than 4% in 2021. At the same time, prices at hotels and restaurants may rise above target this year as some of the slack is eliminated. Ultimately, the question is whether consumer demand will exert enough pressure on prices to prevent both inflation and inflation expectations from converging to target. In our view, such pressure will be insufficient due to household income failing to rise in real terms in the past five years. In 2020, it was more than 7% lower than in 2015. Disposable income is shrinking even faster due to a rapid surge in mortgage borrowing. Rapid credit growth (Chart 11) could be a concern, but CBR Governor Elvira Nabiullina said that rate hikes will not slow credit growth. Indeed, international experience shows that prudential regulation is far more efficient. RUB and OFZ remain attractive Finally, there is the issue of sanctions. Russian authorities have always taken into account the if additional sanctions are risk of crippling sanctions and, thus, have overstated risk premia for Russian assets since the limited in scope Crimean crisis. With new sanctions related to Alexey Navalny’s arrest confined to several officials and not touching important commodity producers or financial institutions, the focus switched to Nord Stream II and accusations of interference in US elections. The almost- completed Nord Stream II is unlikely to trigger retaliatory measures that would affect markets. Potential election interference could lead to more detrimental sanctions, of which sanctions on the OFZ market (probably on issuance) would have the biggest consequences. Without discounting the effects of such measures, which could lead to permanently lower foreign holdings of RUB bonds, the Russian government is not forced to issue. Its limited funding needs could be covered by local banks, which hold just 5.5% of their assets in government bonds, compared to 15-20% at their EM counterparts. If new sanctions are limited in scope, the RUB should rally back towards USD-RUB 70 and part of the risk premium currently priced in to bonds should reduce, ushering in new inflows into OFZs. A slightly undervalued RUB supports portfolio flows into Russia at a time when other EM countries may be under pressure from higher core yields. UniCredit Research page 19 See last pages for disclaimer.
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