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March 2021
CEE
Quarterly
Macro Research
Strategy Research
Credit Research
Stronger recovery requires
pandemic control
2Q2021March 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, erik.nielsen@unicredit.eu
Dan Bucşa, Chief CEE Economist (UniCredit Bank, London)
+44 207 826-7954, dan.bucsa@unicredit.eu
Florin Andrei, PhD, Senior Economist Romania (UniCredit Bank Romania)
+40 21 200-1377, florin.andrei@unicredit.ro
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
Published on 30 March 2021
Hrvoje Dolenec, Chief Economist (Zagrebačka banka)
+385 1 6006-678, hrvoje.dolenec@unicreditgroup.zaba.hr
Dr. Ágnes Halász, Chief Economist, Head of Economics and Strategic Analysis Hungary (UniCredit Hungary)
Erik F. Nielsen +36 1 301-1907, agnes.halasz@unicreditgroup.hu
Group Chief Economist
(UniCredit Bank, London) Ľubomír Koršňák, Chief Economist (UniCredit Bank Czech Republic and Slovakia)
120 London Wall +42 12 4950-2427, lubomir.korsnak@unicreditgroup.sk
UK-London Elia Lattuga, Deputy Head of Strategy Research (UniCredit Bank, London)
EC2Y 5ET +44 207 826-1642, elia.lattuga@unicredit.eu
Mauro Giorgio Marrano, Senior CEE Economist (UniCredit Bank, Vienna)
Imprint: +43 50505-82712, mauro.giorgiomarrano@unicredit.de
UniCredit Bank AG Kristofor Pavlov, Chief Economist (UniCredit Bulbank)
UniCredit Research +359 2 923-2192, kristofor.pavlov@unicreditgroup.bg
Am Eisbach 4 Pavel Sobíšek, Chief Economist (UniCredit Bank Czech Republic and Slovakia)
D-80538 Munich +420 955 960-716, pavel.sobisek@unicreditgroup.cz
Supplier identification: Daniel Vernazza, PhD, Chief International Economist (UniCredit Bank, London)
www.unicreditresearch.eu +44 207 826-7805, daniel.vernazza@unicredit.eu
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.
dan.bucsa@unicredit.eu
■ 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
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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.
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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
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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.
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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.
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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.
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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).
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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.
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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
dan.bucsa@unicredit.eu 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.
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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.
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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.
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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
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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.
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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.
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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.
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