2Q - CEE Quarterly - UniCredit Research

 
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

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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

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
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.

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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