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The impact of COVID-19 in Eastern Europe – could it trigger Deep Recession & Market Volatility?

For Eastern European countries, the economic estimates that two weeks ago were the most pessimistic scenario, have now become the baseline scenario. So strong is the impact of the pandemic. The economic turmoil caused by the COVID-19 pandemic is so great that consensus among experts is that most European countries, including those in Eastern Europe, will enter a recession this year. But the biggest problem is determining how deep the crisis will be.

COVID-19 has struck Europe with stunning ferocity. While we do not know how long the crisis will last, we know that the economic impact will be severe. In Europe’s major economies, nonessential services closed by government decree, account for about one-third of output. This means that each month these sectors remain closed translates into a 3 percent drop in annual GDP, and that’s before other disruptions and spillovers to the rest of the economy are taken into account. A deep European recession this year is a foregone conclusion.

Although the initial trade shock from the Coronavirus has hit Central Europe’s export-dependent economies very hard, we also think that these countries (mostly the 2004 EU joiners) will be able to cope better due to superior healthcare systems and greater fiscal capacity to support workers and firms through the downturn. Over the medium term, however, we expect countries with weaker healthcare systems, a lack of fiscal space, and particular reliance on sectors that will be especially badly hit (for example tourism) to suffer most. This is why we are taking a look today on how COVID-19 has and will be impacting Eastern Europe’s economy, in particular in countries such as Romania, Bulgaria and Hungary.

Stormy times were looming in Hungary since the German car industry decided to cut down expenses. Now, German companies Audi, Mercedes and Opel have suspended production. So has Suzuki, a Japanese carmaker. The car industry contributes 20% to the production of Hungarian industry and 4% to the country’s GDP. Under these conditions, although there are analysts who say that Hungary has one of the highest exposures to the pandemic shocks in the European Union, the central bank forecasted two weeks ago that the economy could sink into a small recession in 2020.

“We assume that the eurozone economy will sink completely into recession,” said the then central bank report, which also showed confidence that the pace of the Hungarian economy will be at least two percentage points higher than in the eurozone. But earlier this month, economists at Britain’s Standard Chartered Bank announced that Hungary’s GDP is expected to contract by 1.4% in 2020. Peter Virovacz, an analyst at ING in Budapest, said that “my forecast for GDP Hungary is down -1% this year, which two weeks ago was the most pessimistic scenario. Now, this forecast is the most optimistic scenario. I tend to believe that the decrease will be closer to -3% “.

In Bulgaria, the government has announced that it is preparing for the most pessimistic scenario, one in which the economy is shrinking by -3% this year. This country has never been one to show strong GDP growth, so a decline like this is equal to a major crisis. The Belgian financial group KBC is more pessimistic, warning of a decrease of -4% in 2020 at best and -12% at worst. KBC is the third largest bank in terms of assets in Bulgaria.

In mid-March, Raiffeisen Bank International forecast contractions of -3.9% for Bulgaria, -4.8% for Croatia and -2.5% for Romania in 2020. At the same time, the Institute for International Finance (IIF) published its Eastern European economic projections for 2020: -2.8% in the Czech Republic, -2.5% in Poland, -3% in Hungary and -2.7% in Romania. “Central and Eastern Europe will be severely affected by the large contraction in euro area production (-4.7%),” IIF analysts said.

For Romanians, the effects of an economic crisis can be most felt by a depreciation of the national currency against the euro, an evolution that is immediately felt in bank loan rates, higher bills for phones or utilities, and in purchasing power for goods such as real estate (apartments, rents, etc.) or cars. Also, many of the investors surveyed on the subject reported supply problems, potential price increases and a worsening of the financial deadlock, according to a study conducted by the consulting company Frames, quoted by Mediafax.

“The Covid-19 epidemic is a significant test for the world economy, one that, unlike the SARS episode, is now much more interconnected, with China as the main player in international trade chains. Growing supply problems, especially in China, the world’s largest exporter, significant fluctuations in resource tariffs, such as oil, gas, copper, etc., are likely to generate prospects for a potential crisis, exacerbated by significant declines in consumption. globally, the main economic engine “, say the analysts quoted by the Frames survey. 

The Romanian authorities however, urge for calm. Florin Cîțu interim Minister of Finance, urged the population to calm down and assured that the officials are very careful about the economic impact of COVID-19 on Romania.

“I am very aware of the possible economic impact of coronavirus. At the moment, the economic effects are only seen in the Chinese market. The data shows that the impact was mainly on the supply side, production decreased. If China’s economy does not recover quickly, although there is a very good chance that it will fully recover in the second half of the year, then there could be, with very low chances, risks for the Romanian economy as well, but risks we have already taken into account “, Florin Cîțu said, in a message published on Facebook.

The countries with the highest exposure to the economic impact of the virus are those with large retail and tourism sectors. This puts Croatia and Turkey at the forefront of the front, as social distancing will mean the entire tourist season is likely to be lost this year, Capital Economics analysts said. Countries with large retail and recreational sectors will also be seriously injured. “These sectors generally account for 20-30% of GDP in the region, and Romania is the most exposed, followed closely by Latvia and Poland.”

As the situation is not expected to improve in the near future, a rapid (V-shaped) return is no longer considered possible by financial analysts.

“Recent developments show that this crisis is turning into a severe crisis of global demand. Now that China’s production facilities are approaching a “back to normal” situation, international economic activity indicators are not returning to previous levels, ” the European Commission says.

In addition, the Commission warns that the spread of coronavirus in the US, the country with the highest number of cases, is likely to prolong the impact of the crisis over time, possibly by summer. Then, secondary shocks may occur. “The impact of a second wave of effects that can be caused by uncertainties and financial losses cannot be estimated at this stage.” The damage is expected to shift from the real economy to the financial sector. To cushion the shocks, governments should take further action in the near future. Among these measures, the Commission mentions the nationalization of companies in vital sectors, a step “that may be necessary”, at least temporarily. However, the EC warns against rescuing burdened companies to the point of refusing “unprofitable loans”.

In assessing the impact of the current crisis, as the Financial Times notes, history may provide some clues, but they are not always gratifying. For example, a study by the Federal Reserve of San Francisco examined the long-term economic impacts of 12 pandemics since the fourteenth century. The conclusion is that the destruction of capital and labor suggests that “the secondary waves of macroeconomic effects of pandemics persist for about 40 years.” But society and technology have evolved since then. So we can at least keep being positive about that. For now.

I. Constantin

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