EASTERN PROMISES

Eastern Europe’s major economies are having an underappreciated “Goldilocks moment”

Germany has long been the engine that drives the EU’s economic growth, but for the past few years it has been outpaced by countries further east—most notably Poland, Romania, and the Czech Republic.

The three largest eastern EU members by GDP are experiencing a “Goldilocks moment” of high economic growth, low unemployment, and manageable inflation of around 2%, according to Diana Amoa, a money manager at JPMorgan Asset Management who specializes in emerging market debt.

The IMF now forecasts that “emerging and developing Europe” economies to grow 4.5% this year, upping their prediction by 1.5 percentage points from six months ago. This increased optimism is based, in part, on bumper growth in the second quarter of 2017, when Romania’s economy increased 5.7% versus a year earlier, the Czech Republic’s by 4.7%, and Poland’s by 4.4%. By comparison, the EU average was 2.4% growth over the same period.

Why are these countries growing so quickly?

All of these economies are still heavily reliant on manufacturing, exporting much of their production to the rest of the EU. For example, the Czech Republic—er, Czechia—has the lowest unemployment rate in the EU and about 35% of the Czech labor force is employed in manufacturing, the highest proportion of any EU country. When Europe is growing, demand for the things made in these economies grows. Often this means cars: automakers including Toyota, Volkswagen, and Peugeot have factories in the Czech Republic. Romania’s largest exporter is Dacia, a subsidiary of French car company Renault.

Robust economic growth and low unemployment also leads to an increase in tax revenues, improving the health of budgets and making these countries more attractive to investors, JPMorgan’s Amoa said.

At the same time, many eastern countries are starting to absorb the money from the EU’s most recent seven-year budgetary cycle, which started in 2014, of which Poland is the biggest beneficiary. The Czech central bank governor recently said that the government’s investment cycle is closely linked to the EU’s budget cycle. The IMF noted that public investment contracted sharply in the country last year because of low take-up of EU funds.

Poland is also benefiting from a surge in workers from Ukraine. It’s estimated that as many as 1 million Ukrainians are working in Poland at any one time, who come for higher wages and more opportunities, especially since the recession that hit after the 2014 annexation of Crimea by Russia. Ukrainian workers have helped address Poland’s demographic issues—an aging population and low fertility rate—in addition to counterbalancing the emigration of millions of Poles after the nation joined the EU in 2004.

Too good to be true?

Recent rapid growth in some of these countries may come at a cost. In Romania, there are fears that economic success is being spurred by unsustainable consumer spending fueled by the government increasing public wages. In August, Fitch Ratings sounded the alarm that this policy risked overheating the economy. Wages are outpacing productivity growth and tax cuts have widened the budget deficit, a Fitch analyst noted even as the agency boosted its forecast for Romanian GDP growth this year.

The biggest concern, perhaps, is politics. Over the weekend, billionaire Andrej Babiš and his populist ANO party won the most votes in the Czech Republic’s legislative election. The anti-establishment candidate looks set to become the country’s next prime minister, even as he’s being investigated for misuse of EU funds. Promising to push for significant constitutional changes, his election was another rebuke for the traditional parties that have held power in Europe for decades.

Meanwhile, Poland’s Law & Justice party are engaged in an ongoing battle with Brussels over efforts to reform the country’s judiciary, which the European Commission has said isn’t up to EU standards. That, and the increasingly authoritarian tendencies of the government, are spooking investors somewhat.

If the relationship between eastern European governments and Brussels worsen, it’s unclear what will happen in the EU’s next funding cycle. Proposals have been floated to restrict funds going to countries that don’t meet certain EU standards.

And even further into the future, these economies will need to shift jobs from manufacturing to services if they want to avoid the inevitable disruption to factory jobs from automation.

For now, the benefits of their economic models seem to outweigh the risks, so the EU’s eastern economies are likely to keep growing, according to JPMorgan’s Amoa. EU funds are there to be invested, central banks have supportive monetary policies, and political tensions aren’t yet at a breaking point. JPMorgan Asset Management is buying these countries’ currencies and government bonds in Poland, Amoa said.

home our picks popular latest obsessions search