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Focus on European Economic Integration Q2/23

Stubbornly high inflation despite cooling economy 1 , 2 , 3

1 Regional overview

Russia’s invasion of Ukraine in early 2022 sent shockwaves through the global economy. Together with the effects of past adverse shocks – most notably the ­pandemic and the associated disruptions of global supply chains – it propelled price growth up to levels not seen for decades. After a period of pronounced economic stress and uncertainty, some of the factors that weighed on the economies of ­Central, Eastern and Southeastern Europe (CESEE) became less pressing as the year 2022 progressed. Commodity prices have moderated and – while the war continues, and geopolitical tensions remain high – the European economy has started to adapt to the new realities of geoeconomic fragmentation. In some fields, the adjustment has been rather successful (e.g. concerning the redirection of ­energy demand away from Russian energy sources and regarding general energy-saving efforts). Also supply chains seem to be functional again after China’s departure from its zero COVID policy. This is evidenced by lower global shipping costs and more readily available inputs among other factors. By the turn of the year, several signs suggested that the fourth quarter of 2022 may have already marked the bottom of the current economic downturn: (1) Fillips from lower food and energy prices, improved supply chain functioning and bold monetary policy finally put a brake on accelerating inflation rates; (2) the euro area economy showed no signs of ­contraction, at least not yet; (3) investment activity withstood tougher financing conditions comparatively well; and (4) sentiment improved notably from the troughs of mid-2022, especially among consumers.

CESEE is not yet out of the woods, though. Economic activity continued to weaken in early 2023 (also compared to the euro area) and inflation remains ­stubbornly high despite the notable cooling of the economy. Adjustments to the measures introduced to shield households from spiraling energy prices have ­introduced quite some volatility in headline inflation rates. Underlying (core) price pressures are proving sticky, with labor markets very tight throughout the CESEE region. At the same time, the fast rise in policy rates is starting to bite, and rising (global) financial sector risks could – despite generally solid fundamentals – spill over into CESEE banking sectors. Public support amid the energy crisis and rising government financing costs have consumed fiscal space and are limiting fiscal ­policymakers’ ability to respond flexibly to new challenges.

Economic activity weakened throughout the review period

How is all the above reflected in the data? After confidence indicators had already deteriorated significantly from early summer 2022 onward – consumer confidence fell to a lower level than at the height of the COVID-19 pandemic – activity ­indicators also weakened from fall 2022. Almost all industrial sectors were ­affected by the downturn, especially energy-intensive industries and industries that are particularly dependent on raw materials and imported components. Average ­industrial production growth declined and output in the sector contracted by 1.5% in the CESEE EU member states in February 2023. This was the strongest ­contraction since the summer of 2020. Retail sales momentum was increasingly driven by daily necessities, while sales of durable goods and fuels weakened. Retail sales in the CESEE EU member states contracted by 0.3% on average in February 2023, a figure comparable to January and February of 2021, a time when lockdown restrictions were still in place in many countries. While activity ­indicators trended down, sentiment indicators recovered somewhat from autumn 2022 onward. This is particularly true for consumer sentiment, but industrial ­sentiment brightened as well.

Output contracted in the CESEE EU member states in Q4 2022

In terms of actual GDP figures, this means that – amid quite some volatility in quarterly growth readings – economic momentum decelerated notably in the ­second half of 2022. Average growth in the CESEE EU member states turned ­negative in the fourth quarter of 2022 (with Czechia and Hungary meeting the criteria for a technical recession), and growth in Türkiye halved compared to the first half of 2022 (see table 1). The Russian economy, however, rebounded from its strong contraction in the second quarter of 2022.

Table 1: Real GDP growth  
2020 2021 2022 Q1 21 Q2 21 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Period-on-period change in %
Slovakia –3.4 3.0 1.7 –1.4 1.9 0.3 0.4 0.3 0.3 0.3 0.3
Slovenia –4.3 8.2 5.4 1.7 2.0 2.9 3.4 1.0 0.8 –1.3 0.8
Bulgaria –4.0 7.6 3.4 2.7 1.3 1.9 1.5 0.4 0.7 0.6 0.6
Croatia –8.6 13.1 6.3 7.2 0.5 2.4 2.1 2.4 1.3 –0.5 0.9
Czechia –5.5 3.6 2.5 –0.5 1.4 1.7 0.8 0.6 0.3 –0.3 –0.4
Hungary –4.5 7.2 4.6 1.1 2.3 1.6 2.5 1.3 0.7 –0.7 –0.4
Poland –2.0 6.8 4.9 2.6 2.2 2.1 1.7 4.2 –2.2 1.1 –2.4
Romania –3.7 5.9 4.8 2.0 1.8 0.8 0.6 1.3 1.2 1.2 1.0
Türkiye 1.9 11.3 5.6 2.6 2.0 2.7 1.6 0.7 1.9 –0.1 0.9
Russia –2.7 5.6 –2.1 0.7 1.6 0.6 0.9 0.2 –4.6 0.5 0.5
CESEE average1 –2.0 7.8 2.2 1.6 1.8 1.5 1.3 1.1 –1.4 0.4 0.2
Euro area –6.1 5.3 3.5 0.0 2.0 2.3 0.6 0.6 0.9 0.4 0.0
Source: Eurostat, national statistical offices.
1 Average weighted with GDP at PPP.

Private consumption almost completely disappeared as a central pillar of growth

In the second half of 2022, the economic momentum in the CESEE EU member states rested primarily on investment, whose growth weakened only slightly, and on net exports. At the same time, private consumption noticeably failed to ­support growth in many countries (see chart 1).

Gross fixed capital formation advanced by close to 5% on average in the region during the second half of 2022 and was especially buoyant in Slovakia, Croatia and Romania. While nominal financing conditions tightened notably throughout ­CESEE, real interest rates remained firmly in negative territory, and high profitability provided sources for internal financing. Capital formation was also ­supported by the beginning utilization of funds under the Recovery and Resilience Facility (RRF), above-average capacity utilization and/or efforts to save (increasingly scarce) labor in several countries. Stock changes, however, weighed on GDP as the high inventories that were built up in 2021 and early 2022 (mostly related to supply chain issues) were slowly being depleted.

Chart 1 entitled “GDP growth and its main components” is a column chart that shows year-on-year GDP growth in % and the growth contribution of GDP components in percentage points for the ten countries of Central, Eastern and Southeastern Europe covered in this report. The chart covers four quarters, from the first quarter of 2022 to the fourth quarter of 2022. Growth declined in almost all countries throughout the year as private consumption expenditure weighed increasingly on GDP dynamics. Only Russia reported somewhat less negative growth readings in the second half of 2022 than it did in the second quarter. In the fourth quarter of 2022, GDP growth ranged from minus 2.7% in Russia to 4.6% in Romania. 

Source: Eurostat, national statistical offices.

Although net exports slowed down toward the end of 2022, they often made a positive contribution to growth – for the first time since late 2020. Real exports increased more strongly than real imports. This in part reflected the unclogging of supply chains amid order backlogs from the past and stronger than expected ­demand from Western Europe. Exchange rate weakness (for example in Hungary), the strong tourist season (for example in Croatia), consumption restraint and/or lower energy imports due to high world market prices and/or energy-saving ­measures also played a role. In 2022, natural gas demand declined notably in ­almost all CESEE EU member states, most strongly so in Romania and Croatia (–14% and –19%, respectively, compared to the 2019–2021 average). In addition, CESEE countries used 4% to 17% less electricity in 2022 than in 2021, with Slovakia and Romania leading the way.

In the review period, poor economic confidence, weakening loan growth and losses in purchasing power in the wake of strong inflation had a growing impact on consumer spending in the CESEE EU member states. By the fourth quarter of 2022, private consumption growth had declined to only 0.5% on average (and was even negative in Czechia and Poland), delivering a moderate contribution to GDP growth at best. The central pillar of growth over the first half of 2022 has thus almost completely disappeared.

Labor market tightness persists

Consumer demand would likely have been even weaker were it not for remaining cushions of pandemic savings (estimated to amount to at least 1% of GDP in most countries) and the still very strong labor markets of the region. Despite weak growth, the average unemployment rate in the CESEE EU member states (at 3.7% in February 2023) currently stands only slightly above the historic lows recorded at the end of 2019. This means that there is practically full employment. A broader measure of the labor market slack – i.e. the share of persons with an unmet need for employment in the extended labor force – even beat its end-2019 reading by a full 0.7 percentage points. At 6% in the fourth quarter of 2022, it reached the ­lowest level since the start of the time series in 2009. And while employment growth has lost steam recently, trends in employment rates and activity rates were also favorable, with both rising to close to or even above historical heights in the final quarter of 2022.

Earthquakes weighed on activity in Türkiye

In Türkiye, the earthquakes of February 6, 2023, weighed on activity and pushed already weakening industrial output into contraction. Retail sale growth held up better, partly thanks to strong pay hikes at the beginning of this year (including a minimum wage increase of 55% and a 30% increase in civil servant wages) and aided by a favorable base effect after the confidence shock from the lira exchange rate crisis in November to December 2021. GDP growth in the second half of 2022 was based on a robust contribution of private consumption while both investments and net exports weakened.

Russian economy is weathering Western sanctions rather well

While growth readings were volatile in the CESEE region and the economic ­momentum generally decelerated, the Russian economy improved steadily from its mid-2022 trough. After the first shock of international economic sanctions had been digested, quarter-on-quarter growth came in at 0.5% in the third and fourth quarter, limiting the annual GDP contraction to –2.1% for the whole year. Russian GDP dynamics benefited from higher (war-related) government spending and from substantially higher prices for energy. Notwithstanding international ­sanctions, the country managed to bring substantial quantities of its energy ­carriers to the world market, in part by redirecting crude oil exports from sanctioning to nonsanctioning countries. With sanctions severely curtailing imports from ­Western economies, the current account surplus rose to more than 10% of GDP in 2022.

Chart 2 entitled “Russia: exchange rate and policy rate” is a line chart that shows the development of the Russian ruble exchange rate against the euro and Russia’s policy rate in %. The chart covers the period from January 1, 2021, to April 14, 2023. The ruble depreciated strongly after the start of the invasion of Ukraine but quickly regained its external value in the subsequent months. Since November 2022, the currency has been on a depreciating trend again and returned to its pre-war level in mid-March 2023. The policy rate was raised from 9.5% to 20% in late February 2022. In the subsequent months, the policy rate was again reduced in six steps by a total of 1,250 basis points to 7.5%, a level at which it stayed from September 2022 onward. 

Source: Macrobond.

The price cap for Russian oil and the European Union’s import ban increased the price discount of Russian oil vis-à-vis oil from other origins from late 2022 ­onward. This weighed on the ruble’s external value and the currency fell back to its pre-invasion level against the euro in late March 2023 (see chart 2). Inflation spiked at 17.8% in April 2022 but came back to 11% in February 2023. After ­reducing its key rate to 7.5% in mid-September 2022, the Bank of Russia (CBR) has so far left it at this level.

Inflation in CESEE EU stabilizes at a high level amid considerable volatility

The strong increase in annual inflation rates that characterized much of 2022 seems to have come to an end in the CESEE EU member states as well, and ­inflation recently stabilized at a high level amid considerable volatility (see chart 3). Energy prices in particular had a disinflationary effect, reflecting lower world market prices and country-specific relief packages for household energy. In ­December 2022, the average inflation rate in the CESEE EU member states ­declined to 16%, which marked the first decrease in two years. From May 2022, it became evident, at a disaggregated level, that the share of items with rising ­inflation rates in the overall consumption basket was declining – from a high level – both in terms of their number and their aggregate weight in the basket. Inflation is therefore currently less broadly based than it was in spring 2022.

Chart 3 entitled “HICP inflation and its main drivers” is a column chart that shows year-on-year change in HICP inflation in % and the contributions of individual HICP components to price growth in percentage points for the ten countries of Central, Eastern and Southeastern Europe covered in this report. Values are shown from the second quarter of 2022 to the fourth quarter of 2022 and for February 2023. Inflation accelerated notably until November 2022 and reached multi-annual peaks. Thereafter, it stabilized on a high level amid quite some volatility. In February 2023, inflation ranged from 9.4% in Slovenia to 55.2% in Türkiye. 

Source: Eurostat, The Vienna Institute for International Economic Studies.

However, price dynamics in the region have not yet embarked on a stable und sustainable downward trend. Core inflation, for instance, remained very high and kept on increasing in several countries of the region. This reflected lagged effects of the pass-through of producer price spikes to consumer bills, an expansion of profit margins in some sectors as well as rising (labor-intensive) services prices. The latter could suggest a stronger translation of wage costs into the general price level amid tight labor markets. Nominal wage growth had already accelerated to around 11% on average in the fourth quarter of 2022. However, the risk of a wage-price spiral is mitigated to some extent by the low unionization in CESEE EU member states and easing inflation expectations. Surveys among consumers show that inflation expectations recently converged back to the values reported in 2018. Inflation expectations in industry, retail and services came down as well but have not yet returned to their pre-pandemic levels.

Moreover, aid packages to shield households from spiraling prices (mostly ­energy prices) had to be adjusted in several instances as they negatively impacted national budgets and/or the balance sheets of energy suppliers. This once again boosted (regulated) energy prices, and the average inflation rate in the CESEE EU member states again edged up to 16.9% by February 2023. Hungary, for instance, abandoned its fuel price caps and increased its regulated prices for household ­energy; Czechia introduced a price cap to replace its (subsidized) energy-saving tariff; and Poland removed tax breaks on fuel and energy. Going forward, further adjustments cannot be ruled out, at least in some countries, as the prices for household energy are not yet aligned with world market prices and/or as tax rates (­especially for food and energy) have not yet returned to pre-pandemic levels. However, statistical effects as the war-related price spikes of early 2022 drop out of the base should also contribute to some easing of price pressures going forward.

Tightening cycles near an end

Against the backdrop of inflation stabilizing at a high level, the incipient economic slowdown and the already far-reaching tightening of monetary policy, most central banks in the region refrained from further interest rate hikes in the review period (see chart 4). For example, the last rate hike in Poland dates back to September 2022, and the last rate hike in Czechia was in June 2022, even further in the past. The Hungarian central bank (MNB) has also refrained from taking a further interest rate step since October 2022. However, this was preceded by strong monetary tightening in reaction to a depreciation of the forint: After the MNB had hiked its operational policy rate by 125 basis points to 13% in late ­September 2022 and communicated the end of its hiking cycle, the forint came under pressure and depreciated to its lowest value against the euro (430 HUF per EUR) on October 13, 2022. The following day, MNB called an emergency ­meeting in which it made several adjustments to its rate tool kit and hiked its operational policy rate to 18%. The policy rate has since stayed at this level – the highest since 1998.

Chart 4 entitled “Policy rates in selected CESEE countries” is a line chart that shows the development of policy rates in % in Czechia, Hungary, Poland, Romania and Turkey. The chart covers the period from January 1, 2021, to April 14, 2023. Policy rates increased strongly in all countries but Türkiye from mid-2021 onward. In Czechia, Poland and Hungary, however, policy rates have remained unchanged for several months now. In Türkiye, the policy rate declined notably between September 2021 and April 2023. By April 14, 2023, effective policy rates amounted to 6.75% in Poland, 7% in Romania, 7% in Czechia, 8.5% in Türkiye and 18% in Hungary. 

Source: Macrobond.

The interest rate ceiling may also have been reached in Romania, after the ­central bank hiked its policy rate by a moderate 25 basis points to 7% at the ­beginning of January 2023. Forward rate agreements for the abovementioned countries indicate that market expectations are broadly in line with current market rates. In Hungary, even some unwinding of the emergency rate step of October 2022 is expected in the course of the year.

In Türkiye, both headline and core inflation decelerated from their peaks (at 85% and 79%, respectively, in October 2022) to 55% and 57%, respectively, in February 2023. In parallel, the Turkish central bank (TCMB) delivered policy rate cuts by 150 basis points each in October and November (to 9%) and another one in February to 8.5%, implying a large negative real key rate. Against this background and despite regulatory measures to foster a “liraization” of banks’ assets and liabilities, the lira depreciated against the euro by 30% in nominal terms since January 2022 (see chart 5).

Most currencies have recovered to levels seen prior to the invasion of Ukraine

Unlike in Türkiye, monetary conditions in CESEE EU member states with independent monetary policies have probably already reached the restrictive range and should have a significantly dampening effect on prices going forward. Real (ex ante) interest rates have turned positive in recent months and the large interest rate differential to the euro area – together with a more supportive risk environment, e.g. with respect to energy markets – supported regional currencies. This applies not least to Hungary, where the forint has recovered significantly from its crash in October 2022, currently trading around 2% below its early 2022 value. The ­recovery was also supported by positive political news concerning long-standing issues between Hungary and the European Commission. The development of the forint compares to a depreciation by 2% of the Polish złoty, a largely stable development of the Romanian leu and an appreciation of the Czech koruna by 6%. The latter, however, was buoyed by exchange rate interventions carried out by the Czech ­National Bank (CNB), which depleted its foreign currency reserves by some 10 percentage points of GDP in the second half of 2022. The central bank has ­ample firepower given the large foreign currency reserves it amassed during the inter­vention-floor policy several years ago.

Chart 5 entitled “Exchange rates of selected CESEE currencies versus euro” is a line chart that shows the development of local currencies’ exchange rates against the euro for Czechia, Hungary, Poland, Romania and Türkiye. The chart covers the period from January 3, 2022, to April 14, 2023, and – for better comparability – exchange rates are indexed to equal 100 on January 3, 2022. The exchange rate of the Romanian leu remained broadly stable throughout the review period of this report, while the Czech koruna appreciated by 6% and the Polish zloty by 3%. The Hungarian recovered from its all-time low of October 2022 and regained around 15% of its value against the euro. 

Source: Macrobond.

Currencies only temporarily affected by international financial market turbulences

The most recent global financial sector turbulences following troubles at Silicon Valley Bank and Credit Suisse had only a temporary impact on CESEE foreign ­exchange markets. The Czech koruna lost 2.5% and the Hungarian forint 6% of value against the euro in mid-March, but both currencies recovered quite quickly. Global financial sector uncertainty currently also does not seem to be leading to an early exit from tight monetary policy. Prior to the events of mid-March, the ­narrative (and the market assessment) was that interest rates in CESEE EU ­member states would not continue to rise and that some interest rate hikes would possibly be reversed in the nearer future (e.g. the emergency hike in Hungary). Recent rate decisions, however, have set a somewhat more hawkish tone. The central banks of the region emphasized that policy adjustments will be data driven and that there is no predetermined path as to when the rates will be brought back to lower levels. CNB policymakers have explicitly noted that they “consider the market expectations regarding the timing of the first decrease in CNB rates to be premature.” Regardless of upcoming rate decisions, ongoing significant declines in equity prices of European banks could lead to tighter lending standards. Periods of bank stress usually raise the costs of capital and thereby constrain their ability to lend.

Banking sector momentum has weakened

Surveys like the European Investment Bank’s CESEE Bank Lending Survey already suggest that credit supply conditions have deteriorated significantly over the last six months. A weak local market outlook (related to the war in Ukraine, high ­inflation and the general economic slowdown) is cited as the most important ­reason for this development. All credit segments have been affected by tighter credit ­standards, though the tightening has been particularly strong in the mortgage ­market. While credit demand has been more resilient than supply, it is increasingly being driven by short-term demand for working capital and debt restructuring. At the same time, geopolitical uncertainty and the weak economic outlook are ­negatively influencing long-term fixed investments and consumer confidence. Among households, housing market prospects as well as non-housing-related ­consumption expenditures are expected to drag down demand further.

This increasingly restrictive situation in CESEE banking sectors is not yet fully reflected in credit market data and banks’ balance sheets. Credit dynamics in the CESEE region decelerated in the review period, reflecting a slowdown in new lending due to higher interest rates, more early repayments than in previous years and declining volumes in housing transactions. The weakening, however, was not observed evenly across countries and sectors. Credit growth rates, for example, remained broadly stable in Croatia, Bulgaria and Hungary amid some deceleration in growth of credit to households and largely unabated corporate sector credit ­dynamics. By contrast, corporate loan growth weighed heavily on credit market developments in Slovenia, Czechia, Poland and Romania.

Yet banks’ results and balance sheets have remained sound

Profitability was bolstered by higher net interest income and remained at around the levels observed in 2021 (see chart 6) – despite partly higher (personnel) ­expenses and provisioning. Credit quality also improved across CESEE and nonperforming loan (NPL) ratios even reached multiannual lows in some countries. Pockets of vulnerabilities exist, however. While NPL ratios are at a historic low, the share of so-called “stage 2” loans, for which banks are less certain of credit quality, is well above NPLs and increasing in several cases (e.g. Czechia, Croatia and Hungary). Furthermore, fast rising interest rates already exposed some banks with large fixed-income assets (see the example of Silicon Valley Bank in the US). Should the need arise, for instance due to funding shocks generated by changing market ­sentiment, these assets would have to be sold at a loss. Such unrealized losses, often associated with sovereign assets held to maturity, are significant for a number of countries, but high capital adequacy ratios provide a buffer.

Chart 6 entitled “Banking sector profitability” is a column chart that shows the return on assets in % for the banking sectors of the ten countries of Central, Eastern and Southeastern Europe covered in this report. The chart compared the values at the end of 2021 and the end of 2022. In this period, profitability remained broadly stable in most countries. Only in Russia, the return on assets declined notably while in Türkiye it was on an upward path. At end-2022, the return on assets ranged from 0.1% in Russia to 3.8% Türkiye. 

Source: IMF, national central banks, OeNB.

In Türkiye, the supervisory authority has required since mid-2022 that ­corporations are only granted access to new lira loans if their foreign exchange holdings (including gold) remain below a low ceiling. Moreover, to contain lira loan growth, the central bank has introduced and gradually raised reserve requirement ratios and securities maintenance ratios on selected commercial lira loans, plus additional ratios for banks with high loan growth or relatively high loan interest rates. Despite these measures, growth of credit to the private sector remained well in the double digits. Banking sector profitability increased amid higher operating income and asset growth was reflected in lower NPL ratios.

Even Russia’s banking sector reported a moderate profit in 2022

In Russia, banks continue to do business in a regime of regulatory lenience, aided by subsidized lending programs related to strategic enterprises, SMEs and households. This kept the expansion of credit to the private sector broadly stable in the review period. The banking sector reported a very modest overall profit of about USD 3 billion in full-year 2022 (which is less than one-tenth of the figure of 2021), after offsetting the loss from the first half of 2022 incurred on the back of sharply rising provisions and foreign exchange transactions.

External balances slid further into deficit amid terms-of-trade effects

The war in Ukraine and the ensuing spike in energy prices had a visible impact on CESEE countries’ external balances. The terms-of-trade shock amid slowing international momentum had a negative impact on trade balances. This effect was compounded by currency weakness in several instances. Depreciation increased the price for (largely demand-inelastic and usually US dollar-invoiced) energy imports further, while offsetting the negative impact of rising labor costs on competitiveness only to some degree. By the fourth quarter of 2022, combined current and capital ­account balances deteriorated by between –1.8 percentage points of GDP in ­Romania and –6.7 percentage points of GDP in Czechia (four-quarter moving sums compared to Q4 2021, see chart 7). Only Bulgaria reported a stable external balance. Against this background, current account balances slipped deeper into deficit in all countries but Croatia and Bulgaria. In some cases, they even ­approached the unsustainable levels seen ahead of and during the global financial crisis.

Chart 7 entitled “Combined current and capital account balance” is a column chart that shows the combined current and capital account and its components in % of GDP (four-quarter moving sum) for the ten countries of Central, Eastern and Southeastern Europe covered in this report. The observed period is the fourth quarter of 2021 to the fourth quarter of 2022. In this period, combined current and capital account positions deteriorated in all countries but Russia. In the fourth quarter of 2022, they ranged from minus 7% of GDP in Slovakia to 10% of GDP in Russia. 

Source: Eurostat, IMF, national central banks.

Sufficient financing for covering external deficits

Other investment and foreign direct investment inflows (FDI), which in some cases declined, while accelerating in others, were sufficient to cover large parts of the current account shortfalls over the past four quarters. Part of the strengths of FDI inflows was related to companies exploiting the interest rate differential ­between CESEE countries and the euro area by increasing intercompany loans. Portfolio flows remained volatile, however. The war, tighter financial conditions around the globe, increased risk aversion and certainly also widening external ­imbalances have been accompanied by a deterioration in market sentiment toward some CESEE economies. Data on high-frequency portfolio flows show that solid inflows since November 2022 stalled in mid-February 2023, with modest outflows through March, mirroring the fever curve of global banking stress. Government bond yields came down somewhat from their October 2022 peaks, but spreads over German bonds remain clearly elevated in a longer-term perspective.

Inflation is boosting government revenues and lowering debt ratios

High bond yields are not only a function of perceived higher risks, they also reflect high inflation and a generally higher interest rate environment amid monetary tightening. Higher financing costs, of course, weigh on government expenditure. Government expenditure also went up as many CESEE governments were trying to fight the energy crisis by transferring money to households and/or offering ­support with rising energy bills. This is particularly true in countries that face elections this year (Slovakia, Bulgaria, Poland and Türkiye) or next (Romania). Legacies from pandemic-related stimuli and/or spending related to refugees from Ukraine further fueled spending in some countries.

At the same time, the unexpectedly strong rising price level also boosted tax receipts and – through higher nominal GDP – reduced public debt ratios.

The above factors translated into somewhat lower headline deficits across most of the region, with the exceptions of Poland and Türkiye. Deficit ratios, however, remained elevated, with only Croatia and Slovakia staying below the 3% of GDP target. Debt ratios were lower than a year earlier and hovered between 39.4% of GDP (Türkiye) and 73.3% of GDP (Hungary). Only Bulgaria (22.9% of GDP) and Russia (15.1% of GDP) reported lower government debt levels in 2022. ­Concerning public finances in Russia, the general government balance reverted from a small surplus in 2021 to a deficit of 1.4% of GDP in 2022. This reflected rising ­budgetary support for strategic enterprises, SMEs as well as households, expanding arms production, and sharply declining imports and thus import taxes due to Western trade restrictions.

2 Slovakia: one-eyed among the blind? The economy grows dull but scrapes past a recession

Slovakia’s lackluster economic performance continued in the second half of 2022, in which GDP growth declined to just above 1%. As a result, real GDP expansion in full-year 2022 nearly halved compared to the hesistant post-pandemic ­recovery in 2021. The country, however, avoided recession, unlike some regional peers. Economic growth was driven by domestic demand. In contrast, the negative contribution of net exports to real growth in 2022 nearly doubled. This was brought about not only by weakened foreign demand but also by disruptions in the global supply chains – despite some easing since the summer. The latter was ­epitomized by a significant contraction of car production. In contrast, domestic demand developments somewhat defied the economic odds. Though private ­consumption growth did slow down noticeably in the second half of the year owing to high and accelerating inflation, it still benefited from savings accumulated during the pandemic and thus contributed more than 2 percentage points to real GDP growth. The mirror image was a steep decline in households’ saving rate throughout 2022. ­Despite rising prices of inputs, cooling foreign demand, a high level of uncertainty and a mediocre absorption of EU funds, investment growth even accelerated in the second half of 2022. In contrast, despite (relatively small) energy support ­measures, government consumption continued its contraction in the six months to December largely owing to the base effect as pandemic-related support measures boosted public consumption in 2021. Interestingly, while ­accumulation of inventories made a neutral contribution to GDP growth in 2022 overall, the quarterly contribution fluctuated strongly, echoing the development of supply chain disruptions.

Labor market indicators have come close to their pre-pandemic levels over the last months. Following a moderate but continuous decline until July 2022, the ­unemployment rate has remained broadly stable since. Employment, in contrast, has kept on rising, although only marginally as demand for labor has weakened amid elevated uncertainty. Foreign workers, particularly refugees from Ukraine, have continued to fill vacant jobs and thus helped mitigate the notorious skill ­mismatch and lack of (skilled) labor. Nominal wages saw a significant increase, predominantly in the public sector, mainly owing to a previously bargained one-off bonus. Yet, while labor cost increases have outpaced productivity growth, nominal wage growth did not keep up with rising costs of living. Headline inflation continuously headed upward and came in at 15.4% in February 2022. While soaring food and energy prices seem to have peaked in November 2022, core inflation continued climbing to more than 15% most recently. Hence, despite a reduction in the VAT rate for selected goods and services, price hikes have been bloated by nearly all components, most notably food and services.

The general government deficit came in at 2% of GDP in 2022. The reduction compared to 2021 was driven by stronger economic growth, higher tax revenues (not least on the back of high inflation) and lower pandemic-related expenditures. However, these positive factors were counteracted by government expenditures related to the war in Ukraine and measures to compensate firms and households for galloping prices. After the government did not survive the no-confidence vote in the parliament in December 2022, it remains in office with a limited care-taking mandate since snap elections have only been scheduled for end-September 2023. This unusually long run-up has some uncommon consequences such as a power shift toward the parliament, which may also bear some risks.

Table 2: Main economic indicators: Slovakia  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices –3.4 3.0 1.7 1.4 1.3 2.9 1.3 1.4 1.1
Private consumption –1.2 1.7 5.1 3.0 3.1 9.3 4.2 2.8 4.5
Public consumption –0.6 4.2 –3.2 1.0 3.9 –1.4 –7.1 –2.1 –2.0
Gross fixed capital formation –10.8 0.2 6.5 –1.8 5.3 6.4 0.5 8.2 9.8
Exports of goods and services –6.4 10.6 1.0 –2.0 2.2 –5.8 –0.9 8.8 2.6
Imports of goods and services –8.2 12.1 3.0 4.4 4.5 –1.5 –1.4 6.9 8.0
Contribution to GDP growth in percentage points
Domestic demand –5.0 4.1 3.6 6.6 3.4 7.5 0.9 0.0 6.3
Net exports of goods and services 1.6 –1.0 –1.9 –5.3 –2.1 –4.6 0.4 1.5 –5.2
Exports of goods and services –5.8 9.0 0.9 –1.6 1.7 –5.8 –0.9 6.9 2.5
Imports of goods and services 7.5 –10.1 –2.8 –3.7 –3.8 1.2 1.3 –5.4 –7.7
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) 5.6 2.7 6.6 4.4 5.5 5.4 6.8 8.8 5.6
Unit labor costs in manufacturing (nominal, per hour) 1.5 –3.0 8.6 10.2 7.7 10.2 11.1 3.6 10.1
Labor productivity in manufacturing (real, per hour) 2.6 9.9 –0.9 1.5 6.4 0.5 –0.2 2.4 –5.7
Labor costs in manufacturing (nominal, per hour) 3.6 7.3 7.6 11.9 14.7 10.8 10.9 6.1 3.8
Producer price index (PPI) in industry –0.5 6.8 27.8 9.3 14.5 24.4 30.6 31.0 25.0
Consumer price index (here: HICP) 2.0 2.8 12.1 3.4 4.8 8.5 11.8 13.3 14.9
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 6.8 6.9 6.2 6.8 6.6 6.4 6.2 6.1 6.1
Employment rate (%, 15–64 years) 67.5 69.5 71.4 70.3 70.8 70.6 71.4 71.6 71.8
Key interest rate per annum (%) 0.0 0.0 0.6 0.0 0.0 0.0 0.0 0.5 1.8
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector1 4.5 7.3 10.5 5.2 7.3 8.9 11.7 12.0 10.5
of which: loans to households 6.1 8.8 10.3 8.0 8.8 10.5 11.3 11.1 10.3
loans to nonbank corporations 1.4 4.3 10.8 –0.2 4.3 5.5 12.6 13.9 10.8
%
Share of foreign currency loans in total loans to the ­nonbank private sector 0.1 0.1 0.1 0.1 0.1 0.1 0.1 0.0 0.1
Return on assets (banking sector) 0.5 0.7 0.8 0.8 0.7 0.5 0.7 0.7 0.8
Tier 1 capital ratio (banking sector) 18.1 18.3 18.0 18.8 18.3 18.1 17.8 17.8 18.0
NPL ratio (banking sector) 2.3 1.9 1.7 1.9 1.9 1.9 1.9 1.8 1.7
% of GDP
General government revenues 39.4 40.1 40.2 .. .. .. .. .. ..
General government expenditures 44.7 45.6 42.3 .. .. .. .. .. ..
General government balance –5.4 –5.4 –2.0 .. .. .. .. .. ..
Primary balance –4.1 –4.4 –1.1 .. .. .. .. .. ..
Gross public debt 58.9 61.0 57.8 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) 54.5 52.7 51.2 .. .. .. .. .. ..
Debt of households and NPISHs2 (nonconsolidated) 46.6 47.9 48.0 .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance 1.1 –0.5 –6.2 –2.6 –1.6 –6.7 –4.3 –4.8 –8.9
Services balance 1.0 0.6 0.4 1.2 0.2 0.5 0.1 0.2 0.6
Primary income –0.8 –1.5 –1.7 –1.4 –2.7 –0.9 –1.9 –1.6 –2.3
Secondary income –0.7 –1.0 –0.8 –0.8 –0.4 –1.5 –0.9 –1.2 0.4
Current account balance 0.6 –2.5 –8.3 –3.6 –4.5 –8.6 –6.9 –7.4 –10.2
Capital account balance 0.8 1.3 1.3 0.2 0.7 –0.1 1.0 1.1 2.8
Foreign direct investment (net)3 2.6 0.3 –2.2 –1.2 0.7 –1.7 –2.2 –3.0 –1.8
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 119.6 135.0 105.0 116.9 135.0 141.5 129.6 111.6 105.0
Gross official reserves (excluding gold) 6.5 7.0 9.0 7.1 7.0 8.8 9.6 9.3 9.0
Months of imports of goods and services
Gross official reserves (excluding gold) 0.9 0.9 1.0 1.0 0.9 1.1 1.2 1.1 1.0
EUR million, period total
GDP at current prices 93,414 98,523 107,730 26,025 25,935 24,076 26,807 28,504 28,344
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Foreign currency component at constant exchange rates.
2 Nonprofit institutions serving households.
3 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

3 Slovenia: inflation moderates as consumption loses steam and energy prices decline

GDP growth slowed to 5.4% in 2022. The economy lost lots of steam in the ­second half of the year, with the growth rate dropping from 10.2% in the first half to 0.2% in the second half of 2022. The deceleration was most pronounced for household consumption, which was hit by the erosion of consumer confidence, slowing employment growth and the continued contraction of real wages, which was only partially cushioned by a decline in households’ saving rate and in their net financial assets. Government consumption slipped into contraction during the second half of 2022, mainly as containment measures related to COVID-19 were scaled back. By contrast, investment growth held up well, mostly owing to construction ­activity. Though housing construction growth slowed considerably, non-housing construction growth accelerated. Investment in machinery and equipment ­weakened along with the deterioration of economic sentiment, worsening export prospects and falling capacity utilization rates. With import dynamics slowing more than exports, the negative contribution of net real exports diminished in the second half of 2022.

The budget deficit amounted to 3% of GDP in 2022, down from 4.6% ­recorded in 2021. This improvement was supported by a strong rise in revenues, which were aided by corporate tax proceeds and VAT revenues. At the same time, budget ­expenditures decreased owing to a fall in current transfers as support measures related to COVID-19 were gradually phased out.

For 2023, the government plans a budget deficit of 5.3% of GDP. The ­widening of the deficit is mainly related to increased spending on measures to mitigate the impact of the energy and cost-of-living crisis, but in part also due to increased ­public sector wages and pension outlays. The Fiscal Council has noted that less than 20% of the adopted measures to ease the cost-of-living crisis represent ­targeted measures. It has also criticized that, excluding crisis mitigation measures, budget expenditure growth is expected to be the highest ever. It also warned that the government will likely have to revise the 2023 budget later in the year, as some expenditure items have been underestimated. In fact, in late March 2023, the ­government announced a proposed revision of the 2023 budget, cutting both ­expenditures and the deficit, stating that fewer measures were needed to mitigate the impact of higher energy costs than previously anticipated.

HICP inflation hovered around 10% and 11% between September and December 2022, before falling back to 9.4% by February 2023. The decline in early 2023 was caused mainly by the prices for energy (and, to a smaller extent, unprocessed food), which partly reflected favorable international energy price developments and government measures to mitigate the impact of rising energy prices. By ­contrast, core inflation edged somewhat higher on the back of accelerating price increases for processed food and services.

The combined current and capital account recorded a deficit during the second half of 2022 as the surplus on the goods and services balance continued to evaporate while the combined deficit on the other items increased modestly. The worsening of the goods and services balance resulted largely from the deterioration of the terms of trade.

Banking sector profitability worsened modestly in 2022. Operating income improved on the back of intensified lending activity and an improvement in the interest margin, but banks created some additional provisions (despite a modest improvement in the quality of the credit portfolio).

Table 3: Main economic indicators: Slovenia  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices –4.3 8.2 5.4 5.1 10.5 10.2 8.6 3.3 0.2
Private consumption –6.9 9.5 8.9 5.8 21.2 20.0 12.9 3.2 2.4
Public consumption 4.1 5.8 0.9 5.4 8.3 4.8 0.8 –0.6 –1.0
Gross fixed capital formation –7.9 13.7 7.8 11.8 13.2 9.4 7.3 8.7 5.9
Exports of goods and services –8.6 14.5 6.5 12.6 13.8 8.2 9.3 11.9 –2.5
Imports of goods and services –9.6 17.6 9.8 19.5 18.1 17.2 12.6 12.6 –1.5
Contribution to GDP growth in percentage points
Domestic demand –4.3 9.0 7.5 8.3 12.3 16.3 10.4 3.2 1.2
Net exports of goods and services 0.0 –0.8 –2.1 –3.2 –1.8 –6.1 –1.9 0.1 –0.9
Exports of goods and services –7.2 11.3 5.4 9.5 11.1 6.9 7.8 9.7 –2.1
Imports of goods and services 7.2 –12.0 –7.5 –12.7 –12.9 –13.0 –9.7 –9.6 1.1
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) 7.6 0.9 1.1 5.0 –4.3 –5.1 –2.3 4.2 8.7
Unit labor costs in manufacturing (nominal, per hour) 6.8 –3.0 2.0 3.9 –0.9 –3.0 2.7 –1.2 9.6
Labor productivity in manufacturing (real, per hour) –3.3 9.9 5.3 2.9 10.4 9.7 6.6 5.1 –0.2
Labor costs in manufacturing (nominal, per hour) 3.2 6.8 7.3 6.9 9.3 6.4 9.5 3.9 9.4
Producer price index (PPI) in industry –0.3 5.5 19.6 7.5 9.9 15.6 21.7 21.2 19.9
Consumer price index (here: HICP) –0.3 2.0 9.3 2.3 4.5 6.3 9.0 11.3 10.6
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 5.0 4.8 4.0 4.5 4.5 4.3 4.2 4.0 3.4
Employment rate (%, 15–64 years) 70.9 71.5 73.1 73.4 72.4 72.5 73.1 73.9 73.0
Key interest rate per annum (%) 0.0 0.0 0.6 0.0 0.0 0.0 0.0 0.5 1.8
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector1 –1.0 5.6 10.4 2.2 5.6 8.0 10.4 12.8 10.4
of which: loans to households 0.1 5.0 7.5 3.6 5.0 6.7 7.9 8.2 7.5
loans to nonbank corporations –2.2 6.2 13.4 0.7 6.2 9.4 13.2 17.6 13.4
%
Share of foreign currency loans in total loans to the ­nonbank private sector 1.4 1.1 0.8 1.2 1.1 1.0 1.0 0.9 0.8
Return on assets (banking sector) 1.0 1.1 1.0 1.0 1.1 0.7 0.8 0.5 1.0
Tier 1 capital ratio (banking sector) 16.7 16.9 15.9 17.0 16.9 15.7 15.7 15.5 15.9
NPL ratio (banking sector) 1.9 0.8 0.7 0.9 0.8 0.9 0.8 0.8 0.7
% of GDP
General government revenues 43.7 44.9 42.5 .. .. .. .. .. ..
General government expenditures 51.4 49.5 45.5 .. .. .. .. .. ..
General government balance –7.7 –4.6 –3.0 .. .. .. .. .. ..
Primary balance –6.1 –3.4 –1.9 .. .. .. .. .. ..
Gross public debt 79.6 74.5 69.9 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) 47.8 46.1 43.1 .. .. .. .. .. ..
Debt of households and NPISHs2 (nonconsolidated) 27.8 26.4 25.1 .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance 5.0 1.7 –3.9 0.5 –1.1 –4.1 –4.1 –2.6 –4.9
Services balance 4.4 4.7 6.1 5.4 4.9 4.5 6.0 7.3 6.3
Primary income –0.8 –1.7 –1.7 –1.1 –2.2 –1.2 –1.6 –2.6 –1.2
Secondary income –1.0 –0.9 –0.9 –0.7 –0.9 –1.0 –1.0 –0.9 –0.7
Current account balance 7.6 3.8 –0.4 4.1 0.7 –1.9 –0.6 1.2 –0.5
Capital account balance –0.5 0.1 –0.4 0.3 –0.1 –0.3 –0.3 –0.1 –1.0
Foreign direct investment (net)3 0.6 –0.8 –2.1 –1.3 3.8 –2.7 –1.8 –2.0 –1.8
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 102.1 97.3 88.0 103.1 97.3 96.2 92.8 90.5 88.0
Gross official reserves (excluding gold) 1.9 3.5 3.3 3.4 3.5 3.5 3.5 3.5 3.3
Months of imports of goods and services
Gross official reserves (excluding gold) 0.3 0.5 0.4 0.5 0.5 0.5 0.5 0.5 0.4
EUR million, period total
GDP at current prices 47,021 52,208 58,989 13,483 14,009 13,313 15,017 15,309 15,349
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Foreign currency component at constant exchange rates.
2 Nonprofit institutions serving households.
3 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

4 Bulgaria risks stagflation after fifth inconclusive election

HICP inflation in Bulgaria increased substantially from fall 2021, peaking at 15.6% in September 2022, with a strong contribution from energy and food price inflation. The pass-through of higher costs affected transport and restaurant services first, but toward the end of the year, inflation also spread to other services, in line with increasing unit labor costs. Subsequently, the HICP inflation rate moderated to 13.7% in February 2023 because of the downward trend in international energy commodity prices. Headline inflation will decelerate in late 2023 but remain high on average in 2023 (between 7% and 10%), as high producer prices, limited supply and labor shortages will continue to weigh on consumer prices in the short run. Against the backdrop of strong wage increases and pro-inflationary fiscal policies, core inflation came in at 10.9% in February 2023 and it is expected to even accelerate in 2023 and to remain high in 2024, dominating headline inflation dynamics.

The interplay of wages and prices also influences economic activity. Despite high inflation, real GDP continued to expand by 3.4% in 2022, supported by robust growth in exports and by wage and social transfer increases that compensated consumers for losses in purchasing power. Private and public consumption as well as the buildup of inventories contributed positively to real GDP growth over the year, while net exports and gross fixed capital investment contributed negatively.

Quarterly data reveal a pronounced cycle of inventories, and stock changes started to dampen GDP growth in the second half of 2022. The cycle was driven by disruptions of global supply chains that changed the incentives for firms to maintain stocks of commodities, raw materials and finished products.

The downward trend in fixed capital investment that started in 2021 persisted in 2022. Rising prices of investment goods and political stalemate that delayed the disbursement of NextGenerationEU (NGEU) funds and, more recently, higher interest rates, have been suppressing new investment. However, fixed capital formation started to add to GDP growth in the final quarter of 2022.

The global energy crisis disrupted the recovery in Bulgaria. While industrial production started to shrink in the second half of 2022, the labor market is lagging behind the cycle. Real GDP is expected to slow down considerably in 2023 in line with weak external demand and rising borrowing costs. GDP estimates range between 0.4% and 2.5%.

The snap general election on April 2, 2023, the fifth in two years, produced yet another highly fragmented parliament with little chance to form a regular government. If the political parties cannot form a temporary technocratic cabinet with a specific agenda, then Kremlin-friendly President Radev will continue ruling through caretaker governments until the next snap vote, which is likely to be held together with the local elections in autumn. Bulgaria’s prolonged political deadlock has already forced the country to delay its target date for adopting the euro until 2025. The uncertainty has also hampered Bulgaria’s ability to harness EU post-pandemic recovery funds by delaying significant reforms and infrastructure investments and in turn slowing down economic convergence.

In the absence of a formal 2023 budget bill, the generous support measures for households and firms are still in force. They are mostly untargeted and distorting price signals – and they are increasingly jeopardizing the path to sound public ­finances. While the debt-to-GDP ratio is low, spending pressures related to aging, health and education, as well as infrastructure and the green transition, are mounting. Moreover, rising interest rates and sovereign spreads and the short tenor of public debt have increased the public debt interest burden.

Table 4: Main economic indicators: Bulgaria  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices –4.0 7.6 3.4 8.6 10.2 4.4 3.9 2.9 2.6
Private consumption –0.6 8.8 4.8 9.8 8.9 5.5 2.1 4.2 6.8
Public consumption 8.3 0.4 6.5 2.9 2.3 6.6 11.6 3.8 4.5
Gross fixed capital formation 0.6 –8.3 –4.3 –11.9 –13.0 –7.4 –11.0 –3.3 2.4
Exports of goods and services –10.4 11.0 8.3 9.6 9.4 4.8 8.9 9.7 9.4
Imports of goods and services –4.3 10.9 10.5 13.0 3.9 12.3 12.3 9.2 8.5
Contribution to GDP growth in percentage points
Domestic demand 0.1 7.4 4.6 10.2 7.3 9.6 6.1 1.7 2.5
Net exports of goods and services –4.0 0.2 –1.2 –1.6 2.9 –5.2 –2.2 1.2 0.1
Exports of goods and services –6.6 6.2 5.1 5.4 5.1 3.9 6.0 5.9 4.4
Imports of goods and services 2.6 –5.9 –6.3 –7.0 –2.1 –9.1 –8.2 –4.7 –4.3
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) 8.9 3.8 15.6 5.0 2.3 10.3 17.9 16.1 18.8
Unit labor costs in manufacturing (nominal, per hour) 1.6 –1.9 3.8 4.7 3.1 3.0 –1.6 4.5 9.1
Labor productivity in manufacturing (real, per hour) 3.7 8.8 13.6 10.5 9.3 14.5 17.2 13.6 9.5
Labor costs in manufacturing (nominal, per hour) 5.2 7.0 17.9 15.7 12.7 17.9 15.4 18.8 19.5
Producer price index (PPI) in industry –2.0 15.5 38.3 17.4 28.9 33.9 40.2 50.2 28.8
Consumer price index (here: HICP) 1.2 2.8 13.0 2.9 6.0 8.9 13.4 15.2 14.5
EUR per 1 BGN, + = BGN appreciation 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 5.2 5.3 4.3 4.6 4.6 5.0 4.7 3.7 3.9
Employment rate (%, 15–64 years) 68.5 68.2 70.4 69.5 68.5 68.4 69.8 71.9 71.5
Key interest rate per annum (%)1 .. .. .. .. .. .. .. .. ..
BGN per 1 EUR 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0 2.0
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector2 4.3 8.6 12.7 7.5 8.6 10.6 12.5 13.5 12.7
of which: loans to households 6.6 13.4 14.6 11.8 13.4 14.1 14.7 15.2 14.6
loans to nonbank corporations 2.9 5.5 11.4 4.8 5.5 8.4 10.9 12.2 11.4
%
Share of foreign currency loans in total loans to the
nonbank private sector
31.9 29.3 26.2 30.2 29.3 29.0 28.4 27.3 26.2
Return on assets (banking sector) 0.7 1.1 1.4 1.1 1.1 1.6 1.5 1.4 1.4
Tier 1 capital ratio (banking sector) 22.1 22.0 20.5 21.8 22.0 21.4 20.7 20.1 20.5
NPL ratio (banking sector) 4.3 3.7 2.8 3.8 3.7 3.3 3.1 3.1 2.8
% of GDP
General government revenues 37.7 37.7 38.5 .. .. .. .. .. ..
General government expenditures 41.5 41.5 41.3 .. .. .. .. .. ..
General government balance –3.8 –3.8 –2.8 .. .. .. .. .. ..
Primary balance –3.3 –3.3 –2.3 .. .. .. .. .. ..
Gross public debt 24.5 24.5 22.9 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) 77.1 69.3 60.2 .. .. .. .. .. ..
Debt of households and NPISHs3 (nonconsolidated) 24.3 23.8 22.8 .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance –3.2 –4.1 –5.8 –2.9 –6.4 –5.8 –3.8 –5.4 –7.8
Services balance 5.1 5.7 6.3 7.9 4.5 5.4 6.4 8.4 4.8
Primary income –3.5 –3.3 –2.9 –4.2 –3.2 –4.8 0.4 –4.1 –3.0
Secondary income 1.6 1.2 1.7 1.8 0.9 1.0 1.5 1.5 2.3
Current account balance 0.0 –0.5 –0.7 2.5 –4.1 –4.2 4.6 0.4 –3.6
Capital account balance 1.4 0.7 0.9 0.6 –0.4 –2.3 0.0 –0.4 5.3
Foreign direct investment (net)4 –4.5 –1.4 –2.4 –2.2 0.9 –7.0 2.7 –2.7 –3.0
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 63.8 58.4 52.5 60.5 58.4 56.0 54.0 54.5 52.5
Gross official reserves (excluding gold) 46.8 45.7 42.8 44.9 45.7 41.6 40.3 42.9 42.8
Months of imports of goods and services
Gross official reserves (excluding gold) 10.4 9.2 7.6 9.3 9.2 8.0 7.4 7.6 7.6
EUR million, period total
GDP at current prices 61,639 71,077 84,561 19,515 20,518 17,248 20,075 22,987 24,251
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Not available in a currency board regime.
2 Foreign currency component at constant exchange rates.
3 Nonprofit institutions serving households.
4 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

5 Croatia: smooth transition into the euro area amid slowing growth

On January 1, 2023, Croatia joined the Schengen Area and the euro area. The euro changeover went smoothly and on January 15, euro banknotes and coins became the sole legal tender in Croatia. Survey data from the Eurobarometer show that most Croatian citizens found it easy to switch to the euro, which is unsurprising given previously high levels of euroization. However, 38% continued to think that euro introduction was not good for Croatia. Moreover, most people thought that euro adoption would lead to higher inflation. From a macroeconomic point of view, euro adoption has removed the previously elevated currency risks stemming from financial asset and liability euroization. This has reduced macroeconomic ­imbalances in Croatia.

At the same time, the geopolitical and economic environment remains challenging. Croatia’s impressive post-pandemic economic expansion has gradually weakened. GDP growth decelerated notably to 4.6% year on year in the second half of 2022 (6.3% for the full-year 2022). Private consumption growth slowed in the second half of the year, while growth of gross fixed capital formation accelerated strongly. Both components made roughly similar contributions to GDP growth. A relatively strong positive contribution came from changes in inventories. Net exports made a negative contribution in the second half of 2022 as the surplus in the services balance could not keep up with rising deficits in the goods balance. On the output side, all sectors except manufacturing expanded in the second half of the year.

CPI inflation was 11.7% year on year in February 2023 – the strongest contributions came from services and processed food items, while tax changes had a dampening effect. During 2022, the government passed two large policy packages to mitigate the effects of higher inflation (worth roughly 6% of 2021 GDP). On April 1, 2023, another policy package worth EUR 1.7 billion (around 2.5% of 2022 GDP) entered into force. The lion’s share (EUR 1.2 billion) has been allocated to energy price caps, the remainder to various measures to support the most vulnerable citizens and to subsidies. To help finance the packages, the government introduced a tax on excess corporate profits generated in 2022, which will bring in roughly 0.3% of GDP in additional revenues according to estimates by the Ministry of Finance.

Croatia’s public sector gross debt in euro has remained roughly unchanged compared to a year ago. However, in relative terms, indebtedness continued to decline to 70% of GDP, helped by strong economic growth. With these debt levels, Croatia broadly mirrors the EU average, while it has the third-highest public debt level among the CESEE EU member states. The budget deficit for 2022 came in at 1.6% of GDP and is expected to increase to 2.3% of GDP in 2023.

The Croatian National Bank announced an increase in the countercyclical ­capital buffer from 0.5% to 1% from December 31, 2023. It noted that cyclical risks are increasing due to continued strong growth of residential real estate prices, robust mortgage lending activity and very high growth of corporate lending. The latter slowed down somewhat in the second half of 2022. The banking sector’s return on assets was 1% in 2022, 0.3 percentage points lower than in 2021. This was due to lower net operating income. Banks’ tier 1 capital ratio declined from 25.4% to 24% between end-2021 and end-2022, mainly due to unrealized losses from bond valuations and an increase in risk-weighted assets. The NPL ratio continued to decrease to 3% at end-2022, while the share of stage 2 loans increased in the second half of 2022.

Table 5: Main economic indicators: Croatia  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices –8.6 13.1 6.3 16.7 12.2 7.8 8.7 5.2 4.0
Private consumption –5.1 9.9 5.1 15.8 7.5 6.2 7.5 5.4 1.3
Public consumption 4.3 3.0 3.0 –4.5 14.3 5.8 –2.2 1.3 6.8
Gross fixed capital formation –5.0 4.7 5.8 0.7 –5.0 2.0 3.9 8.0 9.6
Exports of goods and services –23.3 36.4 25.4 53.0 34.4 27.8 40.3 23.3 14.2
Imports of goods and services –12.4 17.6 25.0 19.8 20.1 29.5 26.5 30.5 14.6
Contribution to GDP growth in percentage points
Domestic demand –3.1 6.5 6.5 –3.0 8.8 14.1 5.5 2.1 5.7
Net exports of goods and services –5.4 6.6 –0.2 19.7 3.4 –6.3 3.2 3.1 –1.7
Exports of goods and services –11.8 15.1 13.0 28.7 13.7 9.4 17.2 17.7 6.8
Imports of goods and services 6.3 –8.5 –13.2 –9.0 –10.2 –15.7 –14.0 –14.6 –8.5
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) .. .. .. .. .. .. .. .. ..
Unit labor costs in manufacturing (nominal, per hour) 2.4 –0.9 6.9 3.5 5.3 4.1 8.3 7.3 8.1
Labor productivity in manufacturing (real, per hour) –2.5 4.7 0.9 1.8 0.7 4.6 –0.2 1.2 –1.8
Labor costs in manufacturing (nominal, per hour) –0.4 3.9 7.9 5.4 6.0 9.0 8.1 8.6 6.2
Producer price index (PPI) in industry –3.2 11.7 25.8 13.1 24.6 25.1 32.5 30.2 15.6
Consumer price index (here: HICP) 0.0 2.7 10.7 3.1 4.6 6.4 10.8 12.6 12.8
EUR per 1 HRK, + = HRK appreciation –1.6 0.1 –0.1 0.4 0.6 0.4 –0.1 –0.3 –0.3
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 7.6 7.6 7.1 6.3 6.3 7.2 7.4 6.8 6.8
Employment rate (%, 15–64 years) 62.0 63.4 65.0 64.6 64.1 64.2 64.9 65.1 65.6
Key interest rate per annum (%) .. .. .. .. .. .. .. .. ..
HRK per 1 EUR 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector1 2.8 2.4 10.4 2.8 2.4 3.9 7.2 10.4 10.4
of which: loans to households 1.6 4.1 5.3 4.5 4.1 4.0 5.1 4.9 5.3
loans to nonbank corporations 4.8 -0.1 18.6 0.2 -0.1 3.6 10.4 19.5 18.6
%
Share of foreign currency loans in total loans to the ­nonbank private sector 52.0 52.2 58.1 51.5 52.2 52.1 52.5 55.1 58.1
Return on assets (banking sector) 0.6 1.2 1.0 1.1 1.2 1.2 1.2 1.3 1.0
Tier 1 capital ratio (banking sector) 25.0 25.4 24.0 25.2 25.4 25.2 24.6 23.5 24.0
NPL ratio (banking sector) 5.4 4.3 3.0 4.7 4.3 4.2 3.8 3.3 3.0
% of GDP
General government revenues 46.7 46.0 45.7 .. .. .. .. .. ..
General government expenditures 54.0 48.5 47.2 .. .. .. .. .. ..
General government balance –7.3 –2.6 –1.6 .. .. .. .. .. ..
Primary balance –5.3 –1.0 –0.3 .. .. .. .. .. ..
Gross public debt 87.0 78.4 70.0 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) 12.4 11.0 10.1 .. .. .. .. .. ..
Debt of households and NPISHs2 (nonconsolidated) 5.0 4.5 4.1 .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance –17.6 –19.6 –26.7 –18.5 –20.7 –29.0 –27.0 –25.8 –25.4
Services balance 10.5 16.9 21.0 41.6 8.3 4.7 17.4 46.3 10.5
Primary income 2.5 0.9 0.9 –0.8 2.8 1.6 0.3 –1.1 3.1
Secondary income 4.0 3.6 3.2 3.3 3.0 3.4 3.1 2.8 3.5
Current account balance –0.5 1.8 –1.6 25.6 –6.6 –19.2 –6.2 22.1 –8.3
Capital account balance 2.1 2.4 2.6 2.2 2.8 2.1 2.1 2.0 4.0
Foreign direct investment (net)3 –1.4 –4.8 –5.6 –7.1 –4.7 –6.8 –4.0 –5.0 –6.7
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 79.6 76.8 74.0 79.8 76.8 80.2 79.8 75.0 73.5
Gross official reserves (excluding gold) 37.6 42.9 41.5 43.6 42.9 40.1 40.4 40.4 41.2
Months of imports of goods and services
Gross official reserves (excluding gold) 9.3 9.8 7.6 10.3 9.8 8.6 8.1 7.6 7.6
EUR million, period total
GDP at current prices 50,427 58,269 67,393 16,412 14,823 14,368 16,854 18,922 17,249
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Foreign currency component at constant exchange rates.
2 Nonprofit institutions serving households.
3 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

6 Czechia: economy navigating troubled waters; technical recession amid eye-catching imbalances

Czechia’s economic growth and its structure changed dramatically in H2 2022. Facing weak domestic demand but relatively sturdy net exports and fixed capital formation, real GDP growth experienced a sharp slowdown to 0.8%, after ­expanding by more than 4% in the first six months of the year. In fact, the economy entered a technical recession. Moreover, the composition of growth drivers changed dramatically. Whereas domestic demand had contributed positively and net exports negatively to growth for more than two years, the roles reversed in the review period. GDP growth was mainly driven by net exports. In contrast, domestic demand provided an increasingly negative contribution to GDP dynamics. This was brought about predominantly by weakened household consumption. Its previously vigorous expansion on the back of pandemic savings and resilient nominal disposable income was replaced by a severe contraction in H2 2022 as high inflation, tightened monetary policy and elevated uncertainty started to bite. While the largest drop was recorded in purchases of durable goods, expenditures on food decreased significantly too. Public consumption made a slightly negative contribution to growth in H2 2022, despite higher defense spending, expenses related to Ukrainian refugees and growing public sector wages and pensions. The expansion of fixed investment and its contribution to GDP growth were relatively robust.

The balance of goods and services turned negative in H2 2022, to a large extent owing to high import prices of energy commodities. This, in combination with a rather high primary income deficit on the back of outflowing dividends, brought about an unusually deep current account deficit (6.1% of GDP in 2022). The ­general government deficit came in at 3.6% of GDP in 2022, while public debt ­increased to more than 44% of GDP. Public finances were burdened by permanent tax reductions implemented during the pandemic, expenditures ­related to the war in Ukraine and incoming refugees as well as by the support to households and firms troubled by strong price increases. These factors notwithstanding, the fiscal outcome was not only significantly better than the Treasury had expected but the deficit was also much smaller than in the previous two years. However, important challenges for public finances remain, e.g. relating to demographics and the pension system. The economic slowdown notwithstanding, the labor market remains rather tight. Despite a very moderate increase, the unemployment rate has stayed contained, hovering at or below 2.5%.

Strong and broad-based price growth accelerated almost continuously throughout 2022 with only a slight breather toward the end of the year owing to some easing in the price pressure of both energy and nonenergy imports. These echoed not only the relaxation on the energy markets but also some easing of the frictions in global supply chains as well as a steadily appreciating koruna. HICP inflation thus averaged just short of 15% in 2022. Yet it accelerated again in January 2023 (19.1%) as a result of electricity prices rising to the government price cap after the energy savings tariff was discontinued. In February, both headline and core inflation eased somewhat, inter alia due to some slowdown of service price growth and imputed rents. The CNB has kept its key interest rate unchanged at 7% since June 2022 as the composition of the CNB board shifted to a more dovish stance. In the new makeup a majority of CNB board members prefer rate stability while ­putting more emphasis on the strong exchange rate to rein in inflation. The CNB expects headline inflation to drop to single-digit levels in H2 2023 and to reach the 2% target in H1 2024.

Table 6: Main economic indicators: Czechia  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices –5.5 3.6 2.5 3.5 3.6 4.9 3.5 1.6 0.1
Private consumption –7.2 4.1 –0.9 4.8 8.4 8.3 –0.1 –5.0 –5.5
Public consumption 4.2 1.4 0.6 5.1 0.6 1.3 1.7 –1.6 1.1
Gross fixed capital formation –6.0 0.8 6.2 1.6 0.7 8.0 7.9 6.8 2.7
Exports of goods and services –8.0 6.9 5.7 –1.7 –3.4 1.2 1.6 11.1 9.3
Imports of goods and services –8.2 13.3 5.7 9.8 6.1 5.4 3.0 7.5 6.9
Contribution to GDP growth in percentage points
Domestic demand –5.1 7.1 2.3 10.7 10.3 7.8 4.4 –0.7 –1.6
Net exports of goods and services –0.4 –3.6 0.2 –7.2 –6.7 –2.9 –0.9 2.3 1.8
Exports of goods and services –5.9 4.8 4.1 –1.1 –2.7 1.0 1.3 7.2 6.6
Imports of goods and services 5.6 –8.4 –4.0 –6.1 –4.0 –3.9 –2.1 –4.9 –4.9
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) 7.2 1.8 4.8 3.8 1.3 4.2 2.9 4.6 7.4
Unit labor costs in manufacturing (nominal, per hour) 2.9 –2.6 4.5 5.1 5.7 7.0 7.6 0.7 3.2
Labor productivity in manufacturing (real, per hour) 4.5 4.7 1.8 –0.1 –0.7 –0.4 –0.3 5.5 2.6
Labor costs in manufacturing (nominal, per hour) 7.1 2.4 6.5 4.9 4.9 6.6 7.2 6.2 5.9
Producer price index (PPI) in industry 0.6 6.2 18.6 8.1 11.0 16.4 21.3 20.6 16.2
Consumer price index (here: HICP) 3.3 3.3 14.8 3.3 5.0 10.2 15.0 17.4 16.5
EUR per 1 CZK, + = CZK appreciation –3.0 3.2 4.4 3.8 5.1 5.8 4.1 3.7 4.1
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 2.6 2.9 2.4 2.8 2.3 2.5 2.4 2.3 2.3
Employment rate (%, 15–64 years) 74.4 74.4 75.5 75.0 75.3 75.0 75.2 75.8 75.8
Key interest rate per annum (%) 0.8 0.9 5.9 0.7 2.4 4.2 5.6 7.0 7.0
CZK per 1 EUR 26.5 25.6 24.6 25.5 25.4 24.6 24.6 24.6 24.4
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector1 3.0 9.7 6.2 6.3 9.7 10.4 9.2 8.6 6.2
of which: loans to households 6.5 9.9 4.8 9.1 9.9 10.3 8.3 6.5 4.8
loans to nonbank corporations –1.3 9.4 8.3 2.8 9.4 10.5 10.5 11.6 8.3
%
Share of foreign currency loans in total loans to the
nonbank private sector
14.6 14.6 19.4 14.1 14.6 15.6 17.3 19.4 19.4
Return on assets (banking sector) 0.6 0.8 1.1 0.8 0.8 1.0 1.2 1.2 1.1
Tier 1 capital ratio (banking sector) 23.6 22.8 21.6 23.2 22.8 21.7 20.9 21.1 21.6
NPL ratio (banking sector) 2.6 2.3 1.9 2.5 2.3 2.2 2.0 1.9 1.9
% of GDP
General government revenues 41.5 41.4 41.0 .. .. .. .. .. ..
General government expenditures 47.2 46.5 44.6 .. .. .. .. .. ..
General government balance –5.8 –5.1 –3.6 .. .. .. .. .. ..
Primary balance –4.9 –4.3 –2.4 .. .. .. .. .. ..
Gross public debt 37.7 42.0 44.1 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) 56.1 53.4 51.5 .. .. .. .. .. ..
Debt of households and NPISHs2 (nonconsolidated) 34.0 35.7 33.2 .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance 4.9 1.2 –1.5 –2.0 –1.7 0.4 –2.2 –2.9 –0.9
Services balance 1.8 1.8 1.3 1.9 1.6 1.6 1.8 1.6 0.3
Primary income –4.2 –3.3 –5.5 –4.7 –2.9 –1.9 –4.3 –11.2 –4.2
Secondary income –0.5 –0.5 –0.5 –0.5 –0.2 –1.3 –0.4 –0.4 0.1
Current account balance 2.0 –0.9 –6.1 –5.3 –3.3 –1.2 –5.0 –12.9 –4.7
Capital account balance 1.2 1.6 0.1 2.4 2.1 –0.3 0.9 0.8 –1.0
Foreign direct investment (net)3 –2.6 –0.1 –2.5 –0.7 0.3 –1.1 –1.9 –1.8 –5.1
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 76.3 75.5 66.8 73.8 75.5 77.5 72.9 67.3 66.8
Gross official reserves (excluding gold) 62.5 64.1 47.2 62.8 64.1 62.9 57.7 50.8 47.2
Months of imports of goods and services
Gross official reserves (excluding gold) 11.9 11.0 7.6 11.0 11.0 10.7 9.6 8.2 7.6
EUR million, period total
GDP at current prices 215,824 238,361 276,659 61,848 63,500 62,484 68,948 71,573 73,653
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Foreign currency component at constant exchange rates.
2 Nonprofit institutions serving households.
3 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

7 Hungary: tight monetary policy, weakening consumption and global raw material prices to reduce inflation substantially

In H2 2022, Hungary’s GDP growth slowed substantially and reached a meager 0.4% in the fourth quarter, pushing Hungary into a technical recession. The weakening was most pronounced for investments, as increasing interest rates, deteriorating economic sentiment, falling capacity utilization rates, worsening export expectations and the delay of public investment projects as part of the government’s fiscal consolidation efforts cooled activity. Household consumption also weakened substantially amid slowing employment growth, falling real wages and sharply worsening consumer confidence. Slowing domestic demand and the acceleration of export growth (exceeding import growth) benefited net real exports, which delivered a positive growth contribution during H2 2022.

The budget deficit declined to 6.2% of GDP in 2022, as revenues were supported by strong economic growth and windfall taxes. Expenditure growth was slowed by the postponement of public investment projects and operational savings to accommodate bigger outlays for the utility bill protection scheme. At the end of 2022, the government modified its 2023 budget deficit target from 3.5% to 3.9% of GDP. This mainly reflected the substantial increase in the cost of the various energy subsidy schemes, but pension outlays, interest expenditure and fiscal ­reserves were also set markedly higher than in the original budget.

In mid-December 2022, the European Commission and the Council of the EU approved Hungary’s recovery and resilience plan (RRP) and the Partnership Agreement with Hungary for 2021–2027. At the same time, the Council decided to withhold EUR 6.3 billion of structural funds until Hungary takes additional measures to safeguard the rule of law. Later on, the Commission specified that it would not disburse any of the EUR 22 billion in cohesion funds until some horizontal enabling conditions are met. These issues mainly concern judicial independence, the so-called “child protection” law and serious risks to academic freedom and the right to asylum. Hungary has pledged to implement the necessary legal requirements but lengthy negotiations with the Commission are ongoing.

Inflation continued to accelerate during the reporting period and presumably peaked at 26.2% in January 2023, before easing to 25.8% in February 2023. However, the decline in February was primarily driven by energy and unprocessed food prices, while core inflation edged up further and price pressures remained broad-based. Increasing fuel shortages forced the government to abandon the price cap on automotive fuels in early December 2022. By contrast, the price cap on selected basic food items was extended until end-April 2023, and the government has indicated that the price cap will remain in place until inflation slows significantly. Nevertheless, food price inflation in Hungary kept on rising during the reporting period and has been the highest in the EU since August 2022.

The MNB maintained its strict policy stance. To additionally absorb banking sector liquidity, it restarted regular auctions of 1-week discount bonds and longer-term deposits from late January 2023 and announced a doubling of the mandatory reserve rate to 10% as of April along with abolishing interest on the first 2.5% of the reserve base. The tight monetary policy together with the MNB’s provision of foreign currency to cover FX liquidity needs in connection with energy imports and news about the approval of Hungary’s Partnership Agreement and RRP supported the forint between mid-December 2022 and mid-March 2023, when it temporarily came under pressure following the outbreak of global banking sector risks (Silicon Valley Bank, Credit Suisse).

Table 7: Main economic indicators: Hungary  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices –4.5 7.2 4.6 6.3 7.6 8.2 6.5 4.0 0.4
Private consumption –1.2 4.6 6.4 6.5 7.7 11.6 8.4 4.7 1.7
Public consumption –0.5 1.7 0.8 2.9 –3.1 4.3 2.5 –0.6 –2.9
Gross fixed capital formation –7.1 6.5 1.2 13.3 1.5 10.9 6.1 1.2 –9.0
Exports of goods and services –6.1 8.8 11.8 2.3 0.5 9.1 9.9 16.4 12.1
Imports of goods and services –3.9 7.7 11.1 5.6 1.3 10.9 9.5 13.7 10.2
Contribution to GDP growth in percentage points
Domestic demand –2.6 6.2 3.9 8.8 8.1 9.9 6.1 2.1 –1.1
Net exports of goods and services –2.0 1.0 0.7 –2.5 –0.5 –1.6 0.4 1.9 1.5
Exports of goods and services –5.0 6.9 9.5 1.8 0.4 8.3 8.1 12.5 9.0
Imports of goods and services 3.1 –5.9 –8.8 –4.3 –1.0 –9.9 –7.7 –10.5 –7.5
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) 6.8 2.6 11.8 3.3 2.6 12.5 6.7 12.1 15.9
Unit labor costs in manufacturing (nominal, per hour) 8.4 0.1 8.0 9.3 11.2 6.9 7.5 4.9 12.2
Labor productivity in manufacturing (real, per hour) –0.2 5.9 3.8 0.2 0.5 4.0 2.6 7.2 1.8
Labor costs in manufacturing (nominal, per hour) 7.4 6.8 12.1 9.5 11.7 11.2 10.3 12.4 14.2
Producer price index (PPI) in industry 4.3 13.5 33.4 14.4 20.7 23.4 32.0 41.2 36.9
Consumer price index (here: HICP) 3.4 5.2 15.3 5.0 7.1 8.3 11.0 18.0 23.3
EUR per 1 HUF, + = HUF appreciation –7.4 –2.0 –8.3 –0.1 –1.0 –0.9 –7.9 –12.3 –11.3
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 4.3 4.1 3.7 3.9 3.7 3.8 3.2 3.7 3.9
Employment rate (%, 15–64 years) 69.7 73.1 74.4 73.6 74.1 74.0 74.3 74.6 74.5
Key interest rate per annum (%) 0.8 1.1 8.0 1.3 2.0 3.1 5.3 10.6 13.0
HUF per 1 EUR 351.2 358.5 390.9 353.9 364.3 364.1 385.3 403.5 410.9
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector1 11.0 12.1 9.9 11.6 12.1 9.3 10.2 10.8 9.9
of which: loans to households 14.1 14.9 6.3 16.0 14.9 11.0 8.9 7.6 6.3
loans to nonbank corporations 8.8 9.9 12.6 8.3 9.9 7.9 11.3 13.3 12.6
%
Share of foreign currency loans in total loans to the
nonbank private sector
22.3 20.3 23.3 20.3 20.3 21.3 22.3 23.6 23.3
Return on assets (banking sector) 0.4 0.9 0.7 1.2 0.9 1.1 0.6 0.7 0.7
Tier 1 capital ratio (banking sector) 17.4 18.1 16.7 16.6 18.1 17.3 16.7 16.2 16.7
NPL ratio (banking sector) 2.4 1.6 2.0 1.8 1.6 1.6 1.9 2.0 2.0
% of GDP
General government revenues 43.6 41.2 41.6 .. .. .. .. .. ..
General government expenditures 51.1 48.3 47.8 .. .. .. .. .. ..
General government balance –7.5 –7.1 –6.2 .. .. .. .. .. ..
Primary balance –5.2 –4.8 –3.4 .. .. .. .. .. ..
Gross public debt 79.3 76.6 73.3 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) 68.6 75.8 79.3 .. .. .. .. .. ..
Debt of households and NPISHs2 (nonconsolidated) 20.1 20.4 18.1 .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance –1.0 –2.9 –8.8 –5.4 –5.8 –7.4 –6.9 –11.3 –9.3
Services balance 2.9 3.2 4.7 4.2 2.7 4.3 4.9 5.7 4.1
Primary income –2.6 –3.3 –3.1 –3.6 –3.6 –2.1 –3.4 –3.8 –3.1
Secondary income –0.5 –1.1 –0.9 –0.7 –0.7 –0.6 –1.0 –1.1 –0.9
Current account balance –1.1 –4.1 –8.1 –5.5 –7.4 –5.7 –6.4 –10.5 –9.3
Capital account balance 2.0 2.5 2.0 1.9 4.2 4.3 2.6 1.0 0.6
Foreign direct investment (net)3 –1.7 –1.9 –2.3 –2.4 –5.2 4.4 –2.7 –8.2 –1.9
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 81.1 84.7 88.2 87.9 84.7 85.6 83.7 85.0 88.2
Gross official reserves (excluding gold) 23.3 21.7 19.8 22.8 21.7 19.8 19.6 20.1 19.8
Months of imports of goods and services
Gross official reserves (excluding gold) 3.6 3.3 2.5 3.4 3.3 2.9 2.7 2.6 2.5
EUR million, period total
GDP at current prices 137,723 154,098 169,726 39,852 44,449 37,627 42,129 43,176 46,794
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Foreign currency component at constant exchange rates.
2 Nonprofit institutions serving households.
3 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

8 Poland: sharp slowdown of growth in the wake of weaker consumption

GDP growth amounted to about 5% in full-year 2022 but declined continuously from 10.5% in the first quarter to about 0.5% in the fourth quarter. In quarter-on-quarter terms, GDP rebounded in the third quarter following a contraction after Russia had escalated its war against Ukraine, but it contracted again by 2.4% in the fourth quarter. Foreign demand contributed more to GDP growth than domestic demand, whether including or excluding the contribution from inventory change. This was true both in year-on-year and quarter-on-quarter terms in the second half and particularly in the fourth quarter, even though its contribution also declined in the fourth quarter. Nevertheless, the parallel slowdown of real imports in the wake of weaker domestic demand was sufficiently strong to lead to a positive contribution of net exports to GDP growth throughout the second half of 2022. Correspondingly, in that period, the surplus of the goods and services balance in balance of payment terms was higher than a year earlier, even though in full-year terms it declined from 3.3% to 1.9% of GDP. With the primary balance deficit roughly unchanged at 4.5%, the combined current and capital account deficit came in at 2.7% of GDP in 2022, still fully covered by net FDI inflows of 4% of GDP. The weakening of domestic demand in the second half of 2022 primarily reflected private consumption, as consumer confidence deteriorated and both real wages and real pension payments declined. In contrast, the slowdown of gross fixed capital formation was less pronounced. While industrial confidence, too, was moderately weaker in the second half and capacity utilization declined, other factors including sales profitability, the share of profitable enterprises and corporate liquidity continued to support business investment. Residential investment (measured by the number of dwellings under construction) and housing loans were lower than a year earlier in the second half of 2022.

In the second half of 2022, nominal unit labor costs (ULC) of manufacturing gross value added were higher than a year earlier and their increase exceeded that in the euro area by about 6.5 percentage points, while the złoty’s nominal value in euro was weaker by about 3%. Thus, in real (ULC-deflated) terms, the złoty was stronger by about 3.5%. According to HICP (and national CPI) definition, annual headline inflation stood at almost 16% (17.3%) in the final quarter and at 17.2% (18.4%) in February 2023, while core inflation stood at 13.2% (11.3%) and at 13.6% (12.0%), respectively. Within core HICP inflation, nonenergy industrial goods inflation stood below average at 10.3% in February. The Monetary Policy Council (MPC), pursuing a CPI inflation target of 2.5% ± 1 percentage points, has maintained its main policy rate at 6.75% since its hike in September 2022. In early April 2023, the MPC stated that the earlier strong monetary policy tightening will lead to a gradual decline in inflation toward the target and that this disinflation would be faster if supported by an appreciation of the złoty, which, in the MPC’s assessment, would be consistent with the fundamentals of the Polish economy.

Regarding fiscal policy, the 2022 general government deficit rose to 3.7% of GDP and, according to the European Commission staff forecast in November, it will increase further to 5.5% in 2023. Despite increased military expenditure and spending on support for displaced persons from Ukraine, the deficit rise resulted primarily from a decline in the revenue-to-GDP ratio induced by anti-inflationary tax policy. The general government debt ratio declined from 53.6% of GDP at end-2021 to 49.1% at end-2022.

Table 8: Main economic indicators: Poland  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices –2.0 6.8 4.9 7.4 9.4 10.5 5.2 4.4 0.5
Private consumption –3.4 6.3 3.0 4.6 8.3 6.5 6.3 0.7 –1.4
Public consumption 4.9 5.0 –0.3 5.0 5.7 0.8 1.1 0.5 –2.6
Gross fixed capital formation –2.3 2.1 4.5 5.8 5.7 7.1 9.1 1.6 2.6
Exports of goods and services –1.1 12.5 4.5 8.0 7.3 4.5 5.2 6.8 1.7
Imports of goods and services –2.4 16.1 5.5 13.4 12.4 9.5 7.0 6.0 0.1
Contribution to GDP growth in percentage points
Domestic demand –2.6 7.9 5.2 9.5 11.4 13.0 5.9 3.9 –0.3
Net exports of goods and services 0.6 –1.0 –0.4 –2.2 –2.0 –2.6 –0.7 0.5 0.9
Exports of goods and services –0.6 6.6 2.6 4.3 3.9 3.0 3.3 3.8 0.8
Imports of goods and services 1.2 –7.6 –3.0 –6.5 –5.9 –5.5 –4.0 –3.3 0.1
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) 7.5 –0.8 9.8 –2.6 –1.6 1.7 10.6 13.9 13.3
Unit labor costs in manufacturing (nominal, per hour) 4.7 –4.6 1.8 0.9 –0.8 –1.6 2.1 2.6 4.3
Labor productivity in manufacturing (real, per hour) 1.9 12.9 8.7 8.8 10.3 12.7 9.7 9.0 4.1
Labor costs in manufacturing (nominal, per hour) 6.2 8.0 10.8 9.8 9.4 10.9 12.1 11.7 8.6
Producer price index (PPI) in industry –0.5 8.1 23.7 9.6 13.6 18.5 25.3 27.5 23.7
Consumer price index (here: HICP) 3.7 5.2 13.2 5.1 7.3 9.0 12.8 14.9 15.9
EUR per 1 PLN, + = PLN appreciation –3.3 –2.6 –2.6 –2.8 –2.4 –1.6 –2.5 –3.8 –2.3
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 3.2 3.4 3.0 3.1 2.9 3.2 2.7 3.0 2.9
Employment rate (%, 15–64 years) 68.7 70.3 71.4 71.0 71.0 71.0 71.4 71.2 71.8
Key interest rate per annum (%) 0.5 0.3 5.3 0.1 1.1 2.7 5.1 6.5 6.8
PLN per 1 EUR 4.4 4.6 4.7 4.6 4.6 4.6 4.6 4.7 4.7
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector1 –1.2 5.0 0.8 2.6 5.0 6.1 6.1 4.8 0.8
of which: loans to households 1.6 4.2 –4.7 4.0 4.2 3.1 0.4 –2.5 –4.7
loans to nonbank corporations –6.0 6.5 10.8 –0.1 6.5 11.7 16.9 18.5 10.8
%
Share of foreign currency loans in total loans to the
nonbank private sector
19.6 17.5 18.5 18.0 17.5 17.6 17.7 19.0 18.5
Return on assets (banking sector) 0.0 0.2 0.5 0.5 0.2 1.0 0.8 0.3 0.5
Tier 1 capital ratio (banking sector) 18.5 17.4 17.6 18.0 17.4 16.7 17.0 16.4 17.6
NPL ratio (banking sector) 7.0 5.8 5.4 6.3 5.8 5.7 5.6 5.7 5.4
% of GDP
General government revenues 41.3 42.3 39.8 .. .. .. .. .. ..
General government expenditures 48.2 44.1 43.5 .. .. .. .. .. ..
General government balance –6.9 –1.8 –3.7 .. .. .. .. .. ..
Primary balance –5.6 –0.7 –2.1 .. .. .. .. .. ..
Gross public debt 57.2 53.6 49.1 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) 44.9 43.4 0.0 .. .. .. .. .. ..
Debt of households and NPISHs2 (nonconsolidated) 33.7 32.1 0.0 .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance 1.3 –1.3 –3.7 –2.7 –3.6 –4.2 –3.6 –4.0 –3.1
Services balance 4.4 4.7 5.6 4.6 4.2 5.2 6.6 5.8 4.9
Primary income –3.8 –4.7 –4.5 –5.5 –3.1 –4.7 –5.5 –5.0 –3.1
Secondary income 0.5 –0.1 –0.3 0.2 –0.3 –0.3 –0.4 –0.4 –0.1
Current account balance 2.4 –1.4 –3.0 –3.5 –2.7 –4.1 –3.0 –3.7 –1.4
Capital account balance 1.4 0.7 0.3 1.0 0.8 –0.5 0.5 0.8 0.3
Foreign direct investment (net)3 –2.4 –4.1 –4.0 –5.9 –2.9 –7.7 –3.1 –4.4 –1.3
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 58.5 56.2 53.0 57.1 56.2 55.1 54.9 53.9 53.0
Gross official reserves (excluding gold) 21.7 23.4 22.0 23.8 23.4 21.8 22.0 22.5 22.0
Months of imports of goods and services
Gross official reserves (excluding gold) 5.5 5.2 4.3 5.5 5.2 4.6 4.5 4.4 4.3
EUR million, period total
GDP at current prices 526,034 574,543 654,275 145,387 161,418 149,585 155,613 164,229 184,849
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Foreign currency component at constant exchange rates.
2 Nonprofit institutions serving households.
3 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

9 Romania: economic activity stays resilient, but current account deficit widens further

Despite a challenging external environment, Romania’s economic activity remained resilient in the second half of 2022, bringing full-year GDP growth to 4.8%. Seasonally adjusted quarter-on-quarter growth was stable in the third quarter and decelerated only mildly in the final quarter of the year.

In the second half of 2022, gross fixed capital formation became the most important growth driver supported by partly EU-funded public investments. Alongside, construction output showed double-digit growth. It is also worth mentioning that substantial investments in the areas of electromobility, electricity storage facilities and solar panels have been launched or announced recently. While domestic credit growth slowed down, it was still positive in real terms within the segment of nonbank corporations, but considerably below the inflation rate in the household segment. Private consumption continued to expand, even though real wage growth remained negative in the second half of 2022 and the unemployment rate edged up in the final quarter. Consumer demand benefited from the energy capping scheme (that was extended until March 2025) and the mild winter that limited utility bills. Net exports contributed negatively to GDP growth in second half of 2022, but the negative contribution decreased in the final quarter. Industrial production continued to shrink in the second half of 2022, as particularly energy-intensive sectors (such as metals and chemistry) were hit by high energy costs. Yet, supply chain bottlenecks in the automotive industry have eased. Meanwhile, unit labor costs in the manufacturing sector grew considerably and the Romanian leu tended to appreciate slightly against the euro in the second half of 2022.

Consumer price inflation stood at 16.4% at end-2022 and came down to 15.5% in February 2023. Remarkably, the National Bank of Romania’s (NBR) estimates that the annual inflation rate would have been about 11 percentage points higher without the energy price capping scheme at end-2022. While headline inflation rate started to decline, core inflation was still rising and reached 15% in February 2023. Against this background, the NBR hiked its key policy rate further to 7% in January 2023, and then left it unchanged at the subsequent two board meetings. The NBR currently projects inflation to go down to 7% at end-2023 and to 4.2% at end-2024. Hence, the central bank assumes that inflation will remain above the upper bound of the inflation target variation band of 2.5% ± 1 percentage point until the end of its forecast horizon. After the general government budget deficit fell to still high 6.2% of GDP in ESA 2010 terms, the budget plan for 2023 envisages a further gradual decline of the budget deficit to 4.4%. Within the framework of the excessive deficit procedure, Romania should put an end to the excessive deficit situation by 2024.

The current account deficit widened to 9.3% of GDP in 2022, compared to 7.2% of GDP in 2021 and 8.2% recorded in the four quarters up to mid-2022. Looking at the full-year comparison, the widening of the deficit was driven by the goods balance and the primary income balance (mainly related to outflows of ­reinvested earnings and dividends). In the fourth quarter, both items tentatively improved compared to the third quarter. Also, the capital account surplus rose in the fourth quarter thanks to increasing EU fund inflows. Nevertheless, the net borrowing position from current and capital accounts remained clearly negative in the fourth quarter as well as over the whole year (6.8% of GDP). Net FDI inflows stayed at an elevated level and covered half of this position in 2022.

Table 9: Main economic indicators: Romania  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices –3.7 5.9 4.8 6.7 2.4 6.3 5.1 3.8 4.6
Private consumption –3.7 8.0 5.6 9.4 9.8 7.1 7.8 2.8 5.1
Public consumption 0.6 2.0 –3.2 –2.0 4.7 –2.4 0.1 2.6 –7.0
Gross fixed capital formation 1.4 2.0 8.8 –1.8 –6.5 1.4 2.7 11.4 16.2
Exports of goods and services –9.4 12.8 8.0 7.2 7.9 8.6 9.5 12.9 1.7
Imports of goods and services –5.8 15.4 9.8 11.5 8.4 10.4 7.0 18.2 3.3
Contribution to GDP growth in percentage points
Domestic demand –2.2 7.3 5.5 7.5 3.1 6.9 3.9 6.8 3.1
Net exports of goods and services –1.5 –1.5 –0.8 –2.1 –0.5 –1.8 0.3 –3.1 –0.5
Exports of goods and services –3.8 4.6 3.5 2.5 2.8 4.7 4.3 4.2 0.5
Imports of goods and services 2.3 –6.2 –4.3 –4.6 –3.3 –6.5 –4.0 –7.3 –0.9
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) 5.5 –2.0 5.6 –3.1 –0.1 3.4 3.5 8.2 8.8
Unit labor costs in manufacturing (nominal, per hour) 7.7 3.9 14.5 9.1 12.4 11.7 15.1 13.8 17.1
Labor productivity in manufacturing (real, per hour) 0.4 3.1 –1.6 0.3 –4.0 –0.1 –2.5 –0.6 –2.9
Labor costs in manufacturing (nominal, per hour) 8.1 7.1 12.7 9.4 7.9 11.6 12.2 13.1 13.7
Producer price index (PPI) in industry 0.0 14.9 44.7 16.4 30.8 46.2 47.3 50.5 36.2
Consumer price index (here: HICP) 2.3 4.1 12.0 4.3 6.6 8.2 12.4 13.3 14.1
EUR per 1 RON, + = RON appreciation –1.9 –1.7 –0.2 –1.8 –1.6 –1.4 –0.4 0.4 0.6
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 5.2 5.6 5.6 5.3 5.9 6.0 5.3 5.4 5.8
Employment rate (%, 15–64 years) 65.6 61.9 63.0 62.3 62.1 62.4 63.5 63.4 62.8
Key interest rate per annum (%) 1.9 1.4 4.3 1.3 1.6 2.3 3.4 5.1 6.5
RON per 1 EUR 4.8 4.9 4.9 4.9 4.9 4.9 4.9 4.9 4.9
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector1 4.8 14.2 12.0 12.7 14.2 15.2 17.1 15.7 12.0
of which: loans to households 4.2 9.3 4.3 8.8 9.3 9.3 8.6 6.3 4.3
loans to nonbank corporations 5.5 19.8 20.0 17.3 19.8 21.7 26.4 25.7 20.0
%
Share of foreign currency loans in total loans to the
nonbank private sector
30.5 27.6 31.2 28.4 27.6 27.3 28.0 29.4 31.2
Return on assets (banking sector) 1.0 1.4 1.5 1.5 1.4 1.2 1.5 1.5 1.5
Tier 1 capital ratio (banking sector) 23.2 20.9 18.8 21.4 20.9 19.0 18.9 18.8 18.8
NPL ratio (banking sector) 3.8 3.4 2.7 3.7 3.4 3.3 3.0 2.8 2.7
% of GDP
General government revenues 32.3 32.7 33.5 .. .. .. .. .. ..
General government expenditures 41.5 39.8 39.7 .. .. .. .. .. ..
General government balance –9.2 –7.1 –6.2 .. .. .. .. .. ..
Primary balance –8.0 –6.0 –5.0 .. .. .. .. .. ..
Gross public debt 46.9 48.6 47.3 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) 33.0 33.1 30.9 .. .. .. .. .. ..
Debt of households and NPISHs2 (nonconsolidated) 16.0 15.7 13.8 .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance –8.6 –9.6 –11.3 –9.4 –9.2 –12.2 –11.4 –11.7 –10.2
Services balance 4.3 3.9 4.4 3.5 4.0 4.4 5.0 4.1 4.1
Primary income –1.5 –2.0 –3.0 –2.7 –1.8 –2.2 –3.7 –4.0 –2.1
Secondary income 0.9 0.4 0.7 0.8 0.3 0.4 0.7 0.8 0.6
Current account balance –4.9 –7.2 –9.3 –7.8 –6.6 –9.5 –9.4 –10.7 –7.6
Capital account balance 1.9 2.2 2.4 1.5 4.1 1.0 2.1 1.5 4.5
Foreign direct investment (net)3 –1.3 –3.7 –3.4 –4.1 –3.5 –5.3 –2.3 –3.9 –2.5
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 57.6 56.6 49.8 56.7 56.6 54.7 52.6 50.4 49.8
Gross official reserves (excluding gold) 17.0 16.8 16.3 17.5 16.8 16.1 16.1 16.0 16.3
Months of imports of goods and services
Gross official reserves (excluding gold) 4.9 4.3 4.0 4.7 4.3 4.1 4.0 3.9 4.0
EUR million, period total
GDP at current prices 220,325 241,099 286,526 65,854 72,934 54,572 67,066 79,062 85,825
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Foreign currency component at constant exchange rates.
2 Nonprofit institutions serving households.
3 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

10 Türkiye: fragile economy hit by earthquake as country awaits election outcome

GDP growth amounted to 5.6% in 2022, declining from almost 8% in the first half to less than 4% in the second half of the year. The main driving force was private consumption, followed by real exports, while gross fixed capital formation almost stagnated in the second half of the year. Real export growth turned negative in the fourth quarter. By contrast, real import growth was far lower than that of real exports in the first three quarters, but it stood at about 10% in the fourth quarter so that net exports’ contribution to GDP turned negative. However, the sum of growth contributions of all published demand components amounted to GDP growth of about 14% in 2022, far above the published rate. The difference could stem from a very large negative contribution of inventory change, for which no figures are published, and from an underreporting of real imports. Balance-of-payments import growth (in USD) was considerably higher, possibly reflecting not only higher energy import prices. It outpaced export growth by far so that both goods and services deficit and current account deficit widened by 4 percentage points year on year, reaching about 4.5% and 5.5%, respectively, of GDP in 2022. Net FDI inflows remained at close to 1% of GDP and, together with net other investment inflows, financed portfolio investment outflows and part of the current account deficit. Net errors and omissions amounted to 3% of GDP, financing the other part and preventing gross official reserves from declining sharply relative to GDP. At the same time, off-balance sheet net short positions due within one year amounted to about 100% of official FX reserves, with about half from FX swaps with domestic banks and the other half from swaps with Arabian and Asian central banks. Most recently, Saudi Arabia joined this list of creditors.

Both headline and core inflation decelerated from their peaks of 85% and 79%, respectively, in October to 55% and 57%, respectively, in February. In parallel, the Turkish central bank (TCMB) delivered policy rate cuts by 150 basis points each in October and November (to 9%) and another one in February to 8.5%, implying a large negative real key rate. While the lira depreciated by 10% in nominal terms against the euro from August to February, it appreciated by about 11% in real (CPI-deflated) terms. Lira stabilization without interest rate hikes resulted (1) from the continuous requirement for exporters to sell part of their FX revenues to the central bank, (2) from government financing and guarantees for new exchange rate-linked lira deposits stemming from converted FX deposits and (3) from regulatory measures to foster “liraization” of banks’ assets and liabilities. Initially, reserve requirement ratios and requirements to hold lira (government) securities depended inversely on a bank’s share of converted deposits in its total FX deposits. From 2023, required securities maintenance depended inversely on a bank’s compliance (or overcompliance) with the new 60% target share of lira deposits. As a result, in the second half of 2022, the correction of banks’ negative on-balance sheet net FX position continued, lowering their need for entering swaps with the central bank by selling FX initially (given the ban on contracting foreign swap partners). In parallel, nonfinancial corporations reduced their overall negative on-balance sheet net FX position further and their positive short-term on-balance net FX position rose moderately again.

The general government fiscal deficit increased to 3.5% of GDP in 2022, up from 1.1% of GDP in 2021. In the wake of the earthquake and related to upcoming elections, the deficit will likely rise further.

Table 10: Main economic indicators: Türkiye  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices 1.9 11.3 5.6 7.9 9.6 7.6 7.9 4.1 3.5
Private consumption 3.3 15.3 19.6 9.4 20.5 20.7 22.3 20.3 16.0
Public consumption 2.5 2.6 5.1 8.0 1.3 4.5 1.6 4.6 9.0
Gross fixed capital formation 7.4 7.4 2.8 –1.3 2.1 4.5 5.3 –0.9 2.6
Exports of goods and services –14.4 24.9 9.1 25.9 21.6 14.3 16.4 12.4 –3.2
Imports of goods and services 6.7 2.4 7.9 –8.7 3.2 2.2 5.8 11.9 10.2
Contribution to GDP growth in percentage points
Domestic demand 4.1 11.4 13.4 6.3 12.7 14.2 15.1 12.6 12.2
Net exports of goods and services –5.4 5.0 0.5 7.4 4.4 3.0 2.8 0.5 –3.4
Exports of goods and services –3.8 5.6 2.3 5.3 5.2 3.5 4.1 3.0 –0.9
Imports of goods and services –1.6 –0.6 –1.8 2.1 –0.8 –0.5 –1.3 –2.5 –2.5
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) .. .. .. .. .. .. .. .. ..
Unit labor costs in manufacturing (nominal, per hour) 10.0 19.1 74.3 29.2 26.7 48.4 53.8 93.7 100.0
Labor productivity in manufacturing (real, per hour) 8.3 –0.2 –0.5 –1.1 3.3 2.1 2.6 –1.0 –5.2
Labor costs in manufacturing (nominal, per hour) 18.9 19.1 73.8 27.8 30.9 51.4 57.8 91.9 89.7
Producer price index (PPI) in industry 12.2 43.9 128.5 44.8 60.6 104.7 131.0 146.7 127.7
Consumer price index (here: HICP) 12.3 19.6 72.3 19.2 25.9 54.8 74.1 81.0 77.3
EUR per 1 TRY, + = TRY appreciation –21.0 –23.2 –39.8 –15.9 –26.4 –43.1 –39.8 –44.3 –32.8
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 13.4 12.2 10.7 11.9 11.2 11.8 10.4 10.3 10.3
Employment rate (%, 15–64 years) 47.5 50.3 52.8 51.6 51.7 50.8 53.0 53.5 54.0
Key interest rate per annum (%) 10.2 17.8 12.9 18.9 15.9 14.0 14.0 13.4 10.2
TRY per 1 EUR 8.0 10.5 17.4 10.1 12.8 15.7 16.8 18.1 19.0
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector1 4.3 8.6 12.7 14.5 36.1 45.1 60.4 68.7 56.3
of which: loans to households 6.6 13.4 14.6 15.9 20.4 22.7 37.5 42.0 55.4
loans to nonbank corporations 2.9 5.5 11.4 14.7 41.9 52.4 67.4 77.5 56.8
%
Share of foreign currency loans in total loans to the ­nonbank private sector 30.9 38.1 27.7 32.2 38.1 37.0 33.9 31.1 27.7
Return on assets (banking sector) 1.0 1.3 3.8 1.1 1.3 2.6 3.3 3.5 3.8
Tier 1 capital ratio (banking sector) 14.1 13.2 15.3 12.9 13.2 15.4 13.6 14.4 15.3
NPL ratio (banking sector) 4.4 3.4 2.2 3.8 3.4 3.0 2.7 2.4 2.2
% of GDP
General government revenues 31.2 31.4 32.1 .. .. .. .. .. ..
General government expenditures 35.9 32.5 35.6 .. .. .. .. .. ..
General government balance –4.7 –1.1 –3.5 .. .. .. .. .. ..
Primary balance –1.6 2.1 –0.8 .. .. .. .. .. ..
Gross public debt 39.7 41.8 39.4 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) .. .. .. .. .. .. .. .. ..
Debt of households and NPISHs1 (nonconsolidated) .. .. .. .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance –5.3 –3.6 –10.0 –3.2 –4.2 –11.8 –9.0 –11.4 –8.4
Services balance 1.6 3.2 5.7 5.3 3.9 3.5 5.3 8.4 4.8
Primary income –1.3 –1.4 –0.9 –1.1 –1.2 –1.3 –1.2 –0.9 –0.6
Secondary income 0.0 0.1 0.0 0.1 0.1 –0.2 –0.1 0.0 0.1
Current account balance –5.0 –1.7 –5.4 1.1 –1.4 –9.9 –5.1 –3.8 –4.1
Capital account balance 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Foreign direct investment (net)2 –0.6 –0.8 –0.9 –1.4 –0.6 –0.4 –1.8 –0.7 –0.8
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 51.3 50.8 44.0 53.0 50.8 51.6 51.1 51.0 44.0
Gross official reserves (excluding gold) 6.5 9.3 9.1 10.7 9.3 8.3 7.5 8.9 9.1
Months of imports of goods and services
Gross official reserves (excluding gold) 2.4 3.2 2.6 3.8 3.2 2.6 2.2 2.5 2.6
EUR million, period total
GDP at current prices 625,392 687,929 853,070 191,802 182,302 160,450 203,933 236,083 252,605
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Nonprofit institutions serving households.
2 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

11 Russia: high oil revenues keep recession relatively mild despite severe Western sanctions

High energy prices, a successful rechanneling of oil exports to nonsanctioning countries and competent fiscal and monetary management have helped cushion the effects of major Western sanctions in response to Russia’s invasion of Ukraine. The EU oil and oil products embargo against Russia and the G7 oil price cap for Russian deliveries to third countries, however, created further challenges from December 2022 (EU oil embargo, G7 oil price cap) and February 2023 (EU oil products embargo) onward.

Russia’s GDP contracted by 2.1% in 2022. Driving forces of the drop in economic activity were the decline of private consumption (–1.4%) and the substantial shrinkage of inventories (following a major buildup in the previous year). On the other hand, economic activity was supported by government consumption (+2.8%) and fixed investment (+3.3%, notably boosted by public investment in transportation infrastructure, enterprise restructuring and increased arms production).

Partly supported by continuing capital controls, the ruble’s exchange rate remained relatively high until November (around RUB 60 per USD), before losing about 20% of its value in late 2022 and early 2023. This downward slide was largely caused by the declining Urals oil price (from USD 67 per barrel in November 2022 to USD 50 in January–February 2023), which was mostly triggered by the abovementioned new EU and US oil sanctions. As of late March 2023, the ­ruble had fallen back to its pre-invasion level (of around RUB 76–77 per USD). Inflation continued to decline to 11% in February 2023 (year on year). After ­reducing its key rate to 7.5% in mid-September 2022, the CBR has so far left it at this level.

The unemployment rate reached a new post-Soviet record low of 3.7% (ILO definition) in January 2023. This i.a. reflects a very tight labor market, after hundreds of thousands left Russia following the start of the Ukraine invasion and the mobilization wave a few months later. Although the average Urals oil price was higher in 2022 than in 2021, the general government balance reverted from a small surplus in 2021 to a deficit of 1.4% of GDP in 2022, on the back of rising budgetary support for strategic enterprises, households and arms production as well as of sharply declining imports and thus import taxes due to Western trade restrictions. The deficit was financed to a larger degree on the domestic debt market, and to a smaller degree by drawing down on the National Wealth Fund. Russia’s low government debt (end-2022: 15.1% of GDP) still provides the authorities with sufficient leeway to take recourse to domestic deficit financing.

The abovementioned substantial dip of the Urals oil price in January–February 2023, combined with (one-off) technical effects of the move to a single tax account system as well as brought-forward VAT refunds, triggered a sharp widening of the budget deficit in those two months. Western oil-related sanctions will likely render the budgetary situation more difficult in 2023. High energy export prices until November 2022 and sharply contracting imports in the wake of sanctions triggered a record current account surplus of 10.2% of GDP in 2022. In the second half-year of 2022, the banking sector managed to offset its initial sanctions-triggered loss and achieve a very modest overall profit of about USD 3 billion in full-year 2022, which is, however, less than one-tenth of the corresponding figure of 2021.

Table 11: Main economic indicators: Russia  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Year-on-year change of the period total in %
GDP at constant prices –2.7 5.6 –2.1 5.0 5.8 3.0 –4.5 –3.5 –2.7
Private consumption –5.9 9.9 –1.4 9.8 7.8 5.6 –4.4 –3.6 –2.7
Public consumption 1.9 2.9 2.8 2.6 2.4 1.9 2.3 2.4 4.7
Gross fixed capital formation –4.0 9.1 3.3 11.3 5.9 7.4 2.7 1.8 3.0
Exports of goods and services –4.2 3.3 –13.9 8.5 6.8 3.6 –15.8 –26.6 –14.6
Imports of goods and services –11.9 19.1 –15.0 21.6 19.8 1.4 –27.6 –20.5 –11.2
Contribution to GDP growth in percentage points
Domestic demand –3.5 8.2 –1.4 7.0 7.7 1.9 –5.9 –0.1 –1.2
Net exports of goods and services 1.1 –2.5 –1.1 –1.3 –1.6 0.8 1.2 –3.9 –1.9
Exports of goods and services –1.3 1.0 –4.2 2.5 1.9 1.1 –4.8 –8.1 –4.1
Imports of goods and services 2.4 –3.5 3.1 –3.8 –3.5 –0.3 6.0 4.2 2.2
Year-on-year change of period average in %
Unit labor costs in the whole economy (nominal, per person) .. .. .. .. .. .. .. .. ..
Unit labor costs in manufacturing (nominal, per hour) 7.6 3.3 16.5 3.3 4.4 12.0 14.8 18.8 20.5
Labor productivity in manufacturing (real, per hour) –1.4 7.2 –1.2 7.7 8.1 4.8 –3.3 –2.1 –3.7
Labor costs in manufacturing (nominal, per hour) 5.9 10.9 15.2 11.3 12.8 17.7 11.0 16.4 16.0
Producer price index (PPI) in industry –3.7 24.6 12.8 28.2 28.3 25.6 21.4 5.2 –1.2
Consumer price index (here: HICP) 3.4 6.7 13.7 6.9 8.3 11.5 16.9 14.4 12.2
EUR per 1 RUB, + = RUB appreciation –12.3 –5.3 18.1 –0.3 9.3 –8.7 24.3 42.7 28.6
Period average levels
Unemployment rate (ILO definition, %, 15–64 years) 5.8 4.8 3.9 4.4 4.3 4.2 3.9 3.9 3.8
Employment rate (%, 15–64 years) .. .. .. .. .. .. .. .. ..
Key interest rate per annum (%) 5.0 5.7 10.6 6.3 7.5 12.7 13.9 8.3 7.5
RUB per 1 EUR 82.6 87.2 73.9 86.6 83.1 98.3 72.0 60.7 64.6
Nominal year-on-year change in period-end stock in %
Loans to the domestic nonbank private sector1 9.6 15.3 14.0 13.9 15.3 15.6 11.7 12.1 14.0
of which: loans to households 12.9 22.1 9.4 20.7 22.1 20.3 12.2 10.2 9.4
loans to nonbank corporations 8.0 12.2 16.4 10.8 12.2 13.3 11.4 13.0 16.4
%
Share of foreign currency loans in total loans to the nonbank private sector 12.6 10.8 7.5 10.8 10.8 11.2 7.3 6.7 7.5
Return on assets (banking sector) 1.9 2.4 0.2 2.6 2.4 –0.8 –2.4 –0.9 0.2
Tier 1 capital ratio (banking sector) 9.7 9.6 10.4 9.8 9.6 .. .. 10.6 10.4
NPL ratio (banking sector) 17.1 15.1 15.3 15.8 15.1 .. .. 15.9 15.3
% of GDP
General government revenues 35.5 35.6 34.6 .. .. .. .. .. ..
General government expenditures 39.5 34.8 36.0 .. .. .. .. .. ..
General government balance –4.0 0.8 –1.4 .. .. .. .. .. ..
Primary balance .. .. .. .. .. .. .. .. ..
Gross public debt 17.6 15.5 15.1 .. .. .. .. .. ..
% of GDP
Debt of nonfinancial corporations (nonconsolidated) .. .. .. .. .. .. .. .. ..
Debt of households and NPISHs2 (nonconsolidated) .. .. .. .. .. .. .. .. ..
% of GDP (based on EUR), period total
Goods balance 6.3 10.4 13.5 11.3 12.4 20.0 17.4 11.4 8.7
Services balance –1.1 –1.1 –1.0 –1.4 –1.1 –0.9 –0.6 –1.1 –1.2
Primary income –2.3 –2.3 –2.0 –2.2 –2.6 –2.0 –2.0 –2.4 –1.5
Secondary income –0.4 –0.3 –0.4 –0.3 –0.2 –0.3 –0.5 –0.3 –0.3
Current account balance 2.4 6.7 10.2 7.4 8.5 16.8 14.3 7.6 5.6
Capital account balance 0.0 0.0 –0.2 0.0 0.0 0.0 –0.2 –0.3 –0.2
Foreign direct investment (net)3 –0.2 1.4 1.3 0.9 2.7 0.2 2.2 1.6 0.9
% of GDP (rolling four-quarter GDP, based on EUR), end of period
Gross external debt 29.9 27.4 16.5 30.1 27.4 25.4 26.1 22.3 16.5
Gross official reserves (excluding gold) 28.6 28.2 19.3 29.5 28.2 25.9 24.4 21.5 19.3
Months of imports of goods and services
Gross official reserves (excluding gold) 16.8 16.4 15.0 16.7 16.4 15.0 15.9 15.6 15.0
EUR million, period total
GDP at current prices 1,301,316 1,558,582 2,162,355 408,332 482,544 370,340 507,680 630,437 653,898
Source: Bloomberg, European Commission, Eurostat, national statistical offices, national central banks, wiiw, OeNB.
1 Foreign currency component at constant exchange rates.
2 Nonprofit institutions serving households.
3 + = net accumulation of assets larger than net accumulation of liabilities (net outflow of capital).
– = net accumulation of assets smaller than net accumulation of liabilities (net inflow of capital).

Ukraine: economy has been hit hard but continues to function due to increasing international financial support

Ukraine’s GDP collapsed by roughly 30% in 2022, because of Russia’s war of aggression, which has affected the economy via the destruction of production capacities and infrastructure, flight movements within the country and abroad, and through a severe restriction of export ­opportunities. In particular, much of the export through Black Sea ports has ceased, with the exception of the possibility of exporting agricultural goods under the Black Sea Grain Initiative through some ports remaining under Ukrainian control. Massive Russian attacks on civilian and energy infrastructure since the fall of 2022 have led to power shortages and interrupted the economic recovery from the shock of the first phase of the full-scale war. After GDP grew 9% quarter on quarter in the third quarter of 2022, it shrank again by 4.7% quarter on ­quarter in the fourth quarter. The liberation of parts of the country from Russian occupation in autumn and resuming business activity as well as rebuilding probably helped contain the renewed GDP drop. The situation in the energy sector started to improve in early 2023.

The trade deficit (goods and services) of USD 25.9 billion in 2022 was almost 10 times higher than in 2021 (USD 2.7 billion), as the slump in exports by far exceeded the decline in imports. Services imports were fueled by expenses of Ukrainians who went abroad due to the war. Yet, as the secondary income balance (as a result of grants and humanitarian aid from abroad) and the primary income balance (as a result of largely stable remittances inflows and sharply falling investment income outflows) improved strongly, there was a current account surplus of USD 8.0 billion.

The deep war-driven recession hit labor demand hard: According to a survey, 36% of those who had a job before the start of the war were unemployed in February 2023. The war, ­together with the resulting currency devaluation, also caused the inflation rate to rise to 26.6% at end-2022 from about 10% before the full-scale war began. Yet, inflation trended down to 24.9% in February 2023. The National Bank of Ukraine has left its key policy rate stable since the hike to 25% in early June last year. The peg vis-à-vis the USD remained unchanged after the 25% devaluation in July 2022.

The budget deficit increased to 16.7% of GDP in 2022 but would have been by about 10 percentage points higher when excluding grants (primarily from the US) from revenues. ­Restraining the deficit at lower levels would have resulted in an even deeper economic slump. This deficit widening without the consequence of much stronger inflation acceleration was only possible due to international financial assistance in the amount of USD 32 billion, which ­financed 60% of the deficit (excluding grants), while bond sales to the central bank (monetary financing) contributed 25% and other bond issues domestically 15%.

For the year 2023, international financial assistance was scheduled to reach more than USD 40 billion, including support from the G7 and other countries, the EU and the IMF. A four-year USD 15.6 billion Extended Fund Facility was approved by the IMF Executive Board at end-March 2023 and is playing a key role in anchoring policies. Monetary financing ceased this year, and the Ukrainian authorities took measures to revive the domestic bond market. Thanks to improving international financial support inflows, Ukraine’s international reserves rose to USD 31.9 billion at end-March 2023 from USD 22.3 billion at end-July 2022 (i.e. the lowest level recorded in 2022). Central bank interventions to support the hryvnia stood at a high level at end-2022 but have decreased since then. In parallel, the spread between the cash market rate and the official exchange rate narrowed, partly also reflecting policy measures.

1 Compiled by Josef Schreiner with input from Katharina Allinger, Stephan Barisitz, Mathias Lahnsteiner, Thomas Reininger, Thomas Scheiber, Tomáš Slacˇík and Zoltan Walko.

2 Cut-off date: April 14, 2023. This report focuses primarily on data releases and developments from October 2022 up to the cut-off date and covers Slovakia, Slovenia, Bulgaria, Croatia, Czechia, Hungary, Poland, Romania, Türkiye and Russia. The countries are ranked according to their level of EU integration (euro area countries, EU member states and non-EU countries).

3 All growth rates in the text refer to year-on-year changes unless otherwise stated.

Relative resilience in the face of post-pandemic and
war-implied challenges, but pockets of vulnerabilities call for continued vigilance 4

Economic slowdown caused by global and domestic factors

Table 1: Real GDP growth  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Annual real change in %
Gross domestic product
Albania –3.3 8.9 4.8 6.9 5.1 7.0 3.1 4.9 4.7
Bosnia and Herzegovina1 –3.0 7.4 3.9 7.6 7.8 5.9 5.8 2.6 1.7
Kosovo –5.3 10.7 3.5 14.5 7.9 2.2 0.7 3.9 6.8
Montenegro –15.3 13.0 6.1 27.9 9.3 4.7 13.6 2.8 4.7
North Macedonia –4.7 3.9 2.1 1.4 1.2 2.2 4.0 2.0 0.6
Serbia –0.9 7.5 2.3 7.8 7.2 4.1 3.8 1.0 0.4
WB average2 –3.0 7.8 3.2 8.3 6.5 4.5 4.3 2.2 1.9
Source: Eurostat.
1 Expenditure-side data.
2 Average weighted with GDP at PPP.

Following a relatively robust recovery from the pandemic in 2021, the economic performance in the Western Balkans 5 (WB) slowed down significantly in 2022, particularly in the second half of the year (table 1). Hence, after 7.7% in 2021, ­average GDP-weighted real economic growth in the region dropped to just above 3% last year. It ranged between about 2% in North Macedonia and 6% in ­Montenegro. It is worth noting that half of the WB countries experienced real GDP growth in 2022 at or below the EU average (3.5%) thus setting back real convergence. Russia’s war against Ukraine and its repercussions have put a significant, although mainly indirect, drag on the Western Balkan economies. The slackening of economic activity was thus predominantly brought about by the global macroeconomic environment, which had clouded because of post-pandemic supply chain frictions and an ubiquitous surge in (commodity) prices that had not been seen in a long time, among other factors. The situation has been exacerbated by Russia’s war in Ukraine, resulting in a simultaneous tightening of financial conditions. On the external side, the small and rather open WB economies have suffered from weak foreign demand, particularly from the EU, which accounts for some 35% to 80% of WB exports. In contrast, the direct trade exposure of the Western Balkans to Russia, Ukraine and Belarus is rather limited. In addition, some idiosyncratic domestic factors affected economic performance in the region last year. For example, the summer drought hampered the relatively important agricultural sector in ­Serbia and, via lower hydropower generation, it impaired industrial production in some countries. In Serbia, in particular the drought aggravated disturbances in ­electricity production owed to damages in the major power station. Industrial ­production thus declined by as much as 43% in Q2 in an annual comparison.

Domestic demand drove moderate economic growth while net exports lagged behind

On the expenditure side, economic growth in the WB region in 2022 was driven by domestic demand while net exports made a negative contribution to GDP growth in all countries but Kosovo. Among the domestic demand components, household consumption played a dominant role, especially in the first half of the year, benefiting from rather buoyant wage growth and improving labor market conditions (table 2). Household consumption was also bolstered to some extent by various government support measures to mitigate the increase in cost of living, strong credit growth (especially in Kosovo), resilient inflows of remittances
and the arrival of (well-off) residents in the wake of Russia’s invasion to Ukraine (especially in Montenegro and Serbia). However, these nominal boosts to disposable incomes have been increasingly counteracted in real terms by accelerated ­inflation.

Investment made a positive contribution to economic growth in Albania, ­Bosnia and Herzegovina and North Macedonia. In Albania, it was particularly fixed investment which benefited from a booming construction sector and strong FDI inflows heading into the real estate and tourism industry. In Bosnia and ­Herzegovina, capital formation profited from favorable lending activity and stockpiling of inventories. Similarly, an accumulation of inventories was the predominant driver of capital formation in North Macedonia. This was brought about by an ­increase in the import of intermediary goods, raw materials, energy products, ­machinery and equipment, among others. Yet barring this special case, gross ­investment was rather muted in general, suffering from elevated input costs and geopolitical uncertainty, subdued foreign demand and contracting industrial ­production (Montenegro).

The contribution of public consumption to growth was rather insignificant in most instances or it was slightly negative as earlier pandemic support measures were phased out. While exports of services in the tourism strongholds benefited from a strong tourism season, overall net exports remained subdued in most of the region in 2022, some recovery in Kosovo and Serbia in the second half of the year notwithstanding. This was owed to muted foreign demand in the EU, which is the region’s most important trading partner by far, as well as to the fact that export growth was outpaced by increases in imports (including those of services, e.g. in Albania due to outbound tourism).

Chart 1, GDP growth and growth contributions in the Western Balkans, is a stacked vertical bar chart showing contributions of demand side components to GDP growth in the six Western Balkan countries. For each country, the chart shows annual data for the years 2021 and 2022 and quarterly data for 2022. In all countries, net exports made a strong negative contribution to growth in 2022 while private consumption made the most significant positive contribution in all countries. Regarding gross (fixed) capital formation the picture is mixed. However, it particularly captures the reader’s attention that, in North Macedonia, there was a very significant positive contribution of gross capital formation (around 9 percentage points) in Q1 and Q2 2022. This was driven predominantly by inventories. 

Source: Eurostat, Vienna Institute for International Economic Studies, national statistical institutes.

While official labor market figures might not provide an entirely accurate picture due to high levels of informality and data (availability) limitations, the readings suggest that labor markets tightened further in 2022. Unemployment, whose solid long-lasting downward trend was partially interrupted during the pandemic, ­resumed its decline in 2022 (table 2) in all countries in the region 6 . At end-2022, the unemployment rate thus ranged between nearly 10% in Serbia and just above 15% in Bosnia and Herzegovina. Employment also somewhat improved in the ­entire region so that at end-2022 between one-third (Kosovo) and two-thirds ­(Albania) of the potential working population were employed. Despite continued improvements, formal employment, in most cases, remains well below the EU ­average (about 70%), suggesting not only persistent structural mismatches ­between labor demand and supply but also a comparably large informal sector.

Labor shortages have become more severe in the face of tightening (formal) labor markets exacerbated by outward migration and adverse demographic trends. Labor shortages have been exerting mounting pressure on wages (table 2), especially in the booming sectors. Nominal wage growth accelerated in all WB economies throughout 2022, largely driven by wage hikes in the private sector and amplified by increases in minimum wages. Shortages of skilled labor are increasingly becoming a binding constraint for firms’ ability to do business. Nonetheless, nominal wage hikes mostly did not keep up with accelerated inflation in 2022 so that real wage growth ended up in negative territory except for Serbia and to a lesser extent ­Albania.

Table 2: Labor market  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
Annual change in %
Average gross wages –
total economy
Albania 2.7 6.3 8.2 6.9 8.4 5.8 7.0 9.2 10.8
Bosnia and Herzegovina 4.0 4.4 11.7 4.5 5.1 8.2 10.7 13.4 14.4
Kosovo –2.3 3.9 19.8 . . . . . . . . . . . .
Montenegro 1.3 1.4 11.3 1.7 1.9 11.3 10.6 11.4 11.8
North Macedonia 8.3 5.7 11.1 4.8 5.4 7.7 10.4 12.0 14.1
Serbia 9.5 9.4 13.8 9.0 11.8 13.4 13.6 14.8 13.4
%
Unemployment rate1
Albania 12.2 12.1 11.3 11.6 11.9 11.7 11.5 10.8 11.0
Bosnia and Herzegovina 16.2 17.5 15.5 . . . . . . . . . . . .
Kosovo 26.0 20.8 0.0 17.7 19.0 16.6 0.0 0.0 0.0
Montenegro 18.4 16.9 15.1 15.0 15.7 17.0 14.9 13.4 14.9
North Macedonia 16.6 15.8 14.6 15.9 15.3 14.9 14.7 14.4 14.2
Serbia 9.5 11.4 9.7 10.8 10.2 11.0 9.2 9.3 9.4
Source: Eurostat, Macrobond, national statistical offices, wiiw.
1 Labor force survey.

Widening external deficits do not appear a major cause for concern

External deficits relative to GDP widened in all countries but Albania in 2022, primarily on account of higher trade deficits. These were brought about mainly by elevated import prices of commodities and comparably weaker export performance attributable to moderated foreign demand. The goods trade deficit thus widened by between 2.9 (Kosovo) and 7.5 (Montenegro) percentage points of GDP in the twelve months to December 2022 while it improved by 2.6 percentage points of GDP in Albania. The deteriorations in the goods trade deficits were partially offset by higher surpluses in the services balance. The latter’s improvement was particularly strong in Albania (more than 6 percentage points of GDP), Montenegro (3.5 percentage points) and Kosovo (2.5 percentage points) thanks to the recovery in ­tourism. The influx of remittances recorded in the secondary income balance ­remained robust. Hence, overall, the combined current and capital account deficit widened by 2 (Kosovo) to 4 (Montenegro) percentage points of GDP during 2022. Albania was the only country where it slightly improved. The combined ­current and capital account deficits thus ranged between some 4.4% of GDP in Bosnia and Herzegovina and 13% in Montenegro. Yet, these imbalances were ­(almost) fully covered by FDI inflows in Albania, Montenegro and Serbia and to a large extent in the remaining countries (chart 2).

Chart 2, External accounts in the Western Balkans, is a stacked vertical bar chart showing the balances of the goods, services, primary and secondary income accounts relative to GDP for the six Western Balkan countries. In addition, the chart displays the share of FDI in GDP as well as the sum of the current and capital accounts relative to GDP. For each country, the chart shows annual data for the years 2021 and 2022 and quarterly data for 2022. In all countries but Albania the combined current and capital account deficit widened by 2 (Kosovo) to 4 (Montenegro) percentage points of GDP during 2022. Albania was the only country where it slightly improved. The combined current and capital account deficits ranged between some 4.4% of GDP in Bosnia and Herzegovina and 13% in Montenegro. These imbalances were (almost) fully covered by FDI inflows (in Albania, Montenegro and Serbia) or to a large extent (in the remaining countries).

Source: National central banks, national statistical offices, Vienna Institute for International Economic Studies.

The development of external accounts was inversely reflected by the level of reserves relative to GDP. It declined in all countries in the region (apart from ­Serbia), reflecting the strong increase in the value of imports (relative to exports) among other factors (table 3). In Serbia, in contrast, international reserves recovered to record highs in absolute terms (more than EUR 21 billion by end-February 2023) thanks to strong FDI inflows and higher external borrowing. The latter ­increased particularly after Serbia had sought help from both the IMF and the United Arab Emirates (UAE) in the second half of 2022 to handle its soaring ­market debt costs. As a result, Serbia turned to the IMF and concluded a Stand-by Arrangement (SBA) and obtained a loan at preferential conditions from the UAE.

Table 3: Reserve assets excluding gold  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
End of period, % of GDP
Albania 28.6 31.9 26.6 19.1 21.8 21.0 20.0 19.6 18.5
Bosnia and Herzegovina 39.1 41.1 34.3 27.7 28.1 26.9 25.7 25.0 23.7
Kosovo1 13.3 13.8 13.1 11.1 9.5 9.8 10.7 11.6 8.8
Montenegro 41.5 35.3 31.4 23.4 23.9 23.6 22.4 23.1 20.9
North Macedonia 27.8 28.1 27.0 20.1 18.7 16.5 15.6 18.6 18.3
Serbia 25.1 27.2 28.7 20.3 18.6 15.4 15.6 16.9 19.4
Source: National central banks, IMF.
1 Reserve assets (including gold).

Despite mostly prudent fiscal stance in the region, pockets of fiscal vulnerability remain and need to be addressed

Except for Montenegro, where the general government deficit widened significantly and contributed to the inflationary pressure, the fiscal stance in the WB region was rather prudent in 2022 and added only marginally to aggregate demand. The fiscal deficit relative to GDP remained broadly unchanged in North Macedonia while Bosnia and Herzegovina recorded a slight increase, yet at a rather low level (table 4). By contrast, the fiscal deficit decreased in Albania and Kosovo, and also marginally in Serbia – despite 2.5% of GDP spent on subsidies and loans to energy state-owned enterprises. Before Serbia managed to successfully return to the ­international capital market in January 2023, the SBA from the IMF and the loan from the UAE helped cover the large extra costs resulting from the energy crisis.

In general, while the revenue side was aided by the still – relatively – robust economic activity in the region, it was particularly driven up by high inflation. To some extent also tax collection improved, most notably in Kosovo, inter alia thanks to the progressing formalization of the economy. Expenditures also increased in nominal terms. On the one hand, this was predominantly attributable to measures aiming to mitigate inflationary pressures on households and firms such as, inter alia, price caps, (energy) subsidies, bonuses, additional pensions and transfers. On the other hand, in most countries, government expenses such as public sector wages and investment costs increased in response to inflationary pressures. In ­contrast, however, in some instances (e.g. in Albania, Kosovo, Montenegro) low execution of public investment plans dampened the expenditure side and thus contributed to a better fiscal outcome.

General government debt relative to GDP declined in most cases, most significantly in Montenegro. In the latter country, this was – despite the highest fiscal deficit in the region – due to strong nominal GDP growth on the one hand and some debt repayment on the other. Yet, the reduction of public debt in Montenegro notwithstanding, it remains the country with the highest debt among its peers. Moreover, from the current budgetary perspective, the expansionary fiscal stance is envisaged to continue in the medium term 7 . This does not only elevate the
fiscal risk but also adds to inflationary pressure, especially in a country with no autonomous monetary policy. Notable fiscal vulnerabilities persist – despite some progress – also in Albania, primarily due to high refinancing requirements and exposure to interest and exchange rate risks amid tightening financial conditions as well as energy price volatility. Against this background, it is key to restore fiscal buffers to be able to cope with future shocks. Rather quick and decisive fiscal ­consolidation is also in the cards for Serbia and North Macedonia, in the former under the auspices of the IMF.

Table 4: Fiscal policy indicators  
2020 2021 2022f 2020 2021 2022f
General government balance General government debt
End of period, % of GDP
Albania –6.7 –4.5 –3.5 74.5 73.2 69.4
Bosnia and Herzegovina –5.2 –0.3 –1.0 36.1 34.0 34.0
Kosovo –7.6 –1.3 –0.5 22.0 21.1 19.6
Montenegro –11.1 –1.9 –5.6 105.3 82.5 75.5
North Macedonia –8.3 –5.4 –5.4 51.9 51.8 51.4
Serbia –8.0 –4.1 –3.9 58.6 57.1 55.2
Ukraine –5.3 –3.4 –17.0 60.4 49.0 85.0
Source: European Commission (Ameco), Macrobond, national central banks, wiiw.

Gradually moderating yet still high inflation deserves continued vigilance

In all WB economies inflation started soaring in mid-2021, although to different extents. Yet after still relatively moderate increases in 2021, consumer price ­inflation climbed sharply in 2022, averaging between 6.7% in Albania and about 14% in Bosnia and Herzegovina as well as North Macedonia (chart 3). Such high readings had not been seen for a very long time or, in some countries, not ever
in recorded history. However, while still high, inflation seems to have mostly ­culminated in October and November 2022 and has somewhat eased since then in all WB countries but Serbia. A combination of supply- and demand-side factors has contributed to price pressures. Supply constraints have driven food and energy prices to record highs and they have been amplified by the war in Ukraine. On the demand side, lingering demand-supply imbalances brought about by the pandemic have continued to weigh on prices. The surge in prices has thus been driven particularly by food items followed by housing and transportation. Food prices have ­contributed between 50% and 60% to headline inflation in the WB (compared to about 30% in the euro area). This primarily echoes the fact that the weight of food items is roughly twice as high in the region’s consumer basket compared to the euro area. The markedly lower acceleration of inflation (remaining in single-digit levels) in Albania is notable not only in comparison to its regional peers but also to other countries in Central and Eastern Europe. This is attributable to a relatively high share of administered prices, energy tariff controls, almost exclusive electricity production in domestic hydropower plants and, last but not least, rather robust currency appreciation for most of 2022. In the two other countries with flexible exchange rates the currencies have remained broadly stable vis-à-vis the euro
(chart 4). Increases in core inflation 8 have been relatively subdued in the region so far. Yet, most recently, core inflation has also accelerated up to 11% in Serbia and Montenegro, suggesting that the pass-through of cost-push factors is becoming more broad-based.

To prevent a de-anchoring of inflation expectations and to bring inflation back on a downward trajectory, the respective central banks in the three countries with autonomous monetary policy started their monetary policy tightening in March (Albania) and April 2022 (North Macedonia and Serbia), respectively. Since then, key policy rates have been raised in 6 steps (25 or 50 basis points each) from 0.5% to 3% in Albania, in 10 steps (25–75 basis points each) from 1.25% to 5.5% in North Macedonia and in 13 steps (i.e. every month since the start of the cycle, 25–50 basis points each) from 1% to 6% in Serbia (chart 5) 9 . In addition, according to the National Bank of Serbia (NBS), it has intervened in the FX market to keep the dinar exchange rate vis-à-vis the euro relatively stable to help contain the ­spillover of rising import prices on domestic prices 10 . In the three countries without autonomous monetary policy – Bosnia and Herzegovina, Kosovo and Montenegro – the tools to combat inflation are mostly limited to minimum reserve requirements and macroprudential tools. Yet in the current inflationary period none of these tools have been actively used for monetary policy purposes so far. The central banks in the three mentioned WB countries have argued that the current inflation is mainly imported and/or that such instruments are predominantly employed for financial stability objectives. In this context, it is important to again stress the ­crucial role of prudent fiscal policy also in the monetary policy context, especially in countries without autonomous monetary policy.

Chart 3, Consumer price developments, is a bar chart showing the annual change in % of consumer price developments for the six Western Balkan countries. For each country, the chart shows annual data for the years 2020, 2021 and 2022 and monthly data for January and February 2023. According to the chart, inflation started soaring in all countries in the region in mid-2021, although to different extents. After still relatively moderate increases in 2021, consumer price inflation climbed sharply in 2022, averaging between 6.7% in Albania and about 14% in Bosnia and Herzegovina as well as North Macedonia. 

Source: Macrobond, Vienna Institute for International Economic Studies.

Looking ahead, inflation is projected to soon start falling noticeably in the ­entire region, including in Serbia, where it has not yet plateaued so far. The ­slowdown is expected to be brought about by weakening global cost-push factors on the back of easing energy and commodity prices as well as global supply chain frictions, among other factors. Moreover, on the domestic front, the impact of tighter monetary policies will take hold and the base effect will start to kick in. Nonetheless, a watchful eye is warranted in light of the persisting geopolitical tensions, rising core inflation, considerably increased inflation expectations in all countries as well as tight labor markets. The risk of potential second-round effects and particularly of wage-price spirals thus needs to be closely monitored 11 .

Chart 4, Exchange rate vis-à-vis the euro, is a line chart showing the development of the Albanian, North Macedonian and Serbian currency vis-à-vis the euro since January 2020 until March 2023. The exchange rates are normalized to equal 100 in January 2020 and defined so that upward movement indicates depreciation and vice versa. Whereas the North Macedonian Denar and Serbian Dinar were broadly stable over the depicted period, the normalized Albanian Lek index went up from 100 in January 2020 to 102.7 in April 2020. Since then the Lek has, more or less continuously, appreciated so that the index reached 93.7 in March 2023. 

Source: Macrobond.
Chart 5, Key interest rates, is a line chart showing the development of the Albanian, North Macedonian and Serbian key interest rates between January 2020 and March 2023. After an initial easing the key interest rates rose eventually in the reported period from 1% to 3% in Albania, from 2% to 5.5% in North Macedonia and from 2.25% to 5.75% in Serbia.

Source: NCBs.

Financial sector appears resilient to recent external shocks

The WB financial sector, which is mostly dominated by foreign-owned banks, ­remains resilient even after the shocks triggered by the pandemic and the war. Bank lending to the nonbank private sector has kept on expanding at a robust pace in the entire region, despite some significant counterweighing factors such as a weakening of the business environment and economic sentiment as well as global and national political uncertainty. Compared to 2021, nominal credit growth ­accelerated in 2022 in four WB economies and cooled down in Albania and Serbia (table 5) owing to tighter credit conditions and the slowdown of the economy. Nonetheless, real credit expansion was negative in the WB countries barring Kosovo and Albania. The pattern behind the nominal credit expansion was not homogenous either. Hence, whereas in Albania and Bosnia and Herzegovina, it was predominantly loans to households that recorded strong growth (in Albania largely for real estate purposes), in the other countries lending to both businesses and households expanded quite vigorously. As for the currency decomposition, in ­Serbia and Albania, and to a lesser extent in North Macedonia, credit growth was driven mainly by foreign currency-denominated lending. This was spurred mainly by lower interest rates of euro loans and, on the supply side, by a shift toward ­foreign currency deposits, especially after the outbreak of the war. In contrast, in Bosnia and Herzegovina, lending in foreign currency had been contracting since 2018, increasingly so in 2022, so that loans in domestic currency dominated. As a result, the share of foreign currency loans dropped to just above 40% in Bosnia and Herzegovina, almost 20 percentage points less than in 2018. In contrast, it has increased somewhat in Albania, North Macedonia and Serbia (table 5). Hence, the de-euroization process in the affected WB countries and particularly the relatively significant dinarization trend observed in recent years in Serbia have been interrupted. However, this has been mainly due to external factors. Data from the OeNB Euro Survey suggest that trust in domestic currencies has somewhat ­declined (except for Albania). However, this decline affected not only national ­currencies but also the euro. Naturally, depreciation fears were ignited immediately after the Russian invasion of Ukraine.

Banks in the region remain liquid and well capitalized (table 5) while their profitability has improved in most instances on the back of higher interest rates and lower noninterest costs. The concern that asset quality could noticeably deteriorate after a removal of the pandemic-triggered support measures has not materialized so far. The share of nonperforming loans (NPLs) to total loans decreased in all countries in 2022 (table 5). However, in some instances this was the result of a relatively stronger growth of the credit volume in the denominator since the NPL stock increased somewhat in half of the WB economies. While these figures ­appear encouraging at first glance, it is warranted to keep a close eye on future asset quality developments, especially in light of potentially mounting credit, exchange and ­interest rate risks. Apart from the fragile geopolitical situation and challenging macroeconomic environment, the microeconomic perspective also calls for ­caution. According to the most recent OeNB Euro Survey data, about 20% of ­interviewed household borrowers in Bosnia and Herzegovina and up to 60% in Albania report that they are unlikely or very unlikely to repay their debt over the next 12 months. The need for a watchful eye is corroborated also from the banks’ view. According to the EIB Bank Lending Survey conducted in September 2022, banks in all WB economies expected deteriorating NPLs in the short to medium term. What is more, if credit risks materialize, structural obstacles continue to complicate NPL resolution in the region. In particular, collateral execution ­remains a difficult task as protection of property rights keeps on lagging behind 12 .

Table 5: Banking sector indicators  
2020 2021 2022 Q3 21 Q4 21 Q1 22 Q2 22 Q3 22 Q4 22
End of period, annual change in %
Bank loans to the domestic nonbank private sector
Albania1 5.9 9.4 8.9 8.4 9.4 10.7 11.3 11.7 8.9
Bosnia and Herzegovina1 –2.5 3.7 5.3 2.7 3.7 4.6 4.9 4.7 5.3
Kosovo 7.1 15.5 16.0 13.5 15.5 18.4 17.4 18.4 16.0
Montenegro 3.0 3.2 8.7 1.1 3.2 6.5 8.9 8.9 8.7
North Macedonia1 4.3 7.3 8.4 6.2 7.3 8.1 7.8 7.3 8.4
Serbia1 10.9 8.5 5.3 6.8 8.5 9.6 9.8 7.4 5.3
End of period, %
Share of foreign currency loans2
Albania 48.3 48.8 49.3 47.5 48.8 49.3 49.0 49.6 49.3
Bosnia and Herzegovina 52.2 47.8 41.2 49.1 47.8 45.9 43.9 42.8 41.2
Kosovo . . . . . . . . . . . . . . . . . .
Montenegro3 2.9 3.2 3.1 3.2 3.4 2.7 4.0
North Macedonia 41.5 40.7 42.6 41.3 40.7 40.9 41.4 42.3 42.6
Serbia4 62.8 61.7 65.2 61.4 61.7 62.4 63.1 64.4 65.2
%
NPL ratio
Albania 8.1 5.7 5.0 6.5 5.7 5.2 5.3 5.1 5.0
Bosnia and Herzegovina 6.1 5.8 4.5 5.5 5.8 5.4 5.2 4.9 4.5
Kosovo 2.7 2.3 2.0 2.4 2.3 2.1 2.1 2.1 2.0
Montenegro 5.5 6.2 5.7 5.6 6.2 6.5 6.3 5.9 5.7
North Macedonia 3.2 3.2 3.1 3.6 3.2 3.3 3.4 3.3 3.1
Serbia 3.7 3.6 3.0 3.6 3.6 3.4 3.3 3.2 3.0
%
Tier 1 capital ratio
Albania 17.2 16.9 16.9 17.2 16.9 16.7 17.8 18.1 16.9
Bosnia and Herzegovina 18.1 18.7 18.7 18.4 18.7 18.6 18.6 18.4 18.7
Kosovo5 16.5 15.3 14.8 17.9 15.3 15.1 15.1 15.8 14.8
Montenegro5 18.5 18.5 19.3 18.5 18.5 19.2 18.9 18.4 19.3
North Macedonia 15.3 15.8 16.6 15.9 15.8 15.5 15.9 16.3 16.6
Serbia 21.6 19.7 18.8 20.6 19.7 18.9 18.2 18.2 18.8
Source: National central banks.
1 Foreign currency component at constant exchange rates.
2 In total loans to the nonbank private sector. As far as available, including loans indexed to foreign currencies.
3 Share in total loans to all sectors.
4 Including securities.
5 Overall capital adequacy ratio.

Some notable political and institutional breakthroughs?

At present, the European Union is engaged in accession negotiations with Montenegro and Serbia. Both countries accepted the revised enlargement methodology endorsed in June 2021, which they continue to apply 13 . According to the European Commission’s 2022 Enlargement Package, which provides a detailed assessment of the state of play and progress made by (potential) candidates on their respective paths toward the EU, Serbia has opened 22 out of 35 chapters since the start of accession negotiations in January 2014. These include all chapters in cluster 1 on the fundamentals and all chapters in cluster 4 on the green agenda and sustainable connectivity. Two chapters have been provisionally closed. Accession negotiations with Montenegro were opened in June 2012. To date, 33 chapters have been opened, three of which have been provisionally closed. The other WB countries will be subject to the revised enlargement methodology in its entirety. In July 2022, the Council of the European Union decided to commence long-awaited ­accession talks with Albania and North Macedonia. Both countries are currently undergoing the screening process to acquaint themselves with the acquis, establish the level of alignment with EU legislation and to outline plans for further ­alignment. Additionally, in December 2022, Bosnia and Herzegovina was granted the EU ­candidate status while the potential candidate Kosovo officially applied for EU membership. In the meantime, in April 2023, the European Parliament agreed a long-awaited removal of visa requirements for Kosovo citizens to enter the Schengen area from 2024 on. In a similar vein, through the implementation of the SAAs 14 as well as other EU programs (e.g. the Economic and Investment Plan), agreements or cooperation frameworks, the EU is keen to accelerate the integration of the WB region prior to full EU membership. In this context and in light of the current ­energy crisis, the EU is for instance opening its electricity market to the Western Balkans, subject to regulatory reforms. In May 2022, the European Commission thus launched the so-called REPowerEU Plan to help reduce the EU’s and the Western Balkans’ dependence on Russian gas.

Yet, the integration progress toward the EU is significantly intertwined with domestic political developments. At end-March 2023, presidential elections took place in Montenegro after a year of political deadlock that had threatened the country’s advancement in EU accession negotiations. The incumbent Milo ­Đukanović, who has served the country as president for more than 20 years (and, taken together with the Prime Minister post, for more than three decades) lost the presidential election to the contender Jakov Milatović. The candidate of the ­Europe Now Movement, who advocates closer ties with both the European Union and ­Serbia won in a close runoff. Further, general elections scheduled for June 2023 could definitely end the long period of political stalemate and instability after two governments did not survive the no-confidence vote in the parliament during 2022. Another noteworthy parliamentary election was held in Bosnia and Herzegovina last October. A new, state-level government was formed in late January 2023. For the EU prospects of Kosovo and Serbia in the period ahead, the so-called Ohrid Agreement will be of utmost importance (see box 1).

With respect to other important institutional relations, in late 2022, the IMF ­approved a two-year SBA for Serbia amounting to about EUR 2.4 billion (equivalent to a 290% of quota). The SBA replaced the previous Policy Coordination Instrument and builds on its reform agenda with appropriate modifications to address new ­policy challenges. In particular, in the context of the energy crisis, the SBA focuses on addressing external and fiscal financing needs, maintaining macroeconomic and financial stability, and fostering structural reforms, especially in the energy sector. In a similar vein, in April 2023, IMF staff and Kosovo authorities reached a staff-level agreement on Kosovo’s economic policies to be supported by a precautionary 24-month SBA worth around EUR 100 million (97% of quota), and an arrangement under the Resilience and Sustainability Facility (RSF) of about EUR 78 million (75% of quota). These requests are subject to the approval of the IMF’s Executive Board, whose considerations about these arrangements are expected to be ­concluded in late May. According to the IMF, the SBA would provide liquidity in case downside risks – including those arising from Russia’s war in Ukraine – materialize. In contrast, the RSF is supposed to provide affordable financing to support Kosovo’s climate change mitigation and adaptation efforts, greener electricity production, and long-run growth prospects. Moreover, it is expected to catalyze other climate financing. Kosovo’s RSF is the first in Europe.

The Ohrid Agreement

Mediated by the EU, on March 18, 2023, Serbia and Kosovo reached a verbal agreement on the Implementation Annex of the “Agreement on the path to normalization of relations” ­between the two countries, informally known as the Ohrid Agreement. This agreement, along with the Implementation Annex, will be integral to the EU accession process for both Serbia and Kosovo. The agreement stipulates particularly the following provisions for the two parties:

  • Development of normal, good-neighborly relations;
  • Mutual recognition of their respective documents and national symbols;
  • Respecting each other’s independence, autonomy and territorial integrity and the right of self-determination;
  • Any disputes are to be settled exclusively by peaceful means;
  • Neither party can represent the other in the international sphere;
  • Serbia will not object to Kosovo’s membership in any international organization;
  • Neither party will block, nor encourage others to block, the other party’s progress on its EU path;
  • Kosovo will ensure the security of the properties of the Serbian Orthodox Church;
  • Both parties will exchange permanent missions to be established in each other’s capitals.

In addition, as part of the agreement, Kosovo committed to immediately commence negotiations within the EU-facilitated dialog on establishing specific arrangements and guarantees to ensure an appropriate level of self-management for the Serbian community in Kosovo, in compliance with previous agreements determined by the EU facilitator. Furthermore, Serbia and Kosovo agreed to establish, within 30 days, a Joint Monitoring Committee, chaired by the EU 15 and tasked with supervising the implementation of all provisions. Within 150 days, the EU will organize a donor conference to establish an investment and financial aid package for Serbia and Kosovo. However, disbursement will not occur until the EU confirms that all provisions of the agreement have been fully met. The document also stipulated that any failure to meet obligations stemming from the agreement may result in direct negative consequences for the EU accession paths of Serbia and Kosovo, as well as the financial aid they receive from the EU.

The fact that the agreement is verbal and was not signed has allowed Serbia’s President Vučić to later question his acceptance of the pact and/or present alternative interpretations. In Serbia, the agreement was met with fierce opposition and protests by parts of the political spectrum; it remains to be seen how the country’s president and government will walk the line between the country’s commitments vis-à-vis the EU and the Ohrid Agreement on the one hand and domestic political pressures on the other.

4 Compiled by Tomáš Slačík.

5 The Western Balkans comprise the EU candidate countries Albania, Bosnia and Herzegovina, Montenegro, North Macedonia and Serbia as well as the potential candidate Kosovo. The designation “Kosovo” is used without ­prejudice to positions on status and in line with UNSC 1244 and the opinion on the Kosovo Declaration of ­Independence.

6 We expect that this also holds true for Kosovo. Even though Labor Force Survey data provided by the Kosovo Agency of Statistics is available only until 2021, more recent data from the Tax Administration of Kosovo indicate a ­further improvement in labor market indicators.

7 According to the latest Economic Reform Programme, the Montenegrin authorities plan a fiscal deficit of 5.9% of GDP in 2023 and 6.2% in 2024 and 2025 on the basis of the continuation of existing legislation. While the ­authorities recognize the need for fiscal consolidation, recent measures will lower revenues and at the same time imply higher mandatory expenditures on public wages, social transfers, pensions and the Health Insurance Fund.

8 Subject to the varying country-specific definitions of core inflation.

9 Monetary policy tightening has been less vigorous in Albania thanks to more contained inflation rises, steady ­currency appreciation and stronger than expected transmission associated particularly with a strong increase of treasury bill yields.

10 2022 was the 5th among the last 6 years that the NBS ended as a net FX buyer. The NBS’s purchases in FX ­market interventions exceeded the sales by over EUR 700 million in 2022 (see NBS | Show news ).

11 For instance, following the adoption of the draft law on salary reform, the average monthly salary in Albania will rise from the current EUR 563 to EUR 900 within a year.

12 In 2022, a score provided by The Heritage Foundation that captures the level of property right protection and is normalized between 0 (worst) and 100 (best) ranged between less than 50 in Kosovo and just above 60 in ­Montenegro. For comparison, the Central and Eastern European region scores between more than 70 in Poland and 90 in Slovenia.

13 The dissatisfaction of some EU countries with the quality of reforms in candidate countries has prompted changes in the methodology of enlargement. The new methodology is based on four principles: credibility, predictability, dynamism and greater political governance.  One of the key novelties is the establishment of six negotiation ­clusters: (1) fundamentals; (2) internal market; (3) competitiveness and inclusive growth; (4) green agenda and sustainable connectivity; (5) resources, agriculture and cohesion and (6) external relations. The new methodology is expected to increase the dynamics and thus the speed of the process if the countries implement the reforms on time. While a greater involvement of the EU in monitoring the process is envisaged the new procedure also allows for reversibility in case of no progress or backsliding. 

14 All WB countries have established Stabilization and Association Agreements (SAAs) with the EU which, inter alia, define the terms and mechanisms for implementing reforms that will bring the respective countries progressively closer to EU policy standards.

15 The committee is chaired by EU Special Representative for the Belgrade-Pristina Dialogue and other Western ­Balkan regional issues, Miroslav Lajčák.

Green transition in CESEE: sectoral emissions and EU recovery plans

Andreas Breitenfellner, Mathias Lahnsteiner, Thomas Reininger 16

The EU’s financial response to the pandemic was designed to also promote climate ­action. This descriptive study investigates to what extent the recovery and resilience plans (RRPs) of EU member states in Central, Eastern and Southeastern Europe (CESEE) address some of the most pressing issues regarding their greenhouse gas (GHG) emission levels ­compared with other EU countries (EU-16). We assess that the ex ante allocation of spending within climate-related RRP spending in CESEE EU countries appears to be broadly ­appropriate. First, their plans’ focus on renewable energy and networks is particularly important given that their per capita GHG emissions in energy industries were, on average, more than 50% higher than in the EU-16 in 2019, despite lower per capita GDP levels. These high emissions result, to a large extent, from a small group of economically significant countries that substantially use coal for power generation and district heating/cooling (as well as directly in the household sector). Given generous financial support, more ambitious coal-exit strategies could have been expected. Second, the focus of CESEE EU countries’ RRPs on energy efficiency is welcome, given high energy intensity in manufacturing and poorly insulated buildings, which are an ­additional cause of high energy industries’ emission levels. In some countries, this area would clearly deserve being made a higher spending priority. Third, the RRPs’ focus on sustainable mobility is justified by the dynamic rise of transport sector emissions in CESEE EU (particularly in international aviation), even though per capita GHG emissions in transport are still lower in most CESEE countries than in the EU-16. While our findings support the general judgment that the RRPs’ spending structures indeed correspond to major country-specific climate-­related weaknesses, we do not assess whether the plans are sufficient to put countries on track to their net-zero goals or whether individual measures are appropriate. Needless to say, the ­current energy crisis related to the Russian invasion in Ukraine and Russia’s earlier restrictions on gas exports already in 2021 adds to the urgent need to steer energy production and ­consumption away from fossil sources and to advance energy saving.

JEL classification: O1, O52, Q54, Q56

Keywords: climate change, low-carbon transition, EU fiscal policy instrument, Central, Eastern and Southeastern Europe

Europe has a particular responsibility in the global quest for an effective and ­efficient response to climate change. 17 The EU’s challenge to deliver appropriate mitigation, adaptation and transition policies is urgent. It is a challenge that has presented itself for a long time and will continue to do so for a long time to come.

The European Green Deal envisaged by the European Commission in 2019 and the emergence of the COVID-19 pandemic in 2020 led to significant adjustments in the European Union’s multiannual financial framework (MFF) 2021–2027 (­European Commission, 2019; European Union, 2020a). Moreover, in response to the pandemic, the European Union agreed on establishing a European Union ­Recovery Instrument (EURI) complementary to the regular EU budget provided by the MFF. 18 The cornerstone of the EURI is the Recovery and Resilience Facility (RRF), which provides funding for EU member states according to national ­recovery and resilience plans (RRPs) if jointly agreed upon at the EU level. The established common guidelines for these RRPs stipulate a minimum share of 37% for a “green pillar” in the RRP expenditures of each member state (European Union, 2020b, 2021; Reininger, 2021).

After Russia already used its energy export policy for strongly driving up EU gas prices in 2021 and then escalated its war against Ukraine, the implementation of the RRPs’ green pillars is both more challenging and even more urgent in most EU member states. Against this background, the REPowerEU Plan aims to reduce the EU’s energy dependency and greenhouse gas (GHG) emissions faster, even if temporary deviations from its ambitious climate goals are tolerated (European Commission, 2022a). National policies, however, are in part undermining these goals, as several member states have been shielding consumers and companies from rising energy prices by (partially) suspending market mechanisms and thus reducing incentives for emission cuts (Sgaravatti at al., 2022).

Against this policy background, this study provides a stocktaking of issues ­related to GHG emissions in EU member states, particularly in Central Eastern and Southeastern Europe (CESEE) in the year 2019, prior to the COVID-19 pandemic. It builds on a previous study which focused on the developments regarding the green transition in the period between 1990 and 2018. In our earlier study, we had confirmed broad compliance with climate policy commitments in both sub­aggregates of 11 EU member states in CESEE (CESEE EU) and 16 other EU member states (EU-16) while highlighting the challenges ahead (Breitenfellner et al., 2021).

This study focuses on the status quo in the year 2019 and only ­occasionally ­refers to developments in the decade following the global financial crisis in 2008. Moreover, it provides comprehensive country-specific information as well as deeper sectoral insights. Following a descriptive and comparative ­approach regarding the European Union, it uses the EU-27 aggregate and the 16 other EU member states, both individually and as EU-16 aggregate, as benchmarks for CESEE EU member states and their aggregate. Methodologically, like in the previous study, we apply the Kaya decomposition to gain a deeper understanding of the relative intensities involved in these countries and sectors (Kaya and Yokoburi, 1997; ­Umweltbundesamt, 2021). According to the Kaya identity, total ­anthropogenic GHG emissions of an economy are the product of four multiplying factors: GHG emission intensity of the energy mix, energy intensity of GDP, GDP per capita, and population. In our paper, the term “carbon intensity” refers to the product of emission intensity and energy intensity and, hence, relates GHG ­emissions to GDP. After presenting an overview on the size of the national RRPs and on the structure and quantitative design of their respective green pillars, the study explores whether the ex ante allocation of spending under these RRPs is ­appropriate to address ­general or country-specific weak spots that emerged in the preceding stocktaking exercise. In no way, however, do we claim to comprehensively assess whether these plans are adequate or whether individual measures ­envisaged therein are sufficient or timely.

The study is structured as follows: Section 1 provides an analysis of various ­aspects of GHG emissions in EU member states, with subsection 1.1 focusing on GHG emissions per capita and their structure by sectors, and subsection 1.2 ­dealing with the economy-wide and sectoral decomposition of these emissions into intensities. Section 2 gives an overview of the RRPs and their green transition ­pillars, especially in CESEE EU member states. In section 3, we wrap up and draw some conclusions.

1 Analysis of GHG emissions in EU member states

This chapter provides a stocktaking of the level and structure of GHG emissions in EU member states, particularly in CESEE, as well as of the relative intensities ­involved in these economies and their sectors.

1.1 GHG emissions per capita and structure by sectors

1.1.1 GHG emissions per capita in 2019
Chart 1 entitled “Greenhouse gas emissions per capita” is a column chart.

The columns represent greenhouse gas emissions per capita, measured in tones of CO2 equivalent per person, for individual EU member states as well as the EU aggregate and the sub-aggregates CESEE-EU and other EU member states termed EU-16 in the year 2019. Columns for countries and aggregates together are ranked in descending order. In 2019 greenhouse gas emissions per capita amounted to 20.4 in Luxembourg, 20.3 in Malta, 13.2 in the Netherlands, 13.0 in Ireland, 13.0 in Belgium, 12.4 in Cyprus, 11.7 in Czechia, 11.6 in Estonia, 10.4  in Poland, 10.2 in Finland, 10.0 in Germany, 9.3 in Austria, 9.1 in Greece, 8.9 in Denmark, 8.7 in CESEE-EU, 8.7 in EU-27, 8.7 in EU-16, 8.6 in Bulgaria, 8.5 in Slovenia, 7.6 in Lithuania, 7.6 in Spain, 7.3 in Slovakia, 7.3 in Italy, 6.9 in France, 6.9 in Portugal, 6.7 in Hungary, 6.6 in Latvia, 6.2 in Croatia, 5.9 in Sweden and 5.9 in Romania. 

In addition to the columns for the year 2019, diamonds indicate the per-capita emission levels in 2008 so that the differences between these two points in time can be witnessed for each country and aggregate from the chart. In 2008 greenhouse gas emissions per capita amounted to 27.8 in Luxembourg, 15.5 in Malta, 16.5 in the Netherlands, 16.0 in Ireland, 16.4 in Belgium, 15.1 in Cyprus, 14.2 in Czechia, 15.7 in Estonia, 10.9  in Poland, 14.1 in Finland, 12.2 in Germany, 10.7 in Austria, 13.1 in Greece, 13.3 in Denmark, 9.6 in CESEE-EU, 10.7 in EU-27, 11.0 in EU-16, 8.8 in Bulgaria, 10.9 in Slovenia, 7.7 in Lithuania, 9.9 in Spain, 9.2 in Slovakia, 9.9 in Italy, 8.7 in France, 7.6 in Portugal, 7.2 in Hungary, 5.7 in Latvia, 7.2 in Croatia, 7.9 in Sweden and 7.2 in Romania.

Source: Authors’ calculations, Eurostat, UNFCCC.

At first glance, CESEE EU member states do not seem to contribute more to ­climate change than other EU member states, relative to the size of their ­population. The subaggregates of the CESEE EU member states (in the following: CESEE EU) and the other EU member states (in the following: the EU-16) had almost the same level of GHG emissions per capita in 2019, and hence were almost equal to the ­EU-27 average of 8.7 tons CO2 equivalent of GHG emissions (see chart 1). 19 These aggregate figures mask pronounced heterogeneity within both country groups. The highest GHG emissions per capita in the EU-27 are recorded by the Benelux countries, Cyprus, Malta and Ireland, with readings that are about 50% higher than the ­EU-27 ­average. These are followed by Czechia, Estonia and Poland, a group of countries that comprises two heavyweights within the CESEE EU subaggregate, with per capita emissions 20% to 35% above average. At the other end of the ­spectrum, with the lowest GHG emissions per capita, are Sweden and Romania with per ­capita emissions about 30% below average. These are followed by ­Croatia, Latvia, Hungary, Portugal and France with slightly higher per capita emissions that are still at least 20% below average.

However, this comparison does not condition on different GDP per capita ­levels, and we will turn to this issue further below.

1.1.2 Uneven decline in GHG emissions between 2008 and 2009

A brief look at the development of GHG per capita levels from 2008 to 2019 shows that the EU-27 average declined by almost 20% in this period, resulting from ­decreases in all EU member states except Malta and Latvia (see chart 1). However, these ­decreases differed markedly in size. The CESEE EU subaggregate posted a decline of only 10%, as most of the included member states had a below-average decline of their per capita emissions, particularly Bulgaria, Poland and Hungary. Estonia is the only CESEE country among those EU member states that have recorded very large decreases of per capita emissions, namely by more than 25% and up to 33%. On a positive note, two CESEE countries, Slovakia and even more so Romania, registered substantial reductions of per capita GHG emissions, i.e. close to the ­EU-27 average, despite starting at already far below-average per capita emissions in 2008.

In general, the dynamics observed from 2008 to 2019 do not fundamentally change when considering demographics and looking at GHG total. Not only per capita but also in terms of total GHG emissions, the decline was far more ­pronounced in the EU-27 than in CESEE EU, as population figures changed only modestly, rising by 2% in the EU-27 but declining by 3% in CESEE EU. 20 ­However, the relative position of a few CESEE EU member states shifts considerably when looking at total emissions. In Romania, where the decline in per capita emissions roughly equaled the EU-27 average, the accompanying substantial population ­decline resulted in a decline of total emissions that was larger than the EU-27 ­average. In Croatia, substantial population decline coupled with a decline in per capita emissions that was smaller than the EU-27 average resulted in a decline of total emissions that roughly equaled the EU-27 average.

1.1.3 The sectoral structure of GHG emissions

International data on GHG emissions differ slightly depending on the source and the underlying concept. Regarding the sectoral structure of GHG emissions, ­according to data provided by the United Nations Framework Convention on ­Climate Change (UNFCCC) 21 , emissions of transport have the largest share in total GHG emissions in the EU-27 aggregate at close to 30%. These are followed by emissions from ­energy industries, comprising (1) generation of electricity and heating/cooling and (2) refineries for oil and petroleum products and coke ovens, with a combined share of 23%, emissions from manufacturing with 20% (breaking down into roughly equal parts stemming from energy use and from industrial processes and product use) and emissions from agriculture with 12% (the bulk of which coming from agricultural processes, mainly emitting non-CO2 GHG, rather than energy use). Finally, there are the emissions from the residential sector (8%), resulting from the burning of fossil energy like coal, oil and gas within households for heating, as well as the emissions from other items (8%), which comprise (1) emissions from the burning of fossil energy within commercial/institutional buildings for heating, (2) emissions from wastewater treatment and solid waste disposal sites and (3) emissions from fossil energy mining and exploration (as “fugitive emissions from fuel”).

Moderately different sector structure results from Eurostat’s Air Emissions ­Accounts (AEA) data. The AEA data follow the residence principle, with emissions assigned to the country where the economic operator causing the emission (the operator of the ship/aircraft in the case of international navigation and aviation) is resident and are classified by economic activity (NACE) (Eurostat, 2022). The UNFCCC data, reported to international conventions, follow the territory ­principle, with emissions assigned to the country where the emission takes place (or, in the case of international navigation and aviation, where the associated fuel is bunkered), and are classified by the type of technical process (UNFCC, 2006). 22 On aggregate, for the EU-27, the difference between the AEA total GHG ­emissions and the UNFCCC total GHG emissions 23 was about 0.5% in 2019. However, in some small and open countries (especially those considerably involved in inter­national navigation and/or aviation) the difference may be substantial. 24

For the sectoral structure, part of AEA emissions may be clustered into the category of “services,” both commercial and public services, which, in turn, ­comprise some emissions covered by the categories “transport sector” and “other items” in the UNFCCC reporting. On the EU-27 aggregate level, the share of ­services accounted for slightly more than 10% of total emissions in 2019, lowering, in turn, the transport sector’s share according to AEA data to the still large size of nearly 25%.

This subsection continues to focus primarily on the sector structure derived from the UNFCCC data, while subsection 1.2 uses AEA data when investigating sectoral decomposition and intensities, as the classification of these emissions data is comparable to that of economic structure.

1.1.4 Differences in the sectoral structure of GHG emissions

Accordingly, the sectoral structure of GHG emissions clearly differs between the CESEE EU and EU-16 subaggregates, with the EU-16 sector structure dominating the EU-27 structure given its coverage of more than three-quarters of the EU. In 2019, the sector structure of the CESEE EU subaggregate was set apart from that of the EU-16 and EU-27, particularly in three categories: first, the considerably larger share of emissions from energy industries (about 32%); second, the ­considerably smaller share of emissions from the transport sector (about 19%); and third, the larger share of emissions summarized under “other items” (about 11%), on account of emissions from waste and from fugitive emissions from fuel (see chart 2). Note that, when using AEA data, similarly sized deviations result for energy industries and the transport sector. Moreover, both the UNFCCC and AEA data clearly ­indicate that in CESEE EU more than half of the difference vis-à-vis the EU-27 figures for the transport sector is attributable to the comparatively lower level of emissions from international navigation and aviation. 25

Chart 2 entitled “Sector structure of greenhouse gas emissions (2019)” is a column chart. For each CESEE member state as well as in the EU aggregate and the sub-aggregates CESEE-EU and other EU member states termed EU-16, it shows the percentage shares of sectors in total greenhouse gas emissions in the year 2019. Columns for countries and aggregates together are ordered by size of energy industries' share of emissions in % of total GHG emissions.

Estonia: Energy industries 53%, Manufacturing, incl. industrial processes and product use: 9%, Transport sector (including international bunkers): 21%, Residential sector: 2%, Agriculture, including energy use: 12%, other items: 4%.

Czechia: Energy industries 40%, Manufacturing, incl. industrial processes and product use: 21%, Transport sector (including international bunkers): 16%, Residential sector: 7%, Agriculture, including energy use: 8%, other items: 9%.

Poland: Energy industries 38%, Manufacturing, incl. industrial processes and product use: 14%, Transport sector (including international bunkers): 18%, Residential sector: 8%, Agriculture, including energy use: 11%, other items: 10%.

Bulgaria: Energy industries 37%, Manufacturing, incl. industrial processes and product use: 24%, Transport sector (including international bunkers): 18%, Residential sector: 2%, Agriculture, including energy use: 11%, other items: 10%.

CESEE-EU: Energy industries 32%, Manufacturing, incl. industrial processes and product use: 19%, Transport sector (including international bunkers): 19%, Residential sector: 7%, Agriculture, including energy use: 12%, other items: 11%.

Slovenia: Energy industries 26%, Manufacturing, incl. industrial processes and product use: 17%, Transport sector (including international bunkers): 36%, Residential sector: 4%, Agriculture, including energy use: 11%, other items: 7%.

EU-27: Energy industries 23%, Manufacturing, incl. industrial processes and product use: 20%, Transport sector (including international bunkers): 29%, Residential sector: 8%, Agriculture, including energy use: 12%, other items: 8%.

EU-16: Energy industries 21%, Manufacturing, incl. industrial processes and product use: 20%, Transport sector (including international bunkers): 31%, Residential sector: 8%, Agriculture, including energy use: 12%, other items: 7%.

Romania: Energy industries 19%, Manufacturing, incl. industrial processes and product use: 23%, Transport sector (including international bunkers): 17%, Residential sector: 7%, Agriculture, including energy use: 18%, other items: 16%.

Hungary: Energy industries 19%, Manufacturing, incl. industrial processes and product use: 20%, Transport sector (including international bunkers): 24%, Residential sector: 12%, Agriculture, including energy use: 13%, other items: 12%.

Slovakia: Energy industries 18%, Manufacturing, incl. industrial processes and product use: 38%, Transport sector (including international bunkers): 21%, Residential sector: 8%, Agriculture, including energy use: 7%, other items: 9%.

Croatia: Energy industries 15%, Manufacturing, incl. industrial processes and product use: 24%, Transport sector (including international bunkers): 29%, Residential sector: 7%, Agriculture, including energy use: 13%, other items: 12%.

Latvia: Energy industries 14%, Manufacturing, incl. industrial processes and product use: 12%, Transport sector (including international bunkers): 38%, Residential sector: 5%, Agriculture, including energy use: 22%, other items: 9%.

Lithuania: Energy industries 11%, Manufacturing, incl. industrial processes and product use: 22%, Transport sector (including international bunkers): 34%, Residential sector: 4%, Agriculture, including energy use: 21%, other items: 8%.

Source: UNFCCC.

The highlighted differences in the sector shares are also reflected in the differences in 2019 sector-specific per capita GHG emissions between CESEE EU on the one hand and the EU-16 and EU-27 on the other hand, given the almost equal level of total per capita emissions.

To put these differences into perspective, note that the (still) lower shares and per capita emissions of the transport sector in CESEE EU do not leave room for complacency. First, these emissions have been growing very dynamically in the relevant CESEE EU subaggregate in both the international and the domestic ­segment while declining in the EU-16 in both segments in recent years. And ­second, particularly the per capita emissions from international aviation in CESEE EU are very likely to rise further from their current, comparatively lower level.

More obviously, the higher shares of energy industries, fugitive emissions and waste emissions and the higher per capita emissions in these sectors in CESEE EU call for specifically targeted climate policy action.

At the same time, even shares and per capita emission levels in manufacturing, the residential sector and agriculture, which are comparable to the EU average, are no excuse for inaction in these countries.

At this point, let us emphasize the distinction between emissions from fuel combustion by the residential sector, which is an activity category in the UNFCCC statistics, and all emissions caused by the energy supply for residential buildings demanded by households. As pointed out above, emissions by the residential sector comprise only emissions directly generated within residential buildings, e.g. by burning fossil fuels. In addition, there are emissions indirectly caused by energy supply for residential buildings, namely emissions generated by the energy industry when producing electricity and heating/cooling for delivery to households. The latter emissions are part of total emissions by energy industries. For emissions from fuel combustion by the commercial/institutional sector, the case is similar. Avoiding this confusion is so important, as for both residential and commercial buildings there is large scope for energy saving via thermal insulation and a change of heating systems both in CESEE EU and in the EU-16. These energy-saving ­measures do not only help reduce per capita emission levels in the residential sector but also the per capita emission levels in energy industries, which are generally far higher than those in the residential sector and – as mentioned above – comparatively even higher in CESEE EU than in the EU-16. 26

Table 1: Sectoral greenhouse gas emissions per capita (2019)  
CZ EE PL CESEE EU EU-27 EU-16 BG SI LT SK HU LV HR RO
Tons of CO2 equivalent per person
Total greenhouse gas emissions 11.7 11.6 10.4 8.7 8.7 8.7 8.6 8.5 7.6 7.3 6.7 6.6 6.2 5.9
Energy industries 4.6 6.2 4.0 2.8 2.0 2.0 3.2 2.2 0.8 1.3 1.3 1.0 1.0 1.1
Manufacturing (including industrial processes and product use) 2.4 1.0 1.5 1.6 1.7 1.7 2.1 1.4 1.7 2.8 1.3 0.8 1.5 1.4
Transport sector (including international bunkers) 1.9 2.4 1.9 1.7 2.5 2.5 1.6 3.0 2.6 1.5 1.6 2.5 1.8 1.0
Residential sector 0.8 0.2 0.9 0.6 0.7 0.7 0.1 0.4 0.3 0.6 0.8 0.3 0.4 0.4
Agriculture ­
(including energy use)
0.9 1.4 1.2 1.0 1.0 1.0 1.0 0.9 1.6 0.5 0.9 1.4 0.8 1.1
Other items 1.0 0.5 1.1 0.9 0.7 0.7 0.7 0.6 0.6 0.6 0.8 0.6 0.7 0.9
Source: Authors’ calculations, Eurostat, UNFCCC.

In which sectors do individual CESEE countries differ markedly from the overall ­regional structure? If we compare chart 2 and table 1, we find that differences in the sector structure of emissions reflect differences not only in the countries’ ­economic structure but also in (past) energy and climate policy. The share of energy ­industries as well as related per capita emissions are markedly lower in Croatia, Slovakia, Hungary and Romania, and particularly high in Estonia, Czechia, Poland and ­Bulgaria. In manufacturing, Slovakia and Czechia do not only have above-average shares but also above-average per capita emission levels. In the transport sector, Slovenia, Lithuania and Latvia stand out with above-average figures, and in the residential sector, Poland, Hungary and Czechia. In agriculture, Romania and Croatia have above-average figures in terms of shares, Poland in terms of per capita emissions and the Baltic countries in terms of both shares and per capita emissions. In the category “other items,” Romania has a particularly high share and Poland clearly above-average per capita emissions; in both cases, this is attributable to the subitem of fugitive emissions from fuel. In addition, within “other items,” per ­capita emissions from waste are particularly high in Czechia, Croatia, Bulgaria and Hungary. Finally, note that there is sizable heterogeneity in sectoral per capita emissions also among the EU-16 countries.

1.2 Intensities in the overall economy and in different sectors

1.2.1 Carbon intensity: GHG emissions per unit of GDP and GVA

In this subsection, GHG emissions of the total economy and of sector clusters of economic activities are related to an economy’s total GDP and the corresponding gross value added (GVA) of these sector clusters, respectively. The GHG emissions allotted to each sector cluster stem from Eurostat’s AEA data (see subsection 1.1.3). Conditioning on related GDP or GVA levels implicitly means that, for an ­appropriate assessment, not only costs (in terms of GHG emissions) but also ­benefits (in terms of products and services for well-being) must be considered.

Chart 3 entitled “Whole economy: GHG/GDP – carbon intensity” is a scatter plot. Indexed values with the EU-27 aggregate equaling 100 for greenhouse gas emission per unit of GDP are plotted on both axes. On the horizontal axis, values are plotted based on GDP at purchasing power parities, while on the vertical axis values are plotted based on GDP at market exchange rate. 

Greenhouse gas emission per unit of GDP at purchasing power parities: Austria 85, Belgium 128, Bulgaria 194, CESEE-EU 134, Croatia 109, Cyprus 153, Czechia 145, Denmark 81, Estonia 163, EU-27 100, Finland 107, France 77, Germany 96, Greece 156, Hungary 101, Ireland 74, Italy 90, Latvia 108, Lithuania 105, Luxembourg 87, Malta 223, Netherlands 117, EU-16 93, Poland 155, Portugal 99, Romania 105, Slovakia 105, Slovenia 112, Spain 95, Sweden 55.

Greenhouse gas emission per unit of GDP at market exchange rate. Austria 75, Belgium 113, Bulgaria 356, CESEE-EU 216, Croatia 165, Cyprus 171, Czechia 200, Denmark 60, Estonia 202, EU-27 100, Finland 85, France 69, Germany 87, Greece 194, Hungary 162, Ireland 65, Italy 88, Latvia 149, Lithuania 158, Luxembourg 73, Malta 258, Netherlands 102, EU-16 87, Poland 268, Portugal 120, Romania 186, Slovakia 154, Slovenia 133, Spain 104, Sweden 46.

Source: Authors’ calculations, Eurostat, UNFCCC.

Obviously, for cross-country comparison, the question arises whether GDP and GVA are measured in euro at purchasing power parity (PPP) or at market ­exchange rates. Focusing on the volume of GHG emissions associated with ­comparative income levels would suggest applying PPP. In contrast, focusing on the volume of GHG emissions associated with international competition in ­tradable goods and economic activities related to their production would suggest using the market exchange rate. Hence, for GDP we consider PPP more appropriate, while for the GVA of ­internationally exposed sectors we ­prefer using the market ­exchange rate. However, for the sake of transparency and comparability between the total economy and individual sectors, we will look at both measures regarding GDP, focusing primarily on the PPP-­related measure while highlighting if the exchange rate-related measure yields considerably different results. The substantially higher GDP-based carbon intensity levels in CESEE EU (according to both measures) ­reveal the need of their further lowering in order to allow per capita income ­convergence within ecologically sustainable limits. Based on GDP at PPP, average carbon ­intensity for CESEE EU was one-third above the EU-27 average, while the EU-16 carbon intensity was 7% below this average in 2019 (see table 2, first ­column). Based on GDP at market exchange rates, CESEE EU carbon intensity was more than 110% higher than in the EU-27 while EU-16 carbon intensity was 13% lower (see table 2, second column). Thus, in chart 3, the dot for CESEE EU lies clearly above the 45° line. According to both measures, carbon ­intensity was above the EU-27 average in each CESEE EU country, with Bulgaria, Estonia, ­Poland and Czechia belonging to the most carbon-intense economies in the EU-27. Among the EU-16 member states, only Malta, Greece and Cyprus were close to such high levels of carbon intensities. On a PPP basis, Belgium and the Netherlands had carbon intensities below those in the four CESEE EU member states mentioned above (and thus also below the CESEE EU average) but higher than those in the remaining seven CESEE EU member states 27 , which in turn had carbon intensities up to 12% above the EU-27 level on a PPP basis (but exceeded that level by at least 30% on an exchange rate basis).

Looking at the dynamics (on PPP basis), carbon intensity declined in each EU member state from 2008 to 2019 and on average by 26% in the EU-27. On the positive side, the decline was stronger on average in the CESEE EU member states, amounting to 32%, with above-average declines in Poland and Estonia, two of the four countries with still above-average levels in 2019. However, among the CESEE countries, Bulgaria together with Latvia and Croatia showed less progress than the EU-27.

1.2.2 Possible explanations for country differences in carbon intensity

Analytically, one way to explore these differences is the decomposition of carbon intensity (GHG emissions per unit of GDP) into emission intensity, that is GHG emissions per unit of energy used, and energy intensity, that is energy used per unit of GDP 28 .

Emission intensities of total economies in CESEE EU were on average 29% higher than in the EU-27 in 2019 (see table 2, third column). This mirrors the above finding that CESEE EU carbon intensity (based on GDP at PPP) was 34% higher than in the EU-27. Moreover, those four CESEE EU countries with carbon intensity above the CESEE EU average (Bulgaria, Estonia, Poland, Czechia) were those (together with Romania) that had above-average emission intensities. The same applies to Greece as one of the three EU-16 countries with above-average carbon intensity. Congruently, five of the seven CESEE EU countries with the lowest carbon intensities (Hungary, Lithuania, Slovakia, Croatia, Slovenia), which exceeded the EU-27 level by only 12% or less, had emission intensities close to the EU-27 average. (Latvia was the only CESEE country with an emission intensity far below the EU-27 average.)

Thus, the emission intensity ranking of most CESEE countries among all EU-27 countries matched their ranking with respect to carbon intensity and, in ­addition, the heterogeneity in carbon intensity resulted mainly from the hetero­geneity in emission intensity. This means that in the CESEE EU countries energy intensity, i.e. the second factor determining carbon intensity, was relatively close to the EU-27 average. At the same time, in each CESEE EU country (except for Romania), energy intensity was above the EU-27 level (see table 2, fourth column). Romania and Latvia were the outliers among CESEE countries, with their ­emission and carbon intensity rankings not matching each other and their energy intensity deviating strongly from the EU-27 average, as Latvia had particularly high and ­Romania particularly low energy intensity in 2019.

Besides, if measuring carbon intensity and hence energy intensity is based on GDP at market exchange rates, then the energy intensity of CESEE EU countries is driven up and is shown to be even more important than emission intensity for determining the above-average carbon intensity levels of CESEE EU countries and the heterogeneity in carbon intensity within the EU-27 (see table 2, fifth column).

This decomposition shows that both saving energy and expanding low-emission energy sources, particularly renewable energy, are even more urgent challenges for the CESEE EU than the EU-16 countries. The scope for reducing carbon intensity toward the lower EU-16 levels is particularly large with respect to emission ­intensity.

Table 2: Decomposition of total emissions  
Carbon intensity (with GDP at
PPP)
Carbon intensity (with GDP at ­market exchange rates) Emission intensity Energy intensity (with GDP at
PPP)
Energy intensity (with GDP at ­market exchange rates)
Malta 223 258 89 251 291
Bulgaria 194 356 165 118 216
Estonia 163 202 136 120 148
Greece 156 194 137 114 142
Poland 155 268 146 107 184
Cyprus 153 171 121 127 141
Czechia 145 200 134 108 149
CESEE EU 134 216 129 104 167
Belgium 128 113 90 142 125
Netherlands 117 102 97 120 105
Slovenia 112 133 97 115 137
Croatia 109 165 98 110 168
Latvia 108 149 77 141 193
Finland 107 85 59 181 145
Slovakia 105 154 99 107 156
Lithuania 105 158 101 104 157
Romania 105 186 132 79 141
Hungary 101 162 96 105 169
EU-27 100 100 100 100 100
Portugal 99 120 101 99 119
Germany 96 87 102 94 85
Spain 95 104 100 95 104
EU-16 93 87 94 98 92
Italy 90 88 99 90 89
Luxembourg 87 73 70 125 104
Austria 85 75 78 108 96
Denmark 81 60 89 91 68
France 77 69 84 91 82
Ireland 74 65 129 57 50
Sweden 55 46 49 114 95
Source: Authors’ calculations, Eurostat, UNFCCC.
Note: Indexed values, EU-27/2019 = 100.
1.2.3 Why was emission intensity so much higher in CESEE EU than in EU-16 countries?
Table 3: Energy industries  
Emission intensity Share of coal, oil and gas Share of coal
% %
Poland 253 85 77
Cyprus 221 94 0
Greece 220 81 33
Estonia 187 5 0
CESEE EU 169 59 47
Germany 162 51 34
Malta 158 93 0
Bulgaria 145 48 40
Czechia 143 53 46
Netherlands 139 71 16
Ireland 135 61 3
Romania 128 55 32
Croatia 120 48 17
Italy 110 61 8
Slovenia 108 37 32
Hungary 101 36 11
EU-27 100 39 19
Portugal 95 58 15
Latvia 87 48 0
EU-16 83 34 12
Luxembourg 79 23 0
Denmark 67 26 13
Finland 66 16 8
Spain 65 40 7
Belgium 61 21 0
Lithuania 60 17 0
Slovakia 55 24 10
Austria 53 28 4
Sweden 14 1 0
France 14 7 1
Source: Authors’ calculations, Eurostat.
Note: Indexed values in the first column, EU-27/2019 = 100, percentage shares in total energy used in the ­second
and third columns.

From a sectoral perspective, energy industries for generation of electricity and heating/cooling are a prime candidate to look at, not least because of their large share in total GHG emissions. Indeed, emission intensities of energy industries for generation of electricity and heating/cooling were on average almost 70% higher in CESEE EU than in the EU-27 in 2019, while 17% lower in the EU-16 (see table 3, first column). At the far end of the spectrum, Poland exceeded the EU-27 level by about 150%, roughly matched only by Greece and Cyprus with deviations by 120% and then followed by Estonia, the only other EU country above the CESEE EU average. Slovenia and Hungary were close to the EU-27 average, while only Latvia, Lithuania and Slovakia were below that level; Lithuania and Slovakia were also ­below the EU-16 ­average. Energy industries’ emission ­intensity is determined first by the share of fossil energy in total energy used in this sector, proxied by the ­combined share of coal, oil and natural gas (see table 3, second column), and ­second by the importance of coal within fossil energy sources (compare table 3, third column, showing the share of coal in total energy used, with the second column). 29 In 2019, more than one-third (35%) of total coal used in energy ­industries for generation of electricity and heating/cooling of the EU-27 aggregate were employed in Germany, further 28% in Poland, 10% in Czechia, 4% each in Bulgaria, Romania and Italy, and 3% each in the Netherlands, Spain and Greece.

A considerable part of electricity and heating/cooling provided by energy ­industries is delivered to households’ residential buildings. In turn, these deliveries constituted a substantial part of total energy used in households for electricity and heating, namely about 33% in the EU-16 and 31% in CESEE EU. The other part is made up by energy that is used to generate electricity and mainly heating directly within households. The relative size of these two parts varies substantially within both country groups as can be seen from table 4, first column.

Table 4: Residential sector  
Energy used to generate E&H ­directly within
HH
Thereof: Emission intensity
Share of coal and peat Share of oil Share of gas
% of total energy
for E&H used in HH
%
Ireland 76 16 54 27 158
Malta 29 0 53 0 145
Belgium 80 1 37 52 133
Luxembourg 83 0 30 64 126
Netherlands 76 0 1 92 118
Poland 71 34 4 25 114
Portugal 61 0 23 16 111
Greece 62 0 45 15 108
Bulgaria 43 11 2 9 106
Germany 74 1 28 52 106
Spain 57 1 29 42 104
Cyprus 58 0 53 0 103
EU-16 67 1 21 51 102
Italy 79 0 8 66 100
EU-27 67 5 17 48 100
France 62 0 18 46 95
Hungary 74 2 2 66 94
CESEE EU 69 16 4 35 92
Czechia 67 14 1 38 92
Slovakia 67 2 0 63 85
Austria 65 0 21 33 81
Romania 77 1 5 43 64
Lithuania 52 6 8 21 63
Slovenia 65 0 18 15 57
Denmark 43 0 11 33 57
Croatia 71 0 6 29 53
Latvia 57 1 8 16 52
Estonia 47 0 2 13 38
Finland 37 0 14 1 34
Sweden 14 0 19 2 30
Source: Authors’ calculations, Eurostat.
Note: E&H = electricity and heating, HH = households; percentage shares in columns 1 to 4; indexed values in column 5, EU-27/2019 = 100.
­Columns 2 to 4: shares in 100 = energy used to generate E&H directly within HH in the respective countries.

The generation of electricity and heating directly within households causes those GHG emissions that are attributed to the residential sector’s activity. Relating these GHG emissions to the energy used for producing electricity and heating ­directly within households yields the corresponding emission intensity. Unlike in energy industries, households’ residential sector had emission intensity levels that in CESEE EU were moderately lower (by 8%) than the EU-27 average, while slightly higher by 2% in the EU-16 in 2019 (see table 4, fifth column). However, these average figures also mask considerable heterogeneity within both country groups. At the high-intensity end of the spectrum, there are EU-16 countries (­Ireland and Benelux) where the emission intensities were higher than the EU-27 average by 18% (Netherlands) to 58% (Ireland), driven by the overall high share of fossil energy (that is, the combined share of coal, peat, oil and natural gas), partly coupled with a substantial share of oil (and coal and peat in Ireland). This is ­followed by the country with the highest emission intensity in CESEE EU, which is Poland, exceeding the EU-27 average by almost 15%. Here, the high share of coal played a decisive role in the relative level of emission intensity. While Poland had a visibly lower overall share of fossil energy than the Netherlands, the large weight of coal within that share caused Poland’s emission intensity to be almost as high as that of the Netherlands (see table 4, second, third and fourth column). 30 In 2019, more than three-quarters (76%) of total coal used by the residential sector (households) in the EU-27 aggregate were used in Poland, further 10% in Czechia, 5% in ­Ireland and 2% in Bulgaria. Note again that these emission intensities do not provide any information about the extent to which above-average volumes of energy may be employed in residential heating and, more generally, about the varying scope for energy saving (e.g. via thermal insulation) across countries in this sector.

1.2.4 Carbon intensity of industry and its decomposition

In how far does CESEE EU’s relative position with respect to carbon, emission and energy intensity differ between the internationally strongly exposed part of the economy and the total economy? Here, the focus is on industry, defined as ­comprising the economic activities of mining (NACE B), manufacturing (NACE C 31 ) and ­construction (NACE F). As pointed out above, for industry as an inter­nationally exposed sector, measuring carbon intensity and energy intensity on the basis of GVA at market exchange rates is considered more appropriate. Accordingly, the carbon intensity of industry was on average almost 85% higher in the CESEE EU member states than in the EU-27, and 13% lower in the EU-16 (see table 5, first column). Thus, in CESEE EU countries, the order of magnitude by which ­industry’s carbon intensity exceeded the EU-27 average was comparable to that of carbon intensity of GDP measured at market exchange rates. In Bulgaria but also Slovakia, Poland, Romania and Croatia, carbon intensities in industry were above the ­CESEE EU average, and again their levels were matched only by Cyprus and Greece among the EU-16. Industry’s carbon intensities in Lithuania, Czechia and Hungary were ranked next, below the CESEE EU average but still 30% to 50% above the EU-27 level, and close to their levels were those of the EU-16 subgroup with the ­second-highest levels (Luxembourg, Belgium, Portugal).

Table 5: Decomposition of industry emissions  
Carbon intensity Emission intensity Energy intensity
Bulgaria 319 133 240
Greece 294 197 149
Slovakia 237 120 197
Cyprus 228 256 89
Poland 206 140 147
Romania 201 148 135
Croatia 197 140 141
CESEE EU 184 127 145
Luxembourg 148 97 154
Lithuania 145 144 101
Belgium 143 93 153
Portugal 142 107 133
Czechia 140 109 129
Hungary 131 86 153
Spain 120 116 103
Ireland 118 123 96
Slovenia 117 113 103
Latvia 112 69 161
Netherlands 112 90 124
Austria 101 92 110
EU-27 100 100 100
Estonia 96 104 92
France 93 105 89
Other EU 87 94 93
Italy 85 111 76
Finland 77 34 228
Germany 66 87 76
Sweden 64 47 138
Malta 49 102 48
Denmark 46 105 44
Source: Authors’ calculations, Eurostat.
Note: Indexed values, EU-27/2019 = 100.

Emission intensities of industry in ­CESEE EU were on average 27% higher than in the EU-27 in 2019 (see table 5, second column). Thus, in CESEE EU countries, the extent to which industry’s emission intensity surpassed the EU-27 average was roughly equally ­pronounced as in the case of the total economy’s (GDP’s) emission intensity. At the same time, both emission intensities surpassed the EU-27 average to a considerably lesser extent than the ­respective carbon intensities of industry and GDP exceeded the EU-27 average.

The combination of the carbon ­intensity of industry in CESEE EU that exceeded the EU-27 average to a very large extent and emission intensity that surpassed the EU-27 average to a considerably lesser albeit still substantial extent implies that the energy intensity of industry in CESEE EU was much higher than the EU-27 average, namely by 45% (see table 5, third column). Thus, like for carbon intensity, in CESEE EU countries, the order of magnitude by which industry’s energy intensity exceeded the EU-27 average was comparable to that observed for energy intensity of GDP measured at market exchange rates, which was 67% higher than in the EU-27. Hence, CESEE EU’s relative position with respect to industry’s intensities was roughly comparable to its relative position with respect to GDP’s intensities measured at exchange rates. In contrast, for GDP measured at PPP, CESEE EU’s energy intensity and thus its carbon intensity exceeded EU-27 levels to a considerably smaller extent, leaving its emission intensity as the considerably more important factor for explaining its higher carbon intensity.

Note that four of the five CESEE EU countries whose industrial sectors ­recorded carbon intensity levels above the CESEE EU average (Bulgaria, Poland, Romania, Croatia but not Slovakia) were those (together with Lithuania) that showed above-average emission intensities. The same applies to Greece and Cyprus among the EU-16 countries. Slovakia registered particularly high energy intensity, and the same is true for Bulgaria, in addition to its emission intensity being only moderately above the CESEE EU average.

In almost all EU countries, more than half of industry’s GHG emissions stem from three manufacturing branches: metal industry, chemical and petrochemical ­industry and non-metallic minerals. On average, their combined share amounted to 65% of GHG emissions in industry in the EU-27, 58% in CESEE EU and 67% in the EU-16 in 2019 (reaching even close to 80% in Lithuania, Luxembourg, ­Cyprus, Austria and Belgium, hence in several of the EU countries with the highest per capita emissions in industry). In contrast, these three branches together ­accounted for not more than 13.8% of total industry’s GVA (at market exchange rates) in the EU-27, 11% in CESEE EU and 14.3% in the EU-16, with the highest share among the EU-16 countries seen in Belgium (32%) and, among CESEE EU countries, in Slovenia (21%). However, the output of these manufacturing branches constitutes important intermediate consumption goods for other branches of ­industry, like e.g. machinery, with substantial gross value added.

If we briefly turn to agriculture, forestry and fishing as the other internationally exposed sector of the economy 32 , we see that the average carbon intensity in CESEE EU (based on GVA at market exchange rates) surpassed the EU-27 level by 40% – thus less strongly than in industry. Moreover, unlike what we saw for industry, there are more EU-16 countries (Ireland, Luxembourg, Belgium, Denmark) than CESEE countries (Poland, Bulgaria, Lithuania) in the group of countries whose carbon intensities are above the CESEE EU average, with intensity levels in Ireland and Luxembourg exceeding the Polish level. Overall in the EU-27, carbon intensity in agriculture is seven times higher than in industry. Note that agricultural GHG emissions do not primarily stem from final energy used but from agricultural processes, which would render decomposition into emission intensity and energy intensity less meaningful.

For the sake of completeness, note that services comprise a large number of ­economic activities as classified by NACE (C33, E, G, H52–53, I to S, and U) and their GVA constitutes a predominant share of the total economy’s GVA (and GDP), but their overall carbon intensity based on PPP (given the largely nontradable ­character of services) amounts to only about one-sixth of total economy’s carbon intensity in absolute terms in the EU-27. Thus, differences relative to the EU-27 average in services, have an only minor effect on the overall ranking of most ­economies’ carbon intensity. Carbon intensity was about two-thirds higher on ­average in the CESEE EU member states than in the EU-27, while 10% lower in the EU-16.

2 The green transition pillar within recovery and resilience plans

The EU’s Recovery and Resilience Facility (RRF), which was created with the ­intention to strengthen and steer EU member states’ economic recovery after the adverse economic effects of the COVID-19 pandemic, provided an opportunity to advance the green transition agenda in CESEE EU member states. Having ­identified several areas where the need for action is particularly evident, this section looks at the green transition pillar forming part of each country’s national recovery and resilience plan (RRP) 33 .

2.1 Overall size and structure of national recovery and resilience plans

As pointed out in the introduction, this section offers a bird’s-eye view on the RRPs’ size and structure, instrumental to the aim of this study to complement the country-specific and sectoral stocktaking of GHG emissions and related intensities with a broad comparison of the structure of emissions and the allocation of green spending under the RRPs. For more detailed as well as more comprehensive ­assessments of RRPs, please refer to the official assessments by the European ­Commission and the critical assessments of draft RRPs provided by the Green ­Recovery Tracker (see Green Recovery Tracker, 2021a–i), a project launched by the Wuppertal Institute and E3G. Reviewing the work done in this framework, Heilmann and Lehne (2021) concluded that most early drafts fell short of the 37% climate spending target. Subsequent drafts did improve in their view but were still not seen as transformational. Further criticism touched upon the lack of decisive reforms (such as tackling national regulatory hurdles that are holding back renewable energy development) and weak points with respect to the drafting processes (which in part involved the compilation of pre-existing projects rather than ­strategic thinking and suffered from a lack of public involvement). In addition, the Climate Action Network (CAN) Europe and CEE Bankwatch Network (2022) published a report that provides detailed critical assessments of individual ­climate-related measures envisaged in the RRPs of seven CESEE EU member states. Moreover, the report also identifies investments and reforms that were not included but should have been included in the view of the authors.

Turning to the overview on RRPs, it is worth noting that CESEE EU member states are among those EU countries that are entitled to receive comparatively large amounts of RRF grants when compared to their GDP. Maximum allocation of multiannual RRP grants (for payout in the years 2021 to 2026) as a percentage of annual GDP in the year 2021 amounts to between 8% and 10% in Bulgaria and Croatia and stands between about 3% (Estonia, Slovenia, Czechia) and 6% (­Slovakia) in the remaining CESEE EU countries. In the CESEE EU aggregate, this ratio amounts to 4.5%. Among the EU-16 member states, Greece (9.5%) matches the level of Croatia and Bulgaria, followed by Portugal (7.5%); Spain (6%), Cyprus and Italy (each 4%) come next, lying in the range of the other CESEE EU ­countries. In contrast, Luxembourg, Ireland and Denmark receive the lowest amounts of multiannual RRP grants, reaching not more than 0.5% of GDP 2021. On top of grants, EU member states are entitled to apply for loans amounting to 6.8% of GNI at terms and conditions that are favorable for the majority of member states, including all CESEE EU member states. Remarkably, among CESEE countries, only Romania requested the full amount of available loans, as did Italy and Greece. While the RRPs of Poland and Slovenia involved requests for portions of the ­available loans, other CESEE countries opted for relying on grants only. Hence, the full potential of the RRF is not going to be used. In several CESEE countries, this might signal authorities’ awareness of some limits of absorption capacity and/or their aim to contain the rise in public indebtedness already pushed up by the pandemic-related crisis.

The RRF regulation (European Union, 2021) obliged each member state to dedicate at least 37% of total RRP expenditures (i.e. grants) contained in its RRP to measures contributing to climate objectives (and at least 20% to digital ­objectives) 34 . Within CESEE countries, Bulgaria surpassed this benchmark with the widest margin (59%). Most CESEE countries (Slovakia, Poland, Slovenia, ­Czechia, Estonia, Romania and Croatia) show a climate spending share between 40% and 45%. Thus, this share tends to be somewhat higher in CESEE EU ­countries than in those EU-16 countries that are also set to receive similarly high amounts of RRF grants relative to GDP. In Greece, Italy, Portugal, Spain and ­Cyprus the share of expenditures devoted to climate objectives ranges from 37% to 41%. For all EU member states taken together (referred to as the “EU-27” but effectively EU-26, as Hungary’s RRP data were not available at the time of ­writing), estimated climate expenditures amount to about 40% of their total RRF grants.

2.2 The structure of expenditure toward climate objectives under the RRPs

The breakdown of expenditure toward climate objectives into policy areas in chart 4 shows that, in most CESEE countries, the three most important areas are renewable energy and networks, energy efficiency and sustainable mobility. While in the EU-27 aggregate the combined share of these three areas makes up about two-thirds of expenditures toward climate objectives, in the CESEE EU countries the combined share ranges from about 50% in Slovenia to 95% in Bulgaria.

The relative importance of the three individual areas also varies widely across CESEE countries.

Bulgaria stands out with a particularly high share of expenditure for renewable energy and networks; Lithuania, Poland, Estonia, Croatia and Czechia also are above the EU average in this respect. Bulgaria inter alia defined the aim of tripling the power generation from renewables, and, at the same time, committed to set out a framework for the coal phaseout (phaseout as soon as possible and at the latest by 2038). In this context, Bulgaria’s RRP also includes binding targets for the ­reduction of the CO2 emissions associated with electricity generation by 40% ­below 2019 levels to be achieved by 2025 35 as well as a regulatory cap on carbon dioxide emissions from coal and lignite power plants applicable as of January 1, 2026. Various types of investments in renewables and grid and storage capacity are part of most CESEE countries’ RRPs. The Polish RRP envisages funding for offshore wind energy plants and terminal infrastructure, as well as regulatory changes facilitating the construction of onshore wind energy plants. In parallel, the Polish RRP is based on the National Energy and Climate Plan 2021–2030 and a strategy entitled Energy Policy of Poland until 2040 (Polish Ministry of Climate and Environment, 2021), which provides for a reduction of the share of coal in electricity generation to 56% by 2030 (from 73.6% in 2019) and 11% to 28% in 2040 as well as the abandonment of direct use of coal in households in cities by 2030 and in ­rural areas by 2040. This strategy is currently under review, following the Russian invasion of Ukraine. On top of this, in late 2020, the Polish government and trade unions agreed a plan to phase out coal mines by 2049. Czechia had a coal phaseout target of 2038 at the time of drafting the RRP. However, in early 2022, the Czech government announced plans to prepare for the phaseout of coal already by 2033. In Romania, the RRP includes reforms to phase out coal-based power production by 2032.

In some CESEE countries, the use of biomass as a renewable energy source for ­heating and electricity generation is a critical issue due to sustainability concerns (see Heilmann et al., 2020). In the context of the EU recovery and resilience plans, an important criterion is the “Do no significant harm” (DNSH) principle 36 . It is worth mentioning that in the framework of Czechia’s RRP investment in biomass (with the aim of reducing coal combustion for heat production and electricity ­generation) is subject to specific conditions and the sustainability criteria for ­renewable energy sources set out in the EU’s Renewable Energy Directive (RED II) 37 . Only biomass waste and residues that can be extracted in a sustainable ­manner shall be used. Moreover, milestones under the RRP include an assessment for the decarbonization of district heating as well as of the trajectories of sustainable use of bioenergy and supply of biomass to be prepared by the Czech authorities (see Council of the European Union, 2021). Within other CESEE countries’ RRPs, biomass projects are also linked to certain criteria and conditions and must comply with the RED II. In Romania, reform measures contained in the RRP aim at ­combating illegal logging and setting out sustainability criteria for forest biomass for energy use.

The share of spending for energy efficiency is particularly high in Slovakia, and it is also above EU average in Latvia, Czechia, Bulgaria and Romania. Expenditures in this area reflect, to a considerable extent, renovation initiatives with regard to public and private buildings. (For a more general discussion on EU policies aimed at reducing emissions related to buildings, see Rochet et al., 2021.) Yet, some countries’ RRPs also contain measures to promote energy efficiency in industry (e.g. Croatia, Romania, Slovenia, Slovakia and Poland), hence supporting industry decarbonization.

In Romania, Latvia and Lithuania, the share of planned expenditures for ­sustainable mobility is above the EU average share. Key measures include: investments in railway and urban transport infrastructure in Romania; an overhaul of the Riga metropolitan area transport in Latvia; phasing out the most polluting road transport vehicles (private, public and commercial); and increasing the share of renewable energy sources in the transport sector in Lithuania. Hanzl-Weiss (2022) points to the fact that CESEE’s automotive industry lags behind in car ­electrification, possibly also due to dependency arising from foreign ownership. In a joint EIB-OeNB-wiiw study (Delanote et al., 2022), the authors criticize the apparent lack of attention given to this issue in the RRPs of most countries. One might, however, argue that the gap in public transport is even more critical.

Going beyond these main three policy areas, chart 4 shows that some CESEE countries (Estonia, Poland, Lithuania, Slovenia, Slovakia and Croatia) have ­earmarked RRF funds for research, development and innovation (R&D&I) in green ­activities, with Estonia and Poland lying above the EU average.

It is also worth highlighting that Estonia shows a relatively high share of ­expenditure in the area of other climate change mitigation. This reflects measures aimed at speeding up the green transition in the business sector, inter alia through a green fund set up to finance innovative green technologies that contribute to solving environmental problems.

Expenditure for climate change adaptation plays a large role in Slovenia and is also above the EU average in Czechia and Romania, with measures addressing flood risks being part of the RRPs in these three countries.

Croatia’s RRP features a relatively high share of expenditures devoted for the transition to a circular economy (e.g. investments to upgrade water and ­wastewater systems). Compared to the EU average, this policy area also plays a larger role in Slovenia (e.g. upgrading energy-efficient wastewater and drinking-water systems), Czechia (e.g. constructing recycling infrastructure and generating water savings in the industrial sector), Romania (e.g. investments in municipal waste management systems) and Bulgaria (e.g. support for companies in modernizing their technology and in their transition to green and circular business practices).

Chart 4 entitled “Breakdown of expenditure towards climate objectives per policy area” is a column chart. It shows the percentage shares of various expenditure categories in total expenditures in the CESEE member states as well as in the EU aggregate and the sub-aggregates CESEE-EU and other EU member states termed EU-16. Columns for countries and aggregates together are ordered by size of the share of renewable energy and networks in % of total expenditures.

Bulgaria: renewable energy and networks 46%, sustainable mobility 15%, energy efficiency 34%, R&D&I in green activities 0%, climate change adaptation 0%, other climate change mitigation 0%, transition to a circular economy 3%, other categories 2%.

Lithuania: renewable energy and networks 35%, sustainable mobility 35%, energy efficiency 21%, R&D&I in green activities 6%, climate change adaptation 2%, other climate change mitigation 0%, transition to a circular economy 0%, other categories 1%.

Poland: renewable energy and networks 34%, sustainable mobility 34%, energy efficiency 21%, R&D&I in green activities 8%, climate change adaptation 0%, other climate change mitigation 1%, transition to a circular economy 0%, other categories 3%.

Estonia: renewable energy and networks 24%, sustainable mobility 24%, energy efficiency 11%, R&D&I in green activities 12%, climate change adaptation 0%, other climate change mitigation 25%, transition to a circular economy 1%, other categories 4%.

CESEE-EU: renewable energy and networks 23%, sustainable mobility 34%, energy efficiency 25%, R&D&I in green activities 4%, climate change adaptation 5%, other climate change mitigation 2%, transition to a circular economy 3%, other categories 4%.

Croatia: renewable energy and networks 21%, sustainable mobility 26%, energy efficiency 27%, R&D&I in green activities 2%, climate change adaptation 5%, other climate change mitigation 0%, transition to a circular economy 10%, other categories 9%.

Czechia: renewable energy and networks 19%, sustainable mobility 25%, energy efficiency 35%, R&D&I in green activities 0%, climate change adaptation 12%, other climate change mitigation 0%, transition to a circular economy 4%, other categories 4%.

EU-25: renewable energy and networks 17%, sustainable mobility 34%, energy efficiency 27%, R&D&I in green activities 7%, climate change adaptation 6%, other climate change mitigation 2%, transition to a circular economy 3%, other categories 5%.

EU-15: renewable energy and networks 15%, sustainable mobility 35%, energy efficiency 27%, R&D&I in green activities 8%, climate change adaptation 6%, other climate change mitigation 2%, transition to a circular economy 2%, other categories 5%.

Slovenia: renewable energy and networks 13%, sustainable mobility 27%, energy efficiency 12%, R&D&I in green activities 4%, climate change adaptation 29%, other climate change mitigation 0%, transition to a circular economy 7%, other categories 8%.

Latvia: renewable energy and networks 12%, sustainable mobility 44%, energy efficiency 39%, R&D&I in green activities 0%, climate change adaptation 5%, other climate change mitigation 0%, transition to a circular economy 0%, other categories 0%.

Slovakia: renewable energy and networks 8%, sustainable mobility 25%, energy efficiency 59%, R&D&I in green activities 3%, climate change adaptation 6%, other climate change mitigation 0%, transition to a circular economy 0%, other categories 0%.

Romania: renewable energy and networks 6%, sustainable mobility 46%, energy efficiency 30%, R&D&I in green activities 0%, climate change adaptation 8%, other climate change mitigation 4%, transition to a circular economy 4%, other categories 2%.

Note: Each recovery and resilience plan must dedicate at least 37% of the plan’s total allocation to climate objectives. To this end, the plans has to specify and justify to what extent each measure contributes fully (100%), partly (40%) or has no impact (0%) on climate objectives, using Annex VI of the RRF Regulation. Combining the coefficients with the cost estimates of each measure allows assessing to what degree the plan contributes to climate objectives and whether it meets the 37% target. No data available for Hungary and the Netherlands (hence EU-15 instead of EU-16). 



Source: European Commission.

3 Conclusions

Taking stock of GHG emissions in the European Union in 2019 shows that ­emissions per capita were equal on average in CESEE EU and in the EU-16 (i.e. non-CESEE EU), with sizable heterogeneity in both country groups. The CESEE EU aggregate showed considerably larger shares of total GHG emissions from ­energy industries (reflecting inter alia the demanded volume of energy supply) and from waste and from fugitive ­emissions from fuel, implying correspondingly higher per capita emissions in these sectors. While a comparison of per capita emissions is useful as a first point of orientation, one also must consider that per capita income levels are still lower in the CESEE EU country aggregate than in the EU-16 country aggregate. Hence, the carbon ­intensity (measuring GHG emissions per unit of GDP) was substantially higher in CESEE EU than in the EU-16. This reveals the urgent need for further lowering emissions in order to enable further per capita income convergence within ecologically ­sustainable limits.

The comparatively higher GDP-based carbon intensity in all CESEE EU countries resulted mainly from higher emission intensity (measuring GHG emissions per unit of energy used), but also from above-average energy intensity (measuring energy used per unit of GDP). This outcome indicates that both saving energy and expanding low-emission sources of energy, particularly renewable energy, are even more ­urgent challenges for the CESEE EU countries than for the EU-16. The higher GDP-based emission intensity in CESEE EU resulted mainly from energy industries for generation of electricity and heating/cooling. Moreover, higher GDP-based ­emission intensity is being driven up by the emission intensity of industry and, ­particularly in Poland, by the intensity of emissions directly generated within ­residential buildings due to the widespread use of coal. The comparatively higher carbon intensity of industry in CESEE EU resulted mainly from higher energy ­intensity.

How do the results of our stocktaking exercise relate to the CESEE EU countries’ spending preferences within climate-related RRP expenditures? Overall, the ex ante ­allocation of spending within climate-related expenditures in the framework of CESEE EU RRPs described in section 2 appears to be broadly appropriate, in as far as the three largest spending categories relate to areas where weaknesses emerged in CESEE. We caution that in no way should this be regarded as a sufficiently detailed assessment of whether the RRPs are adequate in general or whether individual measures envisaged in these plans are sufficient in terms of content or timeliness. The focus on renewable energy and networks is particularly important in view of the fact that, in CESEE EU, per capita GHG emissions in energy industries ­(generation of electricity and heating/cooling as well as refineries for oil products and coke ovens) were on average more than 50% higher than in the EU-16 despite the lower per capita GDP level. At the same time, we appreciate that the RRPs do not ­endorse the expansion of any type of renewable energy production but must ­comply with the “do no significant harm” principle and sustainability criteria. Therefore, regarding the use of biomass, only biomass waste and residues that can be ­extracted in a sustainable manner shall be used and reforms and milestones that advance such types of biomass shall be implemented in the context of the RRPs. The focus on energy efficiency, that is the inverse of energy intensity, at first glance does not ­appear to be much more important in CESEE EU than in the EU-16 if energy ­intensity based on GDP at PPP is taken as the yardstick, while in fact it certainly is an urgent challenge for the EU-16 and hence for CESEE EU, too. Moreover, if we look at energy intensity based on GDP at exchange rates or at energy intensity in industry, the need for catching-up in CESEE EU is still quite substantial indeed. More specifically, energy-saving measures, particularly in residential and commercial or institutional buildings, would be instrumental in lowering per capita ­emissions generated directly within these buildings and lowering per capita emissions in energy industries, which are far higher in CESEE EU than in the EU-16. The focus on sustainable mobility at first sight appears to be even less important in CESEE EU than in the EU-16 when looking at per capita GHG emissions in transport. However, as argued above, both the far more dynamic rise of these emissions in CESEE EU and the expectation of gradual structural alignment of CESEE’s ­participation in international aviation call for sustainability-oriented action in the transport sector early on.

Looking into country-specific spending preferences generally confirms the broad picture for the three largest climate-related spending categories in RRPs, even though some questions arise. In the area of renewable energy and networks, the above-average shares of expenditure in Bulgaria, Poland, Estonia and Czechia ­address these countries’ far above-average per capita GHG emissions in energy ­industry. In this area, coal phaseout is an important issue in the small group of countries that still use coal to a non-negligible extent in energy industries for ­generation of electricity and heating/cooling and directly in the residential sector (households). It appears that this issue is generally addressed in the RRPs or in ­related plans and strategies, but to different extents and with quite different time frames concerning the coal phaseout. While the RRPs of Bulgaria and Romania refer explicitly to their plans to phase out the use of coal, Czechia and Poland ­published phaseout targets only in related documents. Romania appears to pursue the most ambitious target, while Poland seems to have positioned itself at the other end of the spectrum with reduction targets for coal-based power production to be achieved by 2030 and 2040 but no clear target year for the ultimate phaseout. It would be highly welcome if Poland set an ambitious target date for the ultimate phaseout of coal-based power production and adopted a more ambitious approach with respect to the phaseout of coal use by households in rural areas (combined with a strong effort to promote heat pumps).

In the area of energy efficiency, the above-average shares of expenditure in Latvia and Bulgaria address their considerably above-average energy intensity based on GDP at PPP, and in Slovakia and Czechia, spending reflects intensities that exceed the average as well, albeit by a smaller margin. In the case of Estonia, which also shows high GDP-based energy intensity, only a rather modest share of total RRP spending explicitly addresses energy efficiency (especially in dwellings); but the particularly large and somewhat opaque item of “green transition in business” may inter alia advance economy-wide energy efficiency. For Latvia and Bulgaria, it would be important that their energy efficiency plans also comprise significant measures for industry, given the high intensity levels in their industrial sectors. However, the Bulgarian RRP measures for industry contain an only moderate share that contributes to climate objectives and the Latvian RRP hardly mentions climate issues related to industry. In contrast, it is particularly welcome that ­Slovakia’s energy efficiency plans also cover the industrial sector, given the ­particularly high energy intensity of that sector. In this context note that also the RRPs of Croatia, Romania and Poland address their above-average energy ­intensities in industry. In view of the above-mentioned fact that energy-saving measures also help lower per capita emissions in energy industries, a larger general effort to promote energy-saving measures would be very welcome in Poland, given its far above-average per capita emissions in energy industries.

In the area of sustainable mobility, the above-average shares of expenditure in Lithuania, Latvia and Romania address the fact that the per capita GHG emissions in transport were considerably above the EU-27 average in Lithuania and Latvia and that the growth rates of these emissions were particularly high in these two countries and in Romania. In Slovenia, characterized by high per capita GHG emissions in transport, and in Poland, where transport emissions grew particularly rapidly, expenditures for sustainable mobility also play an important role, accounting for the largest share in both countries’ total RRP spending, though they do not exceed the corresponding spending share for the EU-27.

Apart from these three major climate-related spending categories, note that the category of transition to a circular economy, which particularly includes waste management and wastewater treatment, accounts for an above-average share of spending within the RRPs’ climate-related expenditures in Croatia, Czechia and Bulgaria (among others), hence in those countries where (together with Hungary) per capita GHG emissions from waste are above the CESEE EU average and ­between 50% and 110% higher than in the EU-16.

To sum up, the national recovery and resilience plans of CESEE EU member states form part of a sizable EU-coordinated policy intervention effort. Overall, the ex ante allocation of spending within climate-related expenditures under these plans appears to be broadly appropriate in general, in as far as the three largest spending categories relate to areas where CESEE countries exhibit particular weaknesses. Future research may use the updated dataset on climate-related intensities for deriving an output-/performance-based ex post assessment of the actual achievements of this policy effort. But there is ample room for further research even today. One strand could be to add further elements to the emission-related analysis. For instance, a country- and sector-specific dynamic perspective could enrich the analysis and add to policy insights. Also, a look at the country-specific efficiency in electricity and heat supply (e.g. relating energy input to energy ­output) would be interesting. Another strand would be to scrutinize in depth the wide range of measures envisaged under the RRPs to derive detailed policy assessments and recommendations on top of the already existing literature.

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16 Oesterreichische Nationalbank, Economic Analysis and Research Department, , , . Opinions expressed by the authors of studies do not necessarily reflect the official viewpoint of the OeNB or the Eurosystem. The authors would like to thank ­Manuela Strasser (Statistics Austria) for helpful explanations and participants of the OeNB’s 2022 Conference on European Economic Integration as well as Julia Wörz (OeNB) and two anonymous referees for helpful comments and ­valuable suggestions.

17 Europe has a large share in total historical GHG emissions and a still substantial share in total current GHG emissions. Moreover, it has a significant role as an international standard setter, role model and technology ­exporter.

18 The EURI is also called NextGenerationEU recovery plan (NGEU).

19 These GHG emissions include allotted emissions released from international bunkers related to international ­navigation and aviation. They exclude the impact of land use, land use change and forestry (LULUCF).

20 Among EU-16 countries, only Greece and Portugal recorded declines in population figures, which in both ­countries roughly equaled the average decline in CESEE EU.

21 This subsection includes allotted GHG emissions released from international bunkers related to international ­navigation and aviation. We use emissions data without the impact of land use, land use change and forestry (­LULUCF).

22 Note that the volume of emissions caused by nonresidents in the territory of any country is not just an unavoidable result of nonresidents’ decision-making but may well be influenced by policy, like, for instance, tax policy that aims at lifting government revenues via fuel taxes instead of aiming at containing GHG emissions.

23 Including allotted emissions released from international bunkers related to international navigation and aviation. We use emissions data without the impact of land use, land use change and forestry (LULUCF).

24 In Lithuania, Denmark and Ireland, the AEA data for total GHG emissions are 15% or more higher than the ­UNFCCC totals, while in Belgium, Cyprus, Luxembourg, Malta and the Netherlands the AEA data are 10% or more below those totals.

25 Besides, the AEA data show that in 2019 slightly less than half of the transport sector emissions stemmed from households both in CESEE EU and in the EU-16, while in 2008 the household share was just above 40% of ­total transport emissions in CESEE EU but already about 50% in the EU-16.

26 Also note that equal (or, in fact, slightly lower) per capita emission levels in CESEE EU manufacturing where FDI from the EU-16 have a strong or even dominant role, cast doubts over a specific form of carbon leakage ­hypothesis according to which the EU-16’s outward FDI in CESEE EU member states consisted largely in transferring above-average polluting industries to CESEE. However, these data do not allow rejecting this hypothesis either, as the counterfactual is unknown.

27 While the exceptionally high level of per capita GHG emissions and carbon intensity in Malta may be attributed exclusively to the far above-average emissions associated with international navigation and aviation, the later may explain only part of the above-average per capita GHG emissions and carbon intensities in Cyprus, Belgium and the Netherlands. In the Netherlands, per capita emissions in energy industries and in agriculture are ­extraordinarily high, while in Belgium emissions from manufacturing are particularly high.

28 To be precise, total final energy consumption is used for calculating energy intensity.

29 Note that Estonia is a special case where the high emission intensity results from the high share of two special sources of fossil energy, namely shale oil and oil sands as well as manufactured gases, both not included in oil and natural gas in the table below.

30 Note that for a few economically smaller countries the resulting data are quite a bit surprising: For Malta and ­Cyprus and even more so for Portugal and Bulgaria, the share of fossil energy was strikingly low, implying a high share of renewables and biofuels. The fact that emission intensity was nevertheless above the EU-27 average might partly be explained by the share of coal in Bulgaria and the share of oil and petroleum in Malta and Cyprus, which made up the entire fossil energy share while there was no use of natural gas. Both explanations do not work for Portugal, however. At least, these data would suggest sub-optimal technology in using fossil energy in households resident in these countries.

31 Excluding C19 (manufacture of coke and refined petroleum products) categorized under energy industries and C33 (repair and installation of machinery and equipment) categorized under services.

32 Note that, also in this paragraph, we use emissions data without the impact of land use, land use change and ­forestry (LULUCF).

33 Data used in this chapter were obtained from the European Commission (2022g, 2022h), including in particular the European Commission’s Recovery and Resilience Scoreboard (2022f). Hungary’s RRP data were not available at the time of writing. Information on measures included in the RRPs were taken from European Commission factsheets and European Commission assessments (2021a–p and 2022b–e).

34 The RRPs had to specify and justify to what extent each measure contributes fully (100%), partly (40%) or has no impact (0%) on climate and/or digital objectives. The contributions to climate and digital objectives have been calculated using Annexes VI and VII of the RRF Regulation, respectively. Combining the coefficients with the cost estimates of each measure makes it possible to calculate to which degree the plans contribute to climate and ­digital targets.

35 However, in early 2023, Bulgaria’s parliament agreed that the interim government should start talks with the ­European Commission and backtrack from this commitment.

36 ‘Do no significant harm’ technical guidance (2021/C58/01).

37 In particular, see Article 29 of Directive 2018/2001 on the promotion of the use of energy from renewable sources (Renewable Energy Directive, RED II).

Russia’s banking sector and its EU-owned significant banks, against the backdrop of war and sanctions

Stephan Barisitz, Philippe Deswel 16

Russia’s invasion of Ukraine in February 2022 and unprecedented waves of Western sanctions have worsened the overall economic environment for the Russian banking system and ­European banks that are active in the country. The suspension of the publication of key prudential ­indicators by the Bank of Russia (CBR) since the outbreak of the war has also rendered an analysis of most recent banking developments much more difficult. After initial sanctions-­triggered instability in March 2022, the authorities managed to re-establish some fragile ­macroeconomic and financial stability later in spring. Nevertheless, Russia is moving from a resilient post-COVID recovery to a pronounced recession in 2022 and the economy will likely bottom out in 2023. The banking sector, dominated by a few large state-owned players, has gone from driving growth through lending expansion to being affected by the downturn and supported by credit subsidy programs. The largest Russian banks (including Sberbank) have been sanctioned and barred from SWIFT (market share of these banks: almost two-thirds of total sector assets). Due to sanctions and the downswing, the banking sector made a loss of about USD 25 billion in the first half of 2022 (around 12% of its registered capital or more than a fifth of its additional capital buffers at end-2021), the sector’s first loss in seven years. Although Western jurisdictions froze about half of Russia’s sizable international reserves in February, the authorities have continued to benefit in recent months from substantial revenue inflows due to very high energy prices. The CBR and the government currently appear ­prepared to support the economy and banks through 2022 and probably 2023, even in the likely event that banks lose a much larger share of their capital due to the unfolding crisis. In this context, the European banks that qualify as significant institutions (Raiffeisenbank Russia, Rosbank/Société Générale and UniCredit Bank Russia) have been fundamentally revising their strategies and activities. The war in Ukraine and Western sanctions have strongly increased the level of risk of their activities and led them to initiate various disengagement strategies (ranging from full exit to a material reduction of operations). Their provisioning levels have noticeably ­increased, especially with respect to credit risk in a situation where the risk outlook has ­materially deteriorated for a wide range of counterparties. Emerging risk factors like cyber risk, exchange rate risk (with the complexity of hedging strategies), market risk (given ­increased volatility and funding costs) and noncompliance risk with the latest sanctions regime have ­required enhanced monitoring. Reputational risk appears as a key risk factor. Available ­projections show a capacity for European banks to resist further shocks. They are also ­accumulating capital in light of the resilient war-time profitability they have shown so far and their incapacity to distribute dividends abroad. Yet Russia’s war in Ukraine represents a ­paradigm shift given the large share of previously identified threats (in the pre-war period) that materialized in swift succession.

JEL classification: G21, G28, P34

Keywords: banking sector, European banks, Russia, financial stability, sanctions, COVID-19, crisis, crisis-response measures, credit risk, nonperforming loans, profitability, ­regulatory ­forbearance, shock-absorbing factors

Given dramatic developments in recent months triggered by Russia’s invasion of Ukraine in late February 2022, this brief study constitutes an update of the ­authors’ article “European banks in Russia: developments and perspectives from 2017 through the COVID-19 pandemic (2020/2021)” published in Focus on European Economic Integration Q3/21 (Barisitz and Deswel, 2021). This update covers the period from 2021 to October 2022. We appear to be witnessing a decisive change, and the war and sanctions have rendered European banks’ activity in Russia – which remained resilient and profitable in the past few years – considerably more difficult and brought material financial and reputational risks. After a snapshot of developments in the macroeconomic environment and overall Russian banking sector (section 1), the study focuses on recent experiences of the three large ­European banks in Russia (Raiffeisenbank, Rosbank/Société Générale and ­UniCredit Bank; it does not necessarily apply to other European banks that have or had exposure to Russia) 17 with an update in light of the war and new sanctions ­(section 2). Conclusions (section 3) on current risks and shock-absorbing factors and an outlook (section 4) wrap up the study.

1 Developments in the macroeconomic environment and overall banking sector

1.1 From strong post-COVID recovery in 2021 to pronounced recession triggered by war and sanctions in 2022

The oil price recovery from its pandemic-related low in spring 2020 has given a fillip to Russia’s economy throughout the last two years. 2021 GDP growth of 4.7% by far offset the COVID-triggered shrinkage of 2020 (−2.7%). Brisk 2021 growth was driven by private consumption and fixed investment. The average Urals oil price rose by almost two thirds to USD 69 per barrel in 2021 against the previous year, and further rose by about 22% in the period from January to ­September 2022 (to USD 81, year on year). Rising oil prices were driven by the global economic recovery, the OPEC+ agreement and, from early 2022, escalating geopolitical tensions in Eastern Europe. The Russian unemployment rate (ILO methodology) declined to 3.9% in August 2022 – the lowest post-Soviet level to date.

Russia’s invasion of Ukraine (from February 24, 2022) and the unprecedented waves of Western sanctions 18 that ensued profoundly changed the playing field. ­Punitive measures include the freezing of almost half (about USD 300 billion) of the Bank of Russia’s international reserves (of USD 630 billion in late February) – the part placed in Western countries’ jurisdictions – a unique step so far. 19 ­Moreover, the assets of a number of Russian banks, including the largest, ­Sberbank, 20 were frozen and/or banks were excluded from the international financial ­messaging service SWIFT. 21 Additional export controls were imposed, on top of existing ­controls on high-tech products and aircraft parts and components. G7 countries unilaterally stripped Russia of its most favored nation status in trade with them. The US furthermore issued an embargo on purchases of oil, gas and gold, and the EU on purchases of coal from Russia; in June, the EU decided to ban all oil imports from Russia delivered by tankers (the majority of EU oil imports), but only from late 2022. A number of renowned Western firms have already withdrawn or ­curtailed their activities in the country. 22 Russia has responded with selective ­punitive countermeasures (e.g. cessation of gas exports to EU members that refuse to comply with Russia’s demand to pay for gas in ruble, followed in September by near-total suspension of gas deliveries to the EU).

On February 28, in order to prevent monetary and financial destabilization, the Bank of Russia (CBR) more than doubled its key rate (policy rate) from 9.5% to 20.0%, following four previous raises over six months that had added up to three percentage points. Exporters were instructed to exchange 80% of their forex proceeds into ruble, and some other capital controls were established (e.g. ­restrictions on retail forex purchases, on withdrawals from forex-denominated ­accounts and on capital or dividend transfers abroad). 23 The CBR moreover ­intervened with the unfrozen part of its reserves and reportedly spent USD 34 billion (Le Monde, 2022a) to support the ruble. Thanks also to asset valuation changes, this unfrozen part shrunk to USD 252 billion (about 14% of GDP) as of mid-November. The Moscow Stock Exchange was closed for a couple of weeks, then reopened in late March, although a “temporary” ban was imposed on foreign firms and nonresidents selling Russian assets and repatriating the proceeds. A broad sell-off resumed when the market reopened with a sustained downward trend. The ruble – no longer fully convertible – initially lost almost half of its value against the US dollar and the euro from mid-February, but fully recouped its losses by mid-April, and as of early November, was even 15% to 20% more expensive than prior to the invasion. This is largely due to a combination of still very high levels of energy prices and revenues (even after generous discounts), the ­authorities’ remaining capital controls (even after some easing), the impact of Western trade sanctions mostly cutting into Russian imports, and the Russian gas-for-ruble scheme imposed on EU importers. 24

CPI inflation (year on year), pushed by strong domestic demand and structural bottlenecks, grew from 5% to 6% in early 2021 to 9.2% at end-February 2022. Post-invasion, it rapidly accelerated to 17.8% at end-April (the highest level in the last 20 years), before easing to 12.6% (end-October). The sharp rise in March-April was largely due to a convergence of temporary factors (the initial ruble plunge, consumers panic-buying food and durables, and a spike in households’ ­inflation expectations) and longer-lasting factors (sanctions- and ­uncertainty-driven supply chain disruptions) (Ekonomicheskaya Ekspertnaya Gruppa, 2022a; pp. 5, 6, 28). Once temporary factors, inflation dynamics and inflation expectations had weakened or were weakening, the CBR successively cut back its key rate to 17% in early April, 14% in early May, 11% in late May, 9.5% in mid-June, 8% in late July and 7.5% in mid-September. The decline of inflationary pressure and the restabilization of the ruble persuaded the authorities, in late May 2022, to cut the share of exporters’ mandatory exchange of forex proceeds from 80% to 50% and, in mid-June, to abolish the mandatory exchange rule. 25

According to the CBR, the Russian economy has entered a phase of far-­reaching “structural adjustment” toward more self-reliance and less dependence on Western imports, which will also modify the domestic price structure and put upward ­pressure on the prices of certain products (Bank Rossii (ed.), 2022a). Notwithstanding gathering economic difficulties, GDP continued to expand by 3.5% in the first quarter of 2022 (year on year), driven largely by consumption, fixed investment and exports. Yet in the second and third quarters, growth turned strongly negative to −4.1% and −4.0%, respectively (year on year), producing an overall economic contraction of 1.8% in the period from January to September (as against the same period of the previous year).

In 2021, the general government budget again produced a surplus (of 0.7% of GDP), after deficit spending in the 2020 recession. Buoyed by very high oil prices, fiscal surpluses continued in the first half of 2022, but turned into hefty monthly deficits in July and August, followed by a smaller shortfall in September, yielding only a very modest surplus (about 0.1% of pro rata GDP) in the period from ­January to September. The most recent fiscal deterioration was due to a ­combination of ruble appreciation (against USD-denominated oil sales), declining import tax revenues and boosted spending. The assets of the National Wealth Fund (NWF) were slightly larger at end-October 2022 (USD 184.8 billion or about 8% of GDP) than at the beginning of the year. 26 In reaction to the sanctions, the authorities announced increased social assistance payments, pension adjustments, tax breaks and financial support for enterprises. That said, a substantial anticyclical fiscal stimulus is reportedly not planned. The oil price rise contributed to boosting the country’s current account surplus to 6.9% of GDP in 2021 and further to a record 16% of (pro rata) GDP in the first half of 2022. Yet theses surpluses were all but offset by net private capital outflows. Russia’s gross foreign debt shrunk slightly in the first six months of 2022 and came to 26.6% of GDP at end-June. Despite ­partial ­freezing of reserves, continuous substantial inflows of oil and gas proceeds in the first half of 2022 contributed to maintaining Russia’s ability to pay. ­Notwithstanding the authorities’ ability and willingness to pay, Russia defaulted on its ­foreign debt in June (for more details, see section 3).

Table 1: Russia: selected macroeconomic indicators  
2019 2020 2021 H1 22 20226
%
Real GDP growth (year on year) 2.2 –2.7 4.7 –0.5 –3.4
Inflation (CPI, end of period, year on year) 3.0 4.9 8.4 15.9 ..
Unemployment rate (ILO definition, average) 4.6 5.8 4.8 June: 3.9 4.25
Budget balance (general government, % of GDP) 1.9 –4.0 0.8 4.1 –2.05
National Wealth Fund1 (end of period, % of GDP) 6.9 11.7 10.4 11.8 ..
General government gross debt (end of period, % of GDP) 12.4 17.6 16.0 13.3 13.05
Current account balance (% of GDP) 3.9 2.4 6.9 16.1 13.05
Net private capital flows (% of GDP) –1.6 –3.1 –4.6 .. ..
Gross external debt (end of period, % of GDP) 29.0 29.2 28.4 19.7 19.05
Gross international reserves
(including gold, end of period, % of GDP)
32.6 38.2 35.5 15.03 / 31.94 ..
CBR key rate2 (end of period) 6.25 4.25 8.5 9.5 ..
Source: Rosstat, Bank of Russia, Ministry of Finance.
1 The predominant part of this fund is also included in Russia’s gross international reserves.
2 The Russian central bank’s one-week-repo rate.
3 Remaining accessible reserves after Western countries froze large portions of these reserves located in their jurisdictions (ca. USD 300 billion).
4 Total gross international reserves, including frozen portions.
5 wiiw forecast, October 2022.
6 IMF October forecast.

1.2 Banks continued to drive growth until early 2022 but now face major impacts from economic downswing

Apart from the oil price, banking activity, particularly retail lending, was one of the driving forces of Russia’s post-COVID economic recovery in 2021 and the first months of 2022. While available data show a substantial weakening of the economy and bank lending and less so of deposit-taking from March 2022, a number of key macroprudential data – including growth in nonperforming loans (NPLs), forex ratios, external debt ratios, profitability, capital adequacy and loan loss provisions – have not been released since end-January 2022. This of course makes it more difficult to assess the impact of the war and sanctions on banking risks. Moreover, regulatory lenience regarding the measurement of banks’ assets and provisioning, which had been lifted in mid-2021 following the weakening of the pandemic, was reinstated in late February 2022 as a crisis-response measure.

In any case, as table 2 shows, banking activity continued its expansion from late 2020 through late February 2022. Loans to enterprises expanded at rates of 3% to 5%, and growth rates of loans to households increased from 8% (end-2020) to 13% to 14% (early 2022) (in real terms and exchange rate-adjusted). Accelerating retail lending rates were driven by subsidized 27 mortgage loans (+16% to 17% in early 2022), that made up almost half of total retail credit, and by (partly unsecured) consumer loans (+10% to 11% in early 2022). Robust credit expansion ­contributed to a decline of the NPL ratio from 9% (narrow definition) or 17% (broader ­definition) 28 at end-2020 to 7% and 15%, respectively, in early 2022. Loan loss provisions remained slightly above the narrow NPL level. Notwithstanding the slide of the ruble, which accelerated from January 2022 before reversing in late March to April, forex loans’ share in total loans remained relatively low (at 16% in early 2022, also on account of the long-standing ban of forex lending to households). Low real interest rates and growing attractiveness of alternative ­investments in the Russian stock market during most of the observation period (end-2020 to end-September 2022) contributed to the erosion of household deposits (in real terms and exchange rate-adjusted), while enterprise deposits continued to expand and have outsized retail deposits since mid-2021. Banks have remained net external creditors.

After relatively modest profitability during the pandemic with a return on ­equity (ROE) of 15.7% at end-2020, the sector’s ROE exceeded pre-pandemic ­levels in 2021 (end of year: 21.1%) before easing in early 2022 (end-January: 20.5%). The capital adequacy of the sector, which is dominated by large ­state-owned banks, 29 remained at about 12% to 12.5% through most of the observation period, before weakening slightly in early 2022 (end-January: 11.8%). As mentioned ­earlier, the CBR unfortunately discontinued publication of certain important ­prudential indicators in end-February 2022, including those just mentioned (see also table 2).

The latest available data for banks’ credit and deposit dynamics (in real terms and exchange rate-adjusted), for March to September 2022, indicate an abrupt stoppage or reversal of growth, as shown in table 2 and in chart 1. According to the CBR, the sanctions-triggered outflow of households’ funds in late February to early March came to RUB 2.4 trillion or 7% to 8% of total retail deposits (Bank Rossii (ed.), 2022b). Looking at month-to-month data, the more than doubling of the key rate at end-February (to 20%) triggered increased credit and deposit rates in March, sharply reducing credit demand, particularly from households, while bringing about a return flow of ruble retail deposits which fully compensated for the outflow by end-April. The return flow was also helped by the ruble’s recovery from late March. Outflows of forex deposits were reined in in March by the ­abovementioned regulatory means. Extra liquidity was also provided to credit ­institutions.

Table 2: Russia: recent banking sector data (2020−2022)  
End-
2020
Mid-
2021
End-
2021
End-Jan. 2022 End-Mar. 20229 End-June 2022 End-Sep. 2022
Credit risk
Loans to enterprises1 (RUB trillion) 44.76 48.14 52.65 53.22 55.37 50.09 54.23
- real annual growth, exchange rate-adjusted (%) 4.8 4.4 3.1 3.0 –3.1 –6.0 –1.6
Loans to households2 (RUB trillion) 20.04 22.76 25.07 25.31 25.76 25.57 26.51
- real annual growth, exchange rate-adjusted, % 8.2 14.4 13.7 13.5 3.9 –2.9 –3.1
Mortgage loans (real annual growth, exchange rate-adjusted, %) 15.3 20.8 16.6 16.5 8.7 1.6 2.1
Share of mortgage loans in total household loans (%) 47.5 47.6 47.9 48.0 49.3 49.8 ..
Consumer loans (real annual growth, exchange rate-adjusted, %) 3.7 9.9 10.8 10.6 –0.6 –7.1 –7.7
Share of consumer loans in total household loans (%) 48.4 46.8 46.5 46.4 45.3 44.9 ..
Loans to state structures (RUB trillion) 0.81 0.62 0.46 0.41 .. .. ..
NPL ratio (share in total loans, %, narrow definition)3 9.0 8.4 7.1 7.1 .. .. ..
NPL ratio (share in total loans, %, broader definition)4 17.0 16.2 15.1 15.1 .. .. ..
Market and exchange rate risk
Forex loans (share in total loans, %) 17.9 15.8 15.7 16.2 .. .. ..
Forex deposits (share in total deposits, %) 26.1 24.2 23.9 25.7 .. .. ..
Liquidity risk
Deposits of enterprises5 (RUB trillion) 32.65 33.41 38.29 39.54 40.63 36.65 40.81
- real annual growth, exchange rate-adjusted (%) 10.5 9.1 8.9 9.9 1.5 2.6 9.6
Deposits of households6 (RUB trillion) 32.83 32.38 34.70 34.20 33.27 32.94 33.14
- real annual growth, exchange rate-adjusted (%) –0.7 –3.4 –2.5 –2.4 –12.9 –8.5 –8.8
Government deposits (RUB trillion) 3.99 8.26 6.26 6.55 .. .. ..
Loan-to-deposit ratio (%) 94.4 96.6 98.6 98.3 .. .. ..
Loan-to-deposit ratio (enterprises and households, %) 99.0 107.8 106.5 106.5 109.8 108.7 109.2
Banks’ external assets7 (share in total assets, %) 9.5 8.8 8.1 8.6 .. .. ..
Banks’ external liabilities8 (share in total liabilities, %) 3.1 3.1 3.1 3.2 .. .. ..
Profitability
Return on assets (ROA, %) 1.7 2.1 2.1 2.1 .. .. ..
Return on equity (ROE, %) 15.7 20.4 21.1 20.5 .. .. ..
Shock-absorbing factors
Capital adequacy ratio (capital to risk-weighted assets, %) 12.5 12.6 12.3 11.8 .. .. ..
Tier 1 capital ratio (%) 9.7 10.3 9.6 9.2 .. .. ..
Loan loss provisions (relative to total loans) 9.1 8.7 7.8 7.8 .. .. ..
Memorandum items
Total banking sector assets (% of GDP) 96.7 94.4 92.0 .. 92.1 .. ..
Total number of operating credit institutions 406 378 370 368 365 363 362
Source: Bank of Russia, in particular: various issues of “O razvitii bankovskogo sektora Rossiskoy Federatsii,” “Statisticheskie pokazateli bankovskogo sektora Rossiskoy Federatsii,” authors’
own calculations.
1 Corporate loans granted to nonfinancial organizations, individual entrepreneurs and financial institutions.
2 Loans granted to individuals.
3 Share of problem loans (category IV) and loss loans (category V) in total loans (according to CBR regulation no. 254).
4 Share of doubtful (category III), problem (category IV) and loss loans (category V) in total loans (according to CBR regulation no. 254).
5 Funds of corporate customers (nonfinancial organizations, individual entrepreneurs and financial institutions).
6 Funds (deposits) of individuals.
7 Funds (including correspondent accounts with banks and securities acquired) placed with nonresidents.
8 Funds raised from nonresidents (including deposits of legal entities and individuals).
9 From end-February 2022, the CBR has not published some important prudential indicators, like the NPL ratio, share of forex loans, banks’ external assets, profitability, capital adequacy,
loan loss provisions.

While retail deposits have since stabilized overall, confidence has remained fragile. Heightened uncertainty contributed to a substantial shift from long-term to short-term household deposits in the spring of 2022. Some deposit flows from sanctioned (SWIFT-excluded) to unsanctioned banks, including EU-owned ­significant banks, have also been registered and undermine the lending capacity of sanctioned banks (Litova, 2022). That said, oil price rise-triggered growth of ­government revenues reportedly led to a strong increase in public sector deposits in March (BOFIT Weekly, 2022a). The move to short-term deposits was mostly reversed over the summer. On the other hand, the badly organized partial ­mobilization in September to October reportedly triggered deposit withdrawals of around RUB 500 billion (about 1.5% of total retail deposits) before the situation calmed down somewhat in late October/early November. Lending in foreign ­currencies (notably in US dollar and euro) has declined in recent months and some banks have converted existing forex loans to ruble loans (Ekonomika i Zhizn, 2022; p. 4). The share of forex deposits in total deposits reportedly declined from about a quarter before the war to 12% at end-August 2022 (BOFIT Weekly, 2022b). Overall, on a year-on-year basis, by end-September the growth of loans to enterprises (−2%) as well as to households (−3%) was negative (in real terms and exchange rate-adjusted), 30 while enterprise deposits continued to expand (10%, probably helped by inflows from oil and gas firms and/or state-owned firms) (Bank Rossii (ed.), 2022e; p. 2), and retail deposits strongly declined (−9%) (as shown by table 2 and chart 1).

Chart 1, Growth rates of banking sector assets, deposits and loans, depicts growth rates of banking sector assets, deposits and loans in real terms and exchange rate-adjusted, year on year. The chart covers monthly intervals from end-December 2020 to end-September 2022. All indicators, except deposits of households, record growth of about 5% to 15% per annum until February 2022. Until early 2022, deposits of households show small negative growth rates, ranging from 0% to minus 3% per annum. Then all indicators with previously positive growth rates dip into negative territory, except deposits of enterprises whose growth rates remain positive. The growth rates of deposits by households slide further into negative terrain in spring 2022 (minus 12% to minus 13%) before recovering to about minus 8%. Since June 2022, we see an overall slow recovery or at least stabilization of still weak growth rates. Total assets expand at a rate of 6% to 10% per annum up to January 2022; after that, no more statistics on total assets have been released and so the line stops there.

Source: Bank of Russia.

Given at least temporary financial stabilization – notwithstanding persistently high inflation – the gradual reduction of the key rate between March and June back to its pre-war level of 9.5% and, beyond that, to 7.5% in September, may have helped borrowers but was certainly insufficient to restore lending activity, given the Russian economy’s unfolding recession. The government, in cooperation with the monetary authority, therefore launched subsidized lending programs focusing on systemically important enterprises, trade corporations, the agroindustrial ­complex and SMEs, in addition to existing mortgage credit subsidies which were adjusted in late June with interest rate caps lowered from 9% to 7%. Repayment holidays for distressed borrowers, discontinued in mid-2021, were resumed and have met substantial demand.

Nonetheless, the deepening recession and foreign exchange operations 31 are reportedly responsible for Russia’s banks chalking up a loss of RUB 1.5 trillion (about USD 25 billion) in the first half of 2022. That represents about 12% of the sector’s regulatory capital as of end-2021 or around 1.3% of its total assets, with the sector going into the red for the first time in seven years. Most loss makers are relatively large players: Five of the thirteen systemically important credit institutions reportedly made losses in the first six months (see table 3), while eight were profitable, as were the overwhelming share of medium-sized and small banks (Bank Rossii, 2022f). Some minor recapitalization measures totaling about USD 3.5 billion, relating to state-owned banks such as Gazprombank and VEB (Vneshekonombank, a development bank), and financed by the NWF, have already been carried out in recent months.

Table 3: List of systemically important credit institutions according to CBR (as of December 1, 2021)  
Rank Bank name Ownership Assets Share of total banking assets
RUB billion %
1 Sberbank State 37,500 31.5
2 VTB Bank (Vneshtorgbank) State 19,300 16.2
3 Gazprombank State (indirect) 8,300 7.0
4 Alfa-Bank Private (domestic) 5,400 4.5
5 Rosselkhozbank (Russian Agricultural Bank) State 4,000 3.4
6 Moskovsky kreditny bank (Credit Bank of Moscow) State 3,400 2.9
7 Bank Otkrytie State 3,100 2.6
8 Sovcombank Private (domestic) 1,800 1.5
9 Promsvyazbank State n/a n/a
10 Raiffeisenbank Private (foreign) 1,500 1.3
11 Rosbank (Société Générale) Private (foreign) 1,500 1.3
12 UniCredit Bank Private (foreign) 1,200 1.0
13 Tinkoff Bank Private (domestic) 1,100 0.9
Source: Bank of Russia (2022; p. 37).

In 2021 and early 2022, some important and promising bank privatization ­efforts were made, which were unfortunately only partly successful. After ­nationalizing and restructuring the Aziatsko-Tikhookeansky Bank (ATB, Asian-­Pacific Bank), a medium-sized credit outfit, through the CBR-owned Banking ­Sector Consolidation Asset Management Company, the ATB was successfully sold to a Kazakh strategic investor for USD 180 million in fall 2021. The next step should have been the sale of nationalized and restructured Bank Otkrytie, 32 the country’s seventh-largest credit institution in terms of assets in late 2021 (see ­table 3). Privatization negotiations with a prominent Italian investor had reached an ­advanced stage in January 2022, when deepening geopolitical tensions, Russia’s attack on Ukraine and Western sanctions imposed on Otkrytie itself forced the CBR to put off the sale. 33

Furthermore, two recent institutional adjustments are highly relevant for banks: after a first wave of Western sanctions were imposed on Russia in the wake of the country’s annexation of Crimea in 2014, the CBR developed the SPFS (­Systema peredachi finansovykh soobschenii, or System for the Transfer of ­Financial Messages). By 2018, almost all Russian banks had adopted the transaction system. This helped SPFS take the place of SWIFT for domestic payments of banks ­excluded by Western sanctions in early 2022. Yet, according to the CBR, SPFS possesses links with 70 foreign banks in only twelve countries, including Belarus, making it an only partial SWIFT replacement for Russian players. 34

From 2014 to 2017, moreover, the CBR developed the Mir card payment ­system for electronic fund transfers. The authorities mandated that all state ­welfare and pension payments be processed through the system by 2018, which boosted the acceptance of Mir cards. As of end-2021, 87% of the Russian population ­possessed a Mir card, which was the principal means of payment for 42% of people (Teurtrie, 2022; p. 26). When Visa and Mastercard exited Russia under the impact of Western sanctions in 2022, all cards from these international payment systems issued by Russian banks continued to operate for domestic transactions, but cross-border transactions were no longer available. Mir’s market share ­subsequently expanded sharply and there was reportedly little disruption of payments made ­inside Russia, although Mir’s international links are likewise less developed and partly focused on Russian tourist destinations. 35

2 EU-owned significant banks are fundamentally revising their strategy and activities in the Russian market

The Russian war in Ukraine and Western sanctions strongly increase risk levels for EU-owned significant banks operating in Russia, namely Raiffeisenbank Russia, UniCredit Bank Russia and Rosbank/Société Générale. 36 The prospect of ­intensifying sanctions risks, shrinking foreign investments and high recessionary pressures means a decisively more challenging environment than anticipated ­before the war. The war and sanctions undermine the different customer segments of EU-owned significant banks, although risk models may not fully reflect these specific risk factors. The risk-taking capacity of European parent institutions for Russian direct and indirect exposures is also starkly reduced. This situation can nonetheless be partially offset by temporary profitability boosts, such as from net fee and commission income generated by increasing demand for forex-related transactions, from trading-related income or income derived from high deposit inflows in a ­context of increased demand 37 . EU-owned significant banks have ­different profitability trajectories in 2022.

While their rise remained moderate during the pandemic, impairments of EU-owned significant banks have noticeably increased in the context of the war, ­reflecting worsening risk levels, especially regarding credit and sanctions risks. In the first half of 2022, Russia-related impairments represent a significant share of overall provisions of parent institutions 38 and deviate from sectoral trends. ­Impairment policies (and their conservatism) differ between banks and are ­impacted by management overlays. Asset quality deterioration and asset valuation discounts also generate higher risk-weighted assets requirements (which have tended to double compared to 2021), along with forex- and liquidity-related ­effects. At the same time, capital considerations have become central in the context of the war. EU-owned significant banks have kept sufficient and adequate capital levels in the recent past, including in 2020 and 2021 and analysis of worst-case scenarios disclosed by EU-owned significant banks reveals that capital impacts are ­significant but can be absorbed (with assumptions simulating the loss of equity participation, debt, intragroup, cross-border and derivatives exposures, with different degrees of recoverability and off-setting impacts 39 ). Additional ECB projections premised on a severe loss of cross-border exposures and local banking activities (including ­intragroup funding and equity) also confirm the ability of these banks to remain compliant with capital requirements 40 despite such shocks (Mazany and ­Quagliariello, 2022).

Complying with the successive waves of new strict and rapidly evolving ­sanctions raises operational constraints for EU-owned significant banks, while the consequences of noncompliance are deterrents (including potential fines and ­reputational risks).

In retaliation to Western sanctions, Russian countersanctions include new ­restrictions on foreign assets or on the capacity of foreign players to act on the ­Russian market (including local capital markets). This approach also raised ­concerns about nationalization risks (which have the potential to concern EU-owned ­significant banks but have not materialized so far), confiscation and transfer risk. In a context of high uncertainties and increasing reputational risks (with ­unprecedented pressure from public opinions and financial markets), some foreign companies, including a wide range of economic actors from retail or industrial players to specialized financial services providers like auditing firms, have adopted “self-sanctioning” and exited the market of their own accord.

In the context of the war, EU-owned significant banks need to reconsider their strategy, contingency and business plans defined in peacetime. Pre-war, they were expected to engage in selective risk-taking to preserve asset quality in the ­aftermath of the pandemic, embrace cost discipline with restructuring measures, and move forward on digitization with more services. The sharp worsening of risks requires adequate management of the new challenges in close liaison with parent ­institutions and banking supervision authorities, which have developed a comprehensive ­framework at the European level to address the impacts of the war and sanctions for banks (Mazany and Quagliariello, 2022).

In the months before the war some EU-owned significant banks considered expanding further into the Russian markets (with reported interest in banking ­entities or portfolio acquisitions). This approach was completely reversed after the war in Ukraine broke out, at a time when the market valuation of these was also undermined by the war. The three EU-owned banks qualifying as significant ­institutions in the Russian market initiated different forms of disengagement ­strategies. Players either implemented or considered exit strategies, echoing the acceleration of withdrawal initiatives observed for less significant European and American institutions still active in Russia. Concrete actions taken include strong restrictions on new lending (up to freezes), de-risking initiatives and a substantial reduction in cross-border activities.

With the most advanced exit strategy, Société Générale announced in May 2022 that it had completed the sale of Rosbank to a local investor for a loss of around EUR 3.2 billion, negatively impacting the Group’s profitability but with a limited capital impact of less than 10 basis points. The parent institutions of ­Raiffeisenbank Russia and UniCredit announced they were reviewing exit options in an ongoing process. In general terms, such options can take different forms, for instance with a wind-down strategy, a sale (to a local or foreign investor, or partially involving local management), or a deconsolidation via a “bad bank” special purpose vehicle, which all have both advantages and disadvantages. In July 2022, Russian officials indicated that, in the current environment, they would block the sale of foreign banks active in Russia and review any disposal plan case-by-case.

A key consideration regarding such disposals is value preservation. EU-owned significant banks in Russia remained fairly profitable in the years before the war, although with various levels of performance and material impact on the Group’s risk profile (from low to medium). The higher the share of Russian activities in overall profits or total capital, the more sensitive exit strategies become, especially as uncertainties are very high on the medium-term outlook and the next stages of the conflict. As such, EU-owned significant banks can consider options that would avoid a full write-off of Russian operations. Those remaining active on the Russian market can also have certain competitive advantages compared to local peers (not being directly subject to sanctions and ties with parent companies which have broader access to international markets) and can position themselves as key ­partners for European investors that have not fully exited the market. However, there is a reputational risk of negative coverage (from the press, rating agencies or investors) and public pressure for not leaving as the country gradually becomes a war ­economy.

3 Risks and shock-absorbing factors

After projecting GDP drops of 10% to 15% in spring, many institutions have ­considerably scaled back their forecasts of the depth of the Russian recession in 2022 while now expecting the recession itself to be more protracted and ­substantially affect 2023. The IMF adjusted its GDP forecast for Russia for 2022 from −8.5% in March to −6% in July and −3.4% in October; at the same time it changed its 2023 forecast from −2.3% to −3.5% and (back) to −2.3%. The Vienna Institute for International Economic Studies (wiiw) expects a recession of −3.5% in 2022, followed by a further contraction of −3% in 2023.

These changes are largely due to the authorities’ unexpectedly successful (at least temporary) stabilization of the financial sector and the ruble in the weeks ­following the major initial onslaught of the sanctions in late February and early March 2022. Moreover, the authorities also front-loaded a drive to diversify their energy exports away from Western countries in April to June and made some headway (as mentioned above), although the decisive test will come in late 2022, when the EU has resolved to stop 80% to 90% of its oil imports from Russia ­(except via pipelines). If actually carried out in the coming late fall/winter, this ban will probably have an appreciable impact on the Russian economy. This blow and a possible global recession or stagnation, perhaps exacerbated by a further ­retaliatory squeeze on remaining Russian gas deliveries to the EU, may explain Russia’s likely continued, if milder, recession in 2023.

The key rate, which was high throughout most of spring 2022, cut demand for credit. Moreover, ongoing or completed withdrawal from Russia by many foreign investors dampened credit demand. While the key rate was subsequently reduced beyond even its pre-war level in summer 2022, which should support resumed lending, the sanctions-triggered downswing since April, production disruptions and high uncertainty are having the opposite effect and continue to erode the basis for credit demand.

Credit risk will therefore become more pronounced as the recession further unfolds in late 2022, directly through sanctions-triggered production, sales and revenue disruptions 41 and indirectly through the recessionary impact on ­borrowers and demand.

For EU-owned significant banks, a credit risk deterioration is likely across ­segments and regions, as the different components of their credit portfolios are impacted, ranging from domestic retail customers to nonretail counterparties (Russian and international). In parallel, for parent institutions, new regulatory caps regarding the amount of money Russian nationals (nonresidents) can hold as deposits in the European Economic Area may further limit flows with Russian ­clients. Overall, increasing credit and sanctions risks are grounds for a further ­increase in loan loss and sanctions-related provisions, depending on the levels ­already booked proactively at the outset of the war (to anticipate risk at managerial level in Q1 and Q2 2022 as some banks front-loaded material provisions). In turn, this may reduce profits and negatively impact ROE, cost-income ratios and ­dividend payment capacities. As per available projections, EU-owned significant banks have enough capital to absorb further losses. Nevertheless, the introduction of dividend bans by Russian authorities means that profits made by these banks cannot be taken out of Russia, while war-driven restrictions strongly limit potential support from parent companies in case of difficulties. This situation has the potential to block capital flows abroad in the medium term, and to become a structural factor and a performance differentiation factor with local peers over time.

Regarding interest rate risk, the CBR pointed out, as it announced its ­September 2022 key rate cut and again confirmed in October, that its cycle of loosening may have come to an end, given the shift in the balance of deflationary and inflationary risks toward the latter and continued high inflationary expectations. Further, the risk remains that Russian producers’ search for new suppliers or logistical chains or rising demand for domestic production given restrained import possibilities could push up inflationary pressures. That could trigger an upward key rate correction and, in turn, dampen lending activity.

Exchange rate risk is currently less of a problem, given that energy prices are high and the ruble is, in any case, no longer fully convertible. But exchange rate risk, including possibly heightened volatility, might become a problem in 2023, following the substantial expected further tightening of the EU’s oil purchase ­restrictions from late 2022 (as mentioned above). Likely weaker overall Russian oil exports as a result, 42 coupled with a degree of recovery of imports (after a ­reorganization of some supply chains), could put pressure on the ruble in 2023. This might exceed the “corrective” depreciation that some government or ­industrial groups would favor anyway to ease pressures on the budget and facilitate import substitution (Bank Rossii, 2022c).

For EU-owned significant banks and parent institutions, foreign currency risks remain a key risk requiring adequate management using hedging strategies which are increasingly expensive and complex given possible ruble volatility or increased scarcity of hedging products. The overall risk situation is also heightened by the perspective of second-order effects on top of direct impacts. These banks can have exposures to international players dependent on activities with Russia and Ukraine (in terms of revenues, energy or supply chain) or to sectors which are particularly vulnerable in the context of the war and in the aftermath of the pandemic. From a credit risk perspective, certain counterparties are likely to be negatively impacted by the deteriorating macro environment with slower growth, high prices ­(especially energy prices), higher debt yields and a loss of confidence among economic actors (reducing consumption or investment levels). Potential contagion effects related to global markets are to be anticipated. Market risk considerations come alongside higher funding costs or enhanced volatility for certain market products like ­commodity derivatives. Climate and environmental risk are also becoming more critical in bank loan books given disruptions in the energy sector, the search for short-term solutions to energy shortages (which can increase fossil fuels ­production and consumption) and the shift toward a “war economy” in Russia and Ukraine with a lesser focus on environmental footprint.

Concerning shock-absorbing factors, Russian banks went into the current crisis with a capital adequacy ratio of 11.8% at end-January 2022, which is relatively weak compared to other economies of Central, Eastern and Southeastern Europe (CESEE). That said, as table 3 shows, the largest players are state-owned and ­therefore possess an implicit state guarantee. Loan loss provisions in early 2022 covered NPLs as narrowly defined. The overall loan-to-deposit ratio was quite moderate at 98% (as of end-January 2022) 43 . At end-2021, the regulatory capital of the banking sector came to about RUB 12.6 trillion (or approximately USD 165 billion, capital adequacy ratio: 12.3% – see table 3). Moreover, according to the CBR, banks’ accumulated capital cushions, taking into account various buffers, including macroprudential ones, came to around RUB 7 trillion (USD 90 billion to USD 95 billion), or more than half of overall capital (Bank Rossii (ed.), 2022b). Given the loss figures of the first half of 2022 (RUB 1.5 trillion) and a lack of more detailed information, a simplified argument could be made that more than ­one-fifth of that capital cushion had evaporated by mid-2022, and erosion is continuing. Overall, the CBR, in the second quarter, perceived the sector’s loss of about half of its capital by end-2022 under the impact of the unfolding recession and sanctions as a “likely scenario,” which however “does not raise concern” given that “there is a margin of safety” and that the authorities plan to “support lenders if necessary” (Interfax, 2022b; Bank Rossii, 2022f). 44

While the capital cushion exceeding the minimum ratio appears sizable, it is distributed unevenly across the sector, and a major crisis like the current ­downswing will very likely require CBR support measures for at least some ­players. 45 In late July 2022, the CBR pointed out that restructuring activities showed a substantial number of debtors experiencing repayment difficulties, which pointed to expanding NPLs and provisioning needs which in turn weighed on ­capital adequacy. In the of summer of 2022, the CBR reportedly carried out a ­detailed preliminary analysis to study possible recapitalization variants with the government, which would also enhance banks’ lending potential (Ekspert, 2022). 46 As of mid-November, the CBR stated that “negative financial results of the banking sector have declined in recent months” – without substantiating, while “the year 2022 as a whole will hardly yield a profit” (TASS, 2022).

Another at least theoretically cushioning factor is credit institutions’ net ­external assets, representing around 5% to 6% of total assets. However, the share of these assets currently inaccessible because of freezes is not clear. Russia’s ­accessible international reserves (those not placed in Western jurisdictions) ­currently stand at about USD 252 billion or 14% of GDP (see above). These have of course been starkly diminished since the freezing of almost half of the original amount of USD 630 billion in late February. Yet given the high current energy prices, Russia has most recently been able to earn tens of billions of dollars of fresh revenues 47 . The authorities also stand to benefit from the NWF and its liquid ­assets of about 6% of GDP at the disposal of the CBR (also see above).

Notwithstanding recent inflows of sizable forex-denominated public proceeds, Russia defaulted on its foreign debt on June 27 (Bloomberg, 2022). This was due to the authorities being rendered technically unable to forward bond repayments to creditors in US dollar due to sanctions. While the consequences of this technical default are not yet clear, punitive measures have already excluded Russian access to Western financing and the country has done without such access for years. In any case, Russia’s general government gross debt remains at a very modest level of GDP (16% to 17%) compared to most advanced economies.

The picture is completed by Russia’s strong fiscal and current account positions achieved in the first half of 2022. While the current account surplus may reach a ­record level this year (due to continuing high energy prices and a contraction of imports triggered by sanctions and recession), the deepening economic downturn in the third and fourth quarters will probably push the budget into the red. The Ministry of Finance views a year-end federal budget deficit of up to 2% of GDP as possible.

4 Outlook: banks can cope in the short term, major risks lying ahead

Although faced with severe Western sanctions, Russian authorities and banks can cope in the short term. Yet, major risks are lying ahead and European players are at a crossroads. The authorities still appear financially prepared to support the economy and banks through the pronounced recession in 2022 and a probable ­further contraction in 2023. This will apply even if banks lose up to 50% of their capital due to the crisis – something reported as likely by the CBR a couple of months ago. That said, still ample government financial means will likely soon be dented by the impact of the imminent EU oil embargo. What is more, oil and gas money cannot help circumvent Western technology or banking sanctions. In any case, Sberbank felt compelled in mid-May to sell off large parts of its ­“ecosystem,” into which it had invested major resources over years, to a tiny ­little-known ­company in order to protect its digital services from US sanctions. 48 With this company, Sberbank intends to “maintain partner-like relations in the realization of marketing and operational activities” (Korolev et al., 2022). This may be just one example of economic costs and losses some leading Russian banks, firms and ­entrepreneurs may have to sustain from now on.

The outlook for the Russian banking sector and EU-owned significant banks will be sensitive to the next phases of the Russia-Ukraine conflict. A consolidation tendency around larger state-supported players appears likely. Available ­projections show a capacity for EU-owned significant banks to resist further shocks, especially from a capital perspective. Escalation scenarios could nonetheless increase ­economic damage, vulnerabilities and second-order effects generated by the war and sanctions. Additional cuts to Russian energy flows to Europe are a key risk, and their financial consequences would depend on the price and availability of ­alternatives. At the same time, a scenario with a sudden or step-by-step easing of tensions would have positive impacts, although it appears less likely at the moment. Beyond the benefits of peace, it would reduce recession risk, facilitate post-­pandemic recovery and offer the perspective of certain sanctions being lifted over time. The probability of these different options will have to be included in the new strategies defined by the remaining EU-owned significant banks, which have ­disclosed that they are considering all options, including exiting the Russian ­market.

Overall, Russia’s war in Ukraine represents a paradigm shift given a large share of previously identified threats (in the pre-war period) that materialized in a short period of time, while emerging risks like cyber risk and to a certain extent climate and environmental risks have intensified. Moreover, the war in Ukraine and ­related Western sanctions do not only have regional consequences (such as impacting the capacity of EU-owned significant banks to operate in their local environment and leaving the banking sector exposed to second-order effects): they also darken the outlook for the global economy with slowing growth, increasing inflationary ­pressures and disrupted trade flows (including in key sectors like energy, ­commodities and technology). A further decoupling between Europe and Russia, which seems to be looking to build closer economic and energy ties with ­alternative partners in Asia and elsewhere, could make the war a turning point with wide-­ranging economic, financial and geopolitical consequences in the medium term.

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16 Oesterreichische Nationalbank, Central, Eastern and Southeastern Europe Section, ; Off-Site Supervision Division – Significant Institutions, . Opinions expressed by the ­authors of studies do not necessarily reflect the official viewpoint of the Oesterreichische Nationalbank or the ­Eurosystem. The authors are grateful for the valuable comments and suggestions of two anonymous referees. They further wish to thank Elisabeth Beckmann, Thomas Gruber, Birgit Niessner, Gabriela de Raaij and Julia Wörz (all OeNB) for their precious remarks and suggestions, and for additional information provided. Cut-off date for data: November 15, 2022.

17 More precisely, as in the abovementioned previous study, we focus on the three EU-owned banks qualifying as ­significant institutions in the Russian market (until May 2022, when one was sold to a domestic investor). For readability purposes, the three credit institutions named above are hereafter referred to as “EU-owned significant banks.” There are no other foreign-owned significant banks in the country.

18 In our paper, “Western” generally refers to the EU and the G7 (EU member countries France, Germany and Italy as well as the United States, the United Kingdom, Canada and Japan).

19 Given that Russian (Minister of Finance Siluanov) and other sources (e.g. Véron and Kirschenbaum, 2022) argue that frozen CBR reserves total about USD 300 billion, the remainder of these reserves, can therefore be considered unfrozen.

20 Altogether, the assets of credit institutions accounting for about three quarters of total banking sector assets were frozen. Ten banks (including seven of the ten largest, see table 3) were excluded from SWIFT, namely Sberbank, Vneshtorgbank (VTB), Rosselkhozbank (Russian Agricultural Bank), Moskovsky kreditny bank (Credit Bank of Moscow), Bank Otkrytie, Sovcombank, Promsvyazbank, Novikombank, Bank Rossiya, Vneshekonombank (VEB). These ten banks’ assets exceed 60% of total sector assets (Allinger et al., 2022; p. 57; Deuber and Gadeev, 2022).

21 While the banning of Sberbank and some other Russian banks from SWIFT had a smaller impact on the domestic Russian market – as explained in subsection 1.2 – these new measures contributed to a run on customer deposits at Sberbank’s foreign subsidiaries. In early May, its Austrian-based European business (Sberbank Europe) that ­operated 187 branches across Central Europe with 770,000 customers (0.8% of the total number of Sberbank’s customers) was put into orderly liquidation – the first credit institution to fail following the sanctions on Russia (Financial Times, 2022a) and an efficiently managed cross-border resolution under the Single Resolution ­Mechanism (SRM). VTB Bank Europe, the second bank to fail under sanctions, was also a subsidiary outside ­Russia (Wiener Zeitung, 2022) and wound down.

22 Many of the firms that withdrew from Russia appear however to have secured contractual return options (Die Welt, 2022).

23 To be more precise with respect to the retail forex sector: retail purchases of forex cash in banks were prohibited in early March and a limit of the equivalent of USD 10,000 was established for withdrawals from forex accounts, while larger amounts can be withdrawn in ruble at the exchange rate of the day of the withdrawal. The ban on cash forex purchases was loosened in late May in the sense that banks can sell dollar or euro that they have received since April 9.

24 For a more precise discussion of the factors influencing the ruble’s exchange rate post-invasion see Itskhoki and Mukhin (2022).

25 Since then, a government commission has decided amounts of mandatory exchange.

26 69% of these assets, or USD 127.9 billion, are reported to be liquid assets on accounts of the CBR.

27 Mortgage credit is supported by a preferential state program providing interest rate subsidies to a wide range of households. It was originally to expire in July 2021, but was extended until end-2022.

28 The narrow definition of NPLs refers to the share of problem and loss loans in total loans, whereas the broad ­definition of NPLs encompasses the share of doubtful, problem and loss loans in total loans (according to CBR ­regulation no. 254). For further details see footnotes 3 and 4 in table 3 and Barisitz (2019; pp. 64, 70).

29 As of end-November 2021, state-owned banks accounted for about two-thirds of the sector’s total assets. As table 3 shows, the three largest credit institutions were state-owned (Sberbank: 32.2% of total assets, VTB Bank: 16.6%, Gazprombank: 7.1% ), followed by the largest private bank (Alfa-Bank: 4.6%), and another state-owned bank ­(Rosselkhozbank: 3.4%). The three largest EU-owned banks in Russia (Raiffeisenbank, Rosbank/Société Générale and UniCredit Bank) together made up about 3.6% of total assets and occupied, respectively, ranks 10, 11 and 12.

30 Overall, (subsidized) mortgage loans were the only credit category that still featured a positive (+2.1%) growth rate in September (year on year).

31 The latter included transactions with derivative financial instruments (mostly swaps, forward dealings and futures contracts) against the backdrop of the yo-yoing exchange rate and the exceptional financial instability of early spring 2022. Meanwhile, banks’ net interest income in the first half of 2022 only declined 5% (year on year).

32 For more information on Otkrytie’s past turbulences and resolution see Barisitz (2018; pp. 61, 63−64).

33 In late April, the CBR put forward a new plan, not to privatize but to merge Otkrytie with state-owned VTB (­Vneshtorgbank, Russia’s second-largest bank) and its former subsidiary, RNKB (Rossisky natsionalny ­kommerchesky bank/Russian National Commercial Bank), which is focused on serving the Crimean peninsula ­annexed from Ukraine in 2014. The CBR’s proposal apparently received the go-ahead from President Putin ­(Financial Times, 2022b).

34 According to Vice-Governor Skorobogatova, the number of SPFS participants grew from 389 companies and banks at end-2021 to 453 at end-May 2022 (about 4% of the total number of participants in SWIFT) (Interviu Olgy Skorobogatovoy agenstvu TASS, 2022).

35 At end-March 2022, the number of Mir and Mir-compliant cards in circulation reportedly exceeded 125 million. Outside Russia, in the spring of 2022 Mir cards were accepted in Armenia, Belarus, Kazakhstan, Kyrgyzstan, ­Tajikistan, Türkiye, the United Arab Emirates, Uzbekistan and Vietnam (Mironline (ed.), 2022). In July 2022, Iran also decided to join the Mir card system and ATMs in Cuba started to accept Mir cards (Kurier, 2022; Interfax, 2022a). However, following threats of US sanctions in September 2022, some important Turkish, ­Kazakhstani, Uzbekistani and Vietnamese banks recently suspended operations with Mir cards (Pitel, 2022; Russland Aktuell, 2022).

36 To measure the different components of EU-owned significant banks’ exposures in Russia, the most relevant items are local equity, loans (local exposures and via the parent institution), liquidity and funding (including ­intragroup) and off-balance sheet items (such as derivatives or certain types of guarantees). Banks having a multiple point of entry (MPE) resolution strategy were incentivized to clearly separate local operations from their mother company (e.g. regarding their funding or IT infrastructure), although some interdependencies remain.

37 As an impediment to benchmarking, publication of some of the previously disclosed financial indicators stopped in Russia from February 2022 onward, limiting the possibility of quantitative comparisons in the local market for the different quarters of 2022. For EU-owned significant banks IFRS financial data published on Russian ­activities is a relevant alternative.

38 Russia-related risks have also triggered a market price correction for the parent institutions of EU-owned ­significant banks active in Russia and sector-wide. It is notable moreover that, when it comes to exposure levels, these banks represent the most material risk for the European banking sector (compared with less material ­exposures at parent institution level).

39 Off-setting impacts to capital loss scenarios include the RWA relief coming from lost exposures, RUB appreciation effects and the result of de-risking actions (exposure reduction, portfolio disposals, coverage by collateral). Internal capital generated and not distributed as dividends due to local restrictions provides an additional buffer.

40 More broadly, specific European stress test projections in the form of a vulnerability analysis also confirmed the capacity of euro area banks’ capital to resist negative impacts from exposures to vulnerable sectors, worsening ­macrofinancial conditions and market-related revaluation risks (ECB, 2022; p.74).

41 Some of these disruptions have (so far) been marginally softened by Russia’s new policy of legalizing “parallel ­imports” of sanctioned products – via alternate channels, typically retail trade, without permission of trademark owners – in response to sanctions. In the period from mid-May to end-August 2022, for instance, such parallel imports came to about USD 9.4 billion, according to estimates of the Federal Customs Service. In September, ­industry minister Manturov forecast parallel imports to top USD 20 billion at end-2022 (RIA Novosti, 2022).

42 Meanwhile, in recent months Russia has been striving to swiftly redirect some of its oil exports to non-Western ­destinations, including China, India and Türkiye. For example, in May 2022, Russia displaced Saudi Arabia as the top crude oil supplier to China, and Russia advanced to become India’s second-largest oil supplier (following Iraq) (Murtaugh and Chakraborty, 2022). Whereas in February 2022, the EU and Britain still accounted for 53% of Russia’s total crude oil deliveries, this share fell to 21% in October, while emerging, primarily Asian, countries’ share (including China, India, Türkiye and others) expanded from 30% in February to 76% in ­October. Total Russian monthly oil exports increased from 3.0 to 3.3 million barrels per day in this period (Le Monde, 2022b).

43 The loan-to-deposit ratio for enterprises and households only (i.e. disregarding the government sector) was 109% at end-September and thus only three percentage points higher than in early 2022 (see table 2).

44 The regulatory minimum capital (own funds) adequacy ratio (N1.0) for credit institutions in Russia is 8.0%, the minimum tier 1 capital ratio (N1.2) is 6.0% (CBR regulation no. 646-P, dated July 4, 2018). It should of course be noted that in the reinstated regime of regulatory forbearance valid from end-February 2022, actual bank ­compliance with capital ratios is no longer stringently measurable.

45 A European Commission assessment of late June 2022 appeared to be more pessimistic, however, and considered about half of Russia’s banks to be in need of recapitalization (information from John Berrigan, EU Commission).

46 As mentioned above, some smaller recapitalization measures of state-owned banks have already been taken.

47 Federal oil and gas revenues from late February to end-September 2022 exceeded USD 95 billion ­(Ekonomicheskaya Ekspertnaya Gruppa, 2022c; pp. 23−24).

48 The company’s name is “Novye vozmozhnosti.” It was established in March 2022, information on its CEO and shareholders is classified under Russian law (see also Allinger et al., 2022; p. 58).

Event wrap-ups

27th Global Economy Lecture

Sergei Guriev on “The political economy of Putin’s war in Ukraine”

Compiled by Maria Silgoner 49

On January 11, 2023, the Oesterreichische Nationalbank (OeNB) and The Vienna Institute for International Economic Studies (wiiw) hosted the 27th Global ­Economy Lecture 50 , which was delivered by Sergei Guriev, Professor of Economics and ­Provost at Sciences Po in Paris and former chief economist of the European Bank for ­Reconstruction and Development (EBRD). From 2004 to 2013, Guriev was rector of the New Economic School in Moscow. He has published numerous articles on contract theory, corporate governance, political economics and labor mobility. Together with Daniel Treisman, he recently published the book “Spin Dictators” (Princeton University Press, 2022).

In his introductory remarks, OeNB Governor Robert Holzmann praised Sergei Guriev as one of the most renowned experts on the Russian economy. Being a ­Russian, Guriev was able to observe and analyze his native country from the inside until he had to emigrate in 2013. He is a critical and committed scientist, ­deciphering the complex developments in Russia and other authoritarian political regimes. Governor Holzmann emphasized the tremendous dimension of suffering and ­destruction the war in Ukraine has brought about but also raised the question of the war’s global impact and the risk that the war and the related sanctions might result in a bipolar world.

Professor Guriev started his lecture by pointing out that modern autocrats want to be popular. Instead of scaring people into obedience, these autocrats – for whom Guriev coined the term “spin dictators” – manipulate information to project an image of competent leadership. A leader’s popularity, in turn, is highly ­correlated with economic performance. Turning to Russia, Guriev explained that President Putin enjoyed a decade of approval rates of about 80% (based on data provided by the Levada Center ) before Russia’s GDP growth started to decline in 2010/11, causing Putin’s popularity to wane. This decline in popularity, in turn, prepared the ground for Russia’s invasion of Crimea, which can be seen as Putin’s attempt to regain popularity. Indeed, Putin’s approval rates recovered thereafter but ­decreased again when he decided to raise the retirement age in Russia and had to face adverse media campaigns. Russia’s invasion of Ukraine must thus also be seen against the background of Putin’s historically low popularity.

Guriev then elaborated in more detail on pre-war economic conditions in ­Russia. The Russian economy had faced years of slow and below-potential ­economic growth, falling household incomes, large capital outflows, and low and stagnating investment ratios. The Russian growth model was based on widespread corruption that led the country into a middle-income trap, causing it to lag behind the other BRICS countries. At the same time, robust macroeconomic fundamentals – a ­balanced budget, low sovereign debt (20% of GDP), large currency reserves (40% of GDP), a sovereign wealth fund of 12% of GDP and a sound monetary ­framework characterized by a move toward flexible exchange rates and inflation targeting – gave Putin a false sense of security. In response to the COVID-19 pandemic, he opted for fiscal austerity rather than economic stimulus in order to remain ­independent of financial markets. As his approval rates plummeted, Putin ­responded by media repression, leaving the “spin dictator” track.

As Guriev put it, Putin’s major mistake ahead of the invasion of Ukraine was to overestimate Russia’s own financial and military strength while underestimating the courage of Ukraine, the unity of the Western world and the power of ­sanctions. Several studies have found that the sanctions adopted after the invasion of Crimea had only a minor impact on trade or GDP. By contrast, the sanctions adopted in response to the war against Ukraine went much farther, comprising the switching-­off of SWIFT, the freezing of currency reserves, comprehensive export controls (also for central items such as microchips, aircraft and software) and – starting from December 2022 – oil sanctions. These steps were reinforced by a voluntary trade boycott by more than 1,200 Western and several non-Western companies.

As a result, Russia’s trade with the US and the EU declined by at least one-third. Russian GDP, which – before the invasion – was forecast to grow by at least 3% in 2022, declined by 3%. This recession was much milder than what had been forecast for the entire year in mid-2022 (–8%). However, in times of war, GDP is not a good measure of economic activity as it includes the production of ammunition. Other indicators suggest that Russia’s economic performance is much worse: The country’s retail turnover is 10% lower than one year ago, household incomes declined by 10%, and non-oil taxes are 9% lower than in the previous year.

That the economic slump did not get any worse than that is the merit of a very competent central bank. Still, the Russian ruble is much weaker than could have been expected on the basis of current oil prices. Although additional revenues from high oil prices compensated some of the losses from frozen reserves, Russia’s fiscal accounts turned from a surplus into an annualized deficit of about 2.5% of GDP by the end of 2022. This forced Putin to take unpopular decisions, such as cutting pension spending or declaring a partial mobilization instead of relying on mercenary soldiers. However, it has required huge repression efforts to hold back protests.

Over the next few months, Russia will experience a continued recession, fiscal fallouts and ongoing capital flight and brain drain, all with a major adverse growth impact in the long term. According to estimates by the International Monetary Fund (IMF), Russia will see a permanent growth loss of 10 percentage points by 2026 compared to the pre-war potential. Sanctions constrain Putin’s military spending and access to technology. But all these restrictions, according to Guriev, will not be enough to stop him right away. Instead, he will complete the shift from spin dictatorship to fear dictatorship, tightening censorship and repression and cleansing Russia of “national traitors.”

Coming back to the question Governor Holzmann raised about the war’s ­impact on the global economy, Professor Guriev pointed to global growth damage, the current gas shortages (reminding the audience that large quantities of gas ­reserves, which currently are at comfortable levels, are still of Russian origin) and the war’s contribution to prevailing inflation trends. In his opinion, whether the war will result in a bipolar world will ultimately depend on Putin’s success in ­convincing the global South that the West is a threat.

The Global Economy Lecture was followed by a vivid discussion, with contributions from both the in-person and online audience (more than 300 persons in total). The debate revolved, inter alia, around China’s pivotal role as an important buyer of Russian oil. On the other hand, China has so far refrained from supplying military equipment to Russia. The war hurts China as the country’s growth and employment depend on the global economy. Whether the likelihood of a Chinese invasion of Taiwan might be influenced by the outcome of this war is unclear. ­Regarding the reliability of popularity data, Professor Guriev said that polls on political approval do not have a huge bias even in totalitarian regimes but are ­unreliable in times of repression, when survey participants fear being wiretapped by national security.

When asked how long he thought Russia’s war against Ukraine would go on, Sergey Guriev emphasized that a war like this may continue forever, as we can see in Korea, where no peace agreement has ever been reached. Sanctions, the supply of military equipment and financial support certainly tilt the balance of power in favor of Ukraine. But Ukraine will not accept anything less than getting back all its territory plus financial reparations, while Putin would not risk a huge popularity damage by losing this war. Whatever the outcome will be, we should not expect Putin to go back to spin dictatorship anytime soon. Instead, Professor Guriev ­explained, he will keep repression at high levels.

49 Oesterreichische Nationalbank, International Economics Section, .

50 The Global Economy Lecture is an annual event organized jointly by the OeNB and The Vienna Institute for ­International Economic Studies (wiiw).

Conference on European Economic Integration 2022

Economic and monetary policy under wartime conditions – implications for CESEE

Compiled by Antje Hildebrandt 51

This year’s Conference on European Economic Integration (CEEI) was held in ­November 2022. The annual conference hosted by the Oesterreichische Nationalbank (OeNB) was organized in a time in which the world is facing a concurrence of crises: the war in Ukraine and the ongoing recovery from COVID-19 on top of the effects of climate change. While differing very much in nature, these crises all have a decisive effect on economic and monetary policy. The aim of the CEEI 2022 was to develop a deeper understanding of how these transformational crises are likely to impact the economies of Central, Eastern and Southeastern Europe (­CESEE) in the short and medium term. More than 400 participants from various countries attended the conference in person or online.

OeNB Governor Robert Holzmann opened the conference by pointing out that unlike in pre-industrial times, there is little economic rationale for war today. He quoted the German philosopher Immanuel Kant who stated as long ago as the end of the 18th century that “the spirit of trade cannot coexist with war.” Austria’s chief central banker stressed that military conflicts usually benefit only a few individuals and companies, while inflicting suffering on the vast majority. Pivoting to the ­current Russian invasion of Ukraine, Governor Holzmann acknowledged that ­economic sanctions have not left as deep a mark on the aggressor’s economy as was largely expected. However, he expressed confidence that sanctions will bite harder in the longer run. Looking at the European economy, even though it has fared ­better than expected so far in 2022, the Governor cautioned that the economic consequences of the conflict have darkened the short-term economic outlook and pushed up inflation. In contrast, medium- and long-term impacts of the war will depend on future evolvement. However, they might bring opportunities for the European economy e.g. in the form of nearshoring or trade diversion in its favor. Governor Holzmann moved on to stress that while the war has pushed other ­enormous challenges the human race has been facing, namely the pandemic and climate change, somewhat into the background, they will have to be brought back to the forefront soon. The host of the conference concluded his introductory statement on a positive note. He believes that despite the widespread doom-­mongering, there is no compelling reason to be too pessimistic about global ­developments in future. No matter how improbable it may seem today, it is well possible – and in fact necessary – that the West and (hopefully a new) Russia will find a way to coexist peacefully, while meeting the security needs of both Ukraine and Russia.

In the ensuing keynote lecture, Graciela L. Kaminsky from George Washington University compared the current triple crisis in the form of the pandemic, global economic crisis and war on European soil with past crisis episodes (particularly) in CESEE. A general stylized observation is that the severity and persistence of past crises tend to be larger in the case of crises which started in the financial sector. Professor Kaminsky sketched out imbalances that had built up in the run-up to the global financial crisis in CESEE. Large current account deficits, external debt and exuberant credit growth fueled by dramatic capital inflows amid falling USD ­interest rates had created a lot of intrinsic instability and overheating. After the crisis was triggered in the US and spread out across the world, CESEE countries faced partially large exchange rate depreciations and reserve losses. In contrast, the genesis of the current crisis was very different as there were no signs of worrisome economic overheating this time. The current economic malaise was not preceded by massive current account deficits. External debt – even though still partially high – has declined over the last decade. Moreover, there was no credit bonanza prior to the current crisis. While real estate prices did increase, the extent of this was nothing in comparison to the bubble before the global financial crisis of 2008−2009 (GFC). Professor Kaminsky allocated the roots of these crucial differences to the fact that the GFC started out in the financial sector in the US and that the current crisis was thus not heralded by dramatic bonanzas. She concluded her lecture by saying that even though the impact of the crisis is likely to be less severe this time there are still risks that need to be kept closely monitored as we look ahead. In particular, a close eye needs to be kept on rising global economic uncertainty, mounting financial fragilities and sovereign risk especially in Latin America, South Asia and Africa. In the ensuing discussion, participants from the audience ­remarked that it is crucial to make a distinction between the role of private and public ­borrowing. In order to safeguard financial stability in the aftermath of the GFC, the public sector had to bail out the private sector thus increasing its indebtedness. While capital controls could help, they also bear the risk of introducing ­distortions. Another conference participant commented on the first signs of a bust that we are starting to observe. Against this background he was wondering about the odds that deflation rather than inflation will be Europe’s main concern in two years’ time.

Gerhard Fenz, Head of the OeNB’s Business Cycle Analysis Section, chaired session 1 on economic prospects beyond the war. In his introduction, he pointed to the sequence of crises and their combined effects on economic development, the effects of the decoupling of Russia, and the reconstruction of Ukraine as important issues for discussion.

The first speaker in session 1, Elena Flores Gual, Deputy Director General, ­European Commission, highlighted that EU economies were coming out of the COVID-19 crisis when Russia’s war against Ukraine started. Some challenges were already present, such as signs of emerging inflation. The war brought about rising commodity prices, further supply chain disruptions and uncertainty. Flores Gual drew attention to risks of economic divergence in the EU due to different exposures to war-related shocks. She emphasized that it was important to get the mix between fiscal and monetary policies right. Fiscal support for high energy prices should be temporary and well-targeted, while excessive distortions in price signals should be avoided. She argued that the green transition has to continue, which would entail a large need for investment. With regard to Ukraine, Flores Gual pointed to the EUR 18 billion support package for 2023 that the European Commission proposed recently.

Subsequently, Franziska Ohnsorge, Manager of the Prospects Group at the World Bank, gave a global perspective on the outlook for growth and inflation. She showed that currently the global economy is facing the fourth-steepest slowdown since 1970. Moreover, she highlighted the sharp downward revisions of short-term growth forecasts made in the course of 2022. Then she elaborated on inflation ­developments, globally and in different regions of the world. The World Bank’s model-based global CPI inflation projections show that inflation is expected to ­decline from record highs but will remain above the 2015−2019 average until the end of 2024. In this projection, energy prices will no longer drive up inflation starting from 2023. Finally, she made the point that even under a global recession scenario triggered by sharp monetary tightening, inflation would stay elevated through 2024.

The third speaker of this session Mario Holzner, Executive Director, The ­Vienna Institute for International Economic Studies, focused on CESEE. He highlighted the region’s dwindling importance in the world economy. Holzner also showed that some CESEE countries are among the most open economies worldwide. Based on a survey conducted among German companies, Holzner brought in some thoughts about the potential for nearshoring. He pointed to the unprecedented ­demographic decline in CESEE countries as a major challenge, particularly in the working age population. With regard to the upcoming economic slowdown, he argued that the EU Recovery and Resilience Facility will act as an important shock absorber. In this context, Holzner stated that Western Balkan countries should get more access to the EU budget and that the NGEU package was a missed ­opportunity in this respect. He also made clear that Ukraine will not be able to finance the enormous costs of reconstruction from its own resources.

After delivering their presentations, the speakers discussed questions and ­comments from the audience. Issues addressed included the new EU fiscal rules, model assumptions with regard to the World Bank scenarios as well as dependence on Russian energy and essential nonenergy imports. It was also discussed how far it would be realistic for the EU to increase its transfers to Western Balkan ­countries.

In opening the first panel discussion, OeNB Governor Robert Holzmann pointed to continuously high and still rising inflation and high uncertainty and invited his colleagues from two inflation-targeting countries, Poland and Romania, to explain how they assess the role of global policy spillovers and what role exchange rate ­developments play in their conduct of monetary policy. Deputy Governor ­Leonardo Badea from the National Bank of Romania (NBR) noted that spillovers from euro area policy are felt primarily in exports, but nevertheless the NBR puts its focus primarily on inflation rather than on the exchange rate. The NBR started its tightening cycle by reducing unconventional measures before raising interest rates. The fight against inflation was conducted in a balanced way without harming economic growth. Marta Kightley, First Deputy Governor of the National Bank of Poland (NBP), explained the current high inflation level in Poland (almost 18%) by the rather successful performance of the country in the pandemic. With a relatively mild recession of only −2% in 2020, Poland mastered the first recession since the start of transition relatively well. This was followed by a fast recovery, backed by the fiscal impulse, strong export demand and low unemployment, which in turn led to faster consumer price growth than in the euro area. Yet, the NBP started its hiking cycle somewhat later than other central banks in the region. Given a high share of variable loans in Poland and the strong impact on the economy, this hiking cycle has now been paused and the peak of inflation is expected to be passed soon. In Kightley’s view, exchange rate developments are mostly driven by the ­geopolitical situation and less by NBP policy. Yet, in her view, spillovers from the euro area’s monetary policy help to tame inflation as this policy implies an appreciation of the PLN against the USD.

Prompted on comparatively lower inflation in Albania, Governor Gent Sejko from the Bank of Albania referred to two factors: lower energy prices as a result of low import dependence for electricity as well as a strong exchange rate which ­results from capital inflows related to FDI, tourism and remittances. In contrast, the rather high inflation in the Baltic countries is ascribed to the special ­consumption basket in the region with above-average weights for heating and fuels according to Governor Gediminas Šimkus from the Bank of Lithuania. Referring to Lithuania’s exposed position, he emphasized the advantage of being a member of the EU, NATO and the euro area. While Lithuania failed to join the euro area before the global financial crisis, it has entered the pandemic with strong fundamentals which were also backed by euro area membership. Marta Kightley countered that, for ­Poland, the same recipe would not have worked as the exchange rate acted as a ­buffer in the global financial crisis, thus helping Poland to avoid a recession then. Leonardo Badea joined the discussion by pointing to the importance of credibility. He stated that Romania would be better inside the euro area even though current monetary policy independence can help to alleviate idiosyncratic shocks.

Governor Holzman inquired about the role of ECB liquidity lines to the region during the pandemic, which were likely helpful in stabilizing capital flows and asked about potentially remaining pockets of risks in local housing markets or from the fiscal side. Gedimas Šimkus noted the important role of macro- and micro­prudential policies which have to be considered a marathon, not a sprint. Gent Sejko saw a major challenge from banking sector consolidation in Albania while housing market risks appear to be well manageable. In Poland, the situation was stable as house prices had long been rising in tandem with incomes. Although ­rising interest rates and the high share of variable rate loans pose a challenge, the banks are well capitalized. The BNR also considers the banking sector to be ­resilient in Romania but is remaining vigilant according to Leonardo Badea.

Prompted on a potential financial stability risk arising from the high share of variable rate loans in Poland, Marta Kightley emphasized that this also supports the monetary policy transmission. However, the rapid increase in installments for households may justify targeted measures. Gedimas Šimkus added that risks for households can and should be limited via borrower-based measures, such as debt service-to-income ratios and the like. On Governor Holzman’s initial question on the future of repo lines, Gent Sejko underlined the usefulness of the instrument and noted that Albania had already renewed its repo line with the ECB. Gedimas Šimkus pointed out the clear set of rules by the ECB according to which liquidity lines are granted.

In session 2, chaired by Sonˇa Muzikárˇová, macroeconomist and policy advisor, three panelists discussed the topical issues of flight and migration, brain drain and population aging in the CESEE region. In her introductory remarks, Olga Popova, senior researcher at the Leibniz Institute for East and Southeast European Studies, drew attention to the high share of people with migration intentions in CESEE countries. She further touched upon employment gaps between immigrants and refugees in the EU: Refugees start with a larger disadvantage in terms of employment probability than (economic) immigrants. While both groups eventually catch up with natives, the process takes considerably longer for refugees. Relying on Czech data, she argued that current refugees from Ukraine are economically very active and half of the economically active are in paid work. Wages of refugees are low, however, not least due to skill mismatches. She concluded that support in ­language acquisition as well as the recognition of qualifications are particularly important integration policies. Isilda Mara, senior economist at The Vienna ­Institute for International Economic Studies, highlighted changing mobility ­patterns in CESEE. While most countries in the region were net senders of ­migrants, more recently some had turned into net receivers. Changes are also ­visible in terms of migrants’ education: while Western Balkan countries still face net outward migration of the highly skilled, other countries such as Estonia, ­Poland or the Czech Republic became net receivers of highly skilled migrants. She also emphasized that the pandemic increased remote and online work – telemigrants are becoming more frequent and might reverse the trend of brain drain. Róbert Iván Gál, senior researcher at the Hungarian Demographic Research Institute, ­focused on demographic developments in the region and painted a rather optimistic ­picture: he emphasized the considerable increase of the effective retirement age in most countries of Central and Eastern Europe and highlighted that life expectancy at the age of retirement was not increasing. Gains in life expectancy were thus absorbed by the labor market and did not increase the years spent in retirement. Pointing toward strong improvements in human capital, he saw scope for further increases of the retirement age in the future.

The subsequent discussion focused on refugees from Ukraine and their ­potential to alleviate labor shortages in the CESEE countries. Panelists argued that while Ukrainian refugees tend to be highly educated, the majority of refugees are women, many with childcare duties. Also, labor shortages prevail largely in male-­dominated professions and for these reasons panelists’ confidence in Ukrainians easing labor shortages in a significant way was limited. Panelists further doubted that the ­current influx of Ukrainian refugees would lead to a paradigm shift in CESEE countries’ openness toward immigration.

Amid the overall gloomy and highly challenging outlook which was at the heart of many discussions, the day ended on a positive note when Sanja Tomicˇic´, ­Executive Director, Hrvatska narodna banka, delivered her dinner speech, reviewing ­Croatia’s successful integration process, which will culminate in the adoption of the euro on January 1, 2023. The preparations for this important step started a rather long time ago and she reminded the audience that joining a monetary union is a marathon, albeit one that includes some sprints. Croatia had pursued an ­ambitious time frame and started from a difficult initial position. After the global financial crisis, it fell into a six-year-long recession which almost caused ­enthusiasm for the project to disappear. In addition, the procedure for entering ERM II was anything but clear for the Croatian authorities. Yet, in mid-2013 the country joined the EU and the 2016 New Year’s meeting hosted by the Prime Minister revived the process. A strategic document was launched including a detailed cost-benefit ­analysis, the discussion of economic policies consistent with euro introduction started and after the presentation in October 2017 a road show started throughout the country. Sanja Tomicˇic´ shared her experience that sometimes fast moves are necessary to capture opportunities when they arise: the time of good economic performance in Croatia allowed tightly set fiscal targets to be achieved so that ­Croatia could exit the excessive deficit procedure. The rest – so to say – is almost history: Croatia joined the ERM II in July 2020 and engaged in close cooperation within the newly established Single Supervisory Mechanism. Yet, two more ­unexpected stumbling blocks appeared in late 2019 when an earthquake struck the capital city area and the pandemic broke out. But there was no time to be paralyzed by these events; instead Croatia made the best out of the EU presidency, which it was holding at this time. Thus, since July 2020, focus could be put on ­administrative and operational issues until sharply rising global inflation and the Russian attack on Ukraine suddenly threatened the timeline for euro adoption. Fortunately, the ­inflation criterion was met and the EU and ECB convergence reports gave the green light in June 2022. Despite some criticism, financial market indicators show that Croatia’s economy is ready for the euro. Also the majority of the population supports it, even though this is already the third currency changeover since the start of transition. Tomicˇic´ concluded by expressing gratitude for the support that Croatia has received from the European Commission, the ECB and not least from the OeNB through a bilateral informal dialog that had started back in 2005. The discussion centered around potential inflationary effects from euro introduction as well as Croatia’s experience in dealing with high inflation that the new member would be able to bring to the ECB’s governing council.

Birgit Niessner, Director of the OeNB’s Economic Analysis and Research ­Department, opened the second day of the conference by referring to the fast-changing nature of Europe’s energy dependency. In particular, dependence on gas from Russia has been high in Europe, especially so in the CESEE countries, and Russia had already ceased to be a reliable supplier of gas to Europe before it invaded Ukraine and triggered sanctions. As a consequence, many countries, in particular the Baltic countries, Poland, Romania and Croatia, decreased their dependence on Russian gas sharply. The EU Economic and Investment Plan for the Western ­Balkans will also work in this direction. Guntram Wolff, Director and CEO of the German Council on Foreign Relations, started his speech by pointing to the ­important role of gas for Europe. While prices rose sharply in response to supply shortages, the industry reacted very flexibly by relocating energy-intensive parts of production. He distinguished between short-term and medium-term consequences of the supply shortage caused deliberately by Russia: the redirection of gas flows occurred in a very short time. The importance of Norwegian gas and liquified ­natural gas (LNG) have increased and Germany has become a hub from West to East. In addition, measures such as the German gas price cap also include ­incentives to save gas. Wolff emphasized that adjustment must take place with the fewest ­possible frictions in order to avoid any suffering of the deeply integrated EU supply chains. In the medium term, Europe must build on projects of common interest with a strong focus on Southern and Southeastern European counties. The increase in wind and solar energy in the last few years was moderate and energy generation from renewables peaked in 2020. If all measures from the REPowerEU plan were to be implemented, Russian gas could be entirely replaced within five years. The huge increase in imports of solar panels from China observed since the start of the war can partly be attributed to price increases (which he also considered ­temporary) but there was also an increase in terms of gigawatts to be produced. In addition, the significant buildup of LNG import capacity via floating or fixed terminals ­represents good news for Europe. Wolff concluded by alluding to the necessity to maintain the integrity of the energy market. Germany will increasingly function as a transit hub and the West-East flow of gas will be complemented by North-South flows including the Baltics and the Balkans. European, and especially ­Norwegian, infrastructure needs to be protected against hybrid attacks. Yet, the EU must be mindful to avoid building up new dependencies. In the ensuing ­discussion he clarified that this does not mean that Europe should reshore energy supply and production processes entirely. However, diversification of sourcing countries is key. Prompted on fiscal coordination in Europe he referred to the fact that the powerful “double ka-boom” in Germany has made this discussion obsolete.

The third session chaired by Bernhard Grossmann, Head of the Office of the ­Fiscal Advisory Council and Productivity Board at the OeNB, focused on what ­fiscal policy can do to alleviate the negative impact of high inflation and ­commodity price surges on the economy in the short run. How to avoid social unrest while stepping up sanctions against Russia? And how to preserve fiscal space in times of crisis?

Baiba Brusbaˉrde, Chief Economist of the Macroeconomic Analysis Division at Latvijas Banka discussed the short-term fiscal policy response of Latvia that aims at both protecting all vulnerable low- and middle-income households against ­extreme price increases and retaining incentives to save energy. Only households that have insufficient disposable income after deducting all necessary housing and heating expenses are eligible for direct benefits. The monitoring of the state ­support by the central bank shows that the targeted measures dampened the ­inflation increase in 2022 and will contribute positively to GDP growth in 2023. The Latvian experience demonstrates that a broad information campaign is ­necessary since vulnerable households are typically less informed.

Belma Cˇolakovic´, Chief Economist at the Central Bank of Bosnia and ­Herzegovina emphasized the role of country specifics in tailoring short-term fiscal policy ­responses to the energy crisis in CESEE. For instance, Western Balkan countries have a comparably higher share of vulnerable households with little savings and very low incomes. Price shocks hit consumers differently due to the high weight of food items in the consumption basket, which amounts to about 33% compared to 11% in the euro area. She also pointed to the strong dependence on fossil energy, which goes beyond consumption patterns and also implies labor market ­dependencies. Hence, the region appears to be locked into nonsustainable energy production and consumption. Alluding to stepped up sanctions against Russia, she mentioned the rather low direct economic impact on Western Balkan economies, including Bosnia and Herzegovina, due to comparatively low trade volumes and low dependency on Russian oil and natural gas. Only Serbia may be somewhat more dependent.

Zsolt Darvas, Senior Fellow at Bruegel, agreed that the current situation ­warrants government support to vulnerable households. Fortunately, surprise ­inflation temporarily increases the fiscal space of governments through higher tax revenues and falling debt-to-GDP ratios. However, state support measures should restore affordability without fueling further inflation. Particularly, they should not weaken the price signal because some underlying factors of the inflation spike will be long-lived. Hence strong price signals are important to foster adjustment and reallocation – accompanied by structural reforms. Finally, measures need to be (and should have been more) targeted, temporary and tailored to preserve fiscal space even during crisis times. The EU Recovery and Resilience Facility will play an important role in stepping up the short-term fiscal policy response and fostering the urgently needed transition to less dependency on fossil fuels and more generally to a green economy. In the medium- to long-term, fiscal sustainability also ­requires countercyclical policies during good times.

Zsolt Darvas noted that energy and producer prices had already started to ­increase rapidly prior to the Ukraine war. Moreover, the drop in the supply of gas to the EU was caused by Russia and not by EU sanctions. Additionally, EU ­sanctions are gradually becoming more and more effective, impacting Russia’s ­manufacturing adversely and eroding its productive capacity. According to mirror trade statistics, Russia is cut off from high technology from non-EU countries too, and Russian imports and exports dropped except for fossil fuels. Moreover, people need to be reassured on energy security.

Session 4 under the title “Addressing long-term supply challenges via structural policies and green transition” was chaired by Julia Wörz, Head of the OeNB’s ­Central, Eastern and Southeastern Europe Section. She asked whether the current multiple shocks, and responses to them, are accelerating or slowing down the green transition. Veronika Grimm, Member of the German Council of Economic Experts and Professor at Friedrich-Alexander-Universität Erlangen-Nürnberg, spoke of a gas price tsunami that had already started before the war and will not disappear before 2024. Gas prices will stay structurally higher in Europe than in America and Asia, which implies that here hydrogen will sooner become competitive to gas. Grimm commended ­Germany’s well-targeted gas cost subsidies. EU policies, however, should ease the subsidy pressure with new energy supplies mobilized through common gas ­procurement, expansion of renewables, temporary reactivation of nuclear power sources and coal, and energy efficiency. She also stressed the need to prepare for green hydrogen. In order to avoid new dependencies on raw materials critical for the green transition she advocated diversity, not to be confused with “friend-­shoring.”

Elena Paltseva, Associate Professor at the Stockholm Institute of Transition ­Economics, asked whether the EU gas crisis is mobilizing the green transition. She said that the share of Russian gas fell from 45% to 18% of EU imports while LNG increased its share to 39%. However, the massive gas infrastructure investment currently being undertaken is not necessarily good news for the green transition, since natural gas is essentially methane, and LNG imports – typically shale gas from the US – emit twice as much greenhouse gases (GHG) as Russian pipeline gas. Moreover, new investment creates carbon lock-ins and eventually would ­become stranded assets. To reduce the implied uncertainties, Paltseva proposed first to assess LNG infrastructure investment correctly, second to mobilize ­existing infrastructure and third stimulate sustainable energy investment.

Thomas Reininger, Senior Principal at the OeNB, spoke about the green ­transition in CESEE EU member states, most of which have lagged behind in terms of reducing their carbon intensity relative to GDP per capita. While their GHG emissions had fallen sharply from 1990 due to economic transition, since 2008, they have made only small progress. Energy industries’ emissions are substantially larger in CESEE than in the EU-16, while the opposite is true regarding the ­transport sector – of course, these region-wide aggregates mask great variability at the country level. On the upside, the post-pandemic EU funds envisaged for ­spending in 2021−2026 appear to appropriately address climate-related ­weaknesses in energy industries, energy efficiency and transport in CESEE EU, according to their national recovery and resilience plans. These countries tend to benefit most from the EU grants, generally dedicated by more than 40% to climate-related measures. The subsequent discussion on all three presentations covered a variety of issues such as labor shortages, the role of biogas, cycle economy, the ­insufficiency of funds alone and the low public acceptance of green transition in CESEE.

The CEEI concluded with a second panel discussion titled “Banks in transition: is there a need for rescoping toward sustainable markets and products?” The OeNB’s Vice-Governor Gottfried Haber kicked off the exchange of views among distinguished bank practitioners by sketching out the turning points that we are currently facing in several respects. These include inflation, recession, rising ­interest rates, limitations on the supply side and at the same time globally rather tight labor markets. Vice-Governor Haber pointed out that European banks have built up resilience over the last decade, but it remains to be seen whether it will suffice in the future.

Elena Carletti, Professor at Università Bocconi, pinpointed three key elements of the current uncertainty. First of these is the geopolitical instability in Europe, which is neither predictable nor controllable. Second, in a striking contrast to the pandemic, during which economic policies were largely aligned, currently there is a significant divergence between monetary and fiscal policy. Third, while it is ­relatively easy for banks to assess their direct exposure to the countries involved in the war, it is much more difficult to assess the spillover effects. Models based on history are no longer informative so that much more forward-looking analysis is needed. Turning to the issue of high interest rates, Professor Carletti explained why they are boon and bane for banks at the same time. Banks not only benefit from high rates but also face risks from them. It is not only credit risk that needs a watchful eye but also interest rate risks related to banks’ derivatives exposures. In reaction to a question about the risks of a rising sovereign-bank nexus, Professor Carletti stressed that the banks are not only exposed to (worldwide) increased ­government debt but also to government guarantees stemming from the pandemic. Nonetheless, despite the intensified sovereign-bank nexus, she senses a bigger risk in the fragmentation of sovereign spreads in Europe.

Gunter Deuber, Head of Research at Raiffeisen Bank International, started out by referring to the main theme of the conference and emphasized that his bank is conducting banking under war conditions, which has only been possible thanks to thousands of employees in Russia, Ukraine and Belarus. He moved on to point out that Western banks have been de-risking and shifting away from Eastern European countries toward more predictable EU markets since 2014. Yet a turning point has occurred not only on the geopolitical level but also on the funding side. This is ­because times of ample deposit funding are coming to an end and at the same time bond market funding has become more expensive. There will be a certain competition for deposits because major disposable income losses are still ahead of us. However, green funding provides an interesting opportunity, especially in the ­CESEE region, where this market segment is still rather underdeveloped.

Boštjan Jazbec, board member of the Single Resolution Board, played − in his own words − the devil’s advocate by pointing out that despite significant efforts there is still not much of a European banking system. We rather have competing national banking systems which are mainly preoccupied with supporting their ­national economies as the rather stagnant level of cross-border lending over the last twenty years suggests. Even the Basel regulation does not treat the euro area as a common market since it requires additional capital buffers for cross-border ­activities. On a more positive note, Jazbec stated that we have managed to build rather resilient banking systems and that despite recent major shocks the ­prophecies of doom about the next financial crisis have not materialized. This is not least due to the stricter regulatory and supervisory framework which, however, at the same time is reaching the point where it obstructs banks’ profitability and business ­models. Jazbec also cautioned against the view according to which the European market as a whole is overbanked as two out of three banks in Europe are in ­Germany and Italy. He concluded his initial statement by saying that we have still not completed the banking union. We are still only at its second pillar – the Single Resolution Mechanism (SRM) − which is still very fragmented in the sense of ­different insolvency regimes in different countries. The third pillar – the European deposit insurance scheme (EDIS) – is a complete “dead end” according to Boštjan Jazbec.

In the lively ensuing discussion, the panelists agreed that the main – though not the only – obstacle to green investment is the lack of policy credibility and the ­regulatory risk. This starts with the taxonomy, which not only keeps changing but is also being watered down by political compromises. The issue of the incomplete banking union also resonated a lot in the discussion. While Gunter Deuber argued that his bank has contributed a lot to banking market integration, Boštjan Jazbec countered that this is just reaching out to non-banking union jurisdictions when what we need is a common banking system in the EU. Jazbec sees one reason for the fragmented banking market in the lack of trust as there is a strong instinct to resolve ailing banks on the national level. National resolution authorities have a lot of power in contrast to supervisory authorities.

51 Oesterreichische Nationalbank, Central, Eastern and Southeastern Europe Section, . Compiled on the basis of notes taken by Andreas Breitenfellner, Mathias Lahnsteiner, Anna Raggl, Thomas ­Scheiber, Tomáš Slacˇík and Julia Wörz.

Referees for Focus on European Economic Integration 2020−2022

Most of the research papers published in Focus on European Economic Integration (FEEI) are subject to a double-blind peer review process to ensure a high level of scientific quality. The FEEI’s editors in chief wish to thank the following researchers for their work and diligence in reviewing studies published in Focus on European Economic Integration in the period from 2020 to 2022:

 
Tomáš Adam Ivan Huljak
Amat Adarov Karl Kaltenthaler
Sebastian Blesse Evan Kraft
Tamás Briglevics Annette Kyobe
Martin Brown Christoph Lakner
Lucy Chernykh Yannick Lucotte
Andrijana Ćudina Krzysztof Michalak
Mirna Dumičić Richhild Moessner
Johannes Ehrentraud Machiko Narita
Alena Epifanova Grzegorz Peszko
Matteo Falagiarda Olga Popova
Luísa Farinha Monique Reid
Hauke Feil Concetta Rondinelli
Klaus Friesenbichler Paula Sánchez
Zuzana Fungáčová Tobias Schmidt
Kamil Galuščák Helena Schweiger
Christine Gartner Galen Sher
Áron Gereben Laura Solanko
Gastón Giordana Paweł Strzelecki
Olga Goldfayn-Frank Saskia Ter Ellen
Maciej Grodzicki Nathaniel Young
Matthew Harding Christoph Wronka
Martin Hodula Michael Ziegelmeyer
Hans Holzhacker Siegfried Zottel
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