the economic outlook for eca economic update...

ECA Economic UpdateApril 2016

1

Hans TimmerChief EconomistEurope and Central Asia Region

The economic outlook forEurope and Central Asia,

including the impact of China

April 7, 2016Kiev, Ukraine

• Low growth is expected in Europe and Central Asia (ECA), as global headwinds remain strong.

• The headwinds are of structural, rather than cyclical nature. They are part of the new normal.

• This is also true for the slowdown in China, which has a pervasive impact on ECA. The impact creates both opportunities and challenges.

• Policies have to adjust to new circumstances.

2

Overview

3

Subdued growth in new forecast

4

Consumption has sharply declined in Eastern Europe and Central Asia

Annual growth rates, 2015

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

Ukraine Belarus RussianFederation

Azerbaijan Moldova Kazakhstan Armenia Georgia KyrgyzRepublic

Turkey Tajikistan Uzbekistan

GDP growth (%) Private consumption growth (%)

5

Euro Area export growth now outpaces global average

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

2003m12 2006m12 2009m12 2012m12 2015m12

Percentage points difference between growth export volume euro area and global export growth, 12m/12m

6

Strong growth of agriculture in the east

-15

-10

-5

0

5

10

15

UKR BLR RUS MDA KAZ AZE GEO KGZ ARM TUR TJK UZB

Agriculture Industry Services GDP

Percentage change in 2015

• Collapse in oil revenues amounts to large terms-of-trade losses and sharp depreciations.

• Reductions in remittances (deflated by import prices) imply large declines in household incomes.

• Diverging monetary policies and reversals of capital flows lead to changes in competitiveness.

7

Big shifts in relative prices are affecting consumption and exports

8

Ruble exchange rate closely follows oil price

-30

-20

-10

0

10

20

Monthly percentage change

US$ per ruble brent oil price in US$

-10

-8

-6

-4

-2

0

2

4

6

8

10

-4

-3

-2

-1

0

1

2

3

4

5

6

Daily percentage changes

US$ per ruble brent oil price in US$

9

Sharp declines in remittances in 2015

-40

-35

-30

-25

-20

-15

-10

-5

0

BLR ARM UKR MDA KGZ GEO

Percentage growth in 2015 of remittances, deflated by import price

10

European export growth accelerates as U.S. and Chinese exports slow down

CHN

CZE

DEU

DNK

ESPFIN

HUN

ITANLD

POLSLK

SWE

USA

-15

-10

-5

0

5

10

15

-6.0 -5.0 -4.0 -3.0 -2.0 -1.0 0.0 1.0 2.0 3.0 4.0

Ch

ange

of

real

eff

ecti

ve e

xch

ange

rat

e (%

)

Change of export volume growth (%)

Relative price changes might require changes in monetary policy regimes:

• Oil-exporting and remittance-receiving countries need flexible exchange rate in wake of fall in oil prices.

• Central Banks in oil-exporting countries might consider oil price in local currency as a new policy target.

• Other Central Banks could reconsider inflation target, with more emphasis on the GDP deflator and housing prices.

11

Central Banks need to rethink monetary policy

12

Large differences in 2015 between GDP and CPI deflators

change in 2015 over 2014GDP deflator CPI difference

percent percent percentage point

Russia 6.0 15.5 -9.5

Norway -2.0 2.2 -4.2

Canada -0.5 1.1 -1.6

Netherlands 0.3 0.6 -0.3

United States 1.0 0.1 0.9

Japan 2.0 0.8 1.2

Germany 2.0 0.2 1.8

Sweden 2.0 0.0 2.0

13

Home prices recovering in most countries, but falling in oil-exporting countries

• Unemployment in European Union is declining as the EU enters fourth year of recovery.

• Crisis in many countries in eastern part of region starts showing in rising unemployment.

• Digital technologies, sharing economy, migration, and globalization will fundamentally change labor markets, and requires new social contract.

14

Labor markets affected by cyclical and structural factors

15

Unemployment falling in the west and rising in the east

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

Change 2014-2015 Change 2015-2016

-0.2

0.0

0.2

0.4

0.6

0.8

1.0

Kazakhstan Ukraine Turkey RussianFederation

Belarus Moldova

Change 2014-2015 Change 2015-2016

Percentage points

• Slowdown is result of slower expansion of production capacity

• Rebalancing entails

– Shift from investments to consumption

– Shift from low-skilled to high-skilled production

– Shift from inward FDI to outward FDI

16

Growth moderation and rebalancing in China

17

Slowdown in China coincides with decelerating potential growth

5.0

7.0

9.0

11.0

13.0

15.0

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

potential GDP growth actual GDP growth

Annual percentage change

18

China is catching up to the European Union

0

10

20

30

40

50

60

70

80

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

starting share cumulative volume effect cumulative price effect

China’s nominal GDP as percentage of EU’s nominal GDP

19

China’s share of imports by ECA has expanded rapidly

Share of imports from China in total imports, percent

0

5

10

15

20

25

30

35

Central Asia Central Europe Eastern Europe Northern Europe Russia South Caucasus Southern Europe Turkey Western Balkans Western Europe

1996 2014

• Exports are not as big as gravity model predicts. There seem to be special factors impeding exports to China.

• Sharp real depreciations vis-à-vis China have made producers much more competitive.

20

But region can export even more to China

21

Eastern ECA may have greater potential than western ECA to increase exports to China

Exports to China by sector from ECA sub-regions, US$ million

0

500

1000

1500

2000

2500

CentralAsia

CentralEurope

EasternEurope

NorthernEurope

Russia SouthCaucasus

SouthernEurope

Turkey WesternBalkans

WesternEurope

Agriculture

Actual Predicted

0

5000

10000

15000

20000

25000

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope

Low Skill Manufacturing

Actual Predicted

0

20000

40000

60000

80000

100000

120000

140000

160000

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope

High Skill Manufacturing

Actual Predicted

0

5000

10000

15000

20000

25000

30000

35000

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope

Natural Resources

Actual Predicted

22

China’s potential to increase import penetration in ECA is limited

0

200

400

600

800

1000

1200

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope

Agriculture

Actual Predicted

05000

100001500020000250003000035000400004500050000

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope


Actual Predicted

0

20000

40000

60000

80000

100000

120000

140000

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope


Actual Predicted

050

100150200250300350400

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope

Natural Resources

Actual Predicted

Imports from China by sector from ECA sub-regions, US$ million

23

ECA currencies depreciated sharply over past year

Percent change in real exchange rate with China, Jan-Feb 2015 to Jan-Feb 2016

-50

-45

-40

-35

-30

-25

-20

-15

-10

-5

0

Aze

rbai

jan

Bel

aru

s

Ru

ssia

n F

eder

atio

n

Kaz

akh

stan

Ukr

ain

e

Geo

rgia

Mo

ldo

va

Kyr

gyz

Rep

ub

lic

Po

lan

d

Turk

ey

Swed

en

Cyp

rus

Ro

man

ia

Gre

ece

Hu

nga

ry

Spai

n

Bo

snia

an

d H

erze

govi

na

Lith

uan

ia

Cro

atia

Slo

ven

ia

Esto

nia

Slo

vak

Rep

ub

lic

Mac

edo

nia

, FYR

Irel

and

Fin

lan

d

Fran

ce

Bu

lgar

ia

Ger

man

y

Ital

y

Latv

ia

Den

mar

k

Luxe

mb

ou

rg

Po

rtu

gal

Net

her

lan

ds

Au

stri

a

Mal

ta

Bel

giu

m

Cze

ch R

epu

blic

Alb

ania

Un

ited

Kin

gdo

m

Arm

enia

Tajik

ista

n

24

Exchange rate depreciation has created opportunities to compete with imports

Percent change in potential imports as a result of real exchange rate depreciation in ECA

-9

-8

-7

-6

-5

-4

-3

-2

-1

0

1

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope

Agriculture

-14

-12

-10

-8

-6

-4

-2

0

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope


-16

-14

-12

-10

-8

-6

-4

-2

0

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope


-4

-3

-2

-1

0

1

2

3

4

5

6

7

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope

Natural Resources

25

Exchange rate depreciation could boost ECA’s exports to China

Percent change in volume of total exports

0

2

4

6

8

10

12

14

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope

Agriculture

0

2

4

6

8

10

12

14

16

18

20

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope


0

5

10

15

20

25

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope


0

2

4

6

8

10

12

14

CentralAsia

CentralEurope

EasternEurope

NorthernEurope


SouthernEurope


WesternEurope

Natural Resources

26

China’s slowdown has a mixed impact on ECA’s exports

Percentage difference in export volumes in slowdown compared to business as usual scenario

-3.5

-3

-2.5

-2

-1.5

-1

-0.5

0

0.5

1

1.5

Russia Kazakhstan Azerbaijan Kyrgyz Republic Ukraine Poland Bulgaria Turkey and OtherECA

EU and EFTA

27

Change in private consumption relative to business as usual scenario

Percent

1.8

3.3

5.7

3.0

1.4 1.6

-1.0

-1.2 -1.1

-4.7

-0.5

-0.9

-6

-4

-2

0

2

4

6

8

Russian Federation Kazakhstan Azerbaijan Kyrgyz Rep Ukraine EU and EFTA

Full Rebal Slow Down

28

China’s slowdown improves wages, particularly of unskilled workers

Percent change in China slowdown versus business as usual scenarios

-0.1

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Russia Kazakhstan Azerbaijan Kyrgyz Republic Ukraine Poland Bulgaria Turkey andOther ECA

EU and EFTA

wage/rental rate unskilled/skilled wages

• Expected slow GDP growth tells only part of the story. Big changes in relative prices have far-reaching consequences.

• Slowdown and rebalancing in China are key elements of structural changes in global environment.

• There are some silver linings in the outlook. Unemployment is declining in EU and export opportunities are improving.

• Policies challenges most complicated for Eastern Europe and Central Asia.

29

Conclusions

ECA Economic UpdateApril 2016

30

Hans TimmerChief EconomistEurope and Central Asia Region

Thank you!

April 7, 2016Kiev, Ukraine

the economic outlook for eca economic update...

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