Economic Assessment of the Euro Area. Winter 2020/2021
The pandemic led to a historic contraction of economic activity in spring followed by a substantial but incomplete recovery in summer. Due to fewer restrictions, less risk of contamination and the reopening of factories and shops, the recovery in production in the euro-zone in the third quarter of 2020 was substantial but incomplete. In the second quarter, the QoQ decline of GDP was the largest ever recorded, but after that, the increase in the third quarter was also the largest ever. This recovery has compensated at least for two-thirds of the previous production decline. Nevertheless, the remaining decline is still significant: in the third quarter, GDP in the euro area was still 4.4 per cent lower than at the end of 2019. Only the GDP decline at the start of the great recession was greater (-5.3 per cent).
With renewed containment measures in place during the fourth quarter and in the beginning of 2021, the short-term outlook for GDP has become less favourable. Resurging infection rates triggered renewed measures to contain the pandemic in autumn which derailed the recovery. Euro area GDP contracted by 0.7 per cent in the fourth quarter, according to the Eurostat flash estimate, with declines in output concentrated in France, Italy and Austria. PMI data indicate that the manufacturing sector still shows a sustained growth, whereas the service sector is increasingly constrained by severe social distancing measures. The manufacturing data from PMI are corroborated by the industrial production data from Eurostat. The renewed measures will also have a negative impact on economic activity in the first quarter of 2021. A sustained recovery will only start after large scale vaccination amongst the general public reduces contaminations. Due to an anticipated relaxation of the containment measures, production and consumption are expected to pick up from the second quarter onwards. Initially, the recovery is quite strong because of pent-up demand, with GDP growing at 4.9 per cent in 2021(average of the EUROFRAME institutes forecasts). In 2022, the recovery will continue, albeit at a more moderate growth rate of 3.1 per cent.
Economies of Central and Eastern European Countries (CEEC) suffered from the unprecedented Covid-19 epidemic in 2020. Recent projections show that the Czech Republic and Slovakia experienced the most substantial negative impact of Covid-19in the region (6.8 percent decline of GDP in 2020), whereas the economies of Poland and Lithuania are forecasted to decline at a relatively low pace (1.9 percent and 3.5 percent decline, respectively).The GDP decline in 2020 in Bulgaria, Estonia, Romania, and Latvia is expected to range from 4.5 up to 5.5 percent. Unsurprisingly, private consumption and private investment in the second quarter of 2020 were the main drivers of the observed GDP decline. In Poland, the largest economy in the region, private consumption and investment fell in the second quarter by 10.5 and 9.0 percent QoQ respectively. The downfall in private consumption is expected to remain between -3.0 and -4.0 percent in the vast majority of CEECs, whereas private investment was much more volatile across countries with the expected mean decline of over 8 percent. A sharp decline in the economic activity could also be observed on the labour markets as the increase in unemployment rates ranged from 2.7 up to 3.5 percentage points over 2020.
The governments of CEECs responded to the Covid-19 pandemic through various fiscal measures. These measures are expected to increase government expenditure on average by 4.8 and 1.3 percent YoY in 2020 and 2021, respectively. Along with decreased tax revenues, elevated expenditure will lead to a deterioration in the state of the public finances. The average budget balance-to-GDP ratio in the region is projected to reach -7.4 percent in 2020 and -5.2 per cent in 2021. Overall, the general government debt-to-GDP ratio is expected to hit 46.1 percent in 2020 and 48.2 per cent in 2021, in total in the region.
Due to the expected roll-out of the vaccine for the Covid-19 virus and the assumed easing of containment measures, CEEC economies are expected to rebound in 2021. However, GDP in real terms in all CEECs in 2021 will remain below the levels observed in 2019. A full recovery of CEE economies is expected no earlier than in 2022. GDP growth in 2021 is projected to reach up to 5.4 percent year-over-year in Slovakia and as low as 3.1 per cent in Lithuania. Poland, Hungary, and Latvia are the other countries are expected to grow at the pace of over 4 percent. The annual GDP growth for Poland is forecasted at 4.1 percent and 4.0 percent in 2021 and 2022, respectively. Hence, the Polish economy is expected to return to its pre-Covid growth trends.
The rebound will mostly be driven by the aggregates that suffered most throughout 2020, namely private consumption that is expected to increase at the highest pace in Latvia and Poland (5.7 and 4.5 percent year-over-year growth in 2021, respectively). Private investment is projected to be the second most important engine of growth with year-over-year growth exceeding the increase in consumption expenditure. The fastest increase in private investment is forecasted for Slovakia (10.9 percent growth in 2021) and Estonia (7.9 per cent growth). Government consumption in CEE as a whole is forecasted to grow at a decreasing rate whereas trade balances are projected to deteriorate in most of the countries in the region.
EUROFRAME (European Forecasting Associaton for the Macroeconomy) is an association of 10 prominent economic research institutes from 9 countries, including CASE (www.euroframe.org ).