• GDP numbers for Q1 across Central and Eastern Europe surprised significantly on the downside. The weaker-than-expected GDP numbers raise serious doubt about the outlook for budget finances in the region.

Details

Most notable in our view is the speed of the decline in economic activity in Romania and Bulgaria – until Q4 both countries showed very few signs of slowing down. However, the crisis has now hit the two South Eastern European economies with a vengeance. Romanian GDP dropped by 6.4% y/y in Q1 – sharply down from positive GDP growth of 2.9% y/y. This implies that – even when assuming (probably unrealistically) that quarter-to-quarter GDP will stop declining in the remaining quarters of the year - GDP will drop by more than 10% y/y on average for the year. Similarly, Bulgarian GDP dropped by 3.5% y/y – down from +3.5% y/y in Q4.

Another unpleasant surprise was the drop in Slovakian GDP of 5.4% y/y – much worse than the consensus expectation of -2.4% y/y. It is very clear that the Slovak economy is not escaping the crisis and there is no doubt that the weak numbers to a large extent reflect a drop in exports especially within the auto industry. That said, the deterioration of the labour market in Slovakia is beginning to hurt private consumption, which should weigh on economic activity during 2009. Slovak GDP might drop as much as 6% in 2009.

Less surprisingly, Hungarian GDP dropped 6.4% y/y in Q1 - worse than the consensus expectation of -5.75% y/y, but close to our forecast of -6.5% y/y. It now looks like Hungarian GDP could drop more than 8% in 2009.

The Czech GDP numbers surprised on the downside as well dropping by 3.4% y/y, worse than the consensus expectation of -1.8% y/y and down from 0.7% y/y from Q4 2008.

Assessment & Outlook

Overall, the crisis in the CEE economies is very bad and worse than in Western Europe. Especially the countries that have had large external imbalances like Romania, Bulgaria and Hungary are seeing a very sharp drop in economic activity and in our view, the most likely outcome for Romania and Bulgaria is a “Baltic style” recession with double-digit drops in GDP during 2009. Even though one can argue that Q1 GDP are “historical” data and therefore not relevant for the outlook for the CEE economies we think today’s numbers are quite concerning.

An important implication in our view is the impact on public finances. Take for example a country like Romania for which the European Commission forecasts a drop in GDP of 4% this year and a budget deficit of 5.1% of GDP. If Romanian GDP drops by 10-12% instead the budget deficit could fast approach 10% of GDP – which would make additional fiscal tightening necessary to fulfil the budget targets in Romania’s standby-agreement with the IMF.