the long and winding recovery

4Q

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2020

CEE Quarterly

Macro Research Strategy Research Credit Research

The long and winding recovery

September 2020

UniCredit Research page 2 See last pages for disclaimer.

September 2020 CEE Macro & Strategy Research

CEE Quarterly

“Your Leading Banking Partner in

Central and Eastern Europe

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September 2020


CEE Quarterly


Contents

4 CEE: The long and winding recovery

23 CEE Strategy: 4Q20 tensions an opportunity from a medium-term perspective

74 Acronyms and abbreviations used in the CEE Quarterly

COUNTRIES

30 Bulgaria: Political impasse could translate into a weaker recovery

34 Croatia: Can a generous EU package boost the recovery?

38 Czechia: Nearing a stimulus overdose

42 Hungary: From frontrunner to laggard

46 Poland: Leading the pack

50 Romania: A noisy end to the election cycle

54 Slovakia: Pandemic confirms strong dependency on auto sector

56 Slovenia: A gradual recovery

EU CANDITATES AND OTHER COUNTRIES

58 Bosnia and Herzegovina: The economy posted a relatively weak recovery during summer

60 North Macedonia: A slow recovery amid weak external demand

62 Russia: A slow recovery ahead

66 Serbia: Smaller hit from COVID-19 but slower recovery

70 Turkey: Hitting the breaks

Published on 29 September 2020

Erik F. Nielsen Group Chief Economist (UniCredit Bank, London) 120 London Wall UK-London EC2Y 5ET

Imprint: UniCredit Bank AG UniCredit Research Am Eisbach 4 D-80538 Munich

Supplier identification: www.unicreditresearch.eu

Erik F. Nielsen, Group Chief Economist (UniCredit Bank, London) +44 207 826-1765, [email protected]

Dan Bucşa, Chief CEE Economist (UniCredit Bank, London) +44 207 826-7954, [email protected]

Artem Arkhipov, Head of Macroeconomic Analysis and Research Russia (UniCredit Russia) +7 495 258-7258 ext. -7558, [email protected]

Gökçe Çelik, Senior CEE Economist (UniCredit Bank, London) + 44 207 826-6077, [email protected]

Ariel Chernyy, Economist, Macroeconomic Analysis and Research Russia (UniCredit Russia) +7 495 258-7258 ext. 7562; [email protected]

Hrvoje Dolenec, Chief Economist (Zagrebačka banka) +385 1 6006-678, [email protected]

Dr. Ágnes Halász, Chief Economist, Head of Economics and Strategic Analysis Hungary (UniCredit Hungary) +36 1 301-1907, [email protected]

Ľubomír Koršňák, Chief Economist (UniCredit Bank Czech Republic and Slovakia) +42 12 4950-2427, [email protected]

Elia Lattuga, Co-Head of Strategy Research (UniCredit Bank, London) +44 207 826-1642, [email protected]

Mauro Giorgio Marrano, Senior CEE Economist (UniCredit Bank, Vienna) +43 50505-82712, [email protected]

Anca Maria Negrescu, Senior Economist (UniCredit Bank Romania) +40 21 200-1377, [email protected]

Kristofor Pavlov, Chief Economist (UniCredit Bulbank) +359 2 923-2192, [email protected]

Pavel Sobíšek, Chief Economist (UniCredit Bank Czech Republic and Slovakia) +420 955 960-716, [email protected]

https://www.unicreditresearch.eu/

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September 2020


CEE Quarterly


CEE

The long and winding recovery

Dan Bucsa, Chief CEE Economist (UniCredit Bank, London) +44 207 826-7954 [email protected]

■ The economic rebound in CEE was swift in May-July, powered by a rebound in consumer

spending and a prompt unwinding of restrictions.

■ However, the rapid removal of restrictions and poor compliance with regulation led to a faster

flare-up in COVID-19 cases than in the eurozone, especially in the Balkans.

■ We see three sources of differentiation in the upcoming recovery: 1. the spread of the

pandemic; 2. the measures taken to contain it and 3. the efficiency, scope and time horizon

of support measures taken by governments and central banks.

■ We expect EU-CEE1 economies to contract by 5.5% in 2020, with the economies of Russia,

Serbia and Turkey shrinking by 2.5-4%.

■ The recovery in 2021 could be incomplete in all countries but Serbia and Turkey, slowed by

fiscal and credit impulses, as well as economic and (geo)political risks

■ The CBR could cut the repo rate to 4% if inflationary and geopolitical risks abate. The NBR

could cut the policy rate to 1% if fiscal profligacy is avoided.

■ The CBRT could increase rates by 2pp before year-end, before reversing this year’s hikes in

2H21. The CNB might be the first EU-CEE central bank to increase rates next year.

■ We see little scope for FX and bond rallies in CEE in 4Q20. ROMGBs and ROMANIs are the

exception if fiscal spending is reined in. The outlook is better for bonds in 2021.

■ Risk assessment: There are limited threats to the economic policy mix from political

instability in Bulgaria. If pensions increase by 40%, Romania could lose its investment

grade and face political instability after the elections. There is a risk of limited sanctions

against Russia due to Belarus and the poisoning of Alexei Navalny. There is a low risk that

Hungary and Poland may veto the Next Generation EU (NGEU) framework. Geopolitical

and sanction risks against Turkey remain due to tensions in the Mediterranean.

A quick rebound in May-July…

Most CEE economies contracted in 2Q20 in line with the tightness of lockdowns Hungary and Croatia were the worst affected… … while Poland, Russia, Turkey and Serbia fared better

At the height of the COVID-19 crisis, CEE economies contracted in line with developed

economies, with the 2Q20 recession correlated with the tightness of lockdowns. Three

countries stand out, Serbia for having performed much better than restrictions suggest, and

Hungary and Croatia, whose economies shrank much more than those of their peers, despite

comparable lockdowns. In Serbia, the government had a disproportionate role in driving

investment, while the private sector had a poor 1H19 and, as a result, this year’s dip looked

comparatively mild. In Hungary, car production and tourism weighed on growth, but delayed

government support failed to cushion the economy at the onset of the crisis. In Croatia, the

sharp decline was mostly driven by tourism, which accounts for more than a fifth of the

country’s GDP, when including indirect contributions.

Among the countries plotted against the trend line in Chart 1, those with a larger share of

domestic demand (Poland, Russia and Turkey) fared better. In Poland and Turkey, it was the

swift and sizeable disbursement of credit and guarantees through the Polish Sovereign

Investment Fund (PFR) and the Development Bank (BGK) and through (mostly state-owned)

banks in Turkey. In Russia, the gradual spread of the pandemic eastwards meant that

domestic demand fell less in 2Q20 and rebounded less in 3Q20 compared to other

CEE countries.

1Includes CEE countries that are members of the EU, namely Bulgaria, Croatia, Hungary, Poland, Romania, Slovenia and Slovakia.


September 2020


CEE Quarterly


Strong rebound from lockdowns in May-June

Despite large public support, the other small, open economies in EU-CEE and the western

Balkans were unable to avoid the sharpest decline in activity since the fall of communism.

CEE economies rebounded strongly from lockdowns, with June and July data showing that

activity resumed swiftly once restrictions were removed. The carryover into 3Q20 was strong

throughout the region (Chart 2). This was particularly true in industry and retail, where

restrictions affected activity more than in construction. The reopening of shops released some

of the pent-up demand accumulated during lockdowns, while factories covered orders that

could not be filled before COVID-19-related restrictions were imposed.

In contrast, momentum weakened in construction at the start of the summer because fewer

projects were started after the pandemic hit. In some countries, governments scaled back

infrastructure spending to make room for anti-crisis support.

CHART 1: 2Q20 CONTRACTION PROPORTIONAL TO LOCKDOWN TIGHTNESS

CHART 2: STRONG CARRYOVER INTO 3Q20 IN INDUSTRY AND RETAIL

Source: Google Mobility, Eurostat, UniCredit Research

…followed by a slower recovery over the summer…

The recovery lost steam in 3Q20 …due to rising COVID-19 cases… … and the restrictions it triggered

Google mobility (Chart 3) and electricity-consumption data suggest that the recovery continued

in 3Q20, although it lost steam after the sharp rebound in May-June. Among Google’s indices,

traffic at workplaces remains 20-30% below pre-crisis levels, suggesting that activity continues

to be disrupted and that teleworking is replacing office work to some extent.

The number of COVID-19 cases has been rising since July. While the rapid removal of

restrictions allowed CEE to outperform the eurozone at the end of 2Q20, it also triggered a

faster increase in new infections as physical distancing requirements have not been properly

observed. In our April CEE Quarterly we mentioned the possibility of cultural differences and

compliance with regulation and norms as differentiating factors in a recovery. The second

wave of the pandemic is highlighting these differences, with the Balkans more affected than

central Europe. In many CEE countries, confusing communication further sapped the already

low trust in the authorities. The attitude to rules and even the recognition of the danger posed

by COVID-19 became subject of political polemic and mixed messages. In some countries,

this may have permanently eroded compliance with rules at a time when governments are

tightening restrictions to protect health-care systems from becoming overloaded.

General lockdowns may be out of the question due to their economic impact, but regional

lockdowns could become the norm to slow the spread of the virus. Another source of risk for

economies is the decision by most CEE governments to forbid citizens of countries with high

infection rates to enter their countries or, in Hungary’s case, to close borders to foreign travelers.

BG

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Carryover in industrial production

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September 2020


CEE Quarterly


This has led to tourist arrivals from abroad remaining 60-90% below last year’s level (Chart 4). The

most negative impact on growth will be felt by countries were tourism represents 8-25% of

GDP, such as Bosnia-Herzegovina, Croatia, Hungary and Turkey.

Unfortunately, no CEE government has managed to put in place a test-and-trace system

efficient enough to avoid having to keep a fair number of restrictions in place for the rest of

the year. With the exception of Russia, the number of tests per million inhabitants remains

much lower than in western Europe and the US, with some CEE countries actually reducing

the number of tests to detect new infections.

CHART 3: THE REOPENING OF ECONOMIES SLOWED IN 3Q20 CHART 4: FOREIGN TOURIST ARRIVALS REMAIN LOW

Source: Google Mobility, Eurostat, governments, national statistical offices, UniCredit Research

…and an even bumpier one in 4Q20 and 2021…

Car manufacturing remains a risk for the recovery Services to suffer from renewed restrictions The rebound in retail is fizzling out

A lack of adequate testing and a seasonal surge expected in COVID-19 cases signal that the

recovery will be a bumpy one. We expect both supply and demand disruptions to affect

growth in the next five quarters.

On the supply side, some sectors lagging in the rebound could further slow economic growth.

In manufacturing, the production of cars stands out due to its significant weight in industrial

production and exports. While car and car parts producers have seen demand rise over the

summer, many orders are legacy orders from before the crisis. Demand for new cars has an

uncertain future, especially for mid-range cars (reminiscent of the post-financial crisis years,

when buyers were reluctant to borrow to finance purchases), and the industry is likely to suffer

from bottlenecks in supply chains. Car sales not only remain below pre-crisis levels in the

largest markets, but they also weakened at the end of the summer in the US and Europe

(Chart 5). Moreover, car-scrappage schemes in Europe are focusing on electric and hybrid

cars, only one model of which is produced in CEE, by Skoda, in Slovakia.

Restrictions will further affect leisure services, tourism and transport. Although they do not

have a large share in GDP, cultural services may be the hardest hit of all sectors due to lack

of funding and inadequate support from governments in most CEE countries.

On the demand side, recent data confirm that the post-lockdown rebound in retail sales

weakened significantly over the summer. Judging by data from east Asia, sales may not

rebound fully in 3Q20, especially for clothing and apparel. Yet spending restraint is not

confined to clothes.

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September 2020


CEE Quarterly


Chart 6 shows that intentions to make high-value purchases over the next 12 months remain

significantly below pre-crisis levels in most EU-CEE countries. Households fear that

restrictions could further affect job security and wages, leading them to increase

precautionary saving instead. This is likely to affect housing projects, especially if mortgage

lending does not recover until 2021, as we expect.

CHART 5: DEMAND FOR CARS WEAKENING AGAIN IN LARGE MARKETS

CHART 6: CONSUMERS REMAIN CAUTIOUS WHEN PLANNING LONG-TERM INVESTMENT

Source: national statistical offices, Eurostat, UniCredit Research

…that will be shaped by public policies

The second wave of the pandemic is worse in the Balkans CEE countries increased anti-crisis support during the summer Direct support for companies and employees was the most efficient in fighting the downturn

We see three main sources of differentiation in economic performance until the end of next

year: 1. the spread of the pandemic; 2. the measures taken to contain it and 3. the efficiency,

scope and time horizon of support measures taken by governments and central banks.

As we mentioned above, the Balkans have been harder hit in the second wave of the

pandemic. Yet even in Visegrad countries and in Turkey, the number of COVID-19 cases

increased during the tourist season. All could see a further surge in winter. In Russia, the

number of infections has risen above 8,000 per day as decisions and responsibility to contain

the spread were outsourced to regional leaders without giving them full access to appropriate

resources and centralized government purchases.

At the time of writing this report, it is too early to say whether this second wave will be contained

quickly or whether it will impact activity in 4Q20 as well. What it highlights is that support

measures taken by governments may have to be kept in place for longer than first envisaged.

The amount of official support varies greatly across CEE countries, as can be seen from

Table 1. Compared to numbers available three months ago, pledged support has increased in

some countries, most significantly in Romania, where it doubled, mostly through the

expansion of guarantees for borrowers and other financial support schemes. Table 2 shows

actual disbursements of support funding and guarantees, using numbers available by mid-

September. Again, the size of support varies greatly by country, as does the split between

direct support (direct payments and transfers, tax exemptions) and indirect support

(guarantees and other financial instruments). Yet the numbers do not reveal the full story.

The split of direct support among 1. handouts to workers on furlough, the unemployed and

poor households; 2. support for companies; 3. tax exemptions; and 4. other spending, mostly

on investment, is reflected in the post-lockdown rebound. Where governments have poured

more money into direct support for companies and employees, the rebound has been swifter

and the number of furloughed workers has declined at a faster pace.

0

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Dec-19 Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20

USA - car imports

Europe - car registrations

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Intentions to make high-value purchases in the next 12M, change since Feb (pp)

September 2020


CEE Quarterly


Economies may struggle to absorb additional support

Poland, Czechia, Romania, Slovakia and Slovenia chose this path. Where the focus has been

on investment, like in Hungary, the positive impact on the economy will be more gradual and

may be small due to the limited spillover of some investment projects. Hungary also stands

out as having redistributed money from other public spending towards anti-crisis support,

meaning that net spending on containing the effects of COVID-19 has risen slower and later

than in neighboring countries.

There is also a lesson from overdoing support. Czechia’s spending plans are very large, but

their efficiency is questionable. Many local institutions, including the CNB, have highlighted

the threat of increasing non-discretionary public spending. In the same vein, anti-crisis

support in Turkey has been large and front-loaded, but the strain put on public finances and

the rapid easing of monetary conditions has fueled depreciation pressure and forced the

CBRT to tighten financial conditions much sooner than planned. The result may be more

macroeconomic volatility in a country with a credit-driven growth model.

Bulgaria and Russia stand out as being unusually thrifty, despite ample scope for fiscal

support. In these two countries, but also in other CEE countries, the timeliness and size of

anti-crisis support has been affected by bureaucratic procedures and the inefficient, bloated

civil service. Thus, the crisis has highlighted the need of reforms in the public sector. At least

in theory, the EU’s focus on digitalization for the 2021-27 multiannual financial framework

could help the transition to a leaner administrative apparatus.

Not all thrift is bad. Several finance ministers from CEE have openly questioned the need for

more support in their countries, doubting that the private sector can absorb and efficiently use

more funding than has already been disbursed. This is especially evident in indirect support.

In many countries, companies cannot take on more debt due to high leverage and the fact

that many of them were facing solvency and tax-compliance issues even before the crisis.

Such pre-existing conditions disqualify companies from anti-crisis support, which aims to

bridge liquidity gaps, rather than alleviate solvency risk.

TABLE 1: CURRENT SIZE OF SUPPORT PACKAGES… TABLE 2: …AND ACTUAL DISBURSEMENTS

% of GDP Direct support Indirect support Total support

Bulgaria 4.5 2.5 7.0

Croatia 6.7 4.7 11.4

Czechia 6.1 17.2 23.3

Hungary 5.0 5.7 10.7

Poland 7.0 8.8 15.8

Romania 2.3 3.7 6.0

Russia 2.3 1.2 3.5

Slovakia 4.0 1.8 5.8

Slovenia 5.5 4.6 10.1

Serbia 8.1 4.4 12.6

N. Macedonia 6.0 3.6 9.6

Turkey* 3.5 6.8 10.3

Some of the direct support includes temporary tax exemptions. *deferred tax payments exceed the remaining support to be disbursed.

% of GDP Direct support Indirect support Total support

Bulgaria 1.6 0.1 1.7

Croatia 4.8 2.0 6.8

Czechia 5.5 0.5 6.0

Hungary 4.4 1.0 5.4

Poland 2.0 3.7 5.7

Romania 1.7 1.2 2.9

Russia 2.0 0.8 2.8

Slovakia 1.4 0.5 1.9

Slovenia 2.7 0.2 2.9

Serbia 5.9 2.2 8.1

N. Macedonia n.a. n.a. n.a.

Turkey 4.7 5.3 10.0

Numbers available by mid-September 2020.

Source: governments, national statistical offices, UniCredit Research

September 2020


CEE Quarterly


Wide usage of furlough support…

To measure the efficiency and penetration of public support, we look at three ways in which

governments have tried to reduce cash outflows in the private sector: furlough support, loan

moratoria and tax exemptions/deferment.

Furlough support has been one of the most efficient measures to prevent a sharp rise in

unemployment. Table 3 shows that, in most CEE countries, governments managed to cap job

losses at limited cost to their budgets. The stand-out case is Croatia, where a third of the

labor force was covered by furlough support at the height of the crisis. The high percentage is

explained by the proportion of services (especially trade and tourism) and vulnerable

manufacturing in total employment.

In most EU-CEE countries, governments revamped or implemented part-time work schemes

modelled on the German “Kurzarbeit” system. This will give companies flexibility in conducting

business if authorities reimpose restrictions to control the spread of the pandemic.

TABLE 3: FURLOUGH IN CEE

Size (% of GDP)

Maximum level of furlough

(% of labor force)

Current level of furlough

(% of labor force)

Expiry

Bulgaria 1.3 5.4 4.3 30 September. Potential extension to 31 December 2020.

Croatia 3.0 33.0 n.a. 31 December 2020

Czechia 0.3 11.5 1.0 31 October. Potential extension to 31 December 2020.

Hungary 0.5 5.1 n.a. Most of it ended in August

Poland 1.1 9.4 n.a. 31 December 2020 (could be extended)

Romania 0.5 21.3 2.1 31 December 2020 (could be extended)

Russia n.a. 12.0 n.a. No proper furlough scheme available. The level of furlough reflects people temporarily made redundant.

Slovakia 1.2 17.4 n.a. 31 December 2020

Slovenia 2.2 15.0 n.a. 30 September. Replaced with subsidies for short-term working until 31 December 2020.

Serbia 2.6 n.a. n.a. 30 September. Potential extension.

N. Macedonia 1.0 15.0 n.a. 31 December 2020

Turkey 0.8 14.7 n.a. Mid-November. Potential extension to June 2021.

Source: governments, UniCredit Research

…and loan moratoria

Loan moratoria have alleviated financial strains for borrowers. Even in countries where

blanket moratoria were imposed by law (Hungary, Romania), penetration remained below

50% of private-sector loans, a sign that the remaining borrowers were able to service their

debt, despite the economic downturn. Serbia stands out with the highest number of loans for

which repayments were postponed. At the other end of the scale, very few borrowers in

Bulgaria, Czechia, Croatia, Poland, Slovenia and Slovakia renegotiated loan repayments. In

all these countries, interest rates fell sharply to reduce borrowing costs. The end of the loan

moratorium leads us to expect the NBR will cut twice more to 1%, in order to smooth the

transition back to loan repayments.

September 2020


CEE Quarterly


TABLE 4: LOAN MORATORIA IN CEE

Coverage Expiry

Bulgaria 15.4% of loan volume 30 September. Potential extension

Croatia 17% of loan volume 30 November. Potential extension

Czechia 14.6% of loan volume 30 October

Hungary 45% of loan volume

31 December 2020. Extended to 30 June 2021 for unemployed (4% of household loans), pensioners (14,5%) and families with children (33%), fostered workers (1% ) and for businesses suffering min 25% loss of revenues (approx. 1/3 of corporate loans).

Poland Less than 10%

Bilateral agreements between banks and customers. Shield Law 4.0 (Tarcza 4.0) created the possibility of a three month moratorium on loan repayments and four-month moratorium on loan executions.

Romania

Private individuals: 22% of the total loans

Companies: 28% of the total loans 31 December 2020

Russia 6% of loans October 2020

Slovakia 10% of clients

Within 9 months for bank loans, 3 months with possibility of prolonging by other 3 months for non-bank companies

Slovenia 3.6% of total loans 30 November. Firms and individuals can obtain deferrals of bank loan repayments for up to 12 months.

Serbia Apr-Jun: 91% of total clients, Jul-Sep: 82% of total clients End of September, but could be extended

N. Macedonia No moratorium. Changes of loan contract to ease the financial burden of customers End of September but can be extended

Turkey Amount of deferred loan payments: 3.5% of total loans 1st round: 30 June, 2nd round: potential extension to 31 December

Source: governments, UniCredit Research

Deferred tax payments will not be recouped in full

Tax exemptions, delays and rescheduling are the third main way in which CEE governments

attempted to reduce cash outflows in the private sector. According to our estimates, Croatia

stands out again, with tax deferrals estimated to climb up to 2.6% of GDP and write-offs of

1.1% of GDP. Serbia ranks second, with the size of such measures being around 3.3% of

GDP, followed by Turkey (1.5% of GDP), and Poland and Romania (1% of GDP each).

Slovenia (0.6% of GDP) and Bulgaria (0.4% of GDP) used similar measures.

In most countries, tax payments were deferred to 4Q20, or, in Croatia and Slovenia,

to when activity recovers (up to two years). In contrast, Russia gave companies 3-6 months to

pay deferred taxes and expects to recoup most of the missing revenue.

We believe that expectations of large payments of deferred taxes (this year or later on) are too

optimistic throughout the region. Many companies that used these facilities went bankrupt, others

face losses that will affect their ability to pay tax (similar to those individuals who lost their jobs).

Fiscal impulses will slow the recovery in 2021

Positive fiscal impulses in 2020… …with some countries facing negative credit impulses. Incomplete recovery in 2021 due to negative fiscal and credit impulses

The latest widening in budget deficits will lead to positive fiscal impulses in 2020 throughout

the region (Chart 7). Poland’s fiscal impulse includes quasi-fiscal spending through PFR that

will turn into grants (nonrefundable loans). Countries that registered small budget deficits in

previous years afford fiscal impulses of more than 4% of GDP that will help cushion some of

the blow from lower external demand. Turkey’s past deficits mean that most of the stimulus

will come through the credit impulse (Chart 8). As mentioned before, this is likely to be

temporary. Serbia and Croatia also opted for large fiscal and credit impulses, while in most

CEE countries the fiscal impulse is offsetting weaker lending than in previous quarters.

Looking at fiscal and lending stimulus, 2021 looks set to be a challenging year in most CEE

countries, with most economies making an incomplete recovery. Fiscal impulses are expected

to reverse, while credit impulses may recover, but not sufficiently to offset tighter public purses.

Thus, GDP could return to pre-crisis levels in 2021 in Turkey and Serbia and only in 2022 in all

other CEE countries. Turkey will face the sharpest turnaround in credit growth, which could stall

and reverse economic growth in 4Q20 and 1Q21. Most EU-CEE countries are likely to tighten

fiscal policy in an attempt to lower budget deficits and slow the rise in public debt.

September 2020


CEE Quarterly


CHART 7: POSITIVE FISCAL IMPULSES COULD BE REVERSED NEXT YEAR*

CHART 8: CREDIT IMPULSES LIKELY TO SLOW IN 2H20

*Amounts are expressed in percent of GDP. Amounts are maximum allotments. Some of the direct support includes temporary tax exemptions.

Source: governments, central banks, national statistical offices, Eurostat, UniCredit Research

A shallower recession in 2020, a more muted rebound in 2021

GDP could contract by 5.5% in EU-CEE… …and by less than 4% in Russia, Serbia and Turkey Full GDP recovery by 2022

Despite the uncertain outlook, we pencil in smaller GDP contractions for 2020 than in the

previous CEE Quarterly. The main reason for this is a shallower decline in 2Q20 than we

expected for both CEE and the eurozone. Moreover, the eurozone economy had a better

3Q20 than we expected, thanks to large fiscal spending, a rebound in confidence and a

controlled rise in COVID cases in Germany and Italy, CEE’s largest commercial partners.

This year’s performance is likely to be inversely correlated with the depth of the 2Q20 recession.

Thus, the economies that rely less on foreign demand (Poland, Russia and Turkey) are likely to

experience a milder recession, with Serbia being the unexpected outperformer due to the state’s

massive involvement in the economy and positive base effects for the private sector. The most

open economies in EU-CEE are at the other end of the scale, as is Croatia, the biggest exporter

of tourism services. The GDP decline in EU-CEE is an average of 5.5%, significantly worse than

in Russia and Turkey, which are experiencing recessions of up to 4%.

At the same time, next year’s recovery is likely to be more muted than we previously

expected, with GDP rising by around 4.3% in EU-CEE, 2% in Russia and 2.8% in Turkey.

CHART 9: SHARP RECESSION IN 2020… CHART 10: …FOLLOWED BY AN INCOMPLETE RECOVERY IN 2021

Source: national statistical offices, Eurostat, UniCredit Research

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2019 2020F 2021FFiscal impulse, % of GDP

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Mar-20 Jun-20Credit impulse, % of GDP

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Croatia

Slovakia

Slovenia

Hungary

Czechia

Bulgaria

Romania

Poland

Russia

Turkey

Serbia

Private consumption Public consumption Fixed investment

Net exports Inventories, error GDP

yoy (%),pp

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Slovakia

Slovenia

Hungary

Czechia

Bulgaria

Romania

Poland

Russia

Turkey

Serbia

Private consumption Public consumption Fixed investment

Net exports Inventories, error GDP

yoy (%),pp

September 2020


CEE Quarterly


Inflation – demand shocks coming to the fore

Supply and demand shocks will prevent negative inflation… …especially in countries with flexible exchange rates Lower core inflation from September onwards Below-target inflation in Russia in 2020-21 Double-digit inflation in Turkey in 2020-21

Inflation has surprised to the upside in many CEE countries since economies reopened in

2Q20. In our view, there are three main causes of higher-than-expected inflation.

First, the removal of most restrictions released some of the pent-up demand, which is still

pushing up some consumer prices, such as those of home appliances and leisure services.

Second, retailers failed to reflect currency depreciation in prices during lockdowns. Eventually,

though, some of the increase in import prices seeped into retail prices. In countries where currencies

depreciated in 3Q20, such as Turkey, Russia and Hungary, this pressure has been stronger.

Third, governments raised excise duties to cover a small part of missing budget revenues.

Hungary stands out again, but the increase in revenue from tobacco and alcohol duty is

widespread, with fuel excise duties being raised in fewer countries.

All these shocks dissipated any worries of impeding deflation, with inflation unlikely to fall below

the target range in all inflation-targeting countries. Among the three shocks, the second might

have been the strongest, since inflation fell significantly in countries with fixed exchange rates

(Chart 11). However, this does not necessarily mean that inflation-targeters will follow.

A bumpy recovery at the global level, an unclear outlook for exports, uncertainty surrounding

US elections or potential sanctions on Russia and Turkey could stoke FX volatility from time

to time, fueling supply pressure on prices.

At the same time, we expect looser labor market conditions to start to weigh on core inflation

from September onwards. With the post-lockdown spending spree and the summer holiday

season behind us, households may be confronted with new waves of unemployment

(furlough, temporary or permanent), reduced working hours if restrictions are reimposed and

a weak hand in wage bargaining early next year.

As a result, we expect core inflation to keep or drag inflation back inside target ranges in

central Europe. The notable exception may be Hungary, where inflationary base effects, a

pass-through that rose above 15% and higher excise duties could keep headline inflation

close to the top of the target range, with a decisive breach likely between April and July 2021.

In Russia, recent inflation surprises may not continue for much longer and we see inflation ending

2020 below the 4% target as service-price inflation has already fallen below 3% yoy. In contrast,

inflation could rise again in Turkey, mostly due to the pass-through from the sharp TRY depreciation.

If consumer demand strengthens in 2H21, as we expect, inflation could rise throughout

EU-CEE towards the end of next year from a trough registered in 1H21 in all countries but

Hungary. Due to the muted recovery in Russia, we expect inflation to remain below target

in 2021 as well (Chart 12). A return to single-digit inflation in Turkey would require a sharp

and lengthy adjustment in domestic demand, something we do not see as plausible.

CHART 11: CORE INFLATION REMAINS HIGHER IN COUNTRIES WITH FLEXIBLE EXCHANGE RATES…

CHART 12: …LEAVING ROOM FOR ADDITIONAL RATE CUTS

Source: national statistical offices, central banks, UniCredit Research

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

HR SI SK BG RO CZ HU PL

Dec-19 Aug-20Inflation excluding tax, energy and food, yoy (%)

-2

0

2

4

6

8

10

12

14

BH SI HR BG SK RS PL RO CZ RU HU TR

2019 2020F 2021F Inflation targetAnnual inflation (eop, %)

September 2020


CEE Quarterly


Monetary policy – acting only when needed

The CNB could be the first CEE central bank to reverse cuts in late 2021 Opportunistic tightening by the NBH More cuts in Romania only if fiscal spending is reined in One more cut possible in Russia 2pp in additional hikes in Turkey… …with cuts reversed in 2H21. Bond purchases by CEE central banks have slowed

Inflation trends leave little scope for monetary policy action in most CEE countries, the

notable exception being Turkey.

The CNB, the NBP and the NBH are likely to remain on hold this year and next. The CNB

could be the first central bank in EU-CEE to start reversing rate cuts in late 2021. The NBH

may struggle to achieve its multiple goals (low inflation, stable currency, FX reserve

accumulation and rapid loan growth) at the same time. In our view, the preference will still be

to support the economy, with temporary liquidity tightening and the 1W deposit rate increasing

from time to time above 0.6% if the currency needs defending. In our view, the HUF is likely to

depreciate further in the coming years, but only in nominal terms. Since the NBH continues to

believe that inflation cannot diverge from eurozone inflation for several years, the inflation

mandate may be the weakest of the four.

The NBR could deliver two more cuts to 1% if the Constitutional Court rejects or delays the

plethora of spending promises adopted by parliament. We believe that lower interest rates

could smooth the private sector’s transition from loan repayment moratoria back to servicing

debt. To some extent, it would also help offset the fiscal tightening needed next year to

prevent public debt from rising above 50% of GDP.

The CBR could deliver one more cut to 4% if it is convinced that inflation surprises over the

summer were temporary and that there is no flaring up of geopolitical risks. The latter is a

bigger issue but, in our view, may not come to the fore before 2H21.

The CBRT is facing the biggest challenges of all CEE central banks. As we highlighted in

previous issues of the CEE Quarterly, zero or negative real rates in Turkey are always a

harbinger of currency depreciation and balance of payments adjustments due to excessive

credit growth. Ending such episodes requires tightening monetary policy and this is what is

currently happening in Turkey. The CBRT delivered an unexpected 2.0pp hike in September

and we expect another similar increase before year-end. Although the credit impulse is

currently in freefall, it is falling from the highest level on record and its stimulative effects are

likely to linger. This is why we expect the 12M rolling C/A deficit to peak only in October, while

inflation might rise further. We expect currency depreciation to add at least 2.5pp to inflation,

with headline inflation peaking at around 13.8% in April 2021. Thus, we see the repo rate

peaking at 12.25%, with the late liquidity window rate at 15.25%.

The CBRT is likely to tighten liquidity as well to stave off depreciation, so short-term cross-

currency swap rates are likely to spike again at close to or above 20% if the TRY comes

under pressure again. Assuming that the economy will readjust towards the end of this year

and in 1Q21, a smaller C/A deficit next year and lower inflation starting from July 2021 could

help the CBRT lower rates by around 4.25pp to 8% (the repo rate) and 11% (the late liquidity

window rate). While such rates would bring the real effective interest rate at which the central

bank provides liquidity back to zero in 2021, we believe that the temptation to stimulate

growth with faster lending remains and that the Turkish authorities could return to this

strategy, even if it threatens to destabilize the recovery in 2022.

Despite a sharp widening in budget deficits, bond purchases by CEE central banks are

unlikely to match those from 2Q20. One exception is the NBH, whose program still assumes

HUF 646bn (1.5% of GDP) in bond purchases as of 28 September, twice the amount

purchased so far. The Hungarian central bank may have to expand its scheme in terms of

both the size and the range of bonds it is purchasing (currently only maturities of at least 11

years) if it wishes to meet its large issuance needs while keeping yields stable.

September 2020


CEE Quarterly


The CBRT increased its bond holdings to 9% of its assets. The target of 10% implies additional

purchases of TRY 8bn. We do not believe that the CBRT will increase this ceiling because the

remaining funding needs can be covered by local banks and out of fiscal reserves.

The Croatian National Bank has purchased HRK 19.5bn (5.3% of GDP) in government bonds

and we expect it to pause for the year. Local financial institutions are able to cover remaining

issuance, which could be the equivalent of EUR 500mn (0.1% of GDP).

The NBP, the NBR and the NBS may buy more bonds if yields come under pressure. Since

July, the NBP has significantly slowed the pace and size of its purchases, focusing mostly on

bonds issued by BGK (of which it held the equivalent of 1.4% of GDP by the end of

September) and the sovereign investment fund PFR (of which it held the equivalent of 0.8%

of GDP). Its POLGB holdings were equivalent to 2.3% of GDP at the end of 3Q20.

As in the case of monetary easing, the NBR will support ROMGBs only if fiscal spending is

reined in. The NBR had purchased RON 5.3bn (0.5% of GDP) in ROMGBs by the end of August

and could end the year below the forecast we made in 2Q20 of around 1% of GDP. At the same

time, state-owned banks continue to buy ROMGBs in size and the ministry of finance managed

to sell more bonds than planned, so there is no need for the central bank to step in.

The CNB, the CBR and the BNB are the only CEE central banks not buying bonds. Given

strong local demand for bonds, none of these three central banks is likely to start buying bonds.

CHART 13: POLICY RATES STABLE IN EU-CEE AND RUSSIA CHART 14: BOND PURCHASES BY CENTRAL BANKS

Source: national statistical offices, central banks, UniCredit Research

CEE financial assets – facing external headwinds in 4Q20

Risks for EM financial assets

A bumpy global recovery bodes ill for EM for several reasons:

■ Bullwhip effects could affect supply chains and result in higher growth volatility than in

developed economies.

■ EM companies are in a more precarious financial situation than their DM peers and a

longer period of below-potential growth could see liquidity issues metastasize into solvency

problems that may further delay the recovery.

■ Outside the EU, the resources available to EM to fight the downturn are limited and cannot

be expanded due to earlier fiscal profligacy. Several waves of the pandemic and

associated restrictions would only underline this discrepancy and could result in a two-

speed recovery in EM, with EU-CEE and a few other emerging markets that enjoy a stable

macroeconomic environment leading the way.

0.0

3.0

6.0

9.0

12.0

15.0

PL CZ HU RS RO RU TR

2019 2020F 2021FPolicy rates (%)

0

1

2

3

4

5

6

CrNB NBP NBS CBRT NBH NBR

Other bonds Government bondsBond purchases since the start of the crisis, % of GDP

September 2020


CEE Quarterly


The CZK, the HUF and the PLN to remain undervalued EUR-RON to shift to 4.90-5.00 range this year if pensions increase by 40% This year’s USD-TRY peak is probably ahead of us ROMANI and ROMGB bonds are cheap CZGBs preferred if bonds are FX-hedged Support from NGEU not priced in to EU-CEE bonds

■ The recession has reduced the appetite for reform. This bodes ill for macroeconomic

stability, especially in LatAm, South Africa and Turkey.

■ Geopolitical risks cannot be neglected, whether in the South China Sea, the Mediterranean,

the Middle East, Libya or Belarus. All these pressure points may affect the economic

recovery if they result in trade barriers or sanctions and could drive up risk premia.

To this, we need to add the US election, which has the potential to be a knife-edge result that

may be challenged in courts, possibly leading to a protracted period of uncertainty.

In this uncertain EM outlook, EU-CEE does stand out as probably the most stable EM region,

but this does not guarantee a smooth ride in 4Q20.

Although the CZK, the HUF and the PLN are undervalued,2 trade flows are seasonally

negative for all these currencies in the last quarter of the year. Lower revenue from transport

and tourism could keep the trade balance in deficit in 4Q20. In Poland, seasonal weakness

may be partly mitigated by the government selling EU fund inflows on the market through its

national development bank, BGK. However, the NBH is likely to add EU transfers to its FX

reserves. Coupled with little flexibility from monetary policy and the highest inflation rate in EU-

CEE, this may lead the HUF to underperform its regional peers once again. Large HGB issuance

could also contribute to depreciation if it leads to higher yields and subsequent outflows from

foreign investors. The CZK is also facing a quarter of little support from foreign capital flows.

In normal circumstances, the NBR would fight to keep EUR-RON as stable as possible before

parliamentary elections (expected on 6 December). However, parliament’s decision to revert

to a 40% pension increase and the risk of having a double-digit budget deficit in 2021 is

stoking up pressure on the RON. If the Romanian Constitutional Court does not stop

parliament’s spending spree, EUR-RON could spike and settle in a 4.90-5.00 range already in

4Q20, rather than in 1Q21 as we forecast previously.

The RUB is close to its fair value after its gradual depreciation in 3Q20. Seasonal flows are

positive for the currency, as is the current level of oil prices, which are consistent with USD-RUB

at 68-69. Nevertheless, geopolitical risks and investors taking profit from OFZ positions at the

end of the rate cutting cycle could prevent USD-RUB from returning below 70 before year-end.

The CBRT may have to increase rates further to stabilize the TRY, and this year’s peak in

USD-TRY probably remains ahead of us. That said, we expect the central bank to hike and

tighten liquidity eventually, bringing USD-TRY back below 8 before year-end.

There is little scope for a further rally in EU-CEE bonds this quarter. ROMGBs and ROMANIs

are the exception, if the pension increase is capped at 14%. In case of a 40% pension

increase, we expect Romanian bonds to sell off, despite already trading at BB levels. We see

this as a good opportunity to increase exposure.

In case currencies come under pressure, if hedged into EUR, we prefer CZGBs over their

Visegrad peers.

The outlook in 1Q21 and beyond is more positive and 4Q20 could provide good opportunities

to purchase bonds in CEE. We still believe that the market is not pricing in the support of

non-market borrowing from NGEU next year. Bulgaria, Croatia, Hungary, Romania and even

Poland may consider long-term borrowing at below-market prices from the EU’s anti-crisis

facility. All these countries intend to submit the framework for fund absorption in October, in

the hope that the European Commission might approve them by February at the latest. Loans

could arrive earlier than grants and replace some of the usual bond issuance. Besides

relieving some of the potential pressure on yields stemming from the primary market,

borrowing from the NGEU could anchor yield expectations at below market yields.

2Please see pages 27-28 for details.

September 2020


CEE Quarterly


Little scope for OFZ rally in 4Q20

While OFZ remain attractive in our medium-term rate-convergence story, foreign holdings still

exceeded RUB 3tn at the end of August, close to the highest level on record, and foreign

investors may reduce positions if they believe that geopolitical risks are rising. This, together

with substantial issuance, means that a further increase in OFZ yields is likely before year-end.

In Turkey, investors are unlikely to add to positions before the TRY and rates stabilize. This

may take more time after the initial 2.0pp rate increase delivered by the CBRT in September.

Hard-currency bonds continue to be cheaper than their local currency counterparts, with

ROMANI bonds in USD and EUR, and RUSSIA USD bonds the cheapest.

CHART 15: BOND PERFORMANCE PROPORTIONAL TO CENTRAL BANK SUPPORT

CHART 16: ROMANI EUR ARE THE CHEAPEST EUR BONDS IN CEE

Source: Bloomberg, UniCredit Research

Rising political and geopolitical risks

Political uncertainty in Bulgaria may not be resolved through elections We see limited threats to the economic policy mix

The economic crisis that followed measures to control COVID-19 spilled over into CEE

politics, especially in countries where the election cycle is approaching an end.

In Bulgaria, street protests against Prime Minister Boyko Borisov and chief prosecutor Ivan

Geshev brought protest parties, such as Stand up.BG and “There are such people” to the

fore, as well as some small right-wing parties currently outside the parliament such as

Democratic Bulgaria. While the main opposition party, the Bulgarian Socialist Party (BSP),

and Bulgarian President Rumen Radev tried to capitalize on demonstrations directed against

the ruling GERB, their popularity increased far less than that of the protest parties, since the

BSP is seen as part of the country’s political establishment.

With Bulgarians expected to head to the polls in the spring of next year, the outlook is for a

fragmented parliament in which both the GERB and the BSP have the possibility of creating

coalitions that include some of the protest parties. Newcomers are very vague on their

preferred economic policies, so one of Bulgaria’s two main parties is likely to design and

implement fiscal and financial policies going forward. Preserving Bulgaria’s low public debt

and labor competitiveness in the EU would be paramount if the country wants to join the

eurozone. This goal came a step closer when Bulgaria was admitted to the exchange rate

mechanism (ERM II) in July 2020. We do not expect economic policies to deviate significantly

from the current path, although a more fragmented parliament following next year’s elections

may result in wider budget deficits than in the past decade.

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

2020 2025 2030 2036 2041 2047 2052 2058 2063

CZGB HGB POLGB Swap CurveLC yields into EUR (%)

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

2019 2024 2030 2035 2041 2046 2052 2057 2063

ROMANI CROATI POLAND Euro SwapEUR bond yields (%)

September 2020


CEE Quarterly


Romania’s next governing coalition may be less reformist than markets expect Three scenarios for the pension increase in Romania, two of them positive Limited risk of sweeping sanctions against Russia due to Belarus and Alexei Navalny’s poisoning

No matter who exactly will form the next government chances are good to see some further

progress in reforming the judiciary. In particular, we expect Supreme Judiciary Council to be

split to two colleges - one for the judges and one for the prosecutors. Also importantly, we

expect the quota of the parliament in electing members for the Supreme Judiciary Council to

be cut at the expense of an increase of the quota of judges and prosecutors, which should be

fundamental to boost the independence of the judiciary from political and business interest.

In Romania, parliamentary elections expected on 6 December will bring to an end the most

volatile political cycle in Romania’s post-communist history. The National Liberal Party (PNL)

is expected to win parliamentary elections after winning local elections held on 27 September.

The PNL look likely to be able to choose from three parties to form the next governing

coalition, namely the big-tent alliance USR-PLUS, the Hungarian minority party UDMR and

the Popular Movement Party (PMP) of former Romanian President Traian Băsescu. USR-

PLUS is probably the party with the highest appetite for reforms. However, a big win for the

PNL could leave USR-PLUS outside the next government. Alternatively, a four-party

government would also have little appetite for reforms. Regardless of the government’s

composition, the stability of any governing coalition hinges on fiscal stability.

We see three potential outcomes from the Constitutional Court (CC) decision on parliament’s

spending spree put into law in September, which includes a 40% pension increase, higher social

security expenditure, increased wages for teachers and transfers to local administrations.

1. The CC declares the parliament’s spending pledges unconstitutional. This would be the

best outcome for the Liberal government and for markets. This is also our baseline

scenario, for two reasons. First, the CC could reject parliament’s spending initiatives based

on Article 138, paragraph 5 of the constitution, which states that budget spending cannot

increase without indicating the source of funding. There is no funding for the parliament’s

profligate agenda, especially after the impact the COVID-19 crisis has had on budget

revenue. Second, parliament capped public debt at 40% of GDP. This is mathematically

unattainable, unless some discretionary spending is cut. Given CC jurisprudence

forbidding permanent cuts in existing income (wages and pensions), this is very unlikely.

2. The CC admits the 40% pension increase, but allows the government to delay its

implementation until the economy recovers enough to support higher budget spending. Such

a ruling would be based on CC jurisprudence from 2009-10, when pensions and public-

sector wages were temporarily cut to avert a deeper crisis. In our view, this would be a

positive outcome as well, since it would afford the government some flexibility. The pension

increase would then probably remain at 14% this year, with additional increases spread over

several years. Thus, the next government would not have to tighten fiscal policy next year to

keep public debt below 50% of GDP and the country could avoid rating downgrades.

3. The CC rejects the government’s objections and makes all spending pledges compulsory.

In this situation, the budget deficit would exceed 10% of GDP next year, even assuming that

the government starts to tighten non-discretionary spending. Given limited spillover from

higher pensions and social transfers, the impact on economic growth would be negative due

to much tighter financial conditions. In this scenario, we expect Romania to lose its

investment grade from at least two rating agencies. While the government may try to cover a

larger part of investment spending from EU transfers, the European Commission could

condition disbursements on fiscal adjustment. As happened in 2009-12, the consequences of

fiscal profligacy could extend beyond the economy into political and social unrest, probably

affecting the government’s popularity and the stability of the government coalition.

The crisis in Belarus, where the re-election of President Alexander Lukashenko was

recognized by Russia but not by the EU, is unlikely to be resolved quickly. The EU has so far

failed to come up with a list of sanctions against Belarus because Cyprus wants Belarus and

Turkey to be treated similarly.

September 2020


CEE Quarterly


Hungary and Poland are unlikely to veto the NGEU… …due to toothless threats of punishment Tensions between Turkey and NATO allies in the Mediterranean… …may leave Mr. Erdogan’s nationalist allies unhappy,…

This is unlikely to happen. We see the fear of sanctions on Russia stemming from the support

given to Mr. Lukashenko’s regime as overblown. Similarly, the poisoning of Alexei Navalny

may not result in significant sanctions against Russia after Mr. Navalny’s recovery. German

threats to stop the development of the Nord Stream II gas pipeline were made without the

government substantiating alternatives to gas imports from Russia. Between 2016 and 2019,

the proportion of total EU natural gas imports from outside the EU coming from Russia rose

by 6pp to 50%, while Russia’s proportion of total EU liquefied natural gas imports rose from

zero to 14%, according to Eurostat. The same source shows that Germany and Italy account

for half of Europe’s gas imports from Russia, making the substitution of Russian gas from

other sources even more difficult. The closing of the Groningen gas field in 2022, which

accounts for 8% of the EU’s gas consumption, would further hamper Europe’s move to

alternative gas sources. Thus, potential sanctions may be limited in scope and target Russian

institutions and individuals without links to energy. However, these cases further reduce the

likelihood that existing EU sanctions against Russia will be removed soon.

The fear that Hungary and/or Poland could veto the NGEU due to fund disbursements being

tied to observing the rule of law is also exaggerated, in our view, for at least four reasons.

First, the two countries are among the largest net recipients of funds and both governments

plan to use the NGEU to help their economies recover. Second, the conditionality set out in

the European Council agreement is weak. Third, although the European Parliament would like

harsher punishment against governments that undermine the rule of law, imposing such

harsher measures under existing treaties is almost impossible, as many European politicians

admit. Fourth, the symbiosis between the Hungarian government and large German

manufacturers offers the former a good negotiating platform with German politicians. Thus,

we do not expect Fidesz to be kicked out of the European People’s Party, nor do we think that

the Poland’s Law and Justice Party (PiS) will be marginalized in Europe, despite the two

parties’ controversial judicial, social and media agendas.

Finally, tensions in the Mediterranean are a geopolitical threat to Turkey. The double standoff

with the EU, in Libya and in Greek and Cypriot waters, is pitting Turkey against NATO allies, a

situation that would have been inconceivable before the US’s retreat from its position as

arbiter in the region. The two standoffs are linked and explained by Turkey’s desire to have a

bigger role in gas production and transport in the eastern Mediterranean.

Turkey’s claim to a larger economic zone in the Mediterranean infringes on internationally

recognized economic zones belonging to Greece (especially Crete) and Cyprus. Since Turkey

has not signed the UN Convention on the Law of the Sea, a rapid agreement through

international arbitrage is unlikely. The recent de-escalation is a step forward and may be

facilitated by the EU offering Turkey some sweeteners (in addition to sanction threats).

However, there is little scope for an agreement that would please Turkish nationalists allied to

President Recep Tayyip Erdogan.

Turkey’s withdrawal of ships from Greek waters may also have been prompted by the

surprising resignation of Libyan PM Fayez al-Sarraj, the head of the Government of National

Accord (GNA). Turkey has backed the GNA in its conflict with the Libyan National Army (LNA)

of field marshal Khalifa Haftar. With Turkish military support, the GNA remained in power and

reversed LNA gains, despite the latter being supported by Russia, Middle-Eastern countries

at odds with Turkey’s islamist regime (such as Egypt and the United Arab Emirates) and

NATO members such as France. Mr. Erdogan and Mr. Sarraj signed a maritime agreement

that forbids other countries from gas exploration and transport in the corridor linking the

Libyan economic zone to the alleged Turkish economic zone. The treaty would give Turkey a

say in in any future pipes that could take eastern Mediterranean gas to Europe. However, the

Turkish-Libyan agreement ignores Crete’s right to an economic zone and, thus, is unlikely to

be recognized internationally. Greece retaliated by signing a similar agreement with Egypt

that covers adjacent economic zones that are internationally recognized.

September 2020


CEE Quarterly


…would benefit from US involvement,… ...and could require concessions from Greece and Cyprus

At the time of writing, there are many unknowns related to this double standoff between

Turkey and its official allies. The risk of European sanctions against Turkey is material,

although they may be calibrated to have a limited economic impact. Stronger involvement by

the US might lead to a faster resolution of this problem, but the outlook is not promising, since

the US seems to have other priorities in the region. A military treaty signed by the US and

Cyprus was less an endorsement of the island’s position against Turkey and more an attempt

by the US Department of State to reduce Russian influence in Cyprus, especially the use of

Cypriot ports by the Russian fleet.

Ultimately, this crisis cannot be solved unless Turkey gives up some its territorial claims. It

remains to be seen whether EU countries manage to agree on a deal with Turkey, something

that Greece and Cyprus have called “rewarding the bully”. The two EU members may have to

make some concessions as well to ease tensions. Yet, an agreement between NATO allies is

important for the power balance in both the Mediterranean and the Black Sea, something that

the EU’s eastern flank is very much interested in.

September 2020


CEE Quarterly


OUR GLOBAL FORECAST

GDP growth, % CPI (Avg), % Policy rate* 10Y bond yield (EoP), %

Exchange rate

(LC vs. USD)

2019 2020 2021 2019 2020 2021 2019 2020 2021 2019 2020 2021 2019 2020 2021

Eurozone 1.3 -8.0 5.0 1.2 0.3 1.1 -0.50 -0.50 -0.50 1.12 1.22 1.28

Germany 0.6* -5.2* 4.8* 1.4 0.2 1.9 -0.19 -0.40 -0.10

France 1.5 -10.3 6 1.1 0.5 0.7

Italy 0.3 -10 4.7 0.6 -0.1 0.4 1.41 1.10 1.50

UK 1.4 -9.6 6.3 1.8 0.9 1.6 0.10 0.10 0.10 1.32 1.35 1.38

USA 2.3 -3.6 2.9 1.8 1.1 1.7 1.75 0.25 0.25 1.92 0.70 1.25

Oil price, USD/bbl 64 38 48

*Non-wda figures. Adjusted for working days: 0.6% (2019), -5.6% (2020) and 4.8% (2021) : **Deposit rate for ECB Source: Bloomberg, UniCredit Research

THE OUTLOOK AT A GLANCE

Real GDP (% change) 2018 2019 2020F 2021F

CPI (EoP) (% change) 2018 2019 2020F 2021F

C/A balance (% GDP) 2018 2019 2020F 2021F

EU-CEE 4.5 3.6 -5.5 4.4

EU-CEE 1.9 3.4 2.4 2.7

EU-CEE -0.9 -0.4 0.1 0.2

Bulgaria 3.1 3.4 -6.0 3.0

Bulgaria 2.7 3.8 1.3 2.6

Bulgaria 1.0 3.0 3.4 2.3

Czechia 3.2 2.3 -6.4 4.7

Czechia 2.0 3.2 3.0 2.7

Czechia 0.4 -0.3 1.4 0.5

Hungary 5.1 4.9 -6.7 6.0

Hungary 2.7 4.0 4.1 3.3

Hungary 0.0 -0.9 -2.0 -0.4

Poland 5.3 4.1 -4.1 3.7

Poland 1.1 3.4 2.1 2.8

Poland -1.0 0.4 1.8 1.3

Romania 4.4 4.1 -5.1 4.0

Romania 3.3 4.0 2.6 3.1

Romania -4.4 -4.6 -4.5 -4.3

Croatia 2.7 2.9 -8.5 5.6

Croatia 0.8 1.4 0.5 2.0

Croatia 1.9 2.9 -3.2 1.4

Russia 2.3 1.3 -4.0 2.0

Russia 4.3 3.0 3.8 3.5

Russia 6.8 3.8 2.7 1.9

Serbia 4.4 4.2 -2.7 4.4

Serbia 2.0 1.8 1.8 2.6

Serbia -4.8 -6.9 -6.3 -6.2

Turkey 3.0 0.9 -3.4 2.8

Turkey 20.3 11.8 13.2 10.8

Turkey -2.7 1.2 -4.3 -1.5

Extended basic balance (% GDP) 2018 2019 2020F 2021F

External debt (% GDP) 2018 2019 2020F 2021F

General gov’t balance (% GDP) 2018 2019 2020F 2021F

EU-CEE 2.5 2.8 3.3 3.1

EU-CEE 70.4 66.5 70.8 66.0

EU-CEE -0.6 -1.1 -8.8 -5.0

Bulgaria 3.3 5.5 6.0 6.1

Bulgaria 60.3 56.2 64.0 62.4

Bulgaria 2.0 2.1 -2.4 -3.6

Czechia 1.6 1.3 2.7 1.8

Czechia 81.5 76.2 82.5 78.7

Czechia 0.9 0.3 -7.3 -6.0

Hungary 4.3 1.8 2.0 3.7

Hungary 101.0 92.4 104.7 93.9

Hungary -2.1 -2.0 -7.9 -3.0

Poland 3.6 4.6 6.2 4.5

Poland 63.3 59.4 58.4 51.2

Poland -0.2 -0.7 -10.3 -5.7

Romania -1.1 -1.2 -2.0 -1.5

Romania 33.4 33.0 37.8 40.8

Romania -2.9 -4.3 -9.5 -4.9

Croatia 4.8 6.9 2.0 5.9

Croatia 82.7 75.7 88.3 83.0

Croatia 0.2 0.4 -6.6 -3.0

Russia 5.4 4.4 1.4 1.2

Russia 28.0 28.3 29.0 27.5

Russia 2.6 1.8 -4.3 -2.4

Serbia 2.5 0.9 -1.5 -0.2

Serbia 62.2 61.9 67.8 63.3

Serbia 0.6 -0.2 -8.0 -2.0

Turkey -1.5 1.9 -3.8 -0.6

Turkey 56.3 58.1 65.8 64.5

Turkey -3.4 -5.3 -7.1 -5.6

Gov’t debt (% GDP) 2018 2019 2020F 2021F

Policy rate (%) 2018 2019 2020F 2021F

FX vs. EU (EoP) 2018 2019 2020F 2021F

EU-CEE 46.4 44.3 56.4 57.7

EU-CEE - - - -

EU-CEE - - - -

Bulgaria 21.8 19.9 26.0 27.6

Bulgaria - - - -

Bulgaria 1.96 1.96 1.96 1.96

Czechia 32.6 30.8 38.5 41.9

Czechia 1.75 2.00 0.25 0.50

Czechia 25.7 25.4 26.5 25.6

Hungary 68.5 64.7 76.4 72.9

Hungary 0.90 0.90 0.60 0.60

Hungary 322 331 355 350

Poland 48.4 45.4 60.4 62.3

Poland 1.50 1.50 0.10 0.10

Poland 4.30 4.26 4.40 4.35

Romania 34.7 35.2 45.9 48.4

Romania 2.50 2.50 1.25 1.00

Romania 4.66 4.78 4.85 4.95

Croatia 74.7 73.2 89.6 86.6

Croatia - - - -

Croatia 7.42 7.44 7.53 7.53

Russia 12.0 12.4 16.5 17.8

Russia 7.75 6.25 4.00 4.00

Russia 79.5 69.3 87.8 89.0

Serbia 54.4 52.9 61.6 59.8

Serbia 3.00 2.25 1.25 1.25

Serbia 118.2 117.6 118.0 118.5

Turkey 30.2 32.8 41.3 41.4

Turkey 24.00 12.00 12.25 8.00

Turkey 6.07 6.67 9.51 11.14

Source: National statistical agencies, central banks, UniCredit Research

September 2020

CEE Macro & Strategy Research

CEE Quarterly


EM VULNERABILITY HEATMAP

BG CZ HR HU PL RO RS RU SK TR UA MX BR CL SA ID IN CN AG

External Liquidity

Current account (% of GDP) 3.1 1.0 3.9 -0.9 2.3 -4.4 -6.5 2.7 -3.4 -1.5 -0.8 0.0 -3.0 -1.9 -2.0 -2.0 -0.8 1.2 -0.2

Extended Basic Balance (% of GDP) 7.0 0.4 7.7 2.5 6.5 -1.1 0.5 4.4 1.4 -0.9 0.9 1.9 -0.6 0.8 -2.9 -0.6 0.7 1.5 0.0

FX Reserves coverage (months of imports) 9.1 8.0 8.1 2.7 4.9 4.6 6.9 15.5 - 2.5 4.9 5.1 15.3 5.9 5.5 7.9 8.9 15.9 8.3

External Debt (excl.ICL, % of GDP)* 33.4 73.1 63.2 50.3 39.8 35.1 61.8 20.6 91.8 56.4 75.7 35.5 59.4 80.1 44.7 37.4 19.5 14.9 58.2

Short-term debt (% of GDP) 13.2 41.9 25.6 10.0 7.4 5.8 4.2 4.0 43.8 16.7 9.5 3.4 5.0 8.2 9.5 4.1 7.3 8.6 12.8

REER (Index, 2010=100) 106.2 102.1 100.5 87.5 93.6 100.3 126.1 75.5 - 52.4 92.4 74.7 138.0 82.3 89.0 90.1 107.4 120.1 -

Domestic Finances

Corporate debt (% of GDP) 46.9 52.6 64.1 56.7 46.3 37.0 44.3 28.5 54.2 76.1 60.5 43.9 43.6 92.6 56.2 37.5 45.2 159.1 16.9

Household Debt (% of GDP) 20.9 38.1 36.2 21.7 35.5 18.2 20.5 17.6 45.4 16.3 5.7 16.4 30.4 37.8 35.0 16.2 13.0 57.2 5.0

Nonresident holdings of gov.debt (% total) 1.0 35.7 - 28.9 17.5 18.0 25.5 39.4 48.7 3.3 - 22.5 10.6 - 30.6 38.6 - 8.9 - #

Banking System

Credit Impulse (% of GDP) 0.6 -0.7 2.6 0.7 -0.8 -0.6 3.4 -1.5 1.7 10.2 -0.3 -0.6 1.5 4.0 -0.7 -2.9 1.2 7.6 -0.1

Loans/deposit ratio (%) 71.0 62.7 80.8 74.2 83.3 69.7 89.6 88.6 103.2 105.2 144.6 94.5 101.2 123.9 102.6 97.0 111.1 74.6 135.3

NPL (% of total loans) 5.7 2.4 6.7 2.7 3.4 4.4 3.6 9.4 2.8 4.3 48.5 2.0 2.8 2.0 4.0 3.1 8.2 1.9 5.1

Domestic Banks CAR (%) 23.1 19.8 23.4 17.2 17.9 22.8 22.7 12.1 18.9 19.2 21.9 16.5 15.6 12.8 15.8 22.6 14.5 14.5 21.9

Domestic Banks RoE (%) 7.5 11.8 8.5 1.5 4.0 9.8 8.3 19.4 3.6 11.8 24.7 20.6 16.8 16.9 16.6 12.3 0.1 12.1 -

*External debt incl ICL for CZ, RS, TR, MX, CL and SA Source: Haver, Bloomberg, National Statistics Offices, Central Banks, IMF, BIS, UniCredit Research

Legend

Low vulnerability

Moderate vulnerability

Significant vulnerability

High vulnerability

September 2020


CEE Quarterly


EM VULNERABILITY HEATMAP (CONTINUED)

BG CZ HR HU PL RO RS RU SK TR UA MX BR CL SA ID IN CN AG

Policy

Policy Rate, nominal (%) - 0.25 - 0.60 0.10 1.50 1.25 4.25 0.00 8.25 6.00 4.50 2.00 0.50 3.50 4.00 4.00 4.35 38.00

Real policy rate (%) - -3.0 - -3.2 -2.7 -1.2 -0.7 0.9 -1.4 -3.1 3.5 0.4 -0.4 -1.9 0.3 2.6 -2.5 -2.3 -3.1

Real Money market rate (%) - -2.9 -1.8 -3.2 -2.7 -0.8 -0.9 1.2 -1.9 0.5 2.9 0.4 -1.0 -2.1 0.1 3.0 -2.2 1.0 -18.2

Headline inflation (% yoy) 1.2 3.3 -0.1 3.9 2.9 2.7 1.9 3.6 1.4 11.8 2.4 4.0 2.4 2.4 3.2 1.3 6.7 2.4 42.4

Core Inflation (% yoy) 1.4 2.7 0.9 4.2 4.0 3.7 1.2 3.1 1.5 11.0 3.0 4.0 0.9 2.0 3.2 2.4 5.4 0.4 46.2

GG Fiscal balance (% of GDP) -2.3 -4.0 -4.9 -2.7 -2.0 -7.7 -7.1 -0.5 -3.1 -3.6 -4.1 -3.3 -12.2 -5.5 -9.2 -3.0 -6.1 6.4 -4.1

GG Primary balance (% of GDP) -1.7 -3.0 -3.6 -0.4 -0.6 -6.4 -5.2 2.3 -1.7 -0.9 - 0.2 -7.5 -4.5 -5.0 -1.1 -2.8 - -

Government Debt (% of GDP) 20.7 33.0 81.3 66.6 48.6 42.2 58.1 14.1 49.3 35.1 75.7 54.0 85.0 40.1 69.4 56.3 46.5 55.0 68.6

Markets

External Debt Spread (10Y, bp)** 75.2 20.8 137.7 92.8 49.0 230.7 220.1 177.3 53.2 641.7 661.7 199.5 235.6 95.0 426.4 215.3 162.6 46.0 -

Local Currency Curve (5Y, %)*** 0.2 0.6 0.5 1.7 0.7 3.2 2.7 5.3 -0.6 11.9 6.7 5.1 5.1 1.5 8.0 5.6 5.4 3.0 31.1

Local currency bond spread (2s10s)**** 48.8 83.2 57.5 114.1 129.6 78.1 132.7 186.0 35.3 21.0 205.3 134.6 323.7 398.0 283.0 232.8 156.1 39.9 -103.2

CDS (5Y, bp) 51 40 78 65 60 113 115 104 52 532 540 121 204 60 292 85 93 37 1176

FX 3m implied volatility (%) - 5.7 4.0 7.1 6.0 2.3 - 16.4 - 18.1 - 15.3 19.4 13.2 17.6 11.7 7.0 5.8 15.1

Structural*****

IBRD Doing Business 61 41 51 52 40 55 44 28 45 33 64 60 124 59 84 73 63 31 126

WEF Competitiveness Ranking 49 32 63 47 37 51 72 43 42 61 85 48 71 33 60 50 68 28 83

Unemployment (%) 4.4 2.7 7.1 4.6 3.1 5.4 7.7 6.3 6.6 13.4 8.6 5.4 13.3 13.1 30.1 5.0 8.4 5.6 10.0

**Spread between 10Y EUR government bond yields and the corresponding German government bond yields for BG, HR, HU, PL, RO. For CZ, the spread refers to the 5Y yield. For the other countries, the spread is computed with respect to US government bond yields; ***Data for UA refer to the generic USD bond. Data for HR refer to the 4Y bond; ****Data for UA refer to the generic USD bond. Data for CL refer SA to the spread between 8Y and 2Y bond and 9Y and 2Y bond respectively. Data for HU refer to spread between 10Y and 3Y bond.; *****IBRD and WEF indicators for 2018

Source: Haver, Bloomberg, National Statistics Offices, Central Banks, IMF, UniCredit Research

Legend

Low vulnerability

Moderate vulnerability

Significant vulnerability

High vulnerability

September 2020


September 2020


CEE Quarterly

CEE Strategy: 4Q20 tensions an opportunity from a medium-term perspective

Elia Lattuga Co- Head of Strategy Research, Cross Asset Strategist (UniCredit Bank, London) +44 207 826-1642 [email protected]

■ Asset-purchase programs and anchored risk-free yields continue to fuel the hunt for yield

across EM while positioning remains light overall. Risks have not disappeared. Spreads

have tightened sizably and default rates are on the rise while pandemic developments and

politics may dent risk appetite.

■ A selective addition of long positions seems the sensible strategy and increased tensions

in the market might be seen as interesting entry opportunities on fundamentally solid

issuers from a medium-term perspective, particularly across CEE.

Recent performance After the sharp rally in risky assets in 2Q20, the positive momentum has slowed down in

recent months. Equity performance has become more volatile while across fixed-income

markets credit spread tightening has shown signs of fatigue and risk-free rates are broadly

unchanged. As a result, the performance displayed by emerging market bonds has been

moderately positive and mostly as a result of carry. Longer-duration exposure and low-rated

IG market segments have outperformed modestly in 3Q20. From a regional perspective,

LatAm did slightly better than Asia and EMEA, showing higher returns on hard currency

bonds, a performance much in line with high-yield returns in developed markets.

Our strategy view for 2H20 In our view, global equities have nearly exhausted their return potential for the year and

several risks related to the pandemic and its economic and political implications threaten risk

appetite. Fixed income has attracted strong flows in recent months and central banks have

contributed to offering support, especially for high-grade names. In Europe, we think that most

of the return from credit exposure will come from carry rather than spread tightening, but

lower-rated segments might offer more spread-tightening potential in the coming months if

risk appetite holds. Fallen angels have increased the size, improved the liquidity and, to some

extent, the fundamental credit profile of high-yield indices, which bodes well for return over

the coming months. Meanwhile, ECB purchases have helped both corporate and sovereign

borrowers to place large amounts of paper during the crisis and will continue to do so next

year. We expect the ECB to extend asset purchases to the second half of 2021 and to

prevent a material tightening of financial conditions while continuing to fuel yield hunting on

EUR paper. On the other side of the Atlantic, the recent switch to flexible-average-inflation

targeting by the Fed paves the way to official rates staying at the zero lower bound for several

years while asset purchases continue.

CHART 1: POSITIVE BUT MORE MODEST PERFORMANCE IN 3Q CHART 2: DEVELOPMENTS IN CREDIT SPREADS


-40%

-30%

-20%

-10%

0%

10%

20%

30%

40%

LatAm Asia EMEALatAm Asia EMEA A Baa Ba B Caa 1-3Year

7-10Year

LC HC-USD HC-USD HC-USD

3Q20 2Q20 1Q20 2019 2018 2017

0

200

400

600

800

1000

1200

Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 Jul-20

EMBIG EU IG EU HY US IG US HY


September 2020


September 2020


CEE Quarterly

In our view, this will also keep yields anchored at the long end and the US dollar on a

weakening path. Hence, barring large sell-offs on equity markets, financial conditions seems

set to remain easy. However, risks are increasing due to the development of the pandemic

and the threat of more restrictive measures down the road. Moreover, developments related

to the upcoming US presidential election and Brexit might increase uncertainty during the

latter part of the year.

Central-bank liquidity, stable risk-free rates and the weakening trend in the US dollar have

created supportive financial conditions for EM for most of 3Q20. With credit spreads back to

historically low levels, at least across IG exposure, the hunt for yield seems set to continue

over the coming months. Default rates will continue to drift higher for the time being, but fiscal

and monetary policy support is preventing insolvency rates from reaching the levels seen

during the financial crisis and growth is expected to pick up again a few quarters down the

road. Portfolio flows into EM assets recovered somewhat in 2Q20, but this did not last. Over

the past three months, redemptions prevailed, particularly on equity funds, while bonds saw

more mixed flows. As a result, overall positioning remains relatively underweight, which might

pave the way for a return in demand if risk appetite returns. However, pockets of risk remain

as economic developments over 4Q20 remain highly uncertain and high volatility across EM

currencies threatens exposure to local currency denominated bonds. Hence, a selective

addition of long positions seems the most sensible strategy and, from a medium-term

perspective, increased tension in the market could be viewed as an opportunity to gain

exposure to fundamentally solid issuers.

CHART 3: FX VOLATILITY REMAINS HIGH IN EM CHART 4: EM PORTFOLIO FLOWS (4W ROLLING, USD BN)


CEE bonds Across CEE, long-term local-bond yields have been moving mostly sideways over the

summer months, with ROMGBs outperforming, albeit with some volatility. Given the threats to

risk appetite in 4Q20, EU-CEE might benefit from a more cautious approach, but this does not

guarantee a smooth ride. ROMGBs remain the most attractive pick in the region, in our view,

and offer a juicy yield pick-up even accounting for implied currency volatility. ROMANI are

attractive, too. Current levels already price in a downgrade, while central banks action and the

overall underweight positioning by institutional investors might offer support. That said, the

risk of a 40% pension increase and its implication in terms of rating drift (notwithstanding that

mentioned above) might still add pressure to Romanian bonds and the RON. Among lower

yielding bonds, HGBs and CZGBs are cheaper than POLGBs when hedged in EUR. HGBs

have been under pressure lately, partly due to investors negative view of the HUF, with policy

inertia possibly pushing the EUR-HUF higher.

85

87

89

91

93

95

97

99

101

103

105

4

6

8

10

12

14

16

Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 Jul-20

EM FX VIX DXY (rs)

-100

-80

-60

-40

-20

0

20

40


Equity Debt

September 2020


September 2020


CEE Quarterly

Lower yielding issuers in CEE might still be negatively affected by a deterioration in general

market conditions, which we would see as an opportunity to add exposure. In this scenario,

we prefer CZGBs (hedged) over its Visegrad peers. While OFZ remain attractive in our

medium-term rate convergence story, foreign holdings still exceeded RUB 3tn at the end of

July, close to the highest level on record and foreign investors may reduce positions if they

believe that geopolitical risks are rising. Adding large issuance, further increase in OFZ yields

is on the cards before year-end. In Turkey, investors are unlikely to add to positions before

the TRY and rates stabilize. This may take more time after an initial 2.0pp rate increase

delivered by the CBRT in September. Hard-currency bonds continue to be cheaper than local

currency ones, with ROMANI bonds in USD and EUR, and RUSSIA USD bonds the cheapest.

Funding conditions Measures of financial support announced at the EU level seem set to ease supply pressure in

euro area and CEE markets over the course of 2021 and 2022, when deficits, and thus

funding needs, will still be high. ECB purchases will also continue into 1H21 and will most

likely be extended, supporting demand for euro-area issuers and potentially spilling over into

EUR-denominated assets more broadly. High-yielders across CEE will have a greater

incentive to tap into EU funds, but grants (EUR 390bn out of a total of EUR 750bn for the

entire allotment) might be appealing also to high-rated/lower-yielding issuers whose funding

costs are more in line with EU paper. We believe that the market is not be pricing in the

support coming from non-market borrowing next year from NGEU. Bulgaria, Croatia, Hungary,

Romania and even Poland may consider long-term borrowing at below-market prices from the

EU’s anti-crisis facility. All these countries intend to submit the framework for fund absorption

in October, in hope that the European Commission could approve them by February at the

latest. Loans could arrive earlier than grants and replace some of the usual bond issuance.

Besides relieving some of the potential pressure on yields stemming from the primary market,

borrowing from the NGEU could anchor yield expectations below market yields. Romania

might obtain as much as EUR 12bn in EU funds next year (from SURE, grants and loans) and

more in the following one. This would ease supply pressure and offer greater flexibility with regard

to planning market funding, depending on financing conditions. In Hungary, foreign issuance plans

are currently very limited, but EU support might offer an attractive alternative to local-currency

issuance, which is much needed at times of rising borrowing needs. With regard to Croatia and

Bulgaria, EU funds might be instrumental to avoiding a tightening of financial conditions and

ensuring yields remain anchored while economic developments remain uncertain.

More broadly, EM funding markets have been very active in recent months. Since April,

activity has picked up across locations and sectors. YTD sovereign issuance across EM is

comparable to the total amount sold in 2019.

CHART 5: LOCAL YIELDS INTO EUR CHART 6: 5Y YIELDS IN EUR

Source: IIF, Bloomberg, UniCredit Research

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2020 2026 2031 2037 2042 2048 2053 2059 2064

LC

yie

lds in

to E

UR

(%

)

Czech_Rep Hungary Poland EUR Swap Curve

BU

CZ

HR

HU

PO

RO

RS

GEFR

IT

SP PT

BE

SL

SK

GR

-1.0

-0.5

0.0

0.5

1.0

1.5

AAA AA A BBB BB B CCC

5Y yield

5Y EGBs' yield

September 2020


September 2020


CEE Quarterly

When corporate issuance is also taken into account, completed borrowing is higher than it

was for the whole of 2019 and significantly higher than it was in 2018. Wider deficits and

increased liquidity needs as cash flows have dried up (or simply for precautionary reasons)

are behind the increase in demand for funds. This has been met by solid demand (and final

pricing that is significantly below IPTs) with limited impact on spread levels. Supply pressure

tends to ease during the latter part of the year but with the economic backdrop still draining

resources, pre-funding might play a larger role than usual. Importantly, political events

threaten market conditions and might affect issuance windows.

Hedging costs Fed action has contributed to reducing the yield advantage of USD exposure and, combined

with improved market sentiment, has fueled the weakening trend in the USD over recent

months. As a consequence, hedging EUR-USD for US-based investors delivers a much lower

pick-up compared to March. On 3M FX swaps, this would have added over 2% in 1Q20 while

currently it is a more meager 75bp. While credit spreads on USD-denominated exposure have

dropped too, a lower pick-up lifts the bar for crossover investment into EUR and EUR-related

assets. That said, such strategies still make sense for those expecting the USD to remain

strong but still willing to diversify into the euro and emerging Europe.

Political risks to market sentiment

US politics and Brexit represent two key political risks in 4Q20. While polls indicate that

Democratic candidate and former Vice President Joe Biden enjoys a clear lead over the

incumbent, US President Donald Trump, there are still several weeks until the vote is held,

and past experience shows that voting intentions can turn quickly. Uncertainty might continue

to linger for several weeks after polls close, given that the results might be contested. Market

sentiment would remain very fragile during such a period. The future relationship between the

EU and UK is also an open question. Trade talks have yielded little results so far, and year-

end is approaching. While a no-deal Brexit might still be averted, the new normal seems likely

to imply material disruptions to trade while economies are battered by the implications of the

pandemic. An increase in tension in markets as the end of the year approaches cannot be

written off, and EM might come under pressure as a result. Within CEE risk aversion would be

especially penalizing for the TRY, the RUB and (to a lower extent) the HUF, according to

previous episodes of rising implied volatility in equity markets. When broader market tensions

are combined with a rise in uncertainty in the trade relationship between UK and the EU, as

measured from the implied volatility on the GBP, risk also increases for the CZK and PLN,

while the RON is less affected due to the managed float.

CHART 7: SOVEREIGN BORROWING IN EM CHART 8: IMPLIED VOLATILITY VIX, EM FX, GBP

Source: Bloomberg, Bondradar, UniCredit Research

0

20

40

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1 2 3 4 5 6 7 9 101112 1 2 3 4 5 6 7 8 9 101112 1 2 3 4 5 6 7 8 9

2018 2019 2020

CEEMEA Asia LatAm

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GBP EM FX VIX (rs)

September 2020


September 2020


CEE Quarterly

Updating our REER models

PLN

■ EUR-PLN approached 4.37 in August before moving

higher again to the 4.50-4.55 area. In REER terms, the

PLN has fallen below YE 2019 levels.

■ Based on our REER model, we see the PLN as

moderately undervalued.

■ Over the coming months, the PLN will receive support

from a positive C/A and large inflows from the EU, which

will be sold in the market. As the country section argues,

we see the PLN as being undervalued against regional

peers and we forecast EUR-PLN at 4.40 by year end.

CZK

■ After having recovered by nearly 75% after its 1Q20 sell-

off, EUR-CZK has been on a rising trend again since late

August, crossing the 27.00 handle.

■ While volatility in markets and the high risk of revision of

economic data suggest that caution is warranted, our REER

model for the CZK points to an undervaluation of the

currency in the 5% area.

■ However, the CZK is vulnerable to external shocks due to the

open Czech economy and a C/A deficit that is not covered by

EU funds and FDI into the year-end. We see EUR-CZK at

26.5 at YE 2020.

HUF

■ Upward pressure on EUR-HUF in recent weeks has taken

the pair just below 365 and very close to peaks recorded

during a market sell off that occurred in March. However,

in spite of some volatility, the HUF is trading nearly in line

with its 2020 average in REER terms.

■ The HUF remains undervalued in REER terms. However,

the extent of this undervaluation eased in the latter part of

the sample. It is currently nearly 2.5%.

■ The NBH is likely to continue with its temporary and

opportunistic tightening by increasing the 1W deposit rate

whenever the HUF comes under pressure. However, this

limited tightening may be insufficient to derail EUR-HUF

from its gradual depreciation trend.

Source: Haver, Bloomberg, UniCredit Research

-15%

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0%

5%

10%

15%

2.00

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Mar-07 Dec-09 Sep-12 Jun-15 Mar-18

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Jan-00 Sep-02 Jun-05 Mar-08 Dec-10 Sep-13 Jun-16 Mar-19

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Model (rs) EUR USD

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Jan-00 Jun-05 Dec-10 Jun-16

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September 2020


September 2020


CEE Quarterly

RUB

■ The RUB has been extremely volatile this year. The sell-

off that took USD-RUB to above 80 was, in part,

reabsorbed in 2Q20 – before another wave of pressure

took USD-RUB back above 75.

■ Such volatility has caused large swings in the residuals of

our model for the RUB’s REER. The long streak of

overvaluation ended in 1Q20, and the rebound that

followed painted too optimistic a picture according to our

model. Current levels, with the REER more than 15%

below its YE 2019 levels, are broadly in line with our

model’s fair value.

■ We think oil prices will remain close to their current levels

in 4Q20 and expect to see USD-RUB at 69.5 at year-end.

Geopolitical risks could temporarily increase FX volatility,

but we do not expect them to have a lasting impact on the

currency.

TRY

■ Selling pressure on the TRY has been intense in recent

months. USD-TRY has been rising steadily since August

in spite of the CBRT’s tightening. In REER terms, the TRY

is approaching lows seen in 2018.

■ Our models point to an undervalued TRY in REER terms,

in the range of 10%. However, economic data have been

very volatile and might not yet reflect the full extent of the

deterioration in fundamentals.

■ We expect the CBRT to hike once more by 2pp in an

attempt to stop depreciation. Since the economy is

already adjusting, reducing external funding needs,

USD-TRY could end the year below 8.00. A potential

return to rate cuts in 2H21 bodes ill for the TRY.

Source: Haver, Bloomberg, UniCredit Research

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15%

20%

50

60

70

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90

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110

120

Dec-00 Sep-03 Jun-06 Mar-09 Dec-11 Sep-14 Jun-17 Mar-20

RE

ER

und

er/

over

va

luatio

n

RE

ER

Model (rs) REER

-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

50

60

70

80

90

100

110

Mar-03 Dec-05 Sep-08 Jun-11 Mar-14 Dec-16 Sep-19

RE

ER

under/

over

valu

ation

RE

ER

Model (rs) REER

September 2020

September 2020


CEE Quarterly


Countries

September 2020

September 2020


CEE Quarterly


Bulgaria Baa2 positive/BBB stable/BBB stable*

Outlook

We now see a somewhat less severe economic contraction of 6% this year (previously 7.2%) and a less pronounced recovery

of 3% next year (previously 6.7%). The road to full recovery is likely to be bumpier and to take longer than we anticipated three

months ago. There are two main reasons for this shift. First, the end of the coronavirus pandemic is not yet in sight, as the

production and wide application of a vaccine or successful medical treatment of the disease will need more time to materialize.

Second, the escalation of the political confrontation will add to uncertainty, making firms and households even more cautious

about their spending and investment decisions, at least until the next parliamentary elections are held early next year.

Strategy

Ample fiscal reserves and access to EUR 4.6bn in low-cost funding from the Next Generation EU program will anchor yields on

risk-free assets at a very low level, thus also supporting euro adoption in 2025. This will be instrumental in preventing any

significant tightening in the credit conditions in the years of economic recovery from the coronavirus–induced recession.

Author: Kristofor Pavlov, Chief Economist (UniCredit Bulbank)

KEY DATES/EVENTS

■ Oct/Nov: 2021 Government Budget

■ 19 Oct, 13 Nov, 4 Dec: GDP data (revised data for 2019,

3Q20 flash estimate and structure)

■ 16 Nov: Labour force 3Q20

GDP GROWTH FORECAST

INFLATION FORECAST

Source: national statistical institute, UniCredit Research

MACROECONOMIC DATA AND FORECASTS

2017 2018 2019 2020F 2021F

GDP (EUR bn) 52.3 56.1 60.7 58.1 61.3

Population (mn) 7.1 7.0 7.0 6.9 6.9

GDP per capita (EUR) 7,420 8,012 8,728 8,420 8,937

Real economy, change (%)

GDP 3.5 3.1 3.4 -6.0 3.0

Private Consumption 3.8 4.4 5.8 -4.0 2.0

Fixed Investment 3.2 5.4 2.2 -13.3 6.5

Public Consumption 4.3 5.3 5.5 4.9 3.0

Exports 5.8 1.7 1.9 -14.5 8.0

Imports 7.4 5.7 2.4 -12.5 9.0

Monthly wage, nominal (EUR) 530 586 651 686 728

Real wage, change (%) 7.3 7.7 8.0 3.5 3.7

Unemployment rate (%) 6.2 5.2 4.2 5.6 5.3

Fiscal accounts (% of GDP)

Budget balance 1.1 2.0 2.1 -2.4 -3.6

Primary balance 1.9 2.7 2.7 -1.8 -3.0

Public debt 25.0 21.8 19.9 26.0 27.6

External accounts

Current account balance (EUR bn) 1.8 0.6 1.8 2.0 1.4

Current account balance/GDP (%) 3.5 1.0 3.0 3.4 2.3

Extended basic balance/GDP (%) 6.8 3.3 5.5 6.0 6.1

Net FDI (% of GDP) 2.5 1.4 1.4 0.7 0.9

Gross foreign debt (% of GDP) 64.7 60.3 56.2 64.0 62.4

FX reserves (EUR bn) 23.7 25.1 24.8 29.9 32.1

Months of imports, goods & services 8.1 8.0 7.6 11.1 10.7

Inflation/Monetary/FX

CPI (pavg) 2.1 2.8 3.1 1.8 2.4

CPI (eop) 2.8 2.7 3.8 1.3 2.6

Central bank reference rate (eop) -0.39 -0.50 -0.61 -0.68 -0.60

USD/BGN (eop) 1.63 1.71 1.74 1.60 1.53

EUR/BGN (eop) 1.96 1.96 1.96 1.96 1.96

USD/BGN (pavg) 1.74 1.66 1.75 1.72 1.56

EUR/BGN (pavg) 1.96 1.96 1.96 1.96 1.96

Source: Bulgarian National Bank, Eurostat, national statistical institute, UniCredit Research

*Long-term foreign-currency credit ratings as provided by Moody’s, S&P and Fitch, respectively

yoy (%)

-10

-6

-2

2

6

10

2016 2017 2018 2019 2020F 2021F

Private consumption Public consumption Fixed Investments

Net exports Inventories GDP, real growth

September 2020


September 2020


CEE Quarterly

Political impasse could translate into a weaker recovery

Shallower contraction in economic activity is expected this year… …followed by a more muted recovery next year Growing numbers of new COVID-19 cases are likely to weigh on growth in the remaining months of 2020 and in 2021 If political tension does not ease, growth may be damaged further Hard data confirms that strong recovery continued in the first month of 3Q20 Sharp fall in household income requires more vigorous policy response

Economic activity is expected to contract less sharply in 2020 and to rebound less strongly in

2021 than we envisaged in June. For this year, we expect GDP to drop by 6% yoy, compared

with the 7.2% fall we anticipated in June. There are two main reasons for this shift. First, the

lockdown-driven contraction in 2Q20 (-10% qoq and -8.5% yoy) proved smaller than we had

feared. Second, we raised our growth outlook for the euro area, which should help exports

perform better than we had initially thought. At the same time, growth in 4Q20 is likely to be

weaker than we predicted previously, as the escalation of the political confrontation has

increased uncertainty, which will dampen spending and investment further.

For next year, we expect GDP to increase by 3% yoy (previously 6.7%). We now think that the

road to full recovery will be bumpier and take longer to materialize. The economy is likely to need

around two years to fully recoup output losses caused by the pandemic. Full employment is now

not likely before 2024. As fiscal support measures will have to remain in place for a longer period

and perhaps even rise next year, it will take more time to bring the budget position back in line with

the Maastricht criteria. This makes euro adoption unlikely before 2025 (2023 forecasted three

months ago), according to our revised macroeconomic scenario.

What is behind the revised speed and timing of the recovery in our projection? First, the end

of the COVID-19 pandemic is not yet in sight (see chart), as production and wide-scale

application of a vaccine that can eradicate the disease, is unlikely before 2H21. This means

that sectors most exposed to the social-distancing measures, such as tourism and retail, will

have another difficult year in 2021, which, in turn, is likely to increase permanent loses in the

form of job redundancies and company bankruptcies. Second, increased political

confrontation between the presidency and the government, at the same time, has caused

uncertainty to reach proportions not seen since 2013. If the protests intensify further, the

government’s ability to introduce new measures to contain the pandemic will be constrained,

since any tightening of social distancing measures could be interpreted as an attempt to

dampen the protest by undemocratic means. In the worst case, political deadlock risks leaving

the country with blocked public institutions amid the most severe recession since 1997. And

while this is not our baseline scenario, only new elections can put these fears to rest

permanently. However, elections would need time to be organized and held, thus prolonging

the months in which households abstain from spending and companies postpone investment.

Rapid growth driven by “technical” factors is expected to have materialized in 3Q20. Industrial

production rose 2.3% mom in July, after a very solid 6.1% rebound in June. The recovery in

retail sales was subdued, however, reflecting large loses in household income, as the

beneficiaries under the furlough scheme were entitled to receive only a small portion of their

pre-crisis income, while, at the same time, income losses were exacerbated by wage cuts,

working time reductions and a large number of workers on unpaid leave (see chart).

CORONAVIRUS PANDEMIC HAS SURGED IN JULY AND AUGUST WEAK LABOR MARKET HAS EXACERBATED INCOME LOSSES

Source: Worldometer, national statistical institute, UniCredit Research

0

10

20

30

40

50

60

0

200

400

600

800

1000

1200

Apr-20 May-20 Jun-20 Jul-20 Aug-20

New cases per 1 million inhabitants

New deaths per 1 million inhabitants (rs)

0

10

20

30

40

50

Unpaid leave Reduction ofworking time

Reductionof wages

Lay-off

Mar-20 Apr-20 May-20 Jun-20 Jul-20

Share of affirmative responses from all companies participating in the poll%

September 2020


September 2020


CEE Quarterly

New measures amounting to 1.5% of GDP have been announced since June… …thus pushing total fiscal support measures announced toward the end of September to 4.2% of GDP Bulgaria needs to consider strengthening its automatic stabilizers Furlough scheme prevented a sharp increase in the number of unemployed Our baseline scenario envisages a rise of antiestablishment parties and very fragmented parliament Coordination of the political agendas of the main players in the new coalition government is likely to become a cumbersome task, especially when taking into account that some will have almost no political experience

So far, the fiscal policy response has been in line with our expectations. New fiscal stimulus

equivalent to 1.5% of GDP has been announced since June. These include increased

compensation of income under the furlough scheme for workers in the hospitality sector, higher

wages for some categories of public-sector workers (mostly, but not all, in the health-care

sector), increased minimum daily unemployment benefit to BGN 12 from BGN 9 initially, and

new measures to compensate corporate losses in the worst hit sectors. An additional monthly

payment of BGN 50 was added to all pensions, which if it becomes a permanent measure, as

we think it will, will help raise the average monthly pension by an additional 12% in 2020. For the

whole of 2020, we expect actually implemented fiscal support measures to reach 4.5% of GDP,

as further disbursements are likely in the remaining months of the current year.

Next year, we expect fiscal support to reach 5% of GDP, as most measures will be prolonged

and expanded. In addition, the government will raise the minimum wage to BGN 650 (from

BGN 610), which will also boost some social payments linked to it. Still, fiscal measures

deployed this year and next are likely to fall short of what is needed and what is possible,

given the ample room for more fiscal stimulus. To avoid this, the country should consider

strengthening its automatic stabilizers to improve its capacity to deal with future downturns.

Furlough scheme is likely to save 218k jobs this year. It is difficult to say how many of these

people currently on temporary layoff will actually return to their jobs. It seems that a large

proportion of jobs in the hospitality industry will be lost permanently. Still, if not for the furlough

scheme, the unemployment rate in 2020 would have been 8.9%, instead of 5.6% (see chart).

We don’t predict election outcome different from the key opinion polls available at the moment.

However, caution is warranted as the situation is very dynamic and can rapidly change in the

run up to elections. As things stand now, GERB is likely to remain the largest party in the next

parliament. Six other parties have a realistic chance of passing the 4% entry threshold. If they

do, it will produce a deeply fragmented parliament. Given how aggressive the election campaign

promises to be, divisions will be very hard to deal with in the post-election period.

The upcoming elections are likely to produce a shift toward more dysfunctional policies. Public

opinion polls suggest that the main antiestablishment party “There are such people” will garner a

large share of the vote. Given extreme confrontation between the two main political players,

GERB and BSP, the participation of “There are such people” in the next government is almost

certain. Unfortunately, the party has made no serious efforts to develop and articulate any clear

and coherent strategy for the country’s economic development. To make things even more

complicated, little is known about the party’s ideological background and the values it stands for.

This increases the uncertainty regarding the economic policy of the next government, which is

worrisome, especially since it comes at a moment when uncertainty is already elevated due to

the coronavirus pandemic. It could prove a challenge for this multitude of political players with

such diverse ideological backgrounds to work together in the next government.

MODERATE SUPPORT PACKEGES ARE LIKELY IN 2020 AND 2021 FURLOUGH SCHEME PREVENTED A SHARP RISE IN JOB LOSSES

Source: national statistical institute, UniCredit Research

0.8

1.0

0.4

1.3

0.2

0.1

0.0

0.5

0.4

0.6

0.8

0.6

1.4

0.1

0.1

0.1

1.0

0.4

Support for healthcare sector

Direct payments

Tax exemptions/cuts/holidays

Help for furloughed workers

Help for remaining/returning workers

Help for new employment

Payments for redundant workers

Payments for poor households

Infrastructure, R&D, human capital

2021 2020Fiscal support measures (as % of GDP)

5.6

8.9

5.3

8.3

0

3

6

9

12

With furloughscheme

Without furloughscheme

With furloughscheme

Without furloughscheme

Unemployment rate (%)

2020 2021

3.3pp 3.0pp

September 2020


September 2020


CEE Quarterly

Successful bond issuance in September is likely to anchor funding costs at a very favorable level

Fiscal reserves were pushed to record high levels Yield on risk-free assets will be anchored at a very favorable level during the recovery The next Eurobond issue is not expected before 2023 Yields are likely to remain low in the years leading up to euro adoption

The fiscal reserve was pushed to a record high after Bulgaria issued EUR 2.5bn of bonds in mid-

September. This, along with the EUR 4.6bn of low cost funding the country will be entitled to

receive under the Next Generation EU program, should provide the authorities with the fiscal

space needed to navigate the economy through the challenges it faces in the medium term.

As yields on risk-free assets are anchored at very low levels, any significant tightening in

credit conditions during recovery will be prevented. Also importantly, Bulgaria will have the

room to increase fiscal stimulus if the pandemic takes a turn for the worse and a rise in fiscal

stimulus is urgently needed early next year, before disbursements from the Next Generation

fund begin.

As things stand today, the next Eurobond is unlikely to be issued before 2023, when a large

part of the low-cost funding Bulgaria is entitled to receive under the Next Generation fund is

likely to have already been exhausted.

All these developments are likely to keep yields on Bulgarian sovereign bonds at very low

levels, comparable with countries with more favorable sovereign credit ratings, thus also

supporting euro adoption, which we expect to take place in 2025.

THE GOVERNMENT’S GROSS FINANCING REQUIREMENTS GROSS EXTERNAL FINANCING REQUIREMENTS

EUR bn 2019 2020F 2021F

Gross financing requirement 1.2 2.5 3.1

Budget deficit 0.6 1.8 2.5

Amortization of public debt 0.7 0.7 0.6

Domestic 0.5 0.5 0.4

Bonds 0.5 0.5 0.4

Bills 0 0 0

Loans/Other 0 0 0

External 0.2 0.2 0.2

Bonds and loans 0 0 0

IMF/EU/Other IFIs 0.2 0.2 0.2

Financing 1.2 2.5 3.1

Domestic borrowing 0.5 0.6 0.7

Bonds 0.5 0.6 0.7

Bills 0 0 0

Loans/Other 0 0 0

External borrowing 0.6 3.1 1.6

Bonds and loans 0 2.5 0


Privatization/Other 0 0 0

Fiscal reserves change (- =increase)

0.1 -1.2 0.8

EUR bn 2019 2020F 2021F


C/A deficit -1.8 -2.0 -1.4

Amortization of medium and long term debt 3.7 3.3 3.1

Government/central bank 0.2 0.2 0.2

Banks 0.5 0.5 0.5

Corporates/Other 3.0 2.5 2.5

Amortization of short-term debt 8.2 7.7 8.4

Financing 10.0 9.0 10.1

FDI (net) 0.8 0.4 0.6

Portfolio equity, net -1.6 0.5 0.7

Medium and long-term borrowing 4.8 5.7 3.5


Banks 0.6 0.5 0.6


Short-term borrowing 7.7 8.4 8.6

EU structural and cohesion funds 0.7 1.1 1.8

Other -2.6 -2.1 -2.8

Change in FX reserves (- = increase) 0.2 -5.1 -2.2

Memoranda:

Nonresident purchases of LC govt bonds 0 0 0

International bond issuance, net 0 2.5 0

Source: Bulgarian National Bank, ministry of finance, UniCredit Research

September 2020


September 2020


CEE Quarterly

Croatia Ba2 positive /BBB- stable /BBB- stable*

Outlook

The Croatian economy declined less then feared in 2Q20, while the July/August performance in tourism was above initial

projections. We have therefore revised up our GDP forecast for 2020 from -10.5% to-8.5%. We revised down growth in 2021,

from 6.9% to 5.6% due to lower carryover effects. Generous allocations of EUR 9.4bn in the Next Generation EU (NGEU)

package for 2021-2023 (17.4% of 2019 GDP) should provide strong stimulus to growth in the following years, on top of the

EUR 12.7bn allocation from the Multiannual financial framework (MFF) during 2021-2027 (23.5% of GDP). Participation in

ERM II since July may provide an anchor for reforms.

Strategy

Bond yields could be anchored by local support and small issuance needs in 2020 and by borrowing from NGEU in 2021.

Author: Hrvoje Dolenec, Chief Economist (Zagrebačka banka)

KEY DATES/EVENTS

■ 19 Oct: EDP notification

■ Oct: National Recovery & Resilience Plan first draft

■ Nov: 2021 Budget Draft

■ 27 Nov: 3Q GDP estimate

GDP GROWTH FORECAST

INFLATION FORECAST

Source: Eurostat, CNB, Crostat, UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 49.1 51.7 54.0 48.8 52.3

Population (mn) 4.1 4.1 4.1 4.1 4.0



GDP 3.1 2.7 2.9 -8.5 5.6



Public Consumption 2.2 1.3 3.3 3.1 -1.4

Exports 6.8 3.7 4.6 -21.7 20.7

Imports 8.4 7.5 5.0 -14.7 15.0

Monthly gross wage, nominal (EUR) 1,080 1,139 1,182 1,224 1,241

Real wage, change (%) 2.8 3.4 3.0 4.7 0



Budget balance 0.8 0.2 0.4 -6.6 -3.0

Primary balance 3.5 2.5 2.6 -4.2 -0.6

Public debt 77.8 74.7 73.2 89.6 86.6

External accounts

Current account balance (EUR bn) 1.7 1.0 1.6 -1.6 0.7

Current account balance/GDP (%) 3.4 1.9 2.9 -3.2 1.4


Net FDI (% of GDP) 2.3 1.5 1.9 2.7 1.9





CPI (pavg) 1.1 1.5 0.8 0.4 1.5

CPI (eop) 1.2 0.8 1.4 0.5 2.0

Central bank target - - - - -

Central bank reference rate (eop) 0.3 0.3 0.3 0.1 0.1

3M money market rate (Dec avg) 0.6 0.5 0.4 n.a. n.a.

USD/FX (eop) 6.27 6.47 6.65 6.18 5.89

EUR/FX (eop) 7.51 7.42 7.44 7.53 7.53

USD/FX (pavg) 6.62 6.28 6.62 6.61 6.03

EUR/FX (pavg) 7.46 7.41 7.41 7.53 7.53

Source: Eurostat, CNB, NBS, UniCredit Research

*Long-term foreign currency credit rating provided by Moody’s, S&P and Fitch, respectively

-10

-8

-6

-4

-2

0

2

4

6

8

2017 2018 2019 2020 2021

Private Consumption Government Consumption

Investment Inventories

Net Exports GDP

yoy (%)

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21

September 2020


September 2020


CEE Quarterly

Can a generous EU package boost the recovery?

We revised up our GDP forecast for 2020 to -8.5% GDP drop weaker than expected in 2Q20… …with some segments more resilient than anticipated… ..and better performance of tourism in 3Q20 Worsening epidemiological picture at the beginning of autumn increases risk Employment drop was not avoided but contained by the set of policy measures implemented at the peak of the crisis, resulting in lower unemployment… …but personal consumption will drop notably Recovery in 2021 will be slower than previously expected as a result of a lower carryover from 2020… Given the generous financial envelope from the NGEU and MFF 2021-2027, we highlight the upward risk to our projection… …of 2021 growth at 5.6%

We have increased our forecast for 2020 from -10.5% to -8.5%, due to the smaller-than-

expected decline in 2Q20 and the July/August performance in the tourism sector, which came

in above our initial projections. The GDP drop in 2Q20 proved less pronounced than feared

after the first data for April. GDP fell by “only” 15.1% yoy due to the early exit from the

lockdown in the first part of May, which prompted a stronger-than-expected rebound in

economic activity in May and June. The opening of borders for neighboring countries implies

some tourism contribution already in June. With the construction sector proving unexpectedly

resilient (with mild yoy growth in 2Q20) and higher yoy exports of goods in June, 3Q20 started

off stronger than expected. In addition, performance in the tourism sector in July and August

was significantly above expectations (revenues at 50% of 2019 versus 30-35% expected).

Risks to our outlook arise from the worsening epidemiological situation at the end of August,

which prompted some countries to add either Croatia or some of its regions to risk lists. This

resulted in lower expectations with respect to tourism postseason performance and

employment in the tourism sector. Stricter rules for bars, restaurants, night clubs and indoor

sport & leisure activities are likely to hamper domestic consumption and turnover in these

segments of the economy, also putting pressure on employment and the speed of recovery in

4Q20, which will likely be slower now.

The drop in employment was contained thanks to fiscal measures. So far, employment

declined by around 3% yoy, but unemployment is expected to remain in single-digit territory

for the year. An important factor in this respect was the strong fiscal support for people on

furlough during March-May. The government later introduced a scaled-down version of the

support measures for only the worst-hit activities linked to tourism. When the measures were

first introduced, up to 581,000 workers received support. When the economy exited from the

trough, around 80,000 workers were covered under a scaled-down version of the support

package. The latter, together with short-time work, has been extended until year-end.

GDP growth in 2021 is seen at 5.6%, lower than previously expected due to lower carryover

effects, although faster implementation of EU-funded projects might pose an upward risk.

From 2021, the recovery will be supported by significant EU funding. NGEU was very

generous for Croatia, as was the regular MFF 2021-2027. Within the NGEU for 2021-23,

Croatia was allocated EUR 9.4bn (17.4% of 2019 GDP), while an additional EUR 12.7bn was

allocated through the MFF (23.5% of GDP). With spending devoted mostly to public-sector

projects, the NGEU should help accelerate public investment, in 2019 at a moderate 4.3% of

GDP. Speed of deriving a National Recovery Plan and the identification and/or preparation of

projects will be crucial for the initial volume of the allocation used. We project a strong

increase in gross fixed-capital formation in 2021 but driven mainly by projects funded by

existing facilities. Project implementation funded by the NGEU will likely start in 2H21.

TOURISM PERFORMANCE AFTER THE LOCKDOWN... …PULLED SENTIMENT OUT OF THE TRENCH

Source: Crostat, European Commission, UniCredit Research

0

20

40

60

80

100

120

Ja

n-2

0

Feb-2

0

Ma

r-20

Apr-

20

Ma

y-2

0

Ju

n-2

0

Ju

l-2

0

Aug

-20

Sep

-20

Oct-

20

Nov-2

0

Dec-2

0

Tourism nights (% of corresponding month 2019)

Expected at the beginning of the lockdown

%

60

70

80

90

100

110

120

130

Aug

-08

Feb-0

9

Aug

-09

Feb-1

0

Aug

-10

Feb-1

1

Aug

-11

Feb-1

2

Aug

-12

Feb-1

3

Aug

-13

Feb-1

4

Aug-1

4

Feb-1

5

Aug

-15

Feb-1

6

Aug

-16

Feb-1

7

Aug

-17

Feb-1

8

Aug

-18

Feb-1

9

Aug

-19

Feb-2

0

Aug

-20

'000 Economic Sentiment Index Employment Expectations Index

September 2020


September 2020


CEE Quarterly

The summer of 2020 was positive for the current government: it won the election, a big financial package from the EU and joining ERM II… …which was welcomed by the market and investors ERM II solidified the stability of the exchange rate and the credibility of the central bank, with support from the ECB Early euro accession might be possible if preconditions are met in the following two years… …but there are quite a few challenges The fiscal position looks less dramatic than before the summer and funding locked in for the remainder of 2020 Without signals from the MoF, we assume some consolidation in 2021 and solid funding needs

This summer was very fruitful for the current government. In the general election in early July,

it was given another mandate to run the country. Just a few days later, the ECB and the

European Commission confirmed Croatia’s participation in ERM II. In addition, negotiations

for a recovery package and the new EU budget ended with a generous allocation for Croatia.

ERM II participation was welcomed by markets and investors. On the domestic front, it

resulted in anchoring the EUR-HRK exchange rate around central parity of 7.5345. This was

also beneficial for the credibility of the central bank, helping it to restore international reserves

to the level from the end of 2019 (just above EUR 18bn/20% of estimated 2020 GDP). The

reserves and sustainability of the exchange rate policy were tested heavily in the early stages

of the pandemic when the market expected tourism revenues to be lost. The central bank

started to spend reserves to stave off depreciation pressures. The ECB stepped in with a euro

liquidity line (swap line agreement up to EUR 2bn), recently extended until June 2021.

Croatia joining ERM II opens the possibility for the country to potentially join the eurozone in

2023 if all preconditions are met. In terms of policy requirements, the readiness of Croatian

institutions to implement reforms will be tested (efficiency of public administration and

judiciary reform are a few areas to be highlighted). In terms of quantitative criteria, the main

challenge will be to bring public debt on a sustainable declining path. The COVID-19

pandemic resulted in temporary fiscal worsening. The public debt ratio will climb to almost

90% of GDP. We believe that fiscal policy will be aligned so that the ratio declines between

2pp and 3pp per year in the following years. However, by 2023, it may still be high. This

poses a big risk for 2023 as the year of euro accession; therefore, in our baseline scenario,

2024 (with a record of a three-year decline of the public debt ratio to below 80% of GDP again

by then) seems more likely for euro adoption. On a more symbolic note, 2024 will mark

30 years since the introduction of the HRK.

The fiscal position for 2020 looks less dramatic than before the summer. In the first half of the

year, revenues of the central budget dropped 7.2% yoy, while expenditures increased by

15.2%. The cash-based central budget gap stood at HRK 16.7bn (4.3% of GDP). The fiscal

picture has improved with summer tourism and revenues. This means that, despite strong

fiscal stimulus and adjusted expenditures, the deficit should be lower versus previous

projections. In such a scenario, we should end up with a deficit of 6.6% of GDP (vs. previous

estimates of 8.3%). This also means that funding needs for 2020 seem locked in.

The budget proposal for 2021 should include adjustment measures to bring the fiscal gap

within the 3% area and to be aligned with the medium-term objective of -1% (if not adjusted)

as of 2021 – and the new budget proposal for 2021 is expected to incorporate such goal.

Without any details or indications on 2021 plans so far, this remains our baseline assumption.

In this scenario, we still expect the MoF to likely tap international markets in 2021 despite the

EU package at its disposal that may replace some of borrowing from local banks.

FISCAL DETERIORATION HIT PUBLIC DEBT POSITION… …BUT FUNDING OF RECOVERY TO BE BOOSTED BY THE EU

Source: Ministry of Finance, central bank, European Commission, UniCredit Research

50

55

60

65

70

75

80

85

90

95

2013 2014 2015 2016 2017 2018 2019 2020 2021

GDP (%)

0

2

4

6

8

10

12

2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023

GDP (%) NGEU allocation MFF allocation

September 2020


September 2020


CEE Quarterly

Domestic and external anchors for bonds

Good support from local financial companies and, if needed, from the CNB, as well as very little

new issuance left (the equivalent of EUR 500mn or 0.1% of GDP) are likely to anchor yields.

Next year, Croatia could use borrowing from NGEU to replace some of the needed market

borrowing and anchor long-term yields to the cost of European funding.

GOVERNMENT GROSS FINANCING REQUIREMENTS GROSS EXTERNAL FINANCING REQUIREMENTS

EUR bn 2019 2020F 2021F





Bonds 1.0 1.7 0.8

Bills 4.1 3.4 3.4

Loans 1.3 0.6 0.5


Bonds and loans 2.3 2.0 1.8




Bonds 2.7 4.1 2.0

Bills 3.6 3.4 3.4

Loans 1.1 0.8 0.4


Bonds 1.5 2.0 1.5


Privatization/Other 0.1 0 0

EUR bn 2019 2020F 2021F


C/A deficit -1.6 1.6 -0.7



Banks 0.7 0.4 0.5




Banks 1.5 1.1 1.0


Financing 12.1 12.6 10.2

FDI (net) 1.0 1.1 0.9

Portfolio equity, net 0.5 -1.5 0.7



Banks 0.8 0.6 0.8




Other 1.0 1.0 0

Change in FX reserves (- = increase) -1.1 1.8 -2.3

Memoranda:

Nonresident purchases of LC govt bonds n.a. n.a. n.a.

International bond issuance, net 0.2 0.8 0.2

Source: CNB, Croatian ministry of finance, UniCredit Research

October 2020



CEE Quarterly

Czechia Aa3 stable/AA- stable/AA- stable*

Outlook Our forecast has shifted to include a more-moderate GDP decline in 2020 (-6.4%), followed by more-moderate growth in 2021 (4.7%). Czechia’s government has been introducing populist policies, challenging the long-term stability of public finances.Public debt could rise by 11% of GDP in 2020-21, and non-discretionary spending could increase sharply as a share of taxrevenue – in a stark departure from previous fiscal restraint. We now admit that a first CNB rate hike could be delivered already in 2021 if inflation remains under pressure from consumer demand.

Strategy At less than EUR 2.5bn, remaining bond issuance is very manageable. We do not see scope for a further CZGB rally in 4Q20, but the CZGB 2057 remains cheap. The CZK could benefit from a more-hawkish CNB.

Author: Pavel Sobíšek, Chief Economist (UniCredit Bank Czech Republic and Slovakia)

KEY DATES/EVENTS

■ Regional and Senate elections – 2-3 Oct

■ ČNB policy meetings – 5 Nov, 17 Dec

■ 3Q GDP – 30 Oct (flash), 1 Dec (structure)

GDP GROWTH FORECAST

INFLATION FORECAST

Source: CZSO, UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 194.4 211.2 224.0 211.6 229.7

Population (mn) 10.6 10.6 10.7 10.7 10.7



GDP 5.4 3.2 2.3 -6.4 4.7




Exports 7.6 3.7 1.2 -11.1 8.0

Imports 6.5 5.8 1.3 -8.9 7.5

Monthly wage, nominal (EUR) 1,126 1,250 1,329 1,335 1,397

Real wage, change (%) 4.2 5.9 3.5 -0.2 0.7



Budget balance 1.5 0.9 0.3 -7.3 -6.0

Primary balance 2.2 1.6 1.0 -6.3 -4.7

Public debt 34.7 32.6 30.8 38.5 41.9

External accounts

Current account balance (EUR bn) 3.0 0.9 -0.7 3.0 1.1

Current account balance/GDP (%) 1.5 0.4 -0.3 1.4 0.5


Net FDI (% of GDP) 0.9 0.9 1.1 0.7 0.8





CPI (pavg) 2.5 2.1 2.8 3.3 2.6

CPI (eop) 2.4 2.0 3.2 3.0 2.7

Central bank target 2.0 2.0 2.0 2.0 2.0


3M money market rate (Dec avg) 0.75 2.01 2.18 0.35 0.60

USD/FX (eop) 21.3 22.5 22.6 23.0 21.0

EUR/FX (eop) 25.5 25.7 25.4 26.5 25.6

USD/FX (pavg) 23.4 21.7 22.9 23.5 22.0

EUR/FX (pavg) 26.3 25.6 25.7 26.4 26.0

Source: CZSO, CNB, UniCredit Research

*Long-term foreign-currency credit rating provided by Moody’s, S&P and Fitch, respectively

-8

-6

-4

-2

0

2

4

6

2017 2018 2019 2020F 2021F

Net exports Gross capital

Consumption GDP (yoy, %)Contribution to GDP (pp)

-2

-1

0

1

2

3

4

5

Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 Jul-20 Jan-21 Jul-21

CPI PPI

Forecast

yoy (%)

September 2020


September 2020


CEE Quarterly

Nearing a stimulus overdose

Our forecast has shifted up for 2020 and for 2021 Tourism-related services are set to drag on GDP growth Industrial and construction output is expected to show a marked contraction in 2020 Household consumption decline is set to ease, but a full recovery remains distant

The COVID-19 pandemic has continued to weigh on Czechia’s economy. Business activity

staged a sharp improvement in June, turning the 2Q20 GDP outcome less bad than feared.

Since then, however, the recovery has been losing momentum. Our forecast has shifted to

include a more-moderate GDP decline in 2020, followed by more-moderate growth in 2021.

Our view remains unchanged: the 2019 GDP level of 2019 will only be attained in 2022.

Poor demand for tourism-related services is one channel via which GDP growth will be

dragged from 3Q20 onwards. Over the summer months, outbound tourism is estimated to

have fallen by a third in annual terms, while the number of visitors from abroad may have

dropped by two-thirds. Revenue per room per day for Prague hotels was reported as down by

80% yoy, as was the number of air carrier passengers. Apart from pure tourism, some

traditional, prominent cultural and sporting events did not take place this summer, and

cancellations of international conventions and trade fairs are underway for the autumn.

Furthermore, Czechia remained one of the few countries in Europe where manufacturing PMI

remained below 50 in August. Whether this was due to bias in answering the survey or due to

the large number of strained automotive companies that make up the Czech manufacturing

sector remains to be seen. Either way, car registrations in Europe for the whole of 2020 are

now expected down by 25% versus 2019, which should entail more production cuts in the

autumn at many European plants, including those in Czechia. The estimate looks consistent

with an observed decline in capital spending on transport equipment in Czechia (by 20% yoy

in 2Q20). Apart from car manufacturing, output in machinery – another heavyweight among

Czech industrial sectors – has yet to trough. All in all, industrial output may see a drop of

almost 10% in 2020. Construction, which many had hoped would maintain better performance

than the rest of the economy, looks as though it is set to disappoint such expectations too.

We attribute its poor performance not just to a lack of demand but also to the fact that this

sector has failed to be a driver of the economy.

Household consumption, which was, in 2Q20, severely dragged down in terms of both income

and supply, is expected to ease its decline (to 2-3% yoy) in 2H20. The main obstacle to a full

recovery is income uncertainty. Surveys show that the earnings of half of Czechia’s

households have been affected during the pandemic (these have been partially supported by

government subsidies), but additional households may start to lose part of their income once

Czechia’s furlough scheme is phased out at the end of October. Indeed, we expect Czechia’s

unemployment rate, which is still the lowest in Europe (3.8% according to local methodology)

to increase by 1pp by the end of the year. Importantly, job creation is ongoing, suggesting that

layoffs may spur structural shifts in the economy instead of becoming a macroeconomic problem.

MANUFACTURING PMI POINTS TO MITIGATION OF A DECLINE (NOT AN UPTURN) IN INDUSTRIAL OUTPUT

A DROP IN GROSS OPERATING SURPLUS FROM 2Q20 BODES ILL FOR CORPORATE INVESTMENT

Source: CZSO, Markit, Macrobond, UniCredit Research

35

40

45

50

55

60

-25.0

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

Jan-16 Jan-17 Jan-18 Jan-19 Jan-20

Industrial output (MA3, %, yoy) Czech PMI (rs)

-10%

-5%

0%

5%

10%

15%

1Q15 1Q16 1Q17 1Q18 1Q19 1Q20

Gross operating surplus (yoy, %)

Gross fixed capital formation (Non-fin comp., yoy, %)

September 2020


September 2020


CEE Quarterly

More efficient labor-force utilization is needed Lower EBB in 2020 and a rebound in 2021 The government has been introducing populist policies… …amid a lack of viable ideas (not money) for investing Monetary policy may need to tighten before economic recovery can be set on a sustainable path

More efficient labor market utilization is also urgently needed to support the financial health of

Czechia’s corporate sector. In 2Q20, hours worked fell by 9.6% yoy, but the number of

employees declined by only 1.9% yoy. Gross operating income shrank by 8.5% yoy, bringing

the compensation of Czech employees to 47% of GDP, the highest level on record. Until

corporate profitability picks up, capital spending appears set to remain depressed.

Lower dividend payments due to artificial curbs in 2020 and on lower profits in 2021 should

partly offset the deterioration in Czechia’s trade balance that is expected to be seen in 2020.

In 2021, the extended basic balance could improve if global trade rebounds.

The government seemed to be taking uncontroversial measures at a start of the pandemic but has

been moving towards more populist policies. First, extension of the furlough scheme until October

was driven by the political cycle rather than by macroeconomic needs. Regional and senatorial

elections are scheduled for 2-3 October. Second, the government has approved a one-off transfer to

pensioners (in addition to their rather-generous pension indexation) at a cost of CZK 15bn. Finally,

and most importantly, political leaders have proposed a permanent personal-income-tax cut worth at

least CZK 75bn from 2021 onwards – this was done without any discussion about offsets on the

revenue or expenditure sides of the budget. It is not yet certain that this measure will go ahead as

proposed. If the tax cut is implemented, it would lead to a positive fiscal impulse in 2021 for the

second year running. To avoid threatening the long-term stability of Czechia’s public finances, the

government would probably have to tighten fiscal policy sharply in 2022, curbing GDP growth.

The loosening of Czechia’s traditionally solid fiscal discipline was facilitated by the smooth

and inexpensive financing of this year’s deficit, which was legally amended to gigantic

proportions (CZK 500bn [or 9% of GDP]). In reality, we expect the deficit to be significantly

lower (7.3% of GDP), as the government is unable to reasonably boost other spending aside

from social outlays. Also absent is public debate on the utilization of the EU’s recovery fund

(the CNB estimates an investment impulse from EU money at just 0.1% of GDP for 2021

and 2022). Nevertheless, this fits the perception that the government lacks ideas for an

investment plan but does not lack money.

In a rare move, the CNB joined other institutions in criticizing the government’s policy

objectives. Indeed, headline inflation’s persistently overshooting the 3% upper bound of its

target range puts the CNB in a policy dilemma. The reasons behind higher inflation in Czechia

relative to that of other eurozone countries do not include just one-offs but probably also less

slack in Czechia’s economy. With the government supporting household consumption instead

of dealing with structural deficiencies, there is a risk that the CNB will need to tighten

monetary policy before economic recovery can be set on a sustainable path. Unlike three

months ago, we now admit that a first repo-rate hike could be delivered already in 2021.

HOUSEHOLD CONSUMPTION IS SET TO RECOVER FROM A DEEP TROUGH REACHED IN 2Q20

RETAIL SALES RESUMED YOY GROWTH IN JUNE, HELPING TO BOOST VAT COLLECTION

Source: CZSO, UniCredit Research

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

-28.0

-21.0

-14.0

-7.0

0.0

7.0

14.0

May-15 Feb-16 Nov-16 Aug-17 May-18 Feb-19 Nov-19 Aug-20

Consumer confidence Household consumption (%, yoy, rs)

-40.0

-30.0

-20.0

-10.0

0.0

10.0

20.0

30.0

Jan-20 Feb-20 Mar-20 Apr-20 May-20 Jun-20 Jul-20 Aug-20

VAT income (%, yoy) Retail sales (%, yoy)

September 2020


September 2020


CEE Quarterly

Yields are not threatened by issuance

Remaining bond issuance amounts to less than EUR 2.5bn CZGB 2057 is the most attractive bond on the curve The CZK could benefit from a more-hawkish CNB

We estimate that Czechia’s borrowing needs for this year amount to EUR 22bn. This is based on

an expected budget deficit equivalent to 7.3% of Czech GDP. Borrowing needs would rise to

EUR 25.6bn if the deficit were to expand to 9% of GDP. In the year to date, the amount of debt

issued by Czechia has reached EUR 16.5bn, or more than 90% of financing needs if the deficit is

equivalent to 7.3% of GDP. Coverage falls to 75-80% if the deficit is equivalent to 9% of GDP. We

assume that EUR 3bn of these borrowing needs will be covered by a T-bill maturing in 1Q21 and

that a minor part will be covered by non-market instruments. Issuance may not put pressure on

yields. Nevertheless, the scope for a further rally is limited since core rates may not rally from here

– while fiscal risks are rising in Czechia. That said, the CZGB 2057 remains the cheapest bond in

EU-CEE and may be less affected if the rest of the curve corrects further.

The CZK remains slightly undervalued in our view and could benefit from more-hawkish

messages from the CNB, as long as inflation remains outside the target range.

FOREIGN INVESTORS HAVE ADDED TO HOLDINGS SINCE MARCH CZGB 2057 IS THE CHEAPEST BOND IN EU-CEE

Source: Ministry of Finance, CNB, Bloomberg, UniCredit Research

GOVERNMENT GROSS FINANCING REQUIREMENTS

GROSS EXTERNAL FINANCING REQUIREMENTS

EUR bn 2019 2020F 2021F





Bonds 9.2 5.4 6.5

Bills 0.2 0.2 3.0

Loans 0 0 0

External 0 1.0 2.0

Bonds and loans 0 1.0 2.0

IMF/EU/Other IFIs 0 0 0

Financing 10.4 22.0 25.3


Bonds 10.1 16.9 22.9

Bills 0.2 3.0 0.3

Loans 0.1 0 0


Bonds 0 2.0 2.0



Source: CNB, MoF, CZSO, UniCredit Research

EUR bn 2019 2020F 2021F


C/A deficit 0.7 -3.0 -1.1



Banks 3.1 1.9 2.1


Amortization of short-term debt 100.

7 100.6 103.0


Banks 59.6 58.7 59.0


Financing 110.8 105.0 110.8

FDI (net) 2.4 1.5 1.9

Portfolio equity, net 0 0.4 0.2



Banks 3.1 1.9 2.1




Change in FX reserves (- = increase) -8.9 -1.6 -5.0

Memoranda:

Nonresident purchases of LC govt bonds 0.1 4.9 6.2

International bond issuance, net 0 2.0 2.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 Jul-20

Insurance companies Pension funds

Local banks Foreign investors

monthly change in CZGB holdings, % of total holdings

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2020 2025 2030 2036 2041 2047 2052 2058 2063

CZGB HGB

ROMGB Swap curve

LC yields into EUR (%)

September 2020


September 2020


CEE Quarterly

Hungary Baa3 stable/BBB stable/BBB stable*

Outlook

We expect the Hungarian economy to shrink by around 6.7% this year, recovering by approximately 6% in 2021. A deeper

recession than in the rest of CEE is explained by delays in public support, by the country’s reliance on car manufacturing, by

plummeting tourist numbers, and by declining building activity. The government decided to increase this year’s budget deficit to

more than 8% of GDP, which will push public debt above 75% of GDP. Due to debt metrics and poor economic performance,

Hungary cannot afford to veto the NGEU recovery package. The NBH is likely to remain on hold and the HUF could

underperform peers, pushing short-term rates temporarily higher whenever the HUF comes under sustained pressure.

Strategy

The HGB curve could steepen, especially in the 5-10Y segment due to large net issuance, despite the NBH’s bond purchases.

Authors: Dan Bucșa, Chief CEE Economist (UniCredit Bank London) Ágnes Halász, Head of Economics & Strategic Analysis (UniCredit Bank Hungary)

KEY DATES/EVENTS

■ 8 Oct, 10 Nov, 8 Dec: CPI

■ 20 Oct, 17 Nov, 15 Dec: monetary policy decisions

■ 13 Nov, 1 Dec: 3Q20 GDP (flash, structure)

■ 25 Sep: rating update from Moody’s

■ before Dec: parliament vote on NGEU

GDP GROWTH FORECAST

INFLATION FORECAST

Source: HCSO, UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 125.6 133.8 143.8 128.7 139.7

Population (mn) 9.8 9.8 9.7 9.7 9.7



GDP 4.3 5.1 4.9 -6.7 6.0




Exports 6.9 4.3 6.0 -12.4 12.1

Imports 8.2 6.8 6.9 -8.2 9.6

Monthly wage, nominal (EUR) 960 1,035 1,131 1,149 1,199

Real wage, change (%) 10.1 7.9 7.6 5.2 2.0



Budget balance -2.5 -2.1 -2.0 -7.9 -3.0

Primary balance 0.2 0.2 0.2 -5.1 -0.4

Public debt 71.0 68.5 64.7 76.4 72.9

External accounts

Current account balance (EUR bn) 2.9 0 -1.3 -2.6 -0.5

Current account balance/GDP (%) 2.3 0 -0.9 -2.0 -0.4


Net FDI (% of GDP) 1.6 2.0 0.9 1.0 1.5





CPI (pavg) 2.5 2.9 3.6 3.7 4.0

CPI (eop) 2.1 2.7 4.0 4.1 3.3




USD/FX (eop) 259 281 295 291 273

EUR/FX (eop) 310 322 331 355 350

USD/FX (pavg) 274 270 291 305 355

EUR/FX (pavg) 309 319 325 350 355

Source: Eurostat, HCSO, NBH, UniCredit Research


-10.0

-5.0

0.0

5.0

10.0

2017 2018 2019E 2020F 2021F

yoy (%)

Private consumption Public consumption

Fixed investment Change in inventories

Net exports GDP

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Dec-17 Jun-18 Dec-18 Jun-19 Dec-19 Jun-20 Dec-20 Jun-21 Dec-21

Annual inflation rate

Base rate

Inflation target

Target range

Core inflation excluding indirect taxes

yoy (%)

September 2020


September 2020


CEE Quarterly

From frontrunner to laggard

Hungary is undergoing the worst recession in CEE… …due to the government’s reluctance to act Most of the direct support measures are financed by reallocating resources The loan moratorium is the longest-lasting support measure GDP underperformance driven by tourism… …and construction The outlook for car manufacturing is uncertain

Hungary’s fall from growth frontrunner in EU-CEE to laggard in the recovery following the first

wave of the COVID-19 pandemic is a lesson in underestimating the impact of a global crisis

on a small, open economy. Delays in fiscal support offered by the government to the

Hungarian economy contrasts with pre-crisis proactivity by the same authorities. For years,

the government’s coherent planning for a future economy reliant on high-value-added

manufacturing and rising income was based on the proactive pursuit of FDI projects, lower

costs for producers and lower direct taxation for households. It is therefore all the more

puzzling that the Hungarian government spent the first six months of the COVID-19 crisis

planning for a negative fiscal impulse for FY20 at a time when all other EU-CEE countries

were trying to limit the negative impact of lockdowns and collapsing global supply chains.

By late August, the government had funded the Economy Protection Fund (EPF, worth

HUF 1,365bn or 3% of GDP) and the Disease Control Fund (DCF, worth HUF 634bn or 1.4%

of GDP) by reallocating pre-committed public funding (HUF 1,530bn), levying new taxes

(HUF 91bn) and using fiscal reserves (HUF 378bn), rather than by borrowing more. Between

March and July, the cash budget deficit increased by 3% of GDP, but the fiscal measures that

were supposed to be the most efficient did not last long enough. Tax exemptions ended on 30

June and furlough support was offered for only four months, most of it ceasing by the end of

August. The moratorium on loan repayments, currently covering more than HUF 3,500bn in

retail loans and around HUF 4,500bn in corporate loans (45% of outstanding private-sector

loans), will continue beyond year-end for some HUF 1,855bn loans to worse-off households.

The government’s initial optimism for a shallow and short-term downturn was contradicted by

the 14.5% qoq GDP contraction in 2Q20. The main causes for this underperformance could

slow the recovery as well. First, tourism, which accounts for more than 8% of GDP, will be hit

by the cancellation of Danube cruises and the absence of holidaymakers taking city breaks.

Hungary has an average stay per foreign tourist of less than three nights and foreign arrivals

were already down more than 95% yoy before borders were closed to foreign travelers at the

beginning of September. Second, the COVID-19 crisis exacerbated the downturn in

construction, building projects already having been affected by a rise in VAT in 2020. Yet,

lower supply is unlikely to prevent a price correction in Budapest, where a house price bubble

was in the making before the COVID-19 crisis. Thus, prices may fall by up to 10% this year. A

planned curb on Airbnb would accelerate the price correction, with the ensuing negative

wealth effect likely to affect household consumption. Third, car manufacturing has been

recovering slowly, but foreign orders and firm-level evidence point to a very good 3Q20. The

question is whether the sector, which accounts for 27% of industrial production and 18% of

merchandise exports, can maintain high production as the European Automobile

Manufacturers’ Association expects car sales in the EU to drop by 25% in 2020.

A RELUCTANT START TO ANTI-CRISIS SPENDING PLUMMETING NUMBERS OF FOREIGN TOURISTS

Source: HCSO, Ministry of Finance, UniCredit Research

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2017 2018 2019 2020monthly cash budget balance% of GDP, - = deficit

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

Jun-16 Jun-17 Jun-18 Jun-19 Jun-20

North America Asia Europenumber of foreign tourists, mn, SA

September 2020


September 2020


CEE Quarterly

Higher public spending… …is focused too much on low-spillover investment. We expect GDP to fall by around 6.7% in 2020, rebounding by 6% in 2021 Public debt will exceed 75% of GDP this year The EBB will remain positive… …without closing the HUF’s undervaluation. Inflation may exceed the target range in 2Q21… …pushing EUR-HUF and HUF swap rates higher. Hungary cannot afford to veto the NGEU

Faced with a significantly larger downturn than they expected, the Hungarian authorities

decided to increase the FY20 budget deficit to 8-10% of GDP. This spending surge may be

coming too late for some companies and employees, as shown by the sharp increase in

unemployment. Adjusted for those leaving the workforce, the unemployment rate is already

above 5.5% without accounting for furlough and may exceed 7% next year. While public

spending remains focused firmly on investment projects, some of them with limited or no

positive spillovers, the economy may need more financial aid targeted towards SMEs (to

avoid liquidity shortages morphing into solvency issues) and poor households.

Given the aforementioned risks, we expect the Hungarian economy to shrink by around 6.7%

in 2020, followed by a partial recovery in 2021, when GDP could rebound by around 6%. On a

positive note, we expect Hungary to be one of the first countries to tap the NGEU recovery

package for both loans and grants, boosting investment and employment in 2H21.

Public debt is likely to exceed 75% of GDP in 2020 if the budget deficit balloons to around 8%

of GDP. However, such a breach of the constitutional debt rule (which requires the

government to reduce debt every year until it falls below 50% of GDP) is warranted by the

size of the economic contraction. Assuming EU transfers do not decline significantly in 2021,

both deficit and debt will start falling next year, anchoring sovereign ratings.

The COVID-19 crisis may keep the C/A in deficit in 2020-21, although EU funds and, to a lesser

extent, FDI will cover the shortfall. However, a positive extended basic balance will not suffice to

eliminate the HUF’s undervaluation, which we estimate at around 2%. Loose real monetary

conditions and weak domestic support for HGBs may keep the currency undervalued in 2020-21.

While core inflation could start to decline in the coming months amid lower pressure from the

labor market, headline inflation is likely to hover around the top of the target range in 4Q20.

The target could be breached between April and July 2021 if Hungarian companies continue

to increase markups due to higher import prices and excise duties rise further to offset part of

the additional fiscal spending. Even if this happens, we expect the NBH to keep policy rates

unchanged and to tighten liquidity and push BUBOR rates slightly higher only if EUR-HUF

comes under sustained pressure. Even so, the scope for tightening is limited, with the 1W

deposit rate bound on the downside by the 0.6% policy rate, with the upside below 1%, in our

view. The transition to a simplified policy framework is likely to add inertia to policy decisions,

thus increasing the risk of spikes in EUR-HUF.

We assume that the risk of Hungary vetoing the adoption of the NGEU is limited. Current EU

treaties do not allow for financial punishments against countries that undermine the rule of

law. Moreover, Hungary needs to fund a larger part of investment with EU funds to reduce the

budget deficit and public debt. Otherwise, Hungary’s rating improvements may reverse, since

public debt remains above the BBB median as computed by all rating agencies.

HIGH PUBLIC DEBT REDUCES ROOM FOR MANEUVER ABUNDANT LIQUIDITY NOT SUPPORTIVE FOR THE HUF

Source: HCSO, NBH, Bloomberg, UniCredit Research

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

90.0

2014 2015 2016 2017 2018 2019 2020F 2021F

HUF public debt FX public debt% of GDP

300

310

320

330

340

350

360

370

380

390

400

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

May-19 Aug-19 Nov-19 Feb-20 May-20 Aug-20

3M HUF implied interest rate (%) EUR-HUF (rs)

September 2020


September 2020


CEE Quarterly

Bonds cheapening due to issuance and FX risks

HUF remains a risk for HGBs… …with revised financing needs questioning the strength of local demand. FX bond issuance could be increased

HGBs look cheaper than POLGBs and CZGBs when adjusted for funding costs and risk. Yet

investors are not flocking to Hungarian bonds, partly due to their negative view of the HUF. In

the next couple of months, the HUF could correct some of its recent depreciation against the

PLN and the CZK, but this may end by October if inflation climbs back close to 4%.

With short-term rates anchored by the NBH, we expect the HUF and long-term swap rates to

react, with the swap curve in danger of steepening further and putting pressure on bond

yields. Even if the NBH keeps to its promise of buying HUF 40bn of bonds per week, targeting

bonds that mature in 2031 or later, the purchased amount may not be enough to stabilize

yields in the 5-10Y sector of the curve if we consider that remaining issuance needs stand at

HUF 2.11tn (when subtracting accepted bids at previous auctions) compared to remaining

NBH purchases of HUF 646bn. Thus, the central bank may have to step up support, in terms

of both the size and the range of maturities it purchases.

Failure to sell enough bonds on the local market (both wholesale and retail) would result in

higher issuance abroad, although the current official plan is to tap the market for the

equivalent of just EUR 0.5bn in JPY-denominated bonds, including green bonds.

HGBS CHEAPER THAN PEERS IN 5-10Y SEGMENT LOCAL BUYERS MAY STRUGGLE TO COVER HGB SUPPLY

Source: AKK, NBH, Bloomberg, UniCredit Research


EUR bn 2019 2020F 2021F




Domestic 25.6 20.1 19.4

Bonds 6.8 5.6 6.0

Bills 3.1 2.0 2.4

Loans & retail securities 15.7 12.5 11.0


Bonds 1.3 2.5 2.7


Financing 30.7 33.6 27.4


Bonds 8.1 13.8 9.6

Bills 2.2 2.4 1.7

Loans & retail securities 20.5 11.9 11.0


Bonds 0 4.5 4.0


Fiscal reserves change (- =increase) -0.3 0 0

EUR bn 2019 2020F 2021F


C/A deficit 1.3 2.6 0.5



Banks 4.0 5.3 5.3



Financing 22.8 24.4 21.5

FDI (net) 1.3 1.2 2.0

Portfolio equity, net -0.5 0 0



Banks 3.8 4.0 3.9



EU structural and investment funds 2.6 4.0 3.7

Other 1.0 2.0 3.0

Change in FX reserves (- = increase) 0.6 -1.8 -2.7

Memoranda:

Nonresident purchases of LC govt bonds 2.0 -0.2 0.5

International bond issuance, net -1.3 2.0 1.3

Source: HCSO, NBH, GDMA, UniCredit Research

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2020 2025 2030 2036 2041 2047 2052 2058 2063

HGB CZGB POLGB Swap CurveLC yields into EUR (%)

-500

0

500

1000

1500

2000

1H20 3Q20 Remaining

Net issuance

Purchases by other local investors

Purchases by local banks

Purchases by the NBH (according to program)

HUF bn

September 2020


September 2020


CEE Quarterly

Poland A2 stable/A- stable/A- stable*

Outlook

Poland is leading the recovery in CEE and its GDP is expected to shrink by around 4% in 2020. Large and timely public support,

consumer demand and the fastest recovery of construction in CEE could help the economy recoup most of the 2020 losses in 2021.

The budget deficit could swell above 10% of GDP this year, halving in 2021 and pushing public debt above 60% of GDP. The

NBP is likely to remain on hold this year and next. The PLN remains undervalued and is competitive vs. peers.

Strategy

There is limited scope for either a further POLGB rally or a sell-off. Local banks are likely to cover most of the remaining

issuance, with the NBP chipping in, if needed. Foreign positioning is the lightest in 11 years. Next year, funding from NGEU

could help anchor yields.

Author: Dan Bucșa, Chief CEE Economist (UniCredit Bank AG, London)

KEY DATES/EVENTS

■ 7 Oct, 4 Nov, 2 Dec: monetary policy decisions

■ 1/15 Oct, 30 Oct/13 Nov, 1/15 Dec: CPI (flash/details)

■ 9 Oct: rating update from S&P

■ 13 Nov, 30 Nov: 3Q20 GDP (flash, structure)

GDP GROWTH FORECAST

*adjusted with the statistical error

INFLATION FORECAST

Source: Statistics Poland, UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 467.6 497.4 529.1 511.3 558.0

Population (mn) 38.4 38.4 38.4 38.4 38.4



GDP 4.9 5.3 4.1 -4.1 3.7




Exports 9.6 7.0 4.6 -7.1 6.5

Imports 9.8 7.6 2.7 -7.4 7.1


Real wage, change (%) 3.6 5.3 4.2 1.1 3.6



Budget balance (w. PFR) -1.5 -0.2 -0.7 -10.3 -5.7

Primary balance (w. PFR) 0 1.2 0.5 -7.8 -3.1

Public debt (w. BGK and PFR) 50.4 48.4 45.4 60.4 62.3

External accounts

Current account balance (EUR bn) 0.3 -5.0 2.2 9.4 7.2

Current account balance/GDP (%) 0.1 -1.0 0.4 1.8 1.3


Net FDI (% of GDP) 1.4 2.5 2.2 1.1 1.4





CPI (pavg) 2.0 1.7 2.3 3.4 1.9

CPI (eop) 2.1 1.1 3.4 2.1 2.8




USD/FX (eop) 3.48 3.76 3.80 3.61 3.40

EUR/FX (eop) 4.17 4.30 4.26 4.40 4.35

USD/FX (pavg) 3.78 3.61 3.84 3.86 3.47

EUR/FX (pavg) 4.26 4.26 4.30 4.42 4.32

Source: Eurostat, Statistics Poland, NBP, UniCredit Research


-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

2017 2018 2019 2020F 2021F

yoy (%)

Net exports Change in inventories*

Fixed investment Public consumption

Private consumption GDP

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21

Headline inflation Core inflation

Inflation target Target range

yoy (%)

September 2020


September 2020


CEE Quarterly

Leading the pack

Poland is leading the recovery in CEE Public support of almost 6% of GDP… …disbursed mostly through quasi-fiscal spending The budget deficit exceeds 10% of GDP in 2020 …falling below 6% of GDP in 2021 Public debt over 60% in 2020-21

Six months after the COVID-19 crisis started, Poland is leading the recovery in CEE. This is

due to a combination of timely and efficient official support measures, strong domestic

demand and price-competitive Polish products.

In the 3Q20 CEE Quarterly, we pointed out how Polish authorities were the first to react to the

impending recession caused by COVID-19. The timeliness and size of support packages was

doubled by a unique approach to disbursing financial help: instead of relying on the financial

sector to lend with government subsidies and guarantees, the Polish government decided to

lend directly through the sovereign investment fund PFR and the development bank BGK. As a

result, the size of overall support exceeded PLN 130bn already by mid-August (5.8% of GDP),

with the PFR’s Financial Shield exceeding PLN 60bn, while the BGK added PLN 23.8bn in

loan guarantees. In addition, tax deferrals accounted for around PLN 21.8bn, with support for

employees and SMEs at more than PLN 24bn. Both the PFR and the BGK have borrowing

limits set at PLN 100bn each, so their outlays are likely to increase.

Most of PFR’s loans could become grants if companies maintain employment at pre-crisis

levels, so we regard PFR funding as quasi-fiscal spending and we include it in the budget

deficit. Polish authorities hinted at similar accounting methods when they announced that the

budget deficit could reach 12% of GDP this year. We believe that the actual deficit could be

slightly lower because of the government’s large cash reserves available at the time of writing

this report (PLN 125bn, equivalent to 5.5% of GDP at the end of July) and the economy’s

limited absorption capacity under the current lending and guarantee conditions. However, the

government could change these rules if the economy fails to recover in line with expectations.

Next year’s deficit is expected to fall below 6% of GDP compared to this year, as the need for

support will diminish. Even so, the fiscal space generated by increasing the tax burden on

companies by around 3% of GDP before the COVID-19 crisis allows for generous planning,

e.g. for healthcare spending (more than 5% of GDP) and defense (2.2% of GDP). Next year’s

budget deficit could be smaller in cash terms if the government transfers 15% of the residual

funds remaining in defined contribution pension funds (OFE). The transfer could theoretically

reach PLN 20bn, although it may be closer to half of that amount.

As a result of the public spending spree, we expect public debt to exceed 60% of GDP in

2020-21, peaking next year. The level includes the PFR and the BGK and is in line with

government planning. Net of the two state-owned financial institutions, public debt will remain

below the break level of 55% of GDP.

ROOM TO INCREASE SUPPORT THROUGH FINANCIAL SHIELD

PUBLIC DEBT WILL INCREASE ABOVE THE CONSTITUTIONAL LIMIT

Source: Ministry of Finance, Statistics Poland, UniCredit Research

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Financial shield(PFR)

Tax differals Support for SMEsand employment

Financial shield(BGK)

Actual Limit% of GDP

0

10

20

30

40

50

60

70

2019 2020F 2021F

Public debt

Public debt without PFR and BGK

Public debt limit

% of GDP

September 2020


September 2020


CEE Quarterly

After a swift rebound, the recovery seems to be slowing Rising unemployment could postpone a full recovery in consumption to 2H21 Cost competitiveness suggests the PLN is cheaper than peers GDP could fall by around 4% this year, with an incomplete recovery in 2021 Faster recovery than in the rest of EU-CEE No rate hikes expected in 2020-21

So far, Poland weathered the crisis better than its neighbors, with the 2Q20 dip of 8.9% qoq

being smaller than in the rest of EU-CEE. Besides timely and sizeable public support, two

other factors cushioning the blow were the higher weight of domestic demand in GDP and the

price competitiveness of Polish products. Polish households entered the crisis in the best

financial position since the fall of Communism and consumer spending rebounded strongly in

June, once restrictions were eased. Yet the rhythm was not sustained in July and August and

Google Mobility data show that traffic declined in retail outlets towards the end of the summer.

A further rise in unemployment, which could exceed 7% in 1H21, means that consumer

spending could reach pre-COVID-19 levels in 2H21 only. While employment was more

resilient than in neighboring countries owing to support schemes, scarring effects are

inevitable and the return of migrant workers may be delayed by rising infections in Ukraine.

Another factor setting the Polish recovery apart in EU-CEE is the price competitiveness of

Polish products, evident in export resilience and import substitution compared to neighboring

countries. Adding lower income outflows, the C/A strengthened more than expected and is

likely to remain in surplus in 2020-21. The undervalued PLN plays a role, since the Polish

currency was one of the most competitive in EU-CEE (when adjusted for unit-labor costs)

even before the crisis. However, the story probably runs deeper, as production in low value-

added sectors, such as textiles and furniture, has been more resilient than in the rest of

EU-CEE, despite a higher effective tax burden on Polish companies than on their regional peers.

We expect the Polish economy to contract by around 4% in 2020, followed by an incomplete

recovery in 2021. Notably, we are less pessimistic than the government when it comes to this

year’s economic performance, a singular case in CEE. We expect investment to be the

single-largest drag on GDP in 2020, due to both capital expenditure and construction works.

Building activity will remain subdued this year and may not recover before 2H21. However,

real estate developers and investors expect demand to return to the Polish market before all

other EU-CEE markets, given its size and depth, as well as low perceived risk. Infrastructure

spending could rise this year and may accelerate in 2H21 if the Polish government plans well

its drawdowns from NGEU.

Weaker labor market conditions could weigh on core inflation from September onwards, with

headline inflation expected to fall below the 2.5% target in December 2020. Inflation may

exceed target again only in the last months of 2021, allowing the NBP to remain on hold this

year and next. The 6-4 split in the MPC in favor of easier monetary conditions is likely to hold

next year, with policymakers probably waiting for the economy to recoup all losses before

raising rates. Occasional talk about the need for PLN depreciation may be brushed off by the

market. As stated above, we believe that the Polish currency is competitive at current levels.

POLISH LOW-VALUE ADDED MANUFACTURING IS OUTPACING PEERS

EBB SUPPORTED BY CURRENT AND CAPITAL ACCOUNT FLOWS

Source: Eurostat, Statistics Poland, NBP, UniCredit Research

-80-70-60-50-40-30-20-10

0102030

Ma

r-20

Apr-

20

Ma

y-2

0

Ju

n-2

0

Ju

l-2

0

Ma

r-20

Apr-

20

Ma

y-2

0

Ju

n-2

0

Ju

l-2

0

Ma

r-20

Apr-

20

Ma

y-2

0

Ju

n-2

0

Ju

l-2

0

Ma

r-20

Apr-

20

Ma

y-2

0

Ju

n-2

0

Ju

l-2

0

CZ HU PL RO

Textiles and footware

Furniture

industrial production,change vs. February 2020, SA

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

4Q11 4Q12 4Q13 4Q14 4Q15 4Q16 4Q17 4Q18 4Q19 4Q20F 4Q21F

Capital account Current account

Net FDI EBB

% of GDP, 4Q sum

September 2020


September 2020


CEE Quarterly

Unwavering local support for POLGBs

Limited scope for further rally in POLGBs Commercial banks could buy most of the new issuance… …with the NBP chipping in, if needed Foreign POLGB holdings are at an 11-year low Polish bonds and the PLN are likely to outperform in an EM sell-off

The 12% budget deficit implies bond issuance of around PLN 110bn on the local market and around

EUR 1.8bn in FX bonds before year-end. Thus, the scope for a further rally is limited but so is a potential

increase in spreads if risks do not flare up. We expect local banks to cover most of the local supply,

which represents roughly 4.7% of commercial bank assets and around two thirds of the liquidity parked

by banks at the NBP. If local banks purchase most of the new issuance, government securities would

exceed 20% of bank assets, the highest level in EU-CEE. That said, the state controls more bank assets

in Poland than in the rest of EU-CEE. The NBP could also increase its purchases if government yields

come under pressure, with the central bank unlikely to be price sensitive. Foreign investors are

underweight POLGBs, their holdings being 17.7% of outstanding bonds, the lowest in 11 years.

We believe that potential risks to POLGBs and the PLN are external, rather than domestic.

However, in an EM sell-off scenario, Polish financial assets are likely to fare better than other EM

counterparts, given fundamentals and support from local financial institutions. Long-term loans from

NGEU could provide another anchor for yields in 2021.

BANKS HAVE ROOM TO PURCHASE MORE POLGBS FOREIGN HOLDINGS OF POLGBS ARE AT AN 11-YEAR LOW

Source: Ministry of Finance, Bloomberg, UniCredit Research



EUR bn 2019 2020F 2021F




Domestic 20.0 17.5 24.0

Bonds 20.0 17.5 21.6

Bills 0 0 2.4

Loans/Other 0 0 0


Bonds 5.9 5.3 6.8

Loans, IFIs, other 1.4 1.5 0.5

Financing 30.5 76.9 63.4


Bonds 28.7 49.1 42.7

Bills 0 2.4 4.0

Loans/PFR/Other 0 18.3 8.1


Bonds 2.0 5.5 6.0

Loans, IFIs, other 1.2 1.5 2.5

Change in fiscal reserves/Other (-=increase) -1.4 0 0

EUR bn 2019 2020F 2021F


C/A deficit -2.2 -9.4 -7.2



Banks 11.9 11.1 10.5



Financing 92.1 88.4 85.6

FDI (net) 11.7 5.4 8.0




Banks 7.1 7.8 7.4




Other 3.2 -4.0 -6.0


Memoranda:

Nonresident purchases of LC govt bonds -7.8 -1.6 0.5

International bond issuance, net -3.9 0.2 -0.8

Source: Statistics Poland, NBP, Ministry of Finance, UniCredit Research

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jul-20

Government bonds

Deposits at the central bank% of total assets

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0

Jul-14 Mar-15 Nov-15 Jul-16 Mar-17 Nov-17 Jul-18 Mar-19 Nov-19 Jul-20

Local banks Central banksLuxembourg USUK, IE JapanAT, DE, DK, FR, NL Omnibus accounts

% of outstandingsecurities

September 2020


September 2020


CEE Quarterly

Romania Baa3 negative/BBB- negative/BBB- negative*

Outlook

GDP could fall by around 5% in 2020, with an incomplete recovery expected next year. In our baseline scenario, pensions will

increase by 14% in 2020 and the budget deficit could increase towards 9.5% of GDP, with the anti-crisis support of up to 6 3%

of GDP. Reducing the budget deficit below 5% of GDP next year and keeping debt below 50% of GDP will require fiscal

tightening. The NBR could cut the repo rate to 1%. The PNL is the favorite to win the upcoming parliamentary elections.

Strategy

ROMGBs are our top choice among local-currency CEE bonds in 4Q20 if the pension increase remains at 14%. Otherwise, Romania

could lose its investment-grade rating, bonds could sell off and EUR-RON could move to a 4.9-5.0 range already this year.

Authors: Dan Bucșa, Chief CEE Economist (UniCredit Bank London) Anca Negrescu, Senior Economist (UniCredit Bank Romania)

KEY DATES/EVENTS

■ 5 Oct, 5 Nov: monetary policy decisions


■ Oct-Nov: CC decision on pension increase


■ 6 Dec/1Q21: probable date of parliamentary elections

■ 23 Oct, 30 Oct, 4 Dec: rating updates - Moody’s, Fitch, S&P

GDP GROWTH FORECAST

INFLATION FORECAST

Source: NSI, NBR, UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 187.8 204.7 223.3 213.8 224.5

Population (mn) 19.6 19.5 19.4 19.3 19.2



GDP 7.1 4.4 4.1 -5.1 4.0


Fixed Investment 3.6 -1.2 18.2 -1.0 3.3


Exports 7.6 6.2 4.6 -10.3 7.8

Imports 10.8 9.1 8.0 -7.7 6.4

Monthly wage, nominal (EUR) 724 965 1,069 1,115 1,150

Real wage, change (%) 13.0 29.7 8.9 3.3 2.2



Budget balance -2.6 -2.9 -4.3 -9.5 -4.9

Primary balance -1.4 -1.5 -3.2 -8.0 -3.4

Public debt 35.1 34.7 35.2 45.9 48.4

External accounts

Current account balance (EUR bn) -5.2 -9.0 -10.2 -9.7 -9.6

Current account balance/GDP (%) -2.8 -4.4 -4.6 -4.5 -4.3

Extended basic balance/GDP (%) 0.9 -1.1 -1.2 -2.0 -1.5

Net FDI (% of GDP) 2.6 2.4 2.4 0.7 1.4





CPI (pavg) 1.3 4.6 3.8 2.8 2.9

CPI (eop) 3.3 3.3 4.0 2.6 3.1




USDRON (eop) 3.89 4.07 4.26 3.98 3.87

EURRON (eop) 4.66 4.66 4.78 4.85 4.95

USDRON (pavg) 4.05 3.94 4.24 4.23 3.96

EURRON (pavg) 4.57 4.65 4.75 4.83 4.93

Source: Eurostat, NSI, NBR, UniCredit Research *Long-term foreign currency credit rating provided by Moody’s, S&P and Fitch, respectively

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

2017 2018 2019 2020F 2021F

Private consumption Fixed Investment

Public consumption Change in inventories

Net Export GDPyoy (%, pp)

0.0

1.0

2.0

3.0

4.0

5.0

6.0

Dec-17 Dec-18 Dec-19 Dec-20 Dec-21

Consumer price inflation Inflation target

Target range Monetary policy rate

yoy (%)

September 2020


September 2020


CEE Quarterly

A noisy end to the election cycle

The PNL is favorite to win parliamentary elections 14% pension increase and budget deficit at 9.5% of GDP in 2020 Disbursed government support exceeds 3.2% of GDP… …total allotment 6% of GDP. A 5%-of-GDP deficit in 2021 requires fiscal tightening… …and would help preserve the investment rating GDP contraction of 5.1% in 2020, recovery of 4% in 2020

Romania is approaching the end of the election cycle, with parliamentary elections scheduled

for 6 December following local elections held on 27 September. The National Liberal Party

(PNL) made inroads into previous strongholds of the Social Democratic Party (PSD), with the

USR PLUS Alliance having a very strong showing in urban areas. In December, the PNL

could swap their minority, single-party government for a majority government alliance that

could include USR PLUS, the Popular Movement Party of former president Traian Băsescu

and the Hungarian minority party, UDMR. A large PNL win could leave USR PLUS outside

the government, but this looks less likely at the time of writing3.

Until then, the PNL government faces a challenge to its decision to scale back this year’s

pension increase from 40% to 14%. The Constitutional Court (CC) is expected to rule on this

issue before mid-November. We assume that the pension increase will remain at 14% this

year, which would cap this year’s budget deficit at around 9.5% of GDP and, more

importantly, allow next year’s deficit to fall to around 5% of GDP. This year’s deficit could be

lower if fiscal reserves are used, with the Fiscal Council’s estimate at 8.6-9.4% of GDP.

So far, the government’s support measures including tax breaks and direct support for

furloughed workers, poor households and SMEs fall slightly short of 2% of GDP. In addition, the

loan guarantee program supporting SMEs exceeded RON 12bn (1.2% of GDP) by the end of

August. Other programs, including support for leasing and factoring for large companies affected

by the pandemic, will be launched later this year. In mid-September, Finance Minister Florin Cîțu

estimated existing support lines at RON 61.8bn (6% of GDP). Direct support will have to

increase. For example employees and the self-employed whose activity is affected by

COVID-19 will benefit from furlough support until the end of the year.

Next year’s efforts to reduce the deficit below 5% of GDP would need to go beyond capping

the 2020 pension increase at 14%. The Fiscal Council estimates the 2021 budget shortfall at

7.5% of GDP without corrective measures. In our view, public-sector wages will have to be at

most flat compared to 2020 and transfers will have to fall to close to 2019 levels if pensions

are to increase by up to 8%. Keeping the deficit below 5% of GDP would cap public debt

below 50% of GDP, leaving Romania under the BBB median debt thresholds for all three

rating agencies and thus supporting Romania’s investment-grade rating.

This year’s economic contraction could be close to 5% if the recovery loses speed in 2H20.

Due to needed fiscal tightening, next year’s recovery is likely to be incomplete.

THE BUDGET DEFICIT COULD SWELL BEYOND 9% OF GDP

PUBLIC DEBT WILL EXCEED 50% OF GDP ONLY IF PENSIONS INCREASE BY 40% THIS YEAR

Source: Ministry of Finance, NSI, Ministry of Labor, UniCredit Research

3For details on our political outlook, please see EEMEA Macro Flash - Romania: defeat for the Social Democrats in local elections, published on 29 September.

-12.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2019 2020F 2021F

Budget deficit

Budget deficit without crisis impact

% of GDP

0.0

10.0

20.0

30.0

40.0

50.0

60.0

2019 2020F 2021F

Public debt with 14% (2020) and 8% (2021) pension increase

Public debt with 40% (2020) and 0% (2021) pension increase

% of GDP

https://www.research.unicredit.eu/DocsKey/emergingmarkets_docs_2020_177994.ashx?EXT=pdf&KEY=l6KjPzSYBBGzROuioxedUNdVqq1wFeRoxqgIs9IX6LvKgnCvBQrz9w==&T=1

September 2020


September 2020


CEE Quarterly

Lack of competitiveness leads to larger trade deficit EBB expected to be in deficit in 2020-21… …covered by loans and transfers from the EU in 2021… …and unrecorded remittances in 2020. The NBR could cut the policy rate to 1% A new government is not a guarantee for reforms in 2021 and beyond

Romania stands out in EU-CEE due to the sharp widening in its trade deficit in goods. One

reason for this is falling demand for cars, clothing and apparel, all of which are important export

staples. However, the crisis exposed the Romanian economy’s lack of competitiveness. Most

low-value-added sectors suffered more than average, which may indicate that their small

margins could not accommodate weaker demand. The overvalued RON also played a role, as

did the rise in minimum and average wages that has outpaced productivity in the past six years.

Meanwhile, the trade balance with services improved due to fewer Romanians travelling abroad.

Income transfers are likely to fall further amid lower corporate profits, offsetting lower

remittances and the higher trade deficit. As a result, the C/A deficit could remain stable this

year, declining only marginally in 2021. FDI was hit hard in 7M20 as new equity inflows fell

fivefold yoy and debt flows were down a third compared to 7M19. The improvement in 2H20 is

likely to be only marginal. At the same time, transfers from the EU could rise to close to

EUR 4bn this year, as Romania benefitted from support funding from the EU in addition to

larger inflows of structural and investment funds at the end of the EU budget 2014-20. Next

year, we expect Romania to borrow from the EU, starting with SURE support for employees

and companies (country allotment of EUR 4bn), but also from the NGEU. The authorities

expect to submit the absorption frameworks for the EUR 13.7bn in grants and EUR 16.6bn in

loans before the end of October 2020. These loans may help Romania cover the negative

EBB in 2021. This year, part of the coverage will come from the cash brought back by

Romanian workers who returned home during the pandemic. In May, the government

estimated the number at 1.3 million. If every returning person spends EUR 2,000 (a

conservative assumption) two thirds of the negative EBB could be covered in 2020. Many of

these workers will not return quickly to their previous jobs in Italy and Spain, with those

working in care homes and in tourism worst affected. Thus, the authorities expect

500-600,000 of these workers to add to unemployment, which could exceed 6.5% in 1Q21.

Higher unemployment and lower wage growth are likely to weigh on core inflation from

September onwards. This may keep headline inflation inside the target range in 2019-20,

despite pressure from higher excise duties. As a result, the NBR could cut the policy rate

twice more to 1%, to smooth the end of the moratorium on loan repayments, which is

currently covering 20% of private-sector loans.

While elections are likely to result in a pro-European parliamentary majority, reform

momentum is unlikely to pick up if the coalition comprises more than two parties. Moreover,

the large number of defections from the PSD to the PNL questions the willingness of the latter

to advance bold reforms that would enhance judicial independence and meritocracy in the

civil service, while reducing public waste.

LOW-VALUE-ADDED SECTORS AND CAR MANUFACTURING PERFORMING WORST

STABLE EBB AS CAPITAL TRANSFERS OFFSET HIGHER TRADE DEFICIT

Source: NBR, NSI, UniCredit Research

-40.0 -30.0 -20.0 -10.0 0.0 10.0 20.0

Mining of coal and lignite

Leather products

Repair and installation of machinery

Motor vehicles

Wearing apparel

Furniture

Machinery and equipment n.e.c.

Mining support services

Textiles

Printing and recording

Jul-20 2019 2018yoy (%)

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

2019 2020F 2021F

Capital transfers FDI

Income Trade balance - services

Trade balance - goods EBB

% of GDP

September 2020


September 2020


CEE Quarterly

Yield convergence depends on fiscal restraint

ROMGBs top pick in CEE if pension increase stays at 14% If pension increase returns to 40%, Romanian bonds are likely to underperform in 4Q20… …but could recover in 1H21

In our baseline scenario, the government will manage to control public spending and keep

funding needs in check. In this scenario, ROMGBs are our top choice in CEE, before

EUR-RON moves to a 4.90-5.00 range in 1Q21. Possible support for ROMGBs could come

from NBR cuts to 1%, a BB-level valuation, the inclusion of ROMGBs in the Bloomberg-

Barclays Aggregate Index and underweight positioning by foreign investors. Successful

borrowing from SURE and NGEU might compress ROMANI spreads in 2021 by anchoring

expected long-term borrowing costs.

If a 40% pension increase is implemented, EUR-RON could spike to 5.00 or above and then

move into a 4.90-5.00 range as soon as 4Q20. Romania would risk losing its investment

grade from at least two rating agencies (S&P and Fitch). ROMGB and ROMANI yields could

rise due to higher perceived risk and borrowing needs, diverging from Central European

peers for longer. Subsequent yield convergence in 1H21 would be possible if the government

substitutes a portion of market funding with transfers and loans from the EU and its fiscal

adjustment plans are bold enough.

LARGE REMAINING ISSUANCE CAN BE COVERED ONLY IF PENSION INCREASE REMAINS AT 14%

ROMANI EUR STILL TRADE IN JUNK TERRITORY

*assuming EUR 1bn issued in Eurobonds Source: NBR, NSI, Bloomberg, UniCredit Research


EUR bn 2019 2020F 2021F




Domestic 7.0 6.5 11.2

Bonds 5.9 5.8 7.9

Bills 0.8 0.4 2.0

Loans 0.3 0.3 1.3

External 2.5 2.0 0

Bonds and loans 1.5 2.0 0

IMF/EU/Other IFIs 1.0 0 0

Financing 19.7 28.6 21.3


Bonds 12.2 13.2 9.5

Bills 0.4 2.0 2.0

Loans and retail bonds 1.0 1.0 0.5


Bonds 5.0 10.2 4.0



Fiscal reserve change (- = increase) -0.5 0.4 -0.2

EUR bn 2019 2020F 2021F


C/A deficit 10.2 9.7 9.6



Banks 2.2 1.7 1.6



Financing 39.3 38.6 36.3

FDI (net) 5.3 1.6 3.1

Portfolio equity, net 0.1 0.1 0.1



Banks 2.0 1.6 1.4





Memoranda:

Nonresident purchases of LC govt bonds 2.5 1.4 -0.7


Source: Eurostat, NBR, NSI, Ministry of Public Finance, UniCredit Research

0.0 2.0 4.0 6.0 8.0 10.0

Jan

Feb

Mar

Apr

May

Jun

Jul

Aug

Sep

Average remaining issuance

Average remaining issuance*

monthly issuance on the local market, RON bn

AZERBJ USD 2029

BRAZIL USD 2029

CROATI EUR 2029

MOROC EUR 2031

ROMANI EUR 2029

SERBIA EUR 2029

SOAF USD 2029

0

50

100

150

200

250

300

350

400

450

Asset sw

ap

sp

rea

d (

AS

W, bp

)

ASW December 2019 ASW September 2020

BB- BB BB+ BBB-Average rating

September 2020


September 2020


CEE Quarterly

Slovakia A2 stable/A+ stable/A stable*

Outlook

The pandemic-induced downturn turned out to be milder than expected, with the rebound driven mainly by improving sentiment

in car manufacturing. The speed of the recovery in external demand, particularly in car sales, will be crucial for Slovakia’s

economic rebound. Recently rising cases of COVID-19 and higher unemployment are likely to dampen consumer confidence

and household spending. Although the second wave of the pandemic is worse than the first one, Slovak authorities prefer soft

restrictions to tight lockdowns to cap the negative impact on the economy. The budget deficit is set to reach 9% of GDP this

year, while public debt will exceed all debt-brake thresholds.

Author: Ľubomír Koršňák, Analyst (UniCredit Bank Czech Republic and Slovakia)

KEY DATES/EVENTS

■ 9 Oct, 10 Nov, 10 Dec: industrial production


■ 13 Nov: flash 3Q20 GDP

■ 4 Dec: 2Q20 GDP structure

INFLATION TO MODERATE BELOW 2% IN 2020

V-SHAPED RECESSION DRIVEN BY COVID-19

Source: UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 84.5 89.6 94.2 88.6 94.8

Population (mn) 5.4 5.4 5.5 5.5 5.5



GDP 3.0 4.0 2.3 -7.5 5.7




Exports 3.6 5.3 1.7 -14.2 9.3

Imports 3.9 4.9 2.6 -8.4 4.6

Monthly wage, nominal (EUR) 954 1,013 1,092 1,122 1,160

Real wage, change (%) 3.3 3.6 5.0 0.7 1.9



Budget balance -1.0 -1.0 -1.3 -9.0 -5.0

Primary balance 0.5 0.3 -0.1 -7.6 -3.5

Public debt 51.3 49.4 48.0 60.0 61.1

External accounts



Extended basic balance/GDP (%) 1.0 -0.4 -0.1 -0.3 0.9

Net FDI (% of GDP) 2.8 0.9 1.8 0.2 0.5


FX reserves (EUR bn) EUR EUR EUR EUR EUR

Months of imports, goods & services - - - - -

Inflation/monetary/FX

CPI (pavg) 1.3 2.5 2.7 2.0 1.6

CPI (eop) 1.9 1.9 3.0 1.6 1.9

Central bank reference rate (eop) EUR EUR EUR EUR EUR

USD/FX (eop) EUR EUR EUR EUR EUR

EUR/FX (eop) EUR EUR EUR EUR EUR

USD/FX (pavg) EUR EUR EUR EUR EUR

EUR/FX (pavg) EUR EUR EUR EUR EUR

Source: Eurostat, NSI, UniCredit Research


-1,5

-1,0

-0,5

0,0

0,5

1,0

1,5

2,0

2,5

3,0

3,5

Ja

n-1

6

Apr-

16

Ju

l-1

6

Oct-

16

Ja

n-1

7

Apr-

17

Ju

l-1

7

Oct-

17

Ja

n-1

8

Apr-

18

Ju

l-1

8

Oct-

18

Ja

n-1

9

Apr-

19

Ju

l-1

9

Oct-

19

Ja

n-2

0

Apr-

20

Ju

l-2

0

Oct-

20

Ja

n-2

1

Apr-

21

Ju

l-2

1

Oct-

21

yoy (%)

-10,0

-8,0

-6,0

-4,0

-2,0

0,0

2,0

4,0

6,0

8,0

2016 2017 2018 2019 2020F 2021F

Domestic demand Net exports GDPyoy (%, pp)

September 2020


September 2020


CEE Quarterly

Pandemic confirms strong dependency on auto sector

Sentiment recovered quickly, mainly in manufacturing… Recovery of mobility slowed in the summer… Rising COVID-19 cases to weaken consumer confidence again Car sector remains key for Slovak exports… …showing a strong rebound in the summer… … but most likely not sustainable growth Negative impact on unemployment mitigated by furlough scheme, rising economic inactivity and declining working time so far ... … but unemployment is likely to increase in the coming quarters Wage growth to be supported by a further minimum wage increase in 2021 Budget deficit to approach 10% of GDP… … public debt to exceed debt brake, which was, however, disabled

The pandemic-induced economic downturn in 2Q20 turned out to be milder and the economic

rebound over the summer, after the first wave of the pandemic, was faster than we had

expected. Economic sentiment recovered quickly, especially in manufacturing, driven by local

carmakers, while capital goods production lagged behind. Companies in the services and

consumers sectors have yet to regain their confidence. The recovery is not yet visible in the

construction sector, which is struggling with structural issues. Public infrastructure projects are

impacted by several issues, mostly related to delayed tenders, while tighter household

lending conditions affect residential construction. In addition, several projects are delayed due

to expectations of more lenient legislation regarding building permits.

Domestic activity recorded a sharp increase almost immediately after the easing of lockdown

measures during May and June. Later in the summer, the opening of the economy slowed

markedly. This is confirmed by Google mobility data, which show only a negligible increase in

the summer months, as well as by Google searches for "tickets", "purchases" or "cars", which

peaked early this summer. The recent increase in COVID-19 cases has the potential to

weaken the recovery in consumer confidence in the coming months. However, Slovak

authorities have indicated that countrywide lockdowns are unlikely, with targeted restrictions

being preferred. The negative impact on the local economy will therefore be significantly

milder than in the spring, even though the number of new and active cases or hospitalizations

has already exceeded the level of the first wave of the pandemic.

Weak consumer confidence in several European countries could again reduce the demand

for new cars in Europe, thus hitting a key sector of Slovak manufacturing and exports. In

3Q20, carmakers benefited from a strong catch-up effect and sales/deliveries being

postponed in 2Q20. However, the sustainability of car sales growth in Europe is questionable.

This is indicated by the search for “cars” on Google, which peaked in most European

countries during June and July – on average 2.5% above the prior-year level. The correction

of the initial recovery could continue in the coming months, especially in the scenario of a

significant increase in COVID-19 cases in Europe. The outcome could be a temporary halt in

the growth of the Slovak economy in 4Q20. We expect GDP to fall by 7.5% this year before a

predominantly technical rebound of 5.7% in 2021. The GDP loss is unlikely to be fully

recovered until 2022.

The negative effects of the pandemic-induced economic downturn on employment have so far

been dampened by government measures, despite initial problems (high administrative burden).

The decline in economic activity has been reflected in a reduction of the average working time

rather than in an employment decline, while the increase in unemployment has also been

dampened by rising economic inactivity so far. With increasing pressure to optimize costs and

the phasing-out of the furlough scheme, the effects are likely to gradually shift towards a decline

in employment. Furthermore, the unemployment rate may be augmented more than usual by

school-leavers and by imported unemployment in autumn. We estimate that unemployment will

approach 9% by the end of this year before falling gradually in 2021. Nevertheless, wage growth

is expected to accelerate next year, driven by the approved 7.4% increase in minimum wage (to

EUR 623), supporting the recovery of household spending. In the future, the government

intends to create a permanent “short-time work” scheme in the form of a compulsory insurance

contribution, which would most likely not increase the overall tax burden.

Parliament approved the increase of the 2020 state budget deficit to 11.6% of GDP. This

increase should include a reserve for the second wave of the pandemic. We therefore still

expect the general government deficit to be close to 9% of GDP this year, of which lost tax

income is estimated for the equivalent of 2.9% of GDP. A gradual decline below 3% of GDP

after 2023 would require additional tightening measures equivalent to 3.2% of GDP. Public

debt is set to rise above 60% of GDP, exceeding all debt-brake thresholds. However, the debt

brake has been temporarily disabled, and the new four-member government coalition could

use its constitutional majority to amend the debt-break rule.

September 2020


September 2020


CEE Quarterly

Slovenia Baa1 positive/AA- stable/A stable*

Outlook

We have revised up our GDP forecasts for 2020, from -9.0% to -7.0 %, reflecting a smaller contraction than expected in 2Q20,

and revised down growth for 2021, from 9.0% to 4.9%, mainly due to a smaller carryover effect. The fiscal support measures

and the economic downturn will likely lead to fiscal metrics deteriorating in 2020, before some improvement in 2021, although

financing will likely not pose a problem. Government bonds will likely be supported by ECB purchases.

Author: Mauro Giorgio Marrano, Senior CEE Economist (UniCredit Bank, Vienna)

KEY DATES/EVENTS

■ 30 Nov: 3Q20 GDP

■ 9Oct, 10 Nov, 10 Dec: Industrial production

■ 2 Oct: rating update by Moody’s

■ 11 Dec: rating update by S&P

■ 17 Jul: rating update by Fitch

GDP GROWTH FORECAST

INFLATION FORECAST

Source: SURS, UniCredit Research


2017 2018 2019 2020F 2021F

GDP (EUR bn) 43.0 45.8 48.0 44.7 47.5

Population (mn) 2.1 2.1 2.1 2.1 2.1



GDP 4.8 4.1 2.4 -7.0 4.9




Exports 10.5 6.1 4.4 -10.5 8.7

Imports 10.1 6.6 4.2 -11.0 9.2


Real wage, change (%) 1.1 1.4 2.6 3.0 0.6



Budget balance 0 0.8 0.5 -9.4 -2.0

Primary balance 2.5 2.8 2.3 -7.7 -0.3

Public debt 74.1 70.4 66.1 80.0 79.0

External accounts




Net FDI (% of GDP) 1.2 2.0 1.4 0.9 1.5



Months of imports, goods & services - - - - -


CPI (pavg) 1.6 1.9 1.7 0 1.4

CPI (eop) 1.9 1.4 2.0 0.2 1.6

Source: SURS, Eurostat, UniCredit Research


-10

-8

-6

-4

-2

0

2

4

6

8

10

2017 2018 2019 2020F 2021F

Household Consumption Government Consumption

Investments Inventories

Net Exports GDP Growth

yoy (%)

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

Dec-16 Oct-17 Aug-18 Jun-19 Apr-20 Feb-21 Dec-21

yoy (%)

September 2020


September 2020


CEE Quarterly

A gradual recovery We have revised up our GDP forecasts for 2020, due to a better-than-expected 2Q20, and down for 2021 A gradual recovery expected in 2H20 Increase in unemployment mitigated by government support measures… … but the expiration of some of the measures represents a risk Some fiscal room for additional support measures Deterioration in fiscal metrics likely in 2020 Financing will not be an issue Bonds supported by ECB purchases

We have revised up our GDP forecasts for 2020, from -9.0% to -7.0 %, reflecting a smaller

contraction than expected in 2Q20, and have revised down growth for 2021, from 9.0% to

4.9%, due to a smaller carryover effect. GDP fell 9.6% qoq (13% yoy) in 2Q20, less than

anticipated, as, similarly to other countries, the sharp fall in April was followed by a better-

than-expected rebound in May and June as restrictions were eased.

The recovery in 2H20 is likely to be more gradual. First, there will be less scope for a rebound

given stronger-than-expected growth in May and June. Second, we assume COVID-19 cases

will probably rise during the colder months in all countries, weighing on economic activity. Third,

some of the support measures will expire. Hard data for July showed a continued recovery in

industrial production (+8% mom), retail sales (albeit more moderate, 1.1% mom), and exports

and imports. However, timely indicators such as mobility data, energy consumption and freight

traffic on Slovenia’s motorways point to a slowdown of the recovery in the second half of August,

probably reflecting the overall increase in COVID-19 cases. While qoq growth is likely to be

strong in 3Q20, also thanks to significant carryover effects, growth is likely to moderate in 4Q20.

The deterioration in the labor market was contained by the implemented government support

measures but the expiration of some of these measures at the end of September could weigh

on the recovery. The unemployment rate increased to 5.2% in 2Q20, one percentage point

higher than the year before. The increase reflects a drop of 2% yoy in employment and a rise

of 23% yoy in unemployment. Monthly data on registered unemployment show that the bulk of

the increase was in April, followed by a small decline between May and August, suggesting

that the government measures, which include a furlough scheme and subsides for short-term

work, prevented a further increase in unemployment. The expiration of the furlough scheme at

the end of September, however, represents a risk, while the subsidies for short-term work will

remain in place until the end of the year. Data show that around 40,000 people were put on

furlough in June, much less than in May (150,000).

In the revised budget announced in September, the government’s total allocation for direct

measures to mitigate the impact of COVID-19 is EUR 2.6bn for 2020. In addition, there is the

EUR 2.2bn credit guarantee scheme, which brings the total amount to EUR 4.8bn or around

10% of GDP. Data provided by the Fiscal Council up until the beginning of July show that

EUR 1.3bn of the direct measures were implemented. With around EUR 700mn left to be

spent according to the measures announced, there could be around EUR 500mn fiscal room

for further measures. It took two months for the credit guarantee schemes to be implemented

after they were announced in May. This is likely to have weighed on the take-up, which was

only EUR 76mn as of the end of August out of a total of EUR 2.2bn. This was also confirmed

by lending growth to corporates, which slowed from 7.6% yoy in March to 0.6% yoy in June.

The contraction in GDP and the fiscal package could lead to a budget deficit of around 9%,

which would temporarily push government debt above 80% of GDP, before falling back

somewhat in 2021. Data for January to July already show a deficit of 5% of GDP.

Financing is unlikely to be an issue. We estimate financing needs for the remainder of 2020 at

around EUR 2bn, assuming a budget deficit of around EUR 4.2bn for 2020. Fiscal reserves

were at EUR 6.0bn at the end of July, which is more than enough to cover the country’s

financing needs. However, the government might opt for some pre-financing in light of the

funding needs expected in 2021, which we estimate at EUR 4.5bn (EUR 3.5bn of repayments

and a EUR 1bn budget deficit).

Government bonds will be supported by ECB purchases, which we estimate at around

EUR 1.6-1.7bn by year-end. Assuming an additional EUR 500bn PEPP, which we expect to

be announced in December, plus EUR 20bn of traditional purchases per month, ECB

purchases could amount to around EUR 3.9-4.0bn in 2021. In addition, according to the prime

minister, Slovenia will receive EUR 2.1 bn in grants and EUR 3.6bn in loans under the Next

Generation EU plan for the period 2021-23, on top of the EUR 4.6bn in cohesion and

agricultural funds in 2021-27.

September 2020


September 2020


CEE Quarterly

Bosnia and Herzegovina B3 stable/B stable/not rated*

Outlook

High-frequency indicators for 2Q20 are broadly consistent with our projection of a -7.7% decline in GDP for 2020. Monthly data

show that the recovery after COVID-19 restrictions were lifted at the end of May has not been very pronounced, pointing to a

weak recovery in 2H20, and probably also affected by a flare up of COVID-19 cases during the summer. We expect the

recovery to gather momentum in 2021, with growth at 4.9% in 2021 for the full year. On the fiscal front, the financing of an

emerging fiscal gap should not be at risk thanks to funding assistance from the IMF, other international financial institutions (IFIs)

and the EU. Major risks to growth outlook and long-term stability stem from Bosnia and Herzegovina’s (B&H) weak institutions,

reflecting a complex governance system and divisive political environment, in case they continue to hamper effective policymaking.

Authors: Hrvoje Dolenec, Chief Economist (Zagrebačka banka) Nenad Golac, Senior Economist (Zagrebačka banka)

KEY DATES/EVENTS

■ 15 Nov: local elections in B&H

■ 20 Dec: local elections in Mostar

■ 21 Dec: foreign trade Jan-Nov 2020

■ 25 Dec: industrial production Nov 2020

■ 30 Dec: balance of payments 3Q20

■ 30 Dec: GDP 3Q20

GDP GROWTH FORECAST

INFLATION FORECAST

Source: UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 16.04 17.10 17.91 16.40 17.49

Population (mn) 3.50 3.50 3.49 3.48 3.47



GDP 3.2 3.7 2.6 -7.7 4.9


Real wage, change (%) 0.3 1.7 3.7 -2.1 1.0



Budget balance 1.8 1.5 2.1 -5.0 -1.0

Primary balance 2.6 2.4 2.8 -4.2 -0.2

Public debt 40.5 35.8 34.9 39.9 37.3

External accounts



Extended basic balance/GDP (%) -1.2 -0.3 0.1 -3.5 -2.4

Net FDI (% of GDP) 2.1 2.5 2.7 1.6 2.5





CPI (pavg) 1.3 1.4 0.6 -0.8 1.7

CPI (eop) 1.2 1.6 0.3 -0.8 2.7

1M money market rate (Dec avg) -0.37 -0.36 -0.44 -0.53 -0.47

USD/FX (eop) 1.63 1.71 1.75 1.60 1.53

EUR/FX (eop) 1.96 1.96 1.96 1.96 1.96

USD/FX (pavg) 1.74 1.66 1.75 1.71 1.57

EUR/FX (pavg) 1.96 1.96 1.96 1.96 1.96

Sources: Central bank of Bosnia and Herzegovina, Agency for Statistics of Bosnia and Herzegovina, UniCredit Research

*Long-term foreign-currency credit ratings are provided by Moody’s, S&P and Fitch, respectively.

-10

-8

-6

-4

-2

0

2

4

6

2016 2017 2018 2019 2020F 2021F

% yoy

-3

-2

-1

0

1

2

3

4

De

c-1

3

Jun-1

4

De

c-1

4

Ju

n-1

5

De

c-1

5

Ju

n-1

6

De

c-1

6

Ju

n-1

7

De

c-1

7

Ju

n-1

8

De

c-1

8

Ju

n-1

9

De

c-1

9

Ju

n-2

0

De

c-2

0

Ju

n-2

1

De

c-2

1

% yoy

September 2020


September 2020


CEE Quarterly

The economy posted a relatively weak recovery during summer

Available data are still broadly in line with our GDP -7.7% forecast for 2020 The recovery in 2H20 is likely to remain weak, with construction activity more resilient Growth likely to gather momentum in 2021 Bosnia and Herzegovina’s C/A deficit is likely to widen to 6% of GDP in 2020 due to weakening exports and declining remittance inflows, but it should be covered by funding from the IMF, IFIs and the EU and by FDI inflows Bosnia and Herzegovina’s fiscal position is sustainable despite an opening fiscal gap due to the pandemic

High-frequency indicators for 2Q20 are broadly consistent with our forecast of a significant

GDP contraction, a 7.7% decline for the full year in 2020. Industrial production contracted by

13.9% yoy in 2Q20, retail sales shrunk by 17% yoy, while exports declined by 24.1% and

imports by 27.8% yoy. Construction activity performed better, its decrease in 2Q20 was

minimal, just -1% yoy.

Monthly data show that the recovery after the COVID-19 restrictions were lifted at the end of

May was not very pronounced, pointing to a weak recovery in 2H20, probably also affected by

the flare up of COVID-19 cases during the summer. After falling by 10.9% between February

and May, industrial production increased by a cumulative 5.4% in June and July (based on

seasonally adjusted data) but remains 6% below its pre-COVID-19 level. Performance of

manufacturing was even worse. It declined by 12.9% between February and May, followed by

cumulative growth of 7.2% in June and July. Thus, it is 6.6% below its pre-COVID-19 level.

Retail sales fell by 19.1% and recovered by only 1.7% during the same period, but with a

renewed fall of around 6% mom in July. The contraction in exports and imports slowed from

-32.7% and -35.2% yoy in April to -13% and -13.4% in July, respectively. Assuming a slow

recovery in 2H20 reflecting a general increase of COVID-19 cases in Europe and the related

continued uncertainty, we expect the recovery to gather pace at the beginning of 2021, with

growth at 4.9% for the full year (driven primarily by a recovery in domestic demand) and with

an expected rebound in employment and average wages and strong investment activity.

Construction will likely continue to outperform other sectors thanks to ongoing implementation

of big infrastructure projects, especially those involving motorways, for which foreign financing

has already been secured.

Bosnia and Herzegovina’s current-account deficit is likely to widen to 6.0% of GDP in 2020

(from the 3.5% recorded in 2019) as a result of a sharp decline in export revenues and

remittance inflows. However, we have revised downward our estimated deficit by 0.4pp from

our previous forecast due to a decline in imports of goods that was much higher than

expected. Such a deficit should be financed without major problems, as the IMF has already

disbursed emergency assistance equivalent to around 2% of Bosnia and Herzegovina’s GDP

under its Rapid Financing Instrument. IMF financing plays a vital role in catalyzing emergency

assistance from the international community, in particular from other IFIs and the EU, which is

expected to contribute assistance equivalent to 2.4% of Bosnia and Herzegovina’s GDP. FDI

inflows, despite being much lower this year than they were in 2019, should also contribute

towards funding Bosnia and Herzegovina’s C/A gap (with 1.6% of GDP). An additional buffer

could come from a potentially new IMF arrangement, which authorities are expected to start

discussing in October and which will focus on the health sector, Bosnia and Herzegovina’s

response to the COVID-19 crisis and reforms to state-owned companies. They hope to reach

the agreement by the end of year, but realistically this is more likely to happen in 1Q21, as

local elections in Bosnia and Herzegovina will be held in November and December.

Bosnia and Herzegovina’s fiscal position – despite a projected deficit equivalent to 5% of GDP

– seems manageable, primarily as a consequence of the prudent fiscal stance that Bosnia

and Herzegovina has maintained in recent years, registering budget surpluses and moderate

debt levels, and thanks to the IFI financing mentioned above. This is also confirmed by the fact

that S&P and Moody’s affirmed their credit-rating outlooks for Bosnia and Herzegovina in

August (B3 stable and B stable, respectively).

Major risks to Bosnia and Herzegovina’s growth outlook and long-term stability stem from weak

institutions, reflecting a complex governance system and divisive political environment – in case

they continue to hamper effective policymaking. Additional political risk could emerge from an

increase in tensions between the two entities that make up Bosnia and Herzegovina and even

among various cantons and cities.

September 2020


September 2020


CEE Quarterly

North Macedonia Not rated/BB- stable/BB+ Neg*

Outlook We expect a GDP contraction of 6% in 2020, assuming a weak recovery in 2H20 due to expectations of a general increase in COVID-19 cases in Europe, affecting confidence in social interactions and a loss of momentum in the recovery in North Macedonia’s main trading partners. In 2021, we expect growth to rebound to 6%. The government measures and the contraction in GDP might widen the deficit to 9% of GDP and the general government debt ratio to close to 50% this year before falling back in 2021. The necessary funding will likely be covered by borrowing from IFIs, reserves, and securities issuance. The new coalition government will likely continue along the path of EU accession, although the immediate priority will be to deal with the economic and fiscal impact of the COVID-19 crisis. Author: Mauro Giorgio Marrano, Senior CEE Economist (UniCredit Bank, Vienna)

KEY DATES/EVENTS

■ 7 Dec: 3Q20 GDP

■ 13 Nov: rating update by Fitch

GDP GROWTH FORECAST

INFLATION FORECAST

Source: State statistical office, UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 10.0 10.7 11.2 10.6 11.4

Population (mn) 2.1 2.1 2.1 2.1 2.1



GDP 1.1 2.7 3.6 -6.0 6.0


Gross capital formation1 -2.2 -7.3 6.6 -11.3 9.7

Public Consumption -2.6 2.0 4.5 2.5 2.1

Exports 8.3 15.6 8.3 -12.4 11.4

Imports 5.2 9.1 9.0 -11.4 10.1


Real wage, change (%) 1.3 4.2 3.5 4.5 1.4



Budget balance (central government) -2.7 -1.8 -2.0 -8.6 -3.3

Primary balance (central government) -1.4 -0.6 -0.8 -7.3 -2.1

Government debt (general government) 39.4 40.6 40.2 54.0 51.0

External accounts

Current account balance (EUR bn) -0.1 0 -0.3 -0.3 -0.3


Extended basic balance/GDP (%) 1.0 5.6 -0.2 -0.9 -0.7

Net FDI (% of GDP) 1.8 5.6 2.6 1.6 2.2





CPI (pavg) 1.4 1.5 0.8 0.9 1.6

CPI (eop) 2.4 0.9 0.4 1.2 1.6

Central bank target - - - - -


USDMKD (eop) 51.5 53.7 55.0 50.6 48.1

EURMKD (eop) 61.5 61.5 61.5 61.7 61.6

USDMKD (pavg) 54.4 52.2 55.0 52.8 49.3

EURMKD (pavg) 61.6 61.5 61.5 61.6 61.6

**Gross capital formation also includes inventories. The national statistics office does not publish a separate quarterly series for gross fixed capital formation

Source: state statistical office, ministry of finance, National Bank of the Republic of North Macedonia, Bloomberg, UniCredit Research


-10

-8

-6

-4

-2

0

2

4

6

8

2017 2018 2019 2020F 2021F


Gross fixed capital formation Net exports

Other GDP

yoy (%, pp of GDP)

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

De

c-1

6

Ma

r-17

Ju

n-1

7

Sep

-17

De

c-1

7

Ma

r-18

Ju

n-1

8

Sep

-18

De

c-1

8

Ma

r-19

Ju

n-1

9

Sep

-19

De

c-1

9

Ma

r-20

Ju

n-2

0

Sep

-20

De

c-2

0

Ma

r-21

Ju

n-2

1

Sep

-21

De

c-2

1

% yoy

September 2020


September 2020


CEE Quarterly

A slow recovery amid weak external demand

GDP likely to contract by 6% in 2020 Significant drop in GDP in 2Q20, driven by domestic and external demand Mixed picture in terms of recovery A weaker recovery in the remainder of year In particular, external demand unlikely to improve significantly Support measures and GDP contraction will result in a deterioration of fiscal metrics Funding from IFIs, fiscal reserves, and additional securities issuance Formal start of EU accession negotiations in the pipeline The new coalition government will likely continue on the path of EU accession

We expect GDP to drop by 6% in 2020, revised up from a 7% fall, due to a somewhat smaller-than-

expected contraction in economic activity in 2Q20. In 2021, we expect growth to rebound to 6%.

The significant GDP contraction in 2Q20 showed the challenge of a significant drop in

external demand for small open economies like North Macedonia, in addition to the direct

impact of the lockdown. The substantial contraction in industrial production (-25% yoy)

reflected sharp falls in export-oriented sectors. Exports dropped by 31% yoy, mainly driven by

machinery and equipment and chemicals, which are the country’s main exports, although its

impact on growth was mitigated by the fall in imports, 29% yoy. Investment dropped by 26%.

The impact of the lockdown was visible in the services sector (-8% yoy, with a 23% fall in

wholesale and retail trade) and on consumption (-11% yoy).

Monthly data show a recovery in industrial production and exports since the drops in

April/May, but the improvement in retail sales was more muted. Production in manufacturing

recovered after the drop in April, from -40% yoy in April to -7% in July. Exports slowed from

60% yoy in April to 8% yoy in July in nominal terms, with imports following a similar pattern.

The improvement in retail sales was limited, with the contraction remaining around 30% yoy in

July, after the 45% yoy drop in May, probably affected by the flare-up of COVID-19 cases.

We expect a weaker recovery in the remainder of year, under our assumption of a further

general increase in COVID-19 cases in Europe, affecting confidence in social interaction, and

a loss of the momentum in the recovery of the country’s main trading partners.

In particular, external demand is unlikely to improve significantly in the reminder of the year

given the assumed economic outlook for North Macedonia’s main trading partners. The EU is

the destination of around 80% of the country’s exports of goods, with Germany accounting for

50%, and the Western Balkans for around 10% of exports. Given that the recovery is

expected to lose momentum in both region at the beginning of 4Q20, North Macedonia’s

exports are likely to be affected. In particular, a weaker recovery in European automotive

manufacturers would drag on the country’s machinery and equipment exports, due to the

country’s deep integration into the European automotive supply chain.

The government announced further COVID-support measures at the end of September

bringing total support pledged so far to EUR 1bn or 9.6% GDP. The government measures

and the contraction in GDP might widen the deficit to 9% of GDP and the general government

debt ratio to more than 50% in 2020 before falling back in 2021.

The necessary funding for the reminder of year will be covered by borrowing from IFIs,

reserves, and securities issuance. Of the funding committed by the IMF, World Bank, and the

EU, estimated at around EUR 550mn, around EUR 300mn remains to be disbursed. Fiscal

reserves amounted to EUR 700mn at the end of July. Remaining planned issuance in local

currency amounts to around EUR 370mn. These funds appear sufficient to cover the

financing needs until the end of the year, which we estimate at around EUR 1bn, including

debt repayments (around EUR 350mn plus expiring bills and bonds in the amount of

EUR 370mn which will be rolled over ) and the deficit. A more pronounced widening of the

deficit might require additional funding, unless fiscal reserves are depleted.

Regarding the opening of EU accession negotiations, the European Commission presented

the draft negotiation framework to the EU member states. It sets out guidelines for their

accession talks. Once they are approved by the member states, accession negotiations will

start formally at the first inter-governmental conference, which could take place this autumn.

The new government was sworn in after the general elections in July. As expected, it is a

coalition led by the former Prime Minister Zoran Zaev’s party, the Social Democratic Union of

Macedonia (SDMS), and includes the ethnic Albanian parties Democratic Union for

Integration (DUI) and the Democratic Party of Albanians (DPA). The coalition has 62 seats out

of 120. Such a coalition will likely continue on the path of EU accession, although the

immediate priority would be to deal with the economic and fiscal impact of the COVID-19.

September 2020


September 2020


CEE Quarterly

Russia Baa3 stable/BBB- stable/ BBB stable*

Outlook

We expect a GDP contraction of around 4% in 2020, limited by public investment, CBR easing and support for borrowers, and

fiscal expansion. Fiscal support is likely to be withdrawn only gradually in 2021, when the recovery might be slowed by

investment and a negative credit impulse. The CBR is close to the end of the easing cycle. Geopolitical risks are rising but

potential sanctions against Russia may be limited in scope. Authorities are yet to contain the pandemic.

Strategy

OFZ may be affected by large issuance in 4Q20 and by falling foreign demand amid higher geopolitical risks. That said, there is

still scope for the curve to flatten once risks abate. The RUB could remain undervalued in effective terms even if it recoups

some of its recent losses against the USD.

Authors: Artem V. Arkhipov, Head of Macroeconomic and Strategic Research (UniCredit Russia) Ariel Chernyy, Economist (UniCredit Russia)

KEY DATES/EVENTS

■ 6 Oct, 6 Nov 4 Dec: CPI

■ 23 Oct, 18 Dec: monetary policy meetings


■ 18-22 of each month: monthly economic data

■ 4 Dec: rating review from Moody’s

GDP GROWTH FORECAST

INFLATION FORECAST

Source: CBR, Rosstat, UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 1,393.6 1,414.8 1,518.1 1,320.4 1,325.5

Population (mn) 146.9 147.0 147.0 147.0 146.9



GDP 1.6 2.3 1.3 -4.0 2.0




Exports 5.0 6.3 -2.1 -8.0 5.0

Imports 17.4 3.8 2.2 -10.0 10.0

Monthly wage, nominal (EUR) 594.3 586.8 642.4 580.5 586.2

Real wage, change (%) 2.9 6.8 2.7 0 2.5



Budget balance -1.4 2.6 1.8 -4.3 -2.4

Primary balance -0.7 3.4 2.5 -3.4 -1.4

Public debt 12.6 12.0 12.4 16.5 17.8

External accounts




Net FDI (% of GDP) -0.5 -1.4 0.6 -1.3 -0.7





CPI (pavg) 3.7 2.9 4.5 3.5 3.6

CPI (eop) 2.5 4.3 3.0 3.8 3.5




3M money market rate (year avg) 9.4 7.7 7.8 5.4 4.3

USD/RUB (eop) 57.6 69.5 61.9 72.0 69.5

EUR/RUB (eop) 68.9 79.5 69.3 87.8 89.0

USD/RUB (pavg) 58.4 62.7 64.7 72.3 70.1

EUR/RUB (pavg) 65.9 74.0 72.5 83.0 87.3

Source Rosstat, CBR, UniCredit Research


-6

-4

-2

0

2

4

2016 2017 2018 2019 2020F 2021F

yoy (%)Personal Consumption

Fixed Capital Formation

Inventories

Net export

0%

5%

10%

15%

20%

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021

Headline CPI Key CBR rate Target CPI

Forecast

September 2020


September 2020


CEE Quarterly

A slow recovery ahead

Russia weathered the COVID-19 induced contraction better than expected… …helped by public investment,… …CBR support,… …and fiscal spending. The 2020 budget deficit is estimated at 4.3% of GDP GDP could fall by 4% in 2020 and grow by 2% in 2021… …with investment dragging on the recovery.

The Russian economy is gradually recovering from the COVID-19-induced crisis. PMIs

suggest optimism is back among both manufacturers and service producers, while household

savings accumulated in 2Q20 far exceed the recent spike in retail sales and should support

consumption throughout the rest of the year. Investment data for 2Q20 was also better than

anticipated (a drop of only 7.6% yoy compared to an anticipated plunge of 15%), partly due to

the fact that many state-driven projects were excluded from lockdown lists as “systemically

important”. The pace of recovery may surprise on the weak side, however, throughout the

remainder of the year as existing projects are completed but fewer new ones are started.

The recovery is also being supported by the authorities’ anti-crisis response. The CBR has cut

the key rate from 6.25% to 4.25% and offered over RUB 400bn (0.4% of GDP) in subsidized

funding to banks. Banks used another CBR program to delay interest and/or principal

payments by six months for loans equivalent to 5.2% of GDP. As a result, corporate-loan

growth actually accelerated to nearly 6% yoy in July (FX-adjusted), the fastest rate since June

2019, while household-loan growth decelerated only moderately, to 13% yoy.

While the government does not list COVID-19-related expenditure separately, federal budget

spending in March-July on most COVID-19-related areas (national economy, social security,

health care and intra-budgetary transfers) increased by RUB 1.3 trillion (1.2% of GDP) in excess of

the amounts laid out in pre-epidemic budget law. However, the drop in oil prices and the decline in

physical volumes of production and exports, in line with the OPEC+ deal this year, are weighing

heavily on budget revenue from oil and gas, while the economic slowdown and the need to finance

the coronavirus stimulus package resulted in lower non-oil and gas revenues and higher fiscal

spending. Our previous estimate of 5% GDP for this year’s budget deficit seems to be too high, as

the weaker RUB has helped to inflate revenue to some extent. Together with a smaller-than-

anticipated drop in economic activity, this should bring the deficit down to about 4.3% GDP.

Thus, we are revising our GDP forecast for 2020 to -4% from -5.4%. While both domestic and

foreign demand will contribute to growth in 2021, we are expecting an incomplete recovery. First,

credit growth may not support household consumption. The CBR introduced prudential regulation

in 2019 to cool down consumption and the current crisis could further discourage lending. Wage

growth will not be fast enough to support a faster rise in household spending. Second, investment

growth might be weak. Large public investment projects, like the Moscow-Kazan highway, will

make up for the shortfall left by recently-completed projects, but investment in the oil sector will be

subdued due to supply caps imposed under the OPEC+ deal. At the same time, the fiscal impulse

is unlikely to decline quickly after the COVID-19 support measures end. The oil and gas tax budget

proceeds in 2021 will be computed using a production forecast that precedes the OPEC+ deal.

While the budget rule is likely to be re-instated in 2022, the withdrawal of support measures – and

full compliance with the budget rule – will be very gradual.

RESTRCTURED LOANS UNDER THE ANTI-COVID PACKAGE GOVERNMENT SPENDING BY ITEMS

*Spending on national economy, social policy, healthcare and intra-budgetary transfers Source: Rosstat, Russian Ministry of Finance, UniCredit Research

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

30-Mar 30-Apr 31-May 30-Jun 31-Jul 31-Aug

RUB bn Legal entities Individuals SMEs

5,485

7,523

6,111

5,098

5,856 5,680

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

8,000

8M19 8M20 8M20 implied by pre-COVID Budget spending

plan

RUB bn COVID-related spending* other items

September 2020


September 2020


CEE Quarterly

Monetary easing is approaching an end…

…but policy normalization will not happen in 2020-21 Potential portfolio outflows in 4Q20 Potential sanctions may not be significant The pandemic is yet to be contained

Monetary policy eased this year due to the large, negative output gap and below-target

inflation, which are related to virus-containment measures. However, the easing cycle

seems to be drawing to a close. First, GDP growth is likely to be higher than the CBR

expected. Second, inflation expectations jumped in August to 8.8% from 7.9% in March, and

companies report that they are able to cope with cost pressure amid stressed turnover

volumes. Third, there is little scope for interest rates to decline further in developed markets.

Fourth, the FX pass-through to inflation in March-April might have been hampered

temporarily by deferred demand. Unless new lockdowns are imposed, RUB depreciation in

2H20 might have a higher impact on inflation than in 1H20 as local producers are unable to

substitute a substantial portion of the goods they import. As a result, some of the potential

inflation pressure from FX could be carried over into 2021.

While this may prompt an end to rate cuts, a return to neutral rates is not on the cards. In

July, CBR Governor Elvira Nabiullina put the neutral key interest rate at 5-6%. We believe

that a return to this range would turn the credit impulse negative and slow the recovery. The

baseline scenario in the recently-published Monetary Policy Guidelines for 2021-23 suggests

policy normalization should start after 2021, in line with our expectations.

The current account remained in surplus in 1H20, despite declines in both the price and

volume of oil exports. Lockdowns weighed on imports of goods and services (especially

tourism). FX sales under the budget rule helped smooth USD-RUB fluctuations, despite

support from portfolio inflows being limited: net inflows into OFZs in 7M20 were only about

USD 3bn, compared to over USD 12bn in 7M19. Portfolio flows are likely to weaken further in

4Q20 and 1H21 as monetary easing comes to an end while geopolitical risks look set to rise.

Russia is currently facing sanctions from the EU related to the poisoning of street opposition

leader Alexei Navalny. However, a potential ban on completion and usage of the North Stream 2

pipeline is not a base-case scenario due to the closure of the Groeningen gas field in 2022, which

would be difficult to replace by imports from Norway and LNG without substantial price increases.

The resolution of the situation in Belarus and conflicts in the Middle East may also require

Russian involvement. In addition, for procedural reasons, potential sanctions from the US related

to Russian involvement in elections are unlikely to be discussed before 2H21.

Another important source of risk is the COVID-19 pandemic, given that new cases have not

fallen below 5000 per day since April. However, this can be explained by regional

differences in pandemic developments and containment. The epidemic first hit Moscow,

where the majority of Russian cases were registered until mid-May. A tight lockdown and

large-scale testing helped curb the spread in the capital. Meanwhile, the outbreak picked up

and spread to other regions, were restrictions have been more lenient and the response

slower than in Moscow. In our baseline scenario, a second wave of the pandemic could lead

to regional, rather than countrywide lockdowns.

CURRENT ACCOUNT BALANCE IN 2018-21 COVID-RELATED DEATHS’ STATISTICS BY MONTHS

* - "-" stands for increase Source: CBR, Russian Ministry of Finance, Rosstat, UniCredit Research

58

60

62

64

66

68

70

72

74-120

-60

0

60

120

1Q

19

2Q

19

3Q

19

4Q

19

1Q

20

2Q

20

USD bn

Exports, goods Imports, goods

Net services other CA components

Financial account + n.e.o. Change in int.reserves*

RUBUSD, rhs

0

5,000

10,000

15,000

20,000

25,000

30,000

April May June July Aug Sep

Identified main cause (1) Likely main cause (1)

Fatal complications (1) COVID-19 deaths (2)

(1) - RosStat, (2) -State CoViD office

September 2020


September 2020


CEE Quarterly

A likely correction in OFZ

Issuance is a risk for OFZ… …although monetary transmission has not run its course RUB to remain undervalued in 4Q20 and 1H21

Higher risks could lead to outflows from OFZ in 4Q20 and at the beginning of 2021. While

OFZ remain a top pick in the long term, in our view, the remaining borrowing needs for 2020

are large (RUB 1.8tn, equivalent to 2.3% of GDP), which may put pressure on yields. So far,

the ministry of finance appears to be in no hurry to implement its own borrowing plans, even

cancelling debt auctions in times of increased market volatility, but it will have to accelerate

OFZ issuance to fulfill the borrowing program. However, lower issuance needs and,

potentially, geopolitical risks might help yield and swap curves flatten further as the

transmission of monetary policy has been incomplete.

Meanwhile, the RUB could recoup some of the losses against the USD before year-end, but a

higher EUR-USD means that the RUB could remain undervalued into 1H21.

MONETARY POLICY TRANSMISSION IS FAR FROM OVER DEMAND FOR OFZ WEAKENED OVER THE SUMMER

Source: Russian Ministry of Finance, CBR, UniCredit Research



EUR bn 2019 2020F 2021F

Gross financing requirement -15.2 69.1 46.4

Budget deficit -27.1 56.7 32.3


Domestic 9.7 8.1 13.7

Bonds 9.7 6.5 11.9

Bills - - -

Loans 0 1.6 1.8

External( bonds and loans) 2.2 4.4 0.4

Other 0 0 0

Financing -15.2 69.1 46.4


Bonds 28.7 48.6 40.5

Bills - - -

Loans 0.8 1.1 1.9


Bonds 5.7 2.6 2.4

Other 0 0 0


revaluation -14.0 0 0

Change in fiscal reserves (- = increase) -36.4 16.9 1.6

EUR bn 2019 2020F 2021F


C/A deficit -57.8 -35.6 -24.9



Banks 8.2 2.7 3.5



Financing 32.7 48.4 48.5

FDI (net) 9.0 -17.5 -8.9

Portfolio investments (net) -5.8 -2.6 -2.3



Banks -13.7 -6.4 -5.5



other investment (net) 4.0 -14.1 -6.1

Change in FX reserves (- = increase) -59.4 10.8 -2.4

Memoranda:

Nonresident purchases of LC gov't bonds 17.9 13.2 12.8

International bond issuance, net 4.0 -1.2 2.2

Source: CBR, Rosstat, Russian Ministry of Finance, UniCredit Research

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

Repo rate Mosprime3M

5Y IRS 5Y OFZ 10Y IRS 10Y OFZ

12M change (pp)

-600

-400

-200

0

200

400

600

800

Jul-13 Jul-14 Jul-15 Jul-16 Jul-17 Jul-18 Jul-19 Jul-20

Local banks Foreign investorsholdings of OFZ, RUB bn, mom

September 2020


September 2020


CEE Quarterly

Serbia Ba3 positive/BB+ stable/BB+ stable*

Outlook

We are raising our 2020 GDP forecasts from -5% to -2.7% due to a less-severe-than-expected contraction in 2Q20. However

the update does not fully reflect the positive GDP surprise due to assumed slower growth in 2H20. The new quarterly path

implies a smaller carryover to next year and therefore lower growth in 2021 (4.4% vs. 6.3%). The government extended some

support measures to the end of September, bringing the total package to EUR 5.7bn or 12.5% of GDP. Government debt is

likely to rise above 60% of GDP in 2020 before falling back in 2021. Inflation will likely to remain below target in 2020 but a

further policy rate cut is unlikely. Negotiations with Kosovo resumed after an interruption since the end of 2018.

Strategy

We estimate Serbia has enough resources and buffers to cover financing needs for the rest of the year. EUR 400mn of SERBGB

issuance is planned, which should be absorbed by local institutions and foreign investors when appetite for EM improves.

Author: Mauro Giorgio Marrano, Senior CEE Economist (UniCredit Bank, Vienna)

KEY DATES/EVENTS

■ 8 Oct, 12 Nov, 10 Dec: NBS monetary policy meetings

■ 12 Oct, 12 Nov, 11 Dec: CPI inflation

■ 30 Nov: 3Q20 GDP

■ 11 Dec: Moody’s and S&P to update sovereign rating

GDP GROWTH FORECAST

INFLATION FORECAST

Source: SORS, UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 39.2 42.9 45.9 45.5 48.5

Population (mn) 7.0 7.0 6.9 6.9 6.9



GDP 2.0 4.4 4.2 -2.7 4.4



Public consumption 3.3 3.7 2.9 7.0 2.0

Exports 8.2 8.3 8.5 -7.9 7.2

Imports 11.1 11.6 9.5 -7.4 6.2


Real wage, change (%) -1.1 4.0 8.5 4.3 3.0



Budget balance 1.1 0.6 -0.2 -8.0 -2.0

Primary balance 3.6 2.8 1.8 -6.0 0

Public debt 58.7 54.4 52.9 61.6 59.8

External accounts


Current account balance (% of GDP) -5.2 -4.8 -6.9 -6.3 -6.2

Extended basic balance/GDP (%) 0.9 2.5 0.9 -1.5 -0.2

Net FDI (% of GDP) 6.2 7.4 7.8 4.8 6.0





CPI (pavg) 3.1 2.0 1.8 1.6 2.2

CPI (eop) 3.0 2.0 1.8 1.8 2.6




USD/FX (eop) 99.1 103.4 104.9 96.7 89.8

EUR/FX (eop) 118.5 118.2 117.6 118.0 118.5

USD/FX (pavg) 107.8 100.2 105.2 102.8 92.6

EUR/FX (pavg) 121.4 118.3 117.9 117.7 117.9

Source: Bloomberg, Eurostat, SORS, NBS, public debt agency, UniCredit Research


-6

-4

-2

0

2

4

6

8

2017 2018 2019 2020F 2021F


Gross fixed capital formation Net exports

Inventories and discrepancy GDP

yoy (%, pp of GDP)

0

1

2

3

4

5

6

Dec-16 Jun-17 Dec-17 Jun-18 Dec-18 Jun-19 Dec-19 Jun-20 Dec-20 Jun-21 Dec-21

Headline inflation Inflation target

Target range Core inflationyoy (%)

September 2020


September 2020


CEE Quarterly

Smaller hit from COVID-19 but slower recovery

We are raising our 2020 forecast and lowered our forecast for 2021 The recovery is likely to slow in 2H20 Some support measures extended but due to expire soon Most of the initial support measures already implemented

We are raising our 2020 GDP forecasts from -5% to -2.7% due to a less-severe-than-

expected contraction in 2Q20. However, the update does not fully reflect the positive GDP

surprise due to assumed slower growth in 2H20. The new quarterly path implies a smaller

carryover to 2021, therefore lower growth for 2021( 4.4% vs. 6.3%).

After a better than expected performance in 2Q20, we assume a slower recovery in 2H20.

GDP contracted less than expected in 2Q204, by 9.2% qoq and 6.4% yoy, and performed

better than countries that implemented similar lockdown measures. However a slower

recovery in 2H20 is likely due to the following factors: 1. the shallower contraction in 2Q20

means there is less scope for a rebound; 2. COVID-19 cases will likely rise in the colder

months in all countries, weighing on economic activity through its impact on social interactions

and confidence; 3. the expected expiration of some public support measures, in particular

furlough schemes and tax deferrals, at the end of September. In addition, industrial

production will be affected by the expected interruption of production at the largest copper

smelter (the former RTB Bor and Fiat Serbia. Data for July point to some slowdown of the

recovery, probably also affected by increasing COVID-19 cases.

The extension of furlough schemes until the end of September and the further postponement

of payments of company taxes and contributions related to wages for August, supported the

economy over the summer but the planned expiry of these actions represents a risk. The

measures will cost EUR 0.6bn, bringing the total support package to EUR 5.7bn or 12.5% of

GDP. The extension of furlough schemes will target employees at micro-enterprises and

SMEs, with the government now paying 60% of the minimum wage. According to the ministry

of finance, the measure covers around one million employees and will cost EUR 300mn,

bringing total cost of furlough support to EUR 1.1bn. The tax and contributions deferral will

cost EUR 260mn, bring total tax deferral support to EUR 1.5bn. In addition, the moratorium on

loans was extended by two months until the end of September, and the NBS introduced some

measures to support retail lending.

The implementation of the initial support measures was concentrated in 2Q20. The furlough

scheme supported employment, but growth in employment slowed and the reduction of

unemployment stopped in June and July after having contracted by around 9% yoy before the

pandemic. Regarding the tax and contributions postponement, not all funds were utilized as

30% of companies did not utilize the schemes, according to the Fiscal Council. Disbursement

of guarantees is on track, with around EUR 1bn disbursed since 1 May (out of EUR 2bn).

SOME DATA POINT TO A SLOWDOWN IN THE RECOVERY FURLOUGH AND TAX MEASURES EXTENDED

Source: SORS, ministry of finance, UniCredit Research

4For details please see EEMEA Flash -Serbia: Better-than-expected growth in 2Q20 but recovery might lose steam

-70

-60

-50

-40

-30

-20

-10

0

10

20

30

Manuf.(% yoy)

Retail sales(% yoy)

Exports(% yoy)

Imports(% yoy)

Sent. indic(chg, points)

Googlemobility*

Apr May Jun Jul Aug Sep

* deviation from baseline, avg for all the sectors available

Sep: 0.4

0

1

2

3

4

5

6

Total Guarantees Tax measures Furlough Other

First package Extended measuresEUR bn

https://www.research.unicredit.eu/DocsKey/emergingmarkets_docs_2020_177746.ashx?EXT=pdf&KEY=l6KjPzSYBBGzROuioxedUNdVqq1wFeRoDR3PZ-ENuTeuyf_rM7McTg==&T=1

September 2020


September 2020


CEE Quarterly

Deterioration in fiscal metrics Current account deficit likely to narrow due to energy prices Inflation likely to remain below target in 2020 NBS: no more cuts

Dialogue with Kosovo resumed New government

We expect the fiscal deficit to be around 8% of GDP, temporarily pushing government debt to

61% of GDP before returning to slightly below 60% of GDP in 2021. With the deficit already

reaching over 6% of GDP in January-July 2020, there is little fiscal space for further substantial

stimulus, which represents a risk for employment and the resilience of micro-enterprises and

SMEs. The deficit could be larger than expected if growth disappoints and/or support measures

are extended further. The government said that it would revise the budget by the end of

September. Given that the support measures were temporary, the fiscal deficit could narrow to

around 2% in 2021 if public sector wages and pensions do not increase significantly.

After widening to 6.9% of GDP in 2019, the current account deficit is likely to narrow to 6.4% of GDP

in 2020, primarily on the back of lower energy prices. We expect the current account deficit to be

financed by FDI, which we forecast at around EUR 2.2bn or 4.8% of GDP, compared to more than

EUR 3.5bn in 2019 (inflows were already close to EUR 1.5bn in 1H20) with the rest covered by

portfolio and other investment inflows. The dinar might experience some pressure in periods of EM

risk-off sentiment, however, the NBS is likely to intervene to preserve the stability of the currency.

Inflation is likely to remain below target in 2020, although we have a higher path compared to the

previous forecasts due to higher-than-expected core inflation. We expect base effects in food

and energy prices to push inflation slightly above 2.0% yoy by September before it falls back to

1.8-1.9% at the end of the year due to a negative base effect in food prices and slightly lower

core inflation. In our previous CEE Quarterly we expected inflation at 1.4% at year-end, with

upward revision reflecting higher core inflation. In 2021, inflation might rise to 2.2-2.6%, driven by

a base effect in oil prices and a gradual acceleration of core inflation in 2H21.

We expect the central bank to keep its policy rate unchanged due to: 1. better-than-expected

economic performance; 2. inflation picking up; 3. high liquidity in the banking sector; 4. pressure

on the dinar; and 5. the effect of earlier cuts that is yet to trickle down. In case of need, the NBS

has the tools to provide liquidity to the banks, namely repo and FX-swap auctions, as well as

bilateral purchases of dinar government securities from banks, although the banking sector is

currently very liquid, with excess liquidity at around RSD 150-200bn. According the NBS balance

sheet, bilateral purchases between April and June amounted to around RSD 95bn or EUR

0.8bn, which is around 2% of GDP, with the bulk of the purchases being made in April. The NBS

will likely start to purchase corporate bonds, following the planned issuance of Telekom, which

should help develop a local corporate bond market.

Negotiations with Kosovo resumed after having been interrupted since the end of 2018.

Serbian president Aleksandar Vučić and Kosovo’s prime minister Avdullah Hoti met in July in

the context of the EU facilitated dialogue, and again in September at the White House and

Brussels, reaching some agreement on economic cooperation and other topics. While these

are positive developments, the most difficult topics are yet to come to the agenda. The next

EU-led high-level meeting is planned for the end of September.

After the elections on 21 June, a new government is expected to be nominated in October.

LIMITED FISCAL SPACE LEFT PRESSURE ON FX CONTINUED

Source: NBS, SORS, ministry of finance, UniCredit Research

-8.0

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

-10.0

-8.0

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

Jan-15 Jan-16 Jan-17 Jan-18 Jan-19 Jan-20

Tax RevenuesNon-Tax RevenuesInterest expenses (+ = reduction)Other expenditure (+ = reduction)Budget balance (% of GDP) - RS

12M rolling sum, % GDP

-600

-400

-200

0

200

400

600

800

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

2015 2016 2017 2018 2019 2020NBS interventions (EUR bn)

September 2020


September 2020


CEE Quarterly

Sufficient buffer in case of need

We estimate that the financing needs for the remainder of the year can be covered with fiscal

reserves, planned issuance, and IFI funding. We estimate financing needs at around

EUR 1.5bn until the end of the year (excluding a potential buy-back of the USD 2021 bond).

These can be covered with fiscal reserves, planned SERGB issuance (EUR 400mn), and IFI

funding (agreed funding is EUR 380mn, of which we estimate EUR 170mn had already been

disbursed). If required, Serbia could issue a Eurobond, as is already envisaged in the budget,

and has substantial buffer in the form of the IMF Rapid Financing Instrument (Serbia is

entitled to EUR 800mn). In addition, the IMF could transform the current Policy Coordination

Instrument, which does not involve financing, into an stand-by arrangement (SBA), which

could unlock EUR 1.2bn for a year. Serbia could also apply for funding from the EU solidarity

fund and, from 2021, it could draw from the pre-accession instrument III, which amounts to

EUR 12.9bn in total for pre-accession countries.

RSD ISSUANCE PLAN FOR 4Q20 REAL YIELDS ON SERGBS ATTRACTIVE

Source: NBS, ministry of finance, public debt agency, SORS, UniCredit Research



EUR bn 2019 2020F 2021F





Bonds 2.5 2.1 1.3

Bills 0.1 0.1 0.1

IFIs/others 0.1 0.7 0.5


Bonds 1.7 0 0.7




Bonds 3.0 2.7 3.2

Bills 0.1 0.1 0.1

Others 0 0.2 0


Bonds 1.7 3.0 1.0


Fiscal reserves change (- =increase) -0.3 0.4 0.1

EUR bn 2019 2020F 2021F


C/A deficit 3.2 2.9 3.0


Government/Central Bank 2.6 0.9 2.1

Banks 1.0 1.5 1.5

Corporates 0.9 1.2 1.2


Government/Central Bank 0 0 0

Banks 1.2 1.2 1.1



FDI (net) 3.6 2.2 2.9




Banks 1.1 0.9 1.4




Memoranda:

Nonresident purchases of LC govt bonds 0.3 0.2 0.3

International bond issuance, net 0 3.0 0.4

Source: Bloomberg, NBS, ministry of finance, public debt agency, SORS, UniCredit Research

0

20

40

60

80

100

120

140

160

180

5Y 12Y 2Y

EUR mn

0

1

2

3

4

5

6Ja

n-1

9

Fe

b-1

9

Ma

r-19

Apr-

19

Ma

y-1

9

Ju

n-1

9

Ju

l-1

9

Aug

-19

Sep

-19

Oct-

19

Nov-1

9

Dec-1

9

Jan-2

0

Fe

b-2

0

Ma

r-20

Apr-

20

Ma

y-2

0

Ju

n-2

0

Ju

l-2

0

Aug

-20

Sep

-20

Oct-

20

Nov-2

0

Dec-2

0

2023 2024

2025 2026

2028 2032

Inflation (% yoy)

Yield on government bonds (%)

September 2020


September 2020


CEE Quarterly

Turkey B2 negative/B+ stable/BB- negative*

Outlook

A sizable credit impulse, helped Turkey with a shallower GDP contraction in 2Q20 and a rather strong rebound in 3Q20.

However, it also amplified the inflationary pressures and external imbalances. Inflation could increase to 13.2% and current

account deficit might widen to 4.3% of GDP by the end of 2020. CBRT might deliver an additional 2pp rate hike by the end of

the year, if TRY depreciation persists. Tighter financial conditions will lead to a sharp deceleration in credit impulse and hence, a

slower growth path from 4Q20 onward

Strategy

Geopolitical risks might cause headwinds for Turkish assets in 4Q20. Additional tightening by the CBRT could help stabilize the

TRY and rates before the year end.

Author: Gökçe Çelik, Senior CEE Economist (UniCredit Bank, London)

KEY DATES/EVENTS


■ 22 Oct, 19 Nov, 24 Dec: monetary-policy decisions

■ 30 Nov: 3Q20 GDP

■ 4 Dec: rating review Moody’s

GDP GROWTH FORECAST

Source: Turkstat, UniCredit Research

INFLATION FORECAST

Source: Turkstat, CBRT, Bloomberg, UniCredit Research


EUR bn 2017 2018 2019 2020F 2021F

GDP (EUR bn) 759.1 660.3 680.1 569.4 535.8

Population (mn) 80.8 82.0 83.2 83.9 84.9



GDP 7.5 3.0 0.9 -3.4 2.8


Fixed Investment 8.3 -0.3 -12.4 -4.2 3.4


Exports 12.4 9.0 4.9 -14.7 14.7

Imports 10.6 -6.4 -5.3 -4.6 8.2


Real wage, change (%) 2.0 -0.4 2.7 -5.5 3.8



Budget balance -2.3 -3.4 -5.3 -7.1 -5.6

Primary balance -0.5 -1.5 -3.0 -4.1 -2.7

Public debt 28.2 30.2 32.8 41.3 41.4

External accounts

Current account balance (EUR bn) -35.9 -17.6 7.8 -24.7 -7.8

Current account balance/GDP (%) -4.7 -2.7 1.1 -4.3 -1.5

Extended basic balance/GDP (%) -3.7 -1.5 1.9 -3.8 -0.6

Net FDI (% of GDP) 1.0 1.2 0.7 0.5 0.8





CPI (pavg) 11.1 16.3 15.7 12.2 12.0

CPI (eop) 11.9 20.3 11.8 13.2 10.8




USD/TRY (eop) 3.85 5.29 5.95 7.80 8.70

EUR/TRY (eop) 4.56 6.07 6.67 9.51 11.14

USD/TRY (pavg) 3.65 4.84 5.68 7.10 8.06

EUR/TRY (pavg) 4.13 5.69 6.35 8.22 10.07

Source: Turkstat, CBRT, Turkey’s ministry of finance (MoF), Bloomberg, UniCredit Research

*Long-term foreign-currency credit ratings are provided by Moody’s, S&P and Fitch, respectively.

-6.0

-4.0

-2.0

0.0

2.0

4.0

6.0

8.0

10.0

2017 2018 2019 2020F 2021F


Fixed investment Net exports

Inventories GDPyoy (%)

-20.0

0.0

20.0

40.0

60.0

80.0

100.0

0.0

5.0

10.0

15.0

20.0

25.0

30.0

Jan-16 Jan-17 Jan-18 Jan-19 Jan-20 Jan-21

Annual inflation Inflation target TRY basket (rs)

Forecast

September 2020


September 2020


CEE Quarterly

Hitting the breaks

We now expect a smaller contraction in 2020 and a milder recovery in 2021 Economic activity might have reversed bulk of its 2Q20 losses in 3Q20 due to record high credit impulse Monetary tightening will slow recovery from 4Q20 onwards Layoff ban helps curb the surge in unemployment rate but employment losses are sizable

Sizable loan growth led to a shallower trough in GDP in 2Q20 and a faster rebound in 3Q20

than we previously expected. On the flip side, it also fed into import demand and inflationary

pressures, necessitating the partial reversal of monetary stimulus. Further tightening is likely,

which implies a slower recovery from 4Q20 onward, due to weaker credit impulse.

Consequently, we are now revising our GDP forecasts for a smaller contraction in 2020

(from -5.6% to -3.4%) and a slower expansion in 2021 (from 6.6% to 2.8%).

GDP could expand by 8% qoq in 3Q20, following an 11% contraction in 2Q20. High frequency

indicators such as capacity utilization, PMI and electricity consumption hinted at continued

recovery in the manufacturing sector in 3Q20. Moreover, confidence in real sector and

construction returned to their pre-pandemic levels while there is still slack in retail and service

sectors. Although consumer confidence remained low, house and car sales surged in the

summer, supported by the low retail loan rates.

Tighter lending conditions could disrupt the recovery in 4Q20 and 1Q21 because authorities

have started to roll back the monetary easing. The CBRT tightened liquidity conditions in August

and September, sending the average funding cost some 3.4pp higher from its mid-July levels,

which translated into a 6.1pp rise in consumer loan interest rates and 5pp in rise commercial

loan interest rates broadly around the same period. The average funding cost will increase

further, following the CBRT’s surprise rate hike in its September meeting, sending the loan and

deposit interest rates higher and credit impulse lower. Since the government’s support package

has been heavily reliant on bank lending, tighter financial conditions will limit its ability to keep

the economy growing at 3Q20 rates. Direct fiscal support measures have reached 4.7% of GDP

so far. However, these measures include tax and premium deferrals (1.5% of GDP) which are

expected to be paid in 4Q20. Thus, the economic activity could lose momentum in the final

quarter of this year and follow a slower growth path in 2021.

The government has been gradually expanding the direct support measures targeting the

labor market. According to the latest presidential decree, the layoff ban, along with the

furlough benefits, will remain in place until mid-November, while the short term work

payments will continue until the end of October. The Unemployment Insurance Fund paid

1.9mn people TRY 4.4bn of furlough benefits from April to August while TRY 18.5bn was paid

under the short time work scheme. We think the government might extend the layoff ban at

least until the year end to limit the rise in unemployment rate. As a result, the unemployment

rate could increase from 13.7% in 2019 to 14.5% this year, before rising to 16% in 2021.

However, the overall picture is bleaker than this forecast implies due to the drop in labor force

participation. 2.6mn people dropped out of the labor force in 1H20 while the number of

employed decreased by 2.5mn. If the labor force remained at its end-2019 level, the

unemployment rate would end 2020 at 18% and fall to 17.7% in 2021.

STRONG REBOUND FROM TROUGH IN DOMESTIC DEMAND CREDIT IMPULSE HAS PEAKED IN 3Q20

Source: CBRT, TurkStat, UniCredit Research

0

50

100

150

200

250


Car sales House salesSA ('000)

-20.0

-15.0

-10.0

-5.0

0.0

5.0

10.0

15.0

20.0

Mar-08 Mar-10 Mar-12 Mar-14 Mar-16 Mar-18 Mar-20

Corporate credit impulse Consumer credit impulse%

September 2020


September 2020


CEE Quarterly

The recovery in domestic demand has helped tax revenues in 3Q20 but budget deficit is to widen further Loose lending conditions amplified the deterioration in external imbalances… …and in inflation outlook. The CBRT might deliver another 2pp rate hike in 4Q20 if TRY weakness continues

The budget deficit increased to 3.8% of GDP (IMF defined: 5.6%) in August, from 2.9% in 2019. The tax

revenues (particularly those sensitive to domestic demand conditions such as special consumption and

import tax) picked up faster than we initially expected. Consequently, we revise our 2020 budget deficit

forecast from 6.1% of GDP to 5.6% (IMF defined: from 7.7% to 7.1%). We opted for a limited revision as

weaker activity in 4Q20 might weigh on tax revenues while requiring spending to remain elevated as the

credit impulse may drop sharply. The budget deficit could narrow to 4.2% in 2021.

The current account deficit could increase further in 2H20. Despite the recovery in exports since

May, non-energy trade balance has widened as loose financial conditions have fed into the

demand for core and gold imports. Meanwhile, foreign visitors have started to come back in late

summer, but only very slowly, as Turkey was still on the EU’s “caution” list. As a result, the current

account deficit could widen from 2% of GDP in July to 4.3% at the end of this year. In 2021, service

revenues could reverse most of their losses in 2021 and trade balance could improve due to slower

economic activity, bringing the current account deficit to 1.5% of GDP next year.

Despite real wages falling and likely momentum loss in economic activity, annual inflation could

rise to 13.2% by the end of 2020 due to cost push factors (especially a weaker TRY) as hinted by

the acceleration in PMI price indices and domestic producer prices. Both headline and core

inflation might remain around above 13% for most of 1H21, before decelerating gradually from

June onwards. However, they are unlikely to return to the single digits before 2022, in the absence

of an appealing real yield and a stable currency to anchor inflation expectations. Lower inflation

requires a longer adjustment in domestic demand, a policy option which the policymakers would not

sign up for, in our view.

The CBRT hiked its policy rate by 2pp, in a surprise move in September and it might deliver a

similar hike by the year-end, in our view. In the meantime, the central bank will likely continue with

liquidity tightening, pushing the average cost of funding towards the late-liquidity window (LLW) rate

(13.25%) as the inflation will trend upward. However, the risk of additional TRY weakness,

particularly due to geopolitical risks, and the inflation outlook for 1H21 could require rates to go

above the current interest-rate corridor. The CBRT could roll back the hikes in 2H21, bringing the

weekly repo rate to 8% and the LLW rate to 11.25% as the inflation and current account deficit

decline gradually. However, these rates would imply negative real yields and could renew

depreciation pressure.

On the foreign policy front, the ongoing tension with Greece over the maritime rights in the eastern

Mediterranean has eased over the recent weeks as the two countries agreed to hold exploratory talks.

EU sanctions on Turkey remain a material risk, despite the de-escalation of tensions. In case

sanctions are imposed, the EU is likely to opt for a package with limited economic impact, in our view.

Meanwhile, the US presidential elections might factor in as a particular source of uncertainty for

Turkey as the outcome could require a reassessment of foreign policy challenges.

LOAN GROWTH HAS FED INTO NON-ENERGY IMPORT DEMAND AVERAGE FUNDING COST IS TO INCREASE FURTHER

Source: Turkstat, CBRT, Bloomberg,UniCredit Research

-5

0

5

10

15

20

25

30

35

40

45-8.0

-7.0

-6.0

-5.0

-4.0

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

Mar-08 Mar-10 Mar-12 Mar-14 Mar-16 Mar-18 Mar-20

Non-energy trade balance (% GDP)

Loan growth (FX adj, 3M/3M yoy,rs inverted)

0

5

10

15

20

25

30

Jan-17 Jul-17 Jan-18 Jul-18 Jan-19 Jul-19 Jan-20 Jul-20

%

1-week repo O/N borrowing

O/N lending Late liquidity window

Average funding cost

September 2020


September 2020


CEE Quarterly

More headwinds for TRY in 4Q20

The government continued borrowing from domestic market The share of FX borrowing from the locals has increased

The government has continued to rely on domestic issuance to finance the widening budget

deficit in 3Q20. The Turkish treasury borrowed TRY 383bn against its TRY 203bn debt

service, which implies a 190% domestic debt rollover ratio in the first nine months of the year.

The support from CBRT purchases is done as the central bank has not added to its bond

portfolio since July. Meanwhile, foreigners’ TURKGB holdings continued to fall, albeit at a

slower pace as their share is already down to almost 3%.

Almost 40% of the year to date borrowing was done via FX or gold denominated issuance,

implying the treasury opted to tap the locals rather than the international markets. While it

serves the treasury to avoid higher financing cost due to Turkey’s elevated risk premium, it

bodes ill for the exchange rates especially during a period when FX supply is scarce due to

capital outflows. Meanwhile, the private sector’s external debt repayments will increase to

USD 14bn in 4Q20, from USD 9.9bn in 3Q20.

Turkish assets might remain prone to fluctuations in global risk sentiment in 4Q20 due to

increasing external financing needs and challenging foreign policy risks. Additional tightening

by the CBRT could help stabilize the TRY and interest rates before the end of this year.

FOREIGN INVESTORS’ TURKGB HOLDINGS AT THEIR LOWEST

HIGHER EXTERNAL DEBT PAYMENTS BY PRIVATE SECTOR IN 4Q20

Source: CBRT, Bloomberg, UniCredit Research



EUR bn 2019 2020F 2021F




Domestic 13.0 20.9 20.5

Bonds 11.1 18.0 18.2

Bills 1.9 2.8 2.2

Loans 0 0.0 0.0


Bonds 3.7 3.9 5.1

Loans 1.9 0.5 0.5

Financing 53.2 60.1 53.1


Bonds 28.6 44.8 35.2

Bills 3.0 2.6 2.0

Loans 0 0.0 0.0


Bonds 9.2 4.9 7.2

Loans 0.9 0.4 0.7

Privatization/Other 16.0 7.4 7.2

Fiscal reserves change (- = increase) -4.5 0.0 0.9

EUR bn 2019 2020F 2021F


C/A deficit -7.9 24.7 7.8



Banks 33.6 25.1 17.2



Financing 157.0 171.3 142.2

FDI (net) 5.3 3.1 4.5



Government/central bank 7.4 -1.9 10.9

Banks 25.6 18.9 15.6



Other -6.7 0.0 0.0

Change in FX reserves (- = increase) -5.6 35.4 0.5

Memoranda:

Nonresident purchases of LC govt bonds -2.8 -7.2 3.0


Source: CBRT, Turkey’s MoF, UniCredit Research

250.0

350.0

450.0

550.0

650.0

750.0

850.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0


Foreign banks

Non-banking sector (foreign)

Local banks (rs)

TURKGB holdings of foreign investors adjusted for price changes, TRY bn

0

1

2

3

4

5

6

7

Aug-20 Oct-20 Dec-20 Feb-21 Apr-21 Jun-21

Banks CorporatesRepayment of external loans (USD bn)

September 2020

UniCredit Research page 74

September 2020


CEE Quarterly

Acronyms and abbreviations used in the CEE Quarterly

■ BNB – Bulgarian National Bank

■ C/A – current account

■ CBR – Central Bank of Russia

■ CBRT –Central Bank of the Republic of Turkey

■ CE – Central Europe

■ CEE – Central and Eastern Europe

■ CNB – Czech National Bank

■ DM – developed markets

■ EA – euro area

■ EC – European Commission

■ ECB – European Central Bank

■ EDP – Excessive Deficit Procedure of the European Commission

■ EM – emerging markets

■ EMU – European Monetary Union

■ EU – European Union

■ FCL – Flexible Credit Line (from the IMF)

■ FDI – foreign direct investment

■ IFI – international financial institutions

■ IMF – International Monetary Fund

■ MoF – Ministry of finance

■ NBH – National Bank of Hungary

■ NBP – National Bank of Poland

■ NBR – National Bank of Romania

■ NBS – National Bank of Serbia

■ NBU – National Bank of Ukraine

■ PLL – Precautionary and Liquidity Line (from the IMF)

■ PM – prime minister

■ PPP – public – private partnership

■ qoq – quarter on quarter

■ sa – seasonally adjusted

■ SBA – Stand-by Arrangement (with the IMF)

■ SOE – state-owned enterprise

■ WB – World Bank

■ yoy – year on year

■ ytd – year to date

September 2020


September 2020


CEE Quarterly

Legal Notices

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September 2020


September 2020


CEE Quarterly

Banking network

UniCredit Group CEE banking network – Headquarters

Azerbaijan

Yapi Kredi Azerbaijan Yasamal District, Jafar Jabbarlı Str., 32/12, AZ 1065, Baku/Azerbaijan Phone +994 12 497 77 95 Emai: [email protected] www.yapikredi.com.az

Bosnia and Herzegovina

UniCredit Bank d.d. Kardinala Stepinca - bb, BH-88000 Mostar Phone: +387 33 222 999 Emai: [email protected] www.unicreditbank.ba

UniCredit Bank Banja Luka Marije Bursac 7 BA-78000 Banja Luka Phone: +387 80 051 051 Emai: [email protected] www.unicreditbank-bl.ba

Bulgaria

UniCredit Bulbank Sveta Nedelya Sq. 7 BG-1000 Sofia Phone: +359 70 01 84 84 www.unicreditbulbank.bg

Croatia

Zagrebačka banka d.d. Trg bana Josipa Jelačića 10 HR-10000 Zagreb Phone: +385 1 6104 169 Emai: [email protected] www.zaba.hr

Czech Republic

UniCredit Bank Želetavská 1525/1 CZ-140 92 - Prague 4 Phone: +420 955 911 111 Emai: [email protected] www.unicreditbank.cz

Hungary

UniCredit Bank Szabadság tér 5-6 H-1054 Budapest Phone: +36 1 301 12 71 Emai: [email protected] www.unicreditbank.hu

Romania

UniCredit Bank 1F, Blvd. Expozitiei RO-012101 Bucharest 1 Phone: +40 21 200 2000 Emai: [email protected] www.unicredit.ro

Russia

UniCredit Bank Prechistenskaya nab. 9 RF-119034 Moscow Phone: +7 495 258 7258 Emai: [email protected] www.unicreditbank.ru

Serbia

UniCredit Bank Rajiceva 27-29 RS-11000 Belgrade Phone: +381 11 3204 500 Emai: [email protected] www.unicreditbank.rs

Slovakia

UniCredit Bank Sǎncova 1/A SK-813 33 Bratislava Phone: +421 2 4950 1111 www.unicreditbank.sk

Slovenia

UniCredit Bank Šmartinska Cesta 140 SI-1000 Ljubljana Phone: +386 1 5876 600 Emai: [email protected] www.unicreditbank.si


http://www.zaba.hr/

September 2020


September 2020


CEE Quarterly

Contacts for entering into a business relationship with UniCredit’s corporate banking network (UniCredit International Centers)

UniCredit International Center CEE

Roberto Poliak Phone: +43 50505 51030 Email: [email protected] Email: [email protected]

UniCredit International Center Austria

Botond Vincze Phone: +43 50505 58005 Email: [email protected]

UniCredit International Center Germany

Holger Frank Phone: +49 89 378 20141 Email: [email protected]

UniCredit International Center Italy Alessandro Paoli Phone: +39 366 5265414 Email: [email protected]

Bosnia and Herzegovina

UniCredit Bank d.d. Berna Hadžimujagić Phone: +387 33 491 990 Email: [email protected]

UniCredit Bank a.d. Banja Luka Boris Dragić Phone: +387 51 243 320 Email: [email protected]

Bulgaria

Emiliano Steinfl Phone: +359 2 930 97 19 Email: [email protected]

Croatia

Roberta Cupic Phone: +385 1 6305 029 Email: [email protected]

Czech Republic

Jan Świerczyna Phone: +420 602820212 Email: [email protected]

Hungary

Andrea D’Alessandro Phone: +36 1301 1207 Email: [email protected]

Romania

Alessandro Masotti Phone: +4 021 200 1616 Email: [email protected]

Russia

Fabrizio Rollo Phone: +7 495 723 7126 Email: [email protected]

Serbia

Luciano Bellan Phone: +381 11 3028 645 Email: [email protected]

Slovakia

Jan Świerczyna Phone: +420 602820212 Email: [email protected]

Slovenia

Natasa Markov Phone: +386 1 5876 874 Email: [email protected]


September 2020


September 2020


CEE Quarterly

UniCredit Research* CEE Macro & Strategy Research

Erik F. Nielsen Group Chief Economist Global Head of CIB Research +44 207 826-1765 [email protected]

Dr. Ingo Heimig Head of Research Operations & Regulatory Controls +49 89 378-13952 [email protected]

Head of Macro Research Heads of Strategy Research

Marco Valli Head of Macro Research Chief European Economist +39 02 8862-0537 [email protected]

Dr. Luca Cazzulani Co-Head of Strategy Research FI Strategist +39 02 8862-0640 [email protected]

Elia Lattuga Co-Head of Strategy Research Cross Asset Strategist +44 207 826-1642 [email protected]

EEMEA Economics Research

Dan Bucşa Chief CEE Economist +44 207 826-7954 [email protected]

Gökçe Çelik Senior CEE Economist +44 207 826-6077 [email protected]

Mauro Giorgio Marrano Senior CEE Economist +43 50505-82712 [email protected]

Artem Arkhipov Head, Macroeconomic Analysis and Research, Russia +7 495 258-7258 [email protected]

Hrvoje Dolenec Chief Economist, Croatia +385 1 6006-678 [email protected]

Dr. Ágnes Halász Chief Economist, Head, Economics and Strategic Analysis, Hungary +36 1 301-1907 [email protected]

Ľubomír Koršňák Chief Economist, Slovakia +421 2 4950 2427 [email protected]

Anca Maria Negrescu Senior Economist, Romania +40 21 200-1377 [email protected]

Kristofor Pavlov Chief Economist, Bulgaria +359 2 923-2192 [email protected]

Pavel Sobíšek Chief Economist, Czech Republic +420 955 960-716 [email protected]

Cross Asset Strategy Research

Elia Lattuga Co-Head of Strategy Research Cross Asset Strategist +44 207 826-1642 [email protected]

UniCredit Research, Corporate & Investment Banking, UniCredit Bank AG, Am Eisbach 4, D-80538 Munich, [email protected] Bloomberg: UCCR, Internet: www.unicreditresearch.eu

CEE 20/1

*UniCredit Research is the joint research department of UniCredit Bank AG (UniCredit Bank, Munich or Frankfurt), UniCredit Bank AG London Branch (UniCredit Bank, London), UniCredit Bank AG Milan Branch (UniCredit Bank, Milan), UniCredit Bank AG Vienna Branch (UniCredit Bank, Vienna), UniCredit Bank Austria AG (Bank Austria), UniCredit Bulbank, Zagrebačka banka d.d., UniCredit Bank Czech Republic and Slovakia, ZAO UniCredit Bank Russia (UniCredit Russia), UniCredit Bank Romania.

https://www.unicreditresearch.eu/

the long and winding recovery

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