Emerging Europe Sees Stronger Growth Ahead, but Faces New Risks

Much of the region growing at a healthy pace; CIS economies face challenges

Growth expected to turn positive next year, but new risks have emerged

Countries face fiscal challenges; growth-friendly budgets needed

Growth for the region as a whole, however, is expected to turn positive next year, as CIS economies stabilize and start recovering (see Table).

In CEE, Turkey, and most of the Southeastern European (SEE) countries, growth is driven by robust domestic demand, supported by low oil prices and improved prospects in the euro area. In addition, in several European Union (EU) countries, growth is boosted by an increased absorption of EU structural and cohesion funds.

Meanwhile, in CIS, domestic demand is contracting, as Russia’s economy adjusts to low oil prices and Western sanctions, and Ukraine struggles with multiple challenges related to ambitious reforms, significant macroeconomic adjustment and economic dislocations in the East.

Risks have increased

The growth forecast is little changed from the spring 2015 projections, but the risks have shifted to the downside, as new risks have emerged. Even though direct trade links with China are relatively small, commodity exporters (Russia) and more open economies (the Czech and Slovak Republics, Hungary) would be most affected by a decline in the import demand from China. The region remains also vulnerable to contagion from possible renewed volatility in emerging markets that could result in capital outflows and liquidity strains on sovereigns and leveraged firms. In addition, the refugee crisis in Europe could put pressure on public finances and disrupt trade flows, at least in the short-run, as countries struggle to secure their borders.

Policies need to be tailored

Policy priorities depend on how far along the countries are in their post-crisis adjustment and on their exposure to external risks. Where the recovery is well advanced, priorities increasingly shift toward the medium term, including rebuilding fiscal buffers and continuing with structural reforms. At the same time, key crisis legacies––high nonperforming loans and debt overhangs––require further work in some countries (notably in SEE).

For economies that are in recession, the key challenge is to steer the adjustment to terms-of-trade and other shocks with a view to supporting weak demand and reducing high inflation. Countries vulnerable to external shocks need to be prepared to deal with market pressures by using exchange...