The economic outlook for Europe and Central Asia, including the impact of China

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1 ECA Economic Update April 216 The economic outlook for and, including the impact of China Hans Timmer Chief Economist and Region April 7, 216 Kiev, Ukraine 1

2 Overview Low growth is expected in and (ECA), as global headwinds remain strong. The headwinds are of structural, rather than cyclical nature. They are part of the new normal. This is also true for the slowdown in China, which has a pervasive impact on ECA. The impact creates both opportunities and challenges. Policies have to adjust to new circumstances. 2

3 Subdued growth in new forecast 3

4 Consumption has sharply declined in Eastern and Annual growth rates, Ukraine Belarus n Federation Azerbaijan Moldova Kazakhstan Armenia Georgia Kyrgyz Republic Turkey Tajikistan Uzbekistan GDP growth (%) Private consumption growth (%) 4

5 Euro Area export growth now outpaces global average Percentage points difference between growth export volume euro area and global export growth, 12m/12m m12 26m12 29m12 212m12 215m

6 Strong growth of agriculture in the east Percentage change in UKR BLR RUS MDA KAZ AZE GEO KGZ ARM TUR TJK UZB Agriculture Industry Services GDP 6

7 Big shifts in relative prices are affecting consumption and exports Collapse in oil revenues amounts to large terms-of-trade losses and sharp depreciations. Reductions in remittances (deflated by import prices) imply large declines in household incomes. Diverging monetary policies and reversals of capital flows lead to changes in competitiveness. 7

8 Ruble exchange rate closely follows oil price Monthly percentage change Daily percentage changes US$ per ruble brent oil price in US$ US$ per ruble brent oil price in US$ 8

9 Sharp declines in remittances in 215 Percentage growth in 215 of remittances, deflated by import price BLR ARM UKR MDA KGZ GEO

10 Change of real effective exchange rate (%) an export growth accelerates as U.S. and Chinese exports slow down 15 CHN USA CZE POL DNK HUN SLK FIN NLD -5 ESP ITA DEU SWE Change of export volume growth (%) 1

11 Banks need to rethink monetary policy Relative price changes might require changes in monetary policy regimes: Oil-exporting and remittance-receiving countries need flexible exchange rate in wake of fall in oil prices. Banks in oil-exporting countries might consider oil price in local currency as a new policy target. Other Banks could reconsider inflation target, with more emphasis on the GDP deflator and housing prices. 11

12 Large differences in 215 between GDP and CPI deflators change in 215 over 214 GDP deflator CPI difference percent percent percentage point Norway Canada Netherlands United States Japan Germany Sweden

13 Home prices recovering in most countries, but falling in oil-exporting countries 13

14 Labor markets affected by cyclical and structural factors Unemployment in an Union is declining as the EU enters fourth year of recovery. Crisis in many countries in eastern part of region starts showing in rising unemployment. Digital technologies, sharing economy, migration, and globalization will fundamentally change labor markets, and requires new social contract. 14

15 Unemployment falling in the west and rising in the east Percentage points 1. Change Change Change Change Kazakhstan Ukraine Turkey n Federation Belarus Moldova

16 Growth moderation and rebalancing in China Slowdown is result of slower expansion of production capacity Rebalancing entails Shift from investments to consumption Shift from low-skilled to high-skilled production Shift from inward FDI to outward FDI 16

17 Slowdown in China coincides with decelerating potential growth Annual percentage change potential GDP growth actual GDP growth 17

18 China is catching up to the an Union China s nominal GDP as percentage of EU s nominal GDP starting share cumulative volume effect cumulative price effect 18

19 China s share of imports by ECA has expanded rapidly Share of imports from China in total imports, percent Eastern Northern South Caucasus Southern Turkey Balkans 19

20 But region can export even more to China Exports are not as big as gravity model predicts. There seem to be special factors impeding exports to China. Sharp real depreciations vis-à-vis China have made producers much more competitive. 2

21 Eastern ECA may have greater potential than western ECA to increase exports to China Exports to China by sector from ECA sub-regions, US$ million Eastern Northern Agriculture Caucasus Turkey Balkans Eastern Northern Natural Resources Caucasus Turkey Balkans Actual Predicted Actual Predicted Low Skill Manufacturing High Skill Manufacturing Eastern Northern Caucasus Turkey Balkans Eastern Northern Caucasus Turkey Balkans Actual Predicted Actual Predicted 21

22 China s potential to increase import penetration in ECA is limited Imports from China by sector from ECA sub-regions, US$ million Agriculture High Skill Manufacturing Eastern Northern Caucasus Turkey Balkans Eastern Northern Caucasus Turkey Balkans Actual Predicted Actual Predicted Low Skill Manufacturing Natural Resources Eastern Northern Caucasus Turkey Balkans Eastern Northern Caucasus Turkey Balkans Actual Predicted Actual Predicted 22

23 Azerbaijan Belarus n Federation Kazakhstan Ukraine Georgia Moldova Kyrgyz Republic Poland Turkey Sweden Cyprus Romania Greece Hungary Spain Bosnia and Herzegovina Lithuania Croatia Slovenia Estonia Slovak Republic Macedonia, FYR Ireland Finland France Bulgaria Germany Italy Latvia Denmark Luxembourg Portugal Netherlands Austria Malta Belgium Czech Republic Albania United Kingdom Armenia Tajikistan ECA currencies depreciated sharply over past year Percent change in real exchange rate with China, Jan-Feb 215 to Jan-Feb

24 Exchange rate depreciation has created opportunities to compete with imports Percent change in potential imports as a result of real exchange rate depreciation in ECA Agriculture Natural Resources Eastern Northern Caucasus Turkey Balkans Eastern Northern Caucasus Turkey Balkans High Skill Manufacturing Low Skill Manufacturing Eastern Northern Caucasus Turkey Balkans -16 Eastern Northern Caucasus Turkey Balkans 24

25 Exchange rate depreciation could boost ECA s exports to China Percent change in volume of total exports Agriculture Natural Resources Eastern Northern Caucasus Turkey Balkans Eastern Northern Caucasus Turkey Balkans Low Skill Manufacturing High Skill Manufacturing Eastern Northern Caucasus Turkey Balkans Eastern Northern Caucasus Turkey Balkans 25

26 China s slowdown has a mixed impact on ECA s exports Percentage difference in export volumes in slowdown compared to business as usual scenario Kazakhstan Azerbaijan Kyrgyz Republic Ukraine Poland Bulgaria Turkey and Other ECA EU and EFTA

27 Change in private consumption relative to business as usual scenario Percent 8 Full Rebal Slow Down n Federation Kazakhstan Azerbaijan Kyrgyz Rep Ukraine EU and EFTA 27

28 China s slowdown improves wages, particularly of unskilled workers Percent change in China slowdown versus business as usual scenarios wage/rental rate unskilled/skilled wages Kazakhstan Azerbaijan Kyrgyz Republic Ukraine Poland Bulgaria Turkey and Other ECA EU and EFTA 28

29 Conclusions Expected slow GDP growth tells only part of the story. Big changes in relative prices have far-reaching consequences. Slowdown and rebalancing in China are key elements of structural changes in global environment. There are some silver linings in the outlook. Unemployment is declining in EU and export opportunities are improving. Policies challenges most complicated for Eastern and. 29

30 ECA Economic Update April 216 Thank you! Hans Timmer Chief Economist and Region April 7, 216 Kiev, Ukraine 3