SEB

Eastern European Outlook, March 2015: Baltics and Central Europe resilient to Ukraine conflict and Russian recession

The Baltic countries and Central Europe are continuing to show good resilience to the Russia-Ukraine conflict as well as Russia's food import sanctions and accentuated economic weakness. This is mainly because of favourable economic conditions, including strong real household incomes (especially in the Baltics) that are allowing robust private consumption. Looking ahead, the prospect of improving exports to Germany will also provide support. But overall growth rates will be modest during the next couple of years as exports to Russia fall and weak business investments strengthen only slowly due to geopolitical turmoil in the region, writes SEB in the latest issue of its twice-yearly Eastern European Outlook.

As in the rest of Europe, inflation will remain very low in the Baltics and Central Europe, especially due to low energy prices. In Estonia, however, inflation will rebound relatively fast as a result of an increasingly tight labour market, with continued emigration contributing to increased labour shortages and continued high wage and salary growth. All three Baltic countries are struggling with emigration problems and underlying weak demographic trends. 

SEB still expects the Russia-Ukraine conflict to be long-lasting and the ceasefire to be fragile.

"Sanctions policies are increasingly difficult to assess. This is because of a trend towards widening divisions within the European Union on a unified stance towards Russia, both for national economic and political reasons. Our main scenario is that Western sanctions will remain in place at least during 2015," says Mikael Johansson, Head of Eastern European Research at SEB and Chief Editor of Eastern European Outlook.

Russia is moving towards a large GDP decline this year due to the oil price downturn, the rouble-driven inflation shock and continued Western financial sanctions. Strong government financial reserves will provide protection over the next couple of years. But these reserves are meanwhile being drained and the Russian economy - already plagued by major structural problems - will be in far more fragile condition when it emerges from recession in 2017.

"Support for President Vladimir Putin remains strong, driven by his handling of Ukraine and his aggressive stance towards the West. Meanwhile the opposition has weakened greatly in recent years and will have difficulty organising in time for the 2016 parliamentary election, so there is little domestic political risk during the next couple of years," says Andreas Johnson, who is in charge of Russia and Ukraine forecasts at SEB Economic Research.