Short-term Policy Responses to Geoeconomic Shocks in CESEE Countries

IMF News, February 26, 2025

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CESEE growth accelerated from 0.8 percent in 2023 to 2.5 percent in 2024.
Baseline forecast for 2025: around 3 percent, supported by some remaining pent-up demand.
Cyclical recovery largely run its course for three reasons:
- Household spending recovery is nearly complete; wage growth is slowing alongside inflation and uncertainty has raised precautionary savings.
- Business investment is not expected to accelerate further despite improved financing conditions, because firms remain cautious due to diminished growth expectations and uncertainty about trade policies and EU reforms.
- External demand remains weak, limiting reliance on exports for additional growth.
Heterogeneity across countries:
- Albania, Croatia, Montenegro, Bosnia and Herzegovina will continue to benefit from remittances, EU support, and tourism revenues, offering some insulation from external risks.
- Poland, Romania, Bulgaria, and Hungary saw wages grow by more than 10 percent last year (partly due to large public sector and minimum wage increases (RHS)), but these earning gains are not expected to translate into faster consumption growth.

Three key vulnerabilities:
- Rising labor and high energy costs are eroding competitiveness.
- High trade openness and deep integration into global value chains increase exposure to external demand shocks.
- Limited room to return to accommodative macroeconomic policies after recent shocks.
Cost competitiveness and trade effects:
- Net exports subtracted about ½ percentage point from GDP growth last year.
- Energy costs in Europe remain significantly higher than in the US—nearly five times more for natural gas and more than double for electricity (CHART).
- The real effective exchange rate (REER) relative to unit labor costs (CHART) has deteriorated for the region.
- If the REER continues to appreciate by 2 percentage points per year, as observed over the past five years, export growth could be dampened by approximately 0.6-0.8 percentage points per year.
Sectoral and supply-chain risks:
- A recent IMF study shows Chinese EV imports could have very large GDP effects on CESEE countries through the supply chain.
- Estimated negative impact on Hungary and the Czech Republic from a shift to EVs is about 10 times larger than in advanced European economies, reducing GDP by 1.5 to 2.0 percent (cumulatively) over 5 years.

Fiscal situation:
- Despite the recovery, fiscal balances have not improved (LHS) and long-term fiscal spending needs remain high [RHS], mostly aging-related (health and pensions), security-related (defense) and climate-related.
- Fiscal consolidation is necessary but not sufficient; discussion on the next EU budget and expenditures on European public goods (defense, environment) is important.
Monetary policy guidance:
- Monetary policy needs to move cautiously in removing its restrictive stance.
- Weakening external demand is likely to be disinflationary (barring sharp currency depreciations), but inflation persistence remains a concern—especially where inflation expectations remain above inflation targets (RHS) and sustained wage growth is not supported by productivity gains.
Central bank role:
- Effective communication is crucial; clear communication and scenario/sensitivity analyses help steer expectations amid uncertainty.
- Maintaining central bank independence is essential; pressures on institutional independence have risen in several countries, and lower trust in central banks increases the costs of achieving price stability.

Short-term policy priorities:
- Reduce uncertainty through clear communication and credible, sustainable macroeconomic policies.
- Pursue fiscal consolidation while protecting growth-enhancing and resilience-building priorities.
- Move cautiously on monetary policy removal of restrictive stance, with focused communication to anchor expectations.
- Moderate public sector wage raises to signal restraint to the private sector where warranted.
Structural reforms to raise growth potential and resilience:
- Accelerate structural reforms to address gaps where the CESEE region lags European and global peers (see chart).
- Targeted reforms in governance and trade-related barriers, and development of credit and capital markets, can unlock investment and long-term competitiveness gains with limited fiscal costs.
Ongoing work:
- IMF undertaking new work assessing national structural reform priorities across Europe, complementing work on what can be done at the EU level.

Speech by Alfred Kammer, Director, IMF European Department, Amsterdam, February 14, 2025 — posted February 26, 2025.