A Changed Global Landscape: Policy Priorities in CESEE

IMF News, May 23, 2025

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After a respectable recovery last year, the IMF downgraded growth for 2025 and 2026 across Europe; heightened uncertainty and trade policy volatility are the main factors.
The downgrade for the CESEE region has been more sizeable than for advanced Europe: from over 3 percent in 2025 and 2026 to 2.4 and 2.7 percent respectively.
The larger impact is primarily due to a comparatively larger manufacturing sector. The growth revision would have been even larger if not for the German infrastructure package and an acceleration of Europe wide-defense spending.
Inflation in CESEE countries is coming down somewhat faster, but inflation rates will remain above targets for some time; persistent services inflation and lagged effects of still high wage growth are key drivers and a risk to competitiveness.

Direct exposure to US tariffs:
- Exposures are especially large in the Slovak Republic and Hungary.
- Exports to the US (primarily cars, car parts, batteries, and in the case of Hungary electronics) account for about 3 per cent of GDP in 2024.
- Czechia and Hungary also have large export positions to the US via smartphones and computers exports; tariffs on these items have been exempted per the announcement made on April 11.
- Any increase in tariffs would have substantial dampening effects on growth.
Indirect effects via supply chains and trade diversion:
- An increase in EV imports from China could have significant GDP effects in the range of 1-1½ percent over 5 years via supply chains in CESEE countries heavily reliant on the automotive sector.
- A slowdown in Germany’s automotive sector has about a 5-10 times larger impact in percent of GDP in Slovakia and Hungary given their larger share of the sector relative to Germany.
- If US-China trade tensions persist, channels of trade diversion include: higher EU imports from China; U.S. companies seeking new export destinations including in Europe; European firms seeking new export opportunities in the U.S. and China; increased competition on third-country markets (e.g., Turkish businesses competing in third markets).

Preliminary IMF estimates from the April 8 tariff announcements for the EU are for higher imports from China of around 0.25 percent of EU GDP in the near term.
The 90-day rollback of most bilateral tariffs announced by the US and China on May 12 implies lower numbers; the April-8 figure decreases to 0.09 percent with the May-12 tariffs.
Trade diversion would also affect inflation: headline inflation could be reduced by 20 basis points in 2026.
Aggregate trade diversion effects appear manageable overall, but impacts could be large in individual countries and sectors; effects for consumers and producers are mixed (lower final goods prices vs. increased competition and large adjustment costs in some sectors).

Overarching principle: maintain trade openness as much as possible; protectionism will hurt inward investment, lower investment further, and bring down productivity and income growth.
Monetary policy:
- Central banks need to remain focused on durably reaching price stability targets.
- In several large CESEE countries—including Hungary—inflation is slowing, but is still above targets.
- Central banks should ease cautiously because core inflation remains higher than hoped for and inflation expectations are responsive to current inflation.
- Still high wage growth requires close attention; increases have outpaced productivity and contribute to inflation persistency and higher labor costs, posing a risk to competitiveness.
Fiscal policy:
- Rebuilding fiscal buffers remains a priority for many countries.
- Long-term spending pressures are rising from aging, healthcare, climate, and higher defense spending.
- Some countries can accommodate temporary increases in priority spending while keeping debt sustainability in mind; for many CESEE countries space is limited.
- Recommended smart adjustments: (i) make public services more efficient and programs better targeted; (ii) reallocate spending priorities away from low priority areas; (iii) boost fiscal revenues—often without raising tax rates by closing loopholes and improving administration.

Europe’s medium-term concerns: low growth, dwindling labor supply because of aging, slowing investment, and very low productivity growth over the last two decades.
Spending needs are expected to rise significantly over the next decades: for advanced economies by 5¾ percentage points and for emerging economies by 8 percentage points of GDP.
In CESEE, energy-related investment needs are urgent and very large; defense spending is also on the rise.
Domestic structural reforms offer large untapped growth potential:
- A forthcoming study finds comprehensive national reforms could raise real GDP levels by about 5 percent in advanced economies and between 6.6 and 9.3 percent in the CESEE region.
- Priority reform areas: labor market and skill-upgrading reforms; fiscal-structural reforms and lower cost of business regulations; reducing corruption and inefficiencies through governance reforms.
- Successful implementation requires political will and, in some cases, capacity building; overcoming reform inertia is characterized as “the challenge” of Europe.

The EU budget could play a catalyzing role; recent initiatives such as the Recovery and Resilience Facility (RRF) have strengthened policy performance.
The next Multiannual Financial Framework (MFF) for 2028-2034 should build on this momentum and further embed a performance-based approach, especially where current incentives are weak and outcomes depend on effective effort.
For pre-allocated funds tied to national plans, stronger performance incentives can help ensure investments yield meaningful results.
To maximize impact, the budget could reward projects that complement EU-level objectives (for example, streamlining permitting processes for local distribution networks that connect with cross-border energy infrastructure).
Policy coherence across national, regional, and local levels is essential; the EU budget can set incentives, but decisions and ownership need to be made at home.

The CESEE region faces a changed global landscape with heightened uncertainty and trade volatility; impacts vary widely across countries and sectors.
Policymakers should:
- Preserve trade openness and expand trade agreements.
- Keep support measures temporary and targeted, recognizing they cannot substitute for underlying fundamentals.
- Remain cautious on monetary easing while restoring fiscal buffers and implementing smart spending adjustments.
- Prioritize domestic structural reforms to unlock sizable medium-term growth gains.
- Use the EU budget and performance-based incentives in the MFF 2028-2034 to catalyze and sustain reforms.
The aggregate size of trade diversion appears manageable, but preparedness is warranted given potential large impacts in specific countries and sectors.

Speech by Alfred Kammer, Director, European Department, May 23, 2025.