Autumn 2022
More than a cold winter lies ahead for new EU members and the Balkans
Higher energy prices are forcing an economic readjustment for many central and eastern European states, writes Miroslav Singer, former governor of the Czech National Bank.
The challenges for monetary policy when US gas prices are only one-tenth of Europe’s are testing for all European central banks. Especially so for the ‘new’ European Union states, since these economies depend on industry to a higher degree than the ‘old’ EU states. The current focus is on responses and solutions for winter energy shortages.
Traditionally, the responses from central and eastern Europe are much more heterogenous and stereotype-defying than most observers assume. Still, the future of CEE will be shaped majorly by the macroeconomic ramifications of changes in the relative cost structures of manufacturing, such as decreasing competitiveness, increasing inflation and output loss. Bringing inflation down over the long-term requires increasing relevant investments. Those may take time to materialise.
It is easy to overlook how important industry is for the new Europe. Based on the contribution of industry to gross domestic product, Germany, the county commonly deemed to be the European industrial powerhouse, ranks only fifth or sixth, behind Czechia, Poland, Slovakia and Slovenia, and on par with Romania. Among the new EU states, only Estonia, Latvia, Lithuania and tourist-focused Croatia have lower industrial contributions to GDP than the EU average. This industry focus has served new EU states well for years, but now, amid an energy crisis, it presents a significant challenge in both the short and long term.
In the short run, governments are scrambling to secure energy sources for this winter. The current situation too defies simple stereotypes. Viktor Orbán’s Hungary may enjoy higher Russian gas supplies thanks to its more friendly approach to Russia but that does not mean it enjoys it cheaply; the price of deliveries has increased sharply. Poland may have solved its energy predicament better than others via diversifying gas deliveries thanks to Baltic terminals, but it faces a critical situation as its citizens still widely use coal for heating with Russia delivering around half of its consumption.
Romania has little problem as its gas fields supply around half of its consumption even in normal years. Balkan coal needed for electricity production is generally more problematic, though the major complication for deliveries is the fact that Danube waters are low. In addition to this, ex-Yugoslavian countries have been finding themselves able to co-operate on solutions to the energy crisis to a surprising extent, given their historical divisions. Stockpiles of already secured gas mean that, though the winter may be tough, these countries should not have problems securing sufficient, though of course not generous, heating. While still being similar to Hungary’s situation of higher prices, Balkan states have also ensured industrial production should not suffer significantly, as assumed by many analysts earlier.
‘High energy prices are causing a dramatic drop in orders and shifting the manufacturing of energy intensive products out of the EU.’
However, while these different approaches, as well as current buffers and secured energy supplies, should help the new EU states overcome issues this winter, they still face considerable challenges. The cost structures of EU manufacturing are changing dramatically and not in a positive direction. High energy prices are causing a dramatic drop in orders and shifting the manufacturing of energy intensive products out of the EU.
The first anecdotal signs are appearing as aluminium and fertiliser production lines shut down, but that is only the beginning, given global labour shortages and logistical bottlenecks. The monetary tightening carried out almost universally now may change that, freeing up capacities able to substitute parts of European production lines. For the first time in decades, Germany is experiencing negative net foreign trade numbers. Since the German economy plays a major role in finalising logistical chains that help shift CEE and Balkan products to world markets, this drop of net exports is going to have major knock-on effects.
So, one can expect a double hit on demand, cooling inflationary pressures in the new EU economies, as well as other CEE and Balkan economies. The coming drop in net export figures has already been mentioned, the other is the drop of real domestic demand. Despite the rather varied nature of CEE and Balkan economies, there is one common feature providing hope to their monetary policy-makers that the most intense inflationary pressures may abate. Even fast-growing nominal wage numbers so far do not exceed the growth of prices in – almost – all CEE and Balkan economies. This drop in real wages will translate into an additional demand drop. Together with expected job losses in energy-intense manufacturing as well as rate hikes, the general slowdown of demand makes one expect a drop of inflation back to lower one-digit numbers, albeit accompanied with a decline in general output levels.
Still the lesson of the 1970s, which saw a rise of inflation due to an oil supply shock, warrants caution. The initial jump in inflation was followed by a slowdown due to recessions very similar to those we can expect in Europe. However, as demand picked up and capital was invested in the energy sector, inflation rose again to be tamed only by more consistently restrictive monetary policy-making under the new inflation-targeting doctrine. Likewise, to secure a permanent decrease of inflation to previous expected levels, the EU needs to invest not only in facilities allowing it to import more non-Russian energy supplies, but to invest in exploiting more of its own energy sources as well. Such investments should target also the traditional and nuclear energy industry.
Such a change may take time. After all, it requires a policy shift. As foreshadowed by the end of the fracking ban in traditionally environmentally-minded Britain or a reversal of Germany’s nuclear energy policy, changes are likely to come to the EU and wider continent. Broadening energy sources will, rather profitably, complement ever higher use of green energy. Still, such a major change will not arrive swiftly. Inflationary pressures, as a consequence, will not permanently subside with the coming recession.
For the new EU states, it also means that, despite the expected more serious drops of output compared with its old EU neighbours and more services-orientated peers, they face a longer period of readjustment. So, monetary policy will remain stricter, leaving interest rates higher than currently expected in the new EU and Balkans.