 Output in the countries of Central Europe and the Baltics grew by 5 percent in 2004 -- one percentage point higher than the previous year -- according to the World Bank’s latest EU-8 Quarterly Report released in Brussels on January 27, 2005. Growth in the third quarter of 2004, meanwhile, slowed to 4.4 percent (year-on-year), down from 5.4 percent in the second quarter. Within the region, good performance was driven by strong growth in the Baltic countries and Slovakia, a rapid recovery in Poland, and a pick-up of activity in Hungary and Slovenia.
Overall, macroeconomic developments were largely favorable in 2004 in the economies of the eight Central European and Baltic countries recently admitted to the European Union ― Poland, Czech Republic, Hungary, Slovakia, Slovenia, Lithuania, Latvia, and Estonia. Output growth solidified in line with Western Europe’s recovery. The fiscal situation for the eight countries generally improved or surpassed expectations owing to buoyant revenues. Meanwhile, the uptick in inflation related to EU accession and higher oil prices appears to have been contained. Despite strong export growth, external current account deficits remained high in some countries. “After its peak in mid-2004, real GDP growth in the EU8 is expected to ease to around 4.5 percent in 2005, reflecting a waning of the effects of EU accession, less accommodating fiscal and monetary policies, and a slight slowdown in growth among the EU15 countries,” said Thomas Blatt Laursen, lead author of the report, which highlights fourth quarter results for 2004* and has a special section on growth in the Baltics. Exports and FDI increase while unemployment falls  Unemployment in the EU8 dropped below 14 percent in the third quarter, with signs that the recovery in the region has gradually become more job intensive. Meanwhile, bottlenecks (notably shortages of highly-skilled labor) appear to be developing in several labor markets.
While domestic demand continued to lead growth in 2004, the EU-8 countries, in the wake of EU accession, also saw a marked recovery in foreign direct investment (FDI), an increase in exports, a significant pick up in portfolio inflows, and a bullish stock market. Export growth was very strong in virtually all EU8 countries. Exports by the eight countries increased by around 21 percent (year-on-year) in the third quarter, outpacing also rapid import growth of about 18 percent. Export growth was particularly dynamic from Poland and the Czech Republic. While strong export performance was associated with an improvement in the EU-8 trade balance, their aggregate current account deficit rose to almost 7 percent of GDP in the third quarter. External deficits remain very high in the Baltic countries and Hungary.
Financing of the current account gap strengthened. Net FDI inflows recovered throughout 2004, reaching over 3 percent of GDP in EU8 in the third quarter of 2004 (nearly 4 percent of GDP in the Baltic countries). The recovery in FDI was most noteworthy in Slovakia and Hungary, but FDI also rebounded in Latvia and Lithuania. EU8 bond markets also gained stronger attention of investors through 2004. After falling to a very low level in 2003, portfolio investment inflows recovered strongly in 2004, reaching 2.8 percent of GDP in the third quarter.
 While fiscal outcomes were generally better than expected on the back of strong revenues, the deficit increased markedly in Poland and budget balances also weakened in the Baltic countries. Budgets for 2005 point to further fiscal consolidation where most needed, but concerns remain in particular about the large deficit and weak fiscal management in Hungary. Also, in some cases expenditures have been pushed back, and social expenditure restructuring remains incomplete.
“Sustaining rapid output growth will depend on prudent macro policies, improved investment climates, and progress on fiscal and labor market reforms as well as privatization,” said Laursen.
Growth in Baltic tigers outstrips Central European economies
The report notes that output growth in recent years in the so-called Baltic tigers – Lithuania, Latvia and Estonia—has outstripped Central European economies by a wide margin. Laursen attributes this to a combination of factors -- a very low starting base, prudent macroeconomic policies, and rapid economic reforms. In addition, dynamic oil-led growth in Russia may have spilled over to the Baltic countries through trade in services, FDI, and portfolio inflows. “Some slowdown in growth in the Baltic countries, perhaps to 5-6% per year, is likely over the medium to long term as rapid credit growth and large current account deficits are unlikely to be sustainable and demographic changes are likely to reduce labor supply,” said Laursen. >>> Quarterly Economic Reports
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