EBRD slashes 2022 growth forecasts but only nations embroiled in war to enter recession

EBRD slashes 2022 growth forecasts but only nations embroiled in war to enter recession
Ukraine's war-ravaged economy is forecast to contract by 20% this year.
By Clare Nuttall in Glasgow March 31, 2022

The European Bank for Reconstruction and Development (EBRD) has slashed its GDP forecasts for the emerging Europe economies for 2022, but all except those directly involved in the war in Ukraine Russia, Ukraine and Belarus will experience positive growth this year as the post-coronacrisis recovery continues. 

Overall, the bank’s 2022 growth projection across the EBRD regions, which include emerging Europe and some Southern and Eastern Mediterranean (Semed) economies, has been revised downwards by 2.5 percentage points (pp) to 1.7%, the EBRD announced on March 31. 

The only economies to escape negative consequences from the war in Ukraine are two Eurasian oil and gas producers, Azerbaijan and Turkmenistan, whose forecasts for the year were raised. 

According to the EBRD, Azerbaijan “could benefit from increased oil prices, and the move by European countries to alternative suppliers of oil and gas, thus boosting GDP growth in 2022”. 

Turkmenistan, meanwhile, is feeling the benefits of its “splendid isolation”, said the EBRD, on top of its “immense energy reserves, strict rationing of access to hard currency, and its transportation-friendly location on the Caspian Sea”. 

Combatants’ economies devastated 

The worst impact, unsurprisingly, will be on Ukraine, whose war-ravaged economy is set to contract by 20% this year, a 23.5 pp downward revision compared to the bank’s last set of projections issued in November 2021. 

According to the EBRD, at present the war is happening on territories that produce around 60% of Ukrainian GDP. It cites a National Bank of Ukraine (NBU) estimate that 30% of businesses have stopped production and electricity consumption has dropped to around 60% of the pre-war level. In turn, says the EBRD, “This is severely weakening companies’ finances, with some being even physically damaged, thus exposing the banking sector to a drastic deterioration of asset quality.” 

In one positive recent development, Ukraine managed to hook up its electricity system to the continental European Energy System ahead of schedule, and it disconnected from the grids of Russia and Belarus just hours before the invasion. 

Russia’s economy, meanwhile, is projected to contract by 10%, a 13pp downward revision. “Initially it was believed that the robust situation of the Russian economy, arising thanks to the fiscal fortress policy settings of the past few years, would mean the economy would be well placed to withstand the short-term impact of economic sanctions … However, as the severity of the sanctions imposed increases on an almost daily basis, it is clear that the economy will be hit hard,” said the EBRD report. “Sanctions on energy exports and the exclusion of banks from SWIFT have gone from being considered beyond the pale, due to the associated collateral damage, to a reality.”  

There is a lot of uncertainty over how big Russia’s economic contraction will be this year as much depends on what sanctions remain on Russia, which new sanctions will be applied, and how effective the implementation of the sanctions regime will be. A survey recently carried out by the Central Bank of Russia (CBR) of independent professional economists expected the contraction to be between an 8% to 15% contraction in 2022.

Belarus, which has been included in western sanctions, is expected to see a more modest contraction of a 3.2 pp downward revision. 

The EBRD is in the process of closing its resident offices in Moscow and Minsk, as announced in a press release on March 29, in which it affirmed its “unwavering support” for Ukraine. The bank had already suspended all new investment activity in Russia following the annexation of Crimea by Russia in 2014, as well as making any new private sector investments into Belarus following the disputed presidential election in August 2020.

Multiple effects of war

As economies across the region face what the EBRD describes as the greatest supply shock since at least the early 1970s, the war “will have a severe effect on economies far beyond the immediate area of the conflict”, the development bank said. 

“The war on Ukraine is having a profound impact on the economies in the EBRD regions as well as globally. Inflationary pressures were already high prior to the war and they will certainly increase now, which will have a disproportionate effect on many lower income countries where we work as well as on the poorer segments of the population in most countries,” said Beata Javorcik, EBRD chief economist. 

The bank forecast that that the increased cost for commodities such as food, oil, gas and metals will have a “profound impact” on economies, particularly those in lower income countries. As it pointed out, Russia and Ukraine supply a large amount of commodities, including wheat, corn, fertiliser, titanium and nickel. 

The main direct impact on emerging Europe’s second-largest economy, Turkey, will be via higher commodity import prices, particularly energy and wheat. Turkey imports 93% of its oil and 99% of its gas needs. On top of that, tourist arrivals to the Black Sea country are expected to be hit by the war; in a typical year Russia and Ukraine provide over 20% of Turkey’s tourists.

Both these are happening at a time when Turkey is pursuing an economic model that relies on balancing the current account in order to achieve macroeconomic stability. “The higher cost of imports and loss of tourism revenues would not only make achieving current account balance difficult, but also make it harder for the central bank to rebuild its severely diminished foreign exchange reserves, limiting its ability to support the lira if needed,” warned the EBRD. 

“The failure to balance the current account will dent investor confidence in the ability of the new economic model to maintain macroeconomic stability, putting further pressure on the lira, potentially increasing dollarisation once again, and give rise to even more inflationary pressure. These indirect effects in the form of the failure of the new economic model would potentially have a greater impact on activity than the direct impact of a fall in tourism revenues and rising oil prices.” 

All of the Western Balkans countries are also expected to be affected by higher oil prices, while some are also vulnerable to rises in prices of gas and electricity. 

Spillover on Central Asia and the Caucasus 

Aside from commodities, economies in the region will be affected through several other channels. 

All the Central Asian economies except Turkmenistan are forecast to experience lower-than-expected growth this year, with the EBRD making the biggest downward revisions for the region’s two poorest countries, Kyrgyzstan (-4.0 pp) and Tajikistan (-3.2 pp). These economies have been “badly hit by the fall in the value of the ruble and restrictions on its convertibility, as they are heavily dependent on remittances received from Russia,” the EBRD said. 

Remittances from Russia typically amount to between 5% to as much as 30% of GDP in Armenia, Kyrgyzstan, Tajikistan and Uzbekistan. 

Yet another factor weighing on the Caucasus and Central Asia is the pressure on their currencies as markets have been reassessing geo-political risks. 

Tourism recovery postponed

There are already signs the war is having an impact on the tourism sector in the wider region, which is expected to be damaging for countries with substantial tourism sectors such as Armenia, Estonia, Georgia and Montenegro. 

This comes on top of the severe damage to the sector during the first two years of the pandemic, and dashes hopes of a robust rebound in summer 2022. 

Before the war and the pandemic, spending by Russian tourists accounted for 1-2% of GDP in Armenia, Estonia, Georgia and Montenegro. Bulgaria received 450,000 Russian tourists in 2019 and is thus also expected to suffer, while other tourism-dependent countries like Croatia don’t rely on Russian or Ukrainian tourists but are likely to feel the impact of a fall in tourist appetite from western countries.

Central Europe manufacturing affected

The Central European economies with large automotive sectors as well as some in Southeast Europe like Romania and Slovenia have been affected as manufacturing supply chains with Ukraine are hit. “Owing to lack of deliveries of parts from Ukraine, a number of car factories had to partially or fully suspend production and look for alternative suppliers as hostilities escalated,” said the EBRD. 

This is a factor in some countries in the Western Balkans too, where Bosnia & Herzegovina, North Macedonia and Serbia are set to be the hardest hit. 

In Central Europe, Latvia has been identified as the worst affected country, with its GDP growth forecast revised downwards by 3.5 pp to 2.0%. As the EBRD notes, “trade restrictions will have a greater effect on smaller Baltic countries”; Russia is still one of the most important markets for Latvian and Lithuanian goods exports. 

Refugees arrive in huge numbers 

Within Southeast Europe, Moldova is particularly vulnerable given its location on Ukraine’s western flank, and its forecast has been revised downwards by 2.0 pp to 2.0%.  Moldova, Poland and other countries bordering Ukraine have received refugees in what has become the greatest forced displacement of people since the Second World War, with Moldova, as one of Europe’s poorest countries, particularly ill-equipped to handle this despite the best efforts of the population. 

Commenting on the short- and long-term of the influx of refugees from Ukraine, the EBRD said: “Skilled workers from Ukraine may provide a boost to some economies in the longer term, particularly in countries with ageing populations. In the short term, economies are facing fiscal pressures and administrative challenges as they scale up the provision of housing, healthcare and schooling.” 

Better times ahead? 

The EBRD forecasts stronger growth of 5% across the region in 2023, including a strong rebound in Ukraine. 

This is based on the assumption that “a ceasefire is brokered within a couple of months, followed soon after by the start of a major reconstruction effort in Ukraine which will bring GDP by end-2023 back close to, but still below, pre-war levels”, its press release said. 

In the latest developments on March 29, there were some tentatively positive signs, as Russia said it would "drastically reduce combat operations" around Kyiv and the northern city of Chernihiv. 

On the other hand, no such rebound is expected in Russia. "Sanctions on Russia are expected to remain for the foreseeable future, condemning the Russian economy to stagnation in 2023 (after a sharp GDP drop in 2022), with negative spillovers for a number of neighbouring countries in eastern Europe, the Caucasus and Central Asia,” the EBRD said. 

Three years of turmoil 

Finally, the EBRD produced a set of figures showing the change in GDP between 2019 the last ‘normal’ year before the pandemic and subsequent war and 2022. 

By this measure, Serbia was the strongest performer, with projected growth of 11.9% over the period, mainly thanks to its mild contraction during the first year of the pandemic and robust rebound the following year. Despite its financial upheavals, Turkey is forecast to be another strong performer, as is Lithuania. 

At the other extreme, Ukraine and Russia are projected to have the deepest economic contractions over the 2019-2022 period. 

Given the high level of uncertainty at present, the EBRD plans to produce another set of forecasts later in the spring.