Russia’s war in Ukraine has now entered its sixth week. But despite the tragic humanitarian catastrophe and the economic devastation it has already caused in Ukraine, and the economic collapse underway in Russia, it is still too soon to be clear about its economic impact on the countries' neighbours in the Central and Eastern European (CEE) region. The repercussions of the war have not yet been captured in traditional backward-looking macro indicators, given most data are only available through February, at best.
However, we do have some clues about the war's economic impact from higher-frequency financial indicators and survey data. Financial data, unsurprisingly, show a broad deterioration in sentiment, although markets (bonds and currencies) have recovered somewhat from their initial losses. And there have also been statements from policymakers.
In time, too, we should expect to see new country forecasts rolled out from the main international organisations (such as the IMF, World Bank and EBRD) that compare pre-war and post-war prospects – indeed, the EBRD has just published its revised growth projections for the region.
Of course, it is clear that there will be some direct negative impact in terms of weaker growth and higher inflation, coming mainly from Russia's economic collapse (due to sanctions and self-sanctioning) and supply chain disruptions, but the impact will vary by country, in part depending on the extent and nature of economic links with Russia and dependence on commodity imports (where food and oil prices have risen on supply concerns). Meanwhile, the direct economic impact from Ukraine and Belarus to other countries is more limited. There will also be an indirect impact as policymakers' ability to respond to the economic consequences of the war face different policy constraints.
In this report, using our own ranking of various risk factors, we try to assess the potential economic impact of the war in Ukraine on a broad selection of eight countries in the region – Bulgaria, Croatia, the Czech Republic, Georgia, Hungary, Poland, Romania and Serbia (CEE-8). We find that Croatia, Czech Republic, Poland and Romania are the least affected of this group, while Georgia is the most affected, given its greater dependence on Russia. Indeed, this concern is reflected in the IMF's announcement on 1 April of a staff-level agreement on a new programme for Georgia. Bulgaria also shows as one of the more vulnerable to the direct impact, although we think its greater fiscal space acts as a potential risk mitigant, while the indirect impact on Hungary, given its more limited policy space, may add to its overall vulnerability.
We find that:
CEE-8 economies are generally fairly open but they are not very dependent on Russian trade. They tend to rely more on Russian imports than they do exporting to Russia. Georgia has the highest share of its trade (both exports and imports) with Russia. Bulgaria and Serbia also have reasonably high shares of imports from Russia.
Dependence on Russian energy imports is hard to ascertain but overall energy imports are a relatively small share of CEE-8 economies' respective import bills, although all are vulnerable to higher oil prices pushing up the import bill. Bulgaria, Croatia and Georgia are the most exposed to higher energy prices given Russia's already high share of the import bill in these countries.
Dependence on remittances in these countries from Russia, with the exception of Georgia, tends to be limited (compared with, say, Central Asia). Georgia (directly) and Croatia (indirectly) may also be exposed due to their dependence on tourism (accounting for c25-30% of GDP in these countries).
All countries are vulnerable to higher inflation, with inflation already rising even before we see the impact of higher energy and food prices caused by the war feeding through. Inflation had already breached 10% in Bulgaria and Czech Republic and is nearly 14% in Georgia.
Fiscal space varies across CEE-8. Some countries (notably, Bulgaria and Poland, with low debt and deficits) have more flexibility to respond to the shock, whereas fiscal space in Croatia and Hungary is more limited due to existing high debt burdens (70-80% of GDP).
Liquidity buffers also seem to provide reasonable protection in the event of a sudden stop, although high private sector external indebtedness could pose a challenge in some countries.
As for market developments, in fixed income, the most affected countries have been Georgia, Romania, Serbia and Hungary in external debt, while in FX, Hungary, Poland and Georgia currencies saw the largest declines.
That said, in the US$ bond space, given the recent recovery in bond prices, even with the price movements and market volatility we've seen, the sell-off hasn't seemed to open up much value. Georgia ‘26s look to be the only bond that is cheap to the curve on our spreads versus ratings model. However, whether this offers value or signals downward pressure on its BB rating remains to be seen, although the IMF programme may provide near-term support to the bonds. Meanwhile, Serbia ‘30s look closer to fair value.
First, a wider view
The IMF noted recently in its initial assessment of the global impact that energy is the main spillover channel for Europe as Russia is a critical source of natural gas imports, while supply-chain disruptions may also be consequential. These effects will fuel inflation and cause growth to slow. It said Eastern Europe will see rising financing costs and a refugee surge. Fiscal pressures may also arise from additional spending on energy and defence.
The ECB said something similar at its most recent policy meeting on 10 March, noting the Russia-Ukraine war “will have a material impact on economic activity and inflation through higher energy and commodity prices, the disruption of international commerce and weaker confidence.”
A foretaste of what is to come might be found in Germany’s ZEW Institute’s investor sentiment survey. It sent a worrying signal. The March reading for expectations of economic growth, released on 15 March, one of the first major surveys published since the war began, slumped to -39.3 in March from 54.3 in February for Germany. A similar fall was seen in the eurozone, while declines in the US and China were also seen, albeit less pronounced.
Impact on CEE economies
Real GDP growth across the CEE over the first and second quarters is likely to be much weaker compared with pre-invasion forecasts. This reflects higher energy and food costs, reducing real incomes and spending power, and the deterioration in business and consumer confidence, which will affect investment and consumer spending decisions.
Whether this is a short-lived impact or longer-lasting will depend on how long the war lasts, its intensity and whether it spreads, although we expect Western sanctions (and self-sanctioning) on Russia to remain in place long after the war has ended. This could result in a permanent change in trade linkages between CEE (and Europe in general) and Russia, while elevated commodity prices caused by supply disruptions could also last for some time.
That said, CEE-8 economies had reasonable growth momentum coming into this year, which could provide a cushion to absorb a short-term (temporary) shock without falling into recession.
Pre-war growth projections for 2022 showed a solid performance was expected to continue, notwithstanding some slowing from 2021’s elevated post-Covid bounce. IMF growth projections for 2022 contained in the October WEO, ie pre-war projections, ranged from 4.5-6% (Bulgaria, the Czech Republic and Serbia being at the low end of the range, and Croatia and Georgia at the upper end).
The EBRD’s latest Regional Economic Update, published on 31 March, provides one of the more comprehensive and broad-based assessments of the economic fallout from the war so far. The EBRD projects a hit to growth this year of c2% in aggregate (across the countries it covers), with real GDP growth expected to slow to 1.7% compared with its November forecast of 3.8%. This compares with real GDP growth of 6.6% in 2021. Growth was 3.2% in 2019 (pre-Covid).
However, the revisions to growth are not uniform, with some economies performing relatively better than others.
Among CEE-8, Georgia sees the biggest downward revision (down by 3.5% to 2%), followed by Bulgaria, the Czech Republic and Romania (all -1.6%). Poland sees the smallest revision (-0.8%).
Note also, in the EBRD’s forecasts, Russia’s GDP falls by 10%, Ukraine -20% and Belarus -3.0%.
However, from what we can see, policymakers in the region have not yet provided updated country forecasts. That said, the National Bank of Georgia said on 30 March, during its monetary policy meeting (in which it raised rates by 50bps to 11%), that growth this year would be lower, in the range of 3-4%, compared with its previous forecast of 5%. The IMF also expect the war to exert a significant drag on growth in Georgia.
Transmission mechanisms
We highlight four main channels of impact from the Russia-Ukraine war to Central and Eastern Europe:
Direct trade linkages;
Remittances and tourism (remittances from Russia and Russian tourists to CEE);
Financial, through capital flows (and banking exposures), asset markets, financing conditions and risk sentiment; and
Rising commodity prices (food, energy, metals) which will exacerbate inflationary pressures.
The impact of the refugee crisis is of course another dimension.
In addition to the direct shock and first-round effects, CEE-8 countries will also be exposed to the ripple effects of weaker growth across the EU/Eurozone given the high share of intra-regional trade.
Trade linkages
CEE countries are generally fairly open economies, which leaves them vulnerable to external shocks (although, equally, it may mean competitive and flexible markets are able to respond quickly to new opportunities). Among the CEE-8, Hungary is the most open to trade, and Romania the least. Croatia's openness, though, may be understated on this measure, given its greater dependence on tourism (ie higher services income).
However, with the exception of Georgia, most CEE-8 countries are not very dependent on goods' trade with Russia (or with Ukraine and Belarus), although they tend to rely more on imports of goods from Russia (which could be oil/gas) than they do exports of goods to Russia. Georgia is the most exposed, having the highest share of both its exports and imports with Russia (exports to Russia accounted for 13% of its total exports and imports from Russia accounted for 10% of its total imports, in 2019, based on IMF DOTS). It also had the highest share of trade with Russia, Ukraine and Belarus combined (21% of its exports and 15% of its imports).
Serbia is the second most exposed, in terms of both exports and imports with Russia, followed by Bulgaria, which is more dependent on imports from Russia than exports to Russia. At the other end of the scale, Croatia and the Czech Republic have very little goods' trade with Russia.
One point to note is that we’ve used IMF DOTS data for each reporting countries’ trade with Russia. Data for Russia’s trade with each reporting country may differ and could give a different impression (for instance, Russia’s exports to Croatia are 4.5 times what Croatia reports for imports from Russia, while Poland seems to over-report both exports to and imports from Russia compared to what Russia reports as its trade with Poland).
However, the extent to which CEE-8 countries can divert exports to alternative destinations or source imports from other markets, and how quickly they can do this, will depend in part on the type of goods involved and their substitutability, and supply chains and logistics (for which, more granularity in data is needed to make any assessment).
The generally higher reliance on Russian imports, as opposed to exports to Russia, may reflect dependence on Russian energy. However, it is not clear how much energy comes from Russia, or whether demand can be met from other sources. That said, the import bill will go up due to higher oil prices (subject to price elasticity of demand in these countries and alternative sources of energy). Bulgaria, Croatia and Georgia are the most exposed to higher energy prices given its already high share of the import bill in these countries.
Remittances and tourism
While Central Asia relies more heavily on remittances from Russia, these are generally low across the CEE-8, with the exception of Georgia (less than 5% of GDP). By comparison, remittances are some 20% of GDP in Tajikistan and 10% of GDP in Uzbekistan, for instance, according to the EBRD.
Regional dependence on Russian tourists across the CEE-8 is also fairly modest, with the exception of Georgia and Bulgaria, according to the EBRD. Georgia is the most reliant on tourism (over 30% of GDP) and, specifically, Russian tourists, with Russian tourist spending amounting to c1.4% of GDP according to the EBRD and comprising over 10% of its tourists in 2019 according to the IMF. Georgia also received a lot of Ukrainian tourists.
However, the region may also suffer from a general decline in tourism appetite due to risk aversion, especially towards those destinations perceived as 'closer to the crisis', or economic factors (lower spending power caused by economic uncertainty and higher inflation). Here, Croatia may be more exposed given its greater dependence on tourism (25% of its GDP and employment, according to the IMF).
Financial linkages and asset markets
The war in Ukraine has led to widening bond spreads and higher CDS rates, reflecting both a generalised increase in risk aversion (due to uncertainty) and investor differentiation over which countries are most (and least) at risk. This has led to a tightening in financing conditions for sovereign and corporate borrowers, which – if sustained – could affect access to the market and refinancing costs. It may also suggest a withdrawal of portfolio capital from the region and there have been reports of non-resident outflows in domestic government debt markets (although we don’t have data on this). However, so far, sovereign ratings for CEE-8 have remained unchanged.
In terms of the CDS impact, Romania, Serbia and Hungary have suffered the most in absolute terms, in descending order, although proportionately Poland has been the third-worst, after Hungary and Romania (any political uncertainty surrounding Hungary's elections may also have impacted its bonds and CDS rates). The Czech Republic has suffered the least (although that might reflect its small and illiquid hard currency market).
Longer term, countries in the region may benefit from the shift in foreign capital away from Russia.
Inflation
CPI inflation was already rising across the region before the war, as it was across much of the rest of the world, and is expected to rise further as a result of higher commodity prices and supply chain disruptions. For example, inflation had already breached 10% yoy in February in Bulgaria and Czech Republic, and was even higher, at nearly 14%, in Georgia, and that’s before we see the impact of higher energy and food prices caused by the war feed through into headline inflation.
The ECB has already warned about higher inflation.
And central banks in CEE-8 countries that have held monetary policy meetings since the outbreak of the war (and that’s most of them now) have focused more on the upside risks to inflation than the downside risks to growth.
Policy impact
As well as the direct impact through trade linkages and the macro impact on growth and inflation, there will also be an indirect impact as policymakers' ability to respond will face different policy constraints in each country. Generally speaking, however, countries with stronger credit ratings may be seen as better placed to withstand the shock compared to lower-rated sovereigns, which are – by definition – more susceptible.
Regional policymakers will likely face the dilemma of dealing with potentially higher inflation and weaker growth (stagflation). We think central bankers will choose to prioritise their anti-inflation credibility and leave growth concerns to another day, while fiscal policy – which acts more with a lag anyway – may initially seek to cushion the distributional impact (and, in some cases, boost defence spending), leaving bigger decisions on tax policy and spending to when the war is over or, at least, until there is greater visibility on what the domestic impact has been.
Monetary policy
Central banks have already responded to rising inflation, commencing their post-Covid tightening cycles around the middle of last year, although upside risks to inflation from higher food and energy prices caused by the war suggest there is more to come.
Real interest rates across the region are still very negative (ranging from -3% in Georgia, -5% in Hungary, around -6% in Poland and Romania, -6.5% in the Czech Republic and -7.8% in Serbia) suggesting there is plenty of room – and need – to tighten further.
However, policymakers may also prefer to accommodate initial spikes in inflation, if they see it as temporary, in order to protect growth and only act on second-round effects or if inflation expectations are under threat.
So far, out of the six CEE-8 countries with an independent monetary policy (Bulgaria has a currency board with the euro while Croatia aims at stability of the nominal exchange rate against the euro), four central banks of the five that have held a scheduled policy meeting since the war started have increased their policy rates (the Czech Republic +50bps, Hungary +100bps, Poland +75bps, Georgia +50bps). Serbia kept its rate unchanged. Romania hasn’t met yet.
Those with flexible exchange rates have also seen their currencies weaken, which one might expect and see as an appropriate response, allowing the currency to work as a shock absorber. However, if sustained, this could lead to inflation pass-through, raise the local currency cost of foreign debt service, and/or pose greater risks in situations of FX mismatches. The greater currency volatility in the past six weeks also follows a period of relative currency stability at the beginning of the year.
Hungary, Poland and Georgia saw the largest falls initially (depreciation of up to 15% against the US currency). That might also be because they are the more liquid currencies. However, most of these losses have since been recovered.
Of the two with fixed exchange rates, Croatia's regime could allow some weakening against EUR in order to preserve some competitiveness. Bulgaria, however, is subject to the constraints of its currency board and will benefit only to the extent that EUR weakens against the US dollar.
Such modest currency moves, if they persist, should not add too much to inflation risks in a credible monetary policy setting or lead to more onerous debt service on foreign currency debts.
However, central banks in the Czech Republic and Poland have undertaken currency interventions, according to reports, in order to limit currency volatility.
Fiscal policy and impact on debt sustainability
Fiscal deficits across CEE-8 countries remain relatively well contained on the whole after the Covid shock. IMF (pre-war) projections, from the October WEO, show fiscal deficits were expected to narrow in 2022 compared with 2021. The Czech Republic, Hungary and Romania were expected to run the widest deficits (c5.5-6% of GDP), with Poland the narrowest (c2%).
However, fiscal space varies. Some countries (notably, Bulgaria and Poland), with low debt and deficits, have more flexibility to respond to the shock (for example, in terms of a counter-cyclical fiscal response or limiting the distributional impact on low-income households of higher food and energy prices), whereas Croatia and Hungary, where concerns about debt sustainability may be higher, have less fiscal space given already high public debt burdens (70-80% of GDP).
That said, we think a temporary shock is unlikely to disturb debt sustainability prospects in these countries, providing authorities stick to sound fiscal policies.
External debt and liquidity
If public debt sustainability is less of a concern at this stage, the other consideration for countries in the region is external indebtedness and vulnerability to a sudden stop in capital flows. Countries with higher liquidity buffers (strong international reserve coverage to imports or debt service) will be better placed to withstand a period of prolonged higher risk aversion, weaker investor appetite and lower portfolio capital flows into EM, being able to run down savings – or, for more mature markets, turn to domestic markets for financing – in order to bridge financing needs.
Generally, liquidity buffers seem to provide reasonable protection in the event of a sudden stop across CEE-8 countries. For example, reserves tend to have adequate import coverage (although reserves/imports is a less valuable metric for those with flexible exchange rate regimes). Among the lower-rated countries in this group, Serbia and Georgia have c4.5-5 months' import cover and Croatia (which seeks to maintain currency stability) has nearly 10 months, according to IMF IFS data (based on goods and services imports). Hungary, however, has less than three months' import cover. Public external debt service also appears to be manageable (although Hungary, Poland and Romania have high foreign bond stocks in absolute terms).
However, total external debt (public and private) for some CEE countries is high. Whereas public external debt is more limited (given deeper domestic debt markets), high private external debt and debt service needs can present more of a vulnerability, given high corporate borrowing in foreign debt markets. This leads to higher external financing needs, and hence greater vulnerability to refinancing risks. This can pose macro risks if it leads to a drain on official reserves or if private debt migrates to the public sector balance sheet. This might be more of a concern in Croatia, Czech Republic, Georgia and Serbia.
IMF engagement
Of the eight countries in our sample, only Serbia currently has a formal arrangement with the IMF, albeit an unfunded policy coordination instrument (PCI). Georgia is the last country to have had a funded programme, although it expired last year (April 2021). The extended fund facility (EFF), originally for three years, was approved in April 2017. In May 2020, it was extended by one year and augmented to US$672mn (230% of quota) because of the pandemic. Georgian authorities have however recently requested a new programme (see below).
None of the other countries in our CEE-8 are in an IMF programme (or have an unfunded arrangement or credit line), and, with the exception of Georgia, they haven’t needed one for some time. Serbia’s last funded programme expired in 2018 (although it is now under a PCI with the Fund which was approved in June 2021) and Romania’s in 2015, while Hungary last had a programme during the global financial crisis, which expired in 2010. Poland had a flexible credit line over 2013-17.
Of course, should any country decide it needed a programme, precautionary or otherwise, the IMF would remain ready to support it.
And that's what's happened in Georgia, which we think, although not the first request or agreement for IMF support made since – and in part because of – the war, may be the most advanced (eg Egypt has also made a request and Sri Lanka has expressed interest, while Tunisia's need for a programme pre-dates the war, although discussions – on something – have seemingly only just begun; Mozambique's programme request has nothing to do with the war).
The IMF announced on 1 April that it has reached staff-level agreement on a new three-year Standby Arrangement (SBA) with Georgia for an amount of US$289mn (100% of quota), although the statement noted that programme discussions began last November (so the war may have just added extra urgency and greater financial need for a programme that was going to happen anyway). The statement noted that the programme aims to maintain and further entrench macroeconomic stability in the context of back-to-back shocks from the pandemic and the war in Ukraine. Real GDP growth is expected to fall to c3% this year from 10.4% in 2021, a sharp decline, while the current account deficit is expected to widen (the external deficit was estimated at 10% of GDP in 2021 and was projected to narrow to 7.6% this year, in the October WEO). The programme is expected to go to the IMF board in May.
Of the remaining countries in our group, the IMF has released statements following staff visits in two countries since the start of the war – Croatia and Serbia. The IMF concluded a staff visit to Serbia to conduct the second review of the PCI on 22 March, after the first review was concluded in December 20221. It noted that the economy navigated through the pandemic well but faced significant uncertainty from the spillovers from the conflict. It noted, too, that staff will revise growth projections down relative to the previous review, with risks tilted to the downside, but no figures were given at this stage.
An IMF statement on 7 March following a staff visit to Croatia said the conflict cast a shadow over an “otherwise strong economic outlook”, but near-term inflationary risks continue to tilt higher.
Vulnerability scorecard
We rank seven indicators used in this report to reflect a country's exposure to the direct economic consequences of the war, according to our own subjective assessment of risk (high/low/medium), in order to come up with a risk score to proxy the country's overall vulnerability. The indicators are based on economic and financial factors, rather than geopolitical, military, or social (eg refugees) considerations, and we exclude solvency and liquidity indicators as indirect consequences.
On this basis, we find the lowest risks (countries with lowest vulnerability) are Croatia, Czech Republic, Poland and Romania.
The highest risks (countries showing the most vulnerability) are Georgia and Bulgaria.
However, this also ignores the indirect impact via the policy response, which could either mitigate the impact (where countries have sufficient policy space to be able to adjust and absorb the shock) or exaggerate the impact (where countries have limited space to deal with it). On that basis, we think Bulgaria's greater fiscal space acts as a risk mitigant. Conversely, Hungary's lack of fiscal space could add to its overall vulnerability.
Investment implications
The CEE-8 in our sample embody a wide range of countries as gauged by perceptions of country risk and sovereign ratings; from solid investment-grade sovereigns (the Czech Republic, Poland) to higher-risk BB sovereigns (Georgia, Serbia). In fact, five of our eight are IG, with one crossover and two sub-IG.
Hence, the wide variation among them in asset price movements as some countries are seen as riskier than others in terms of pre-existing vulnerabilities (ie the starting point) and in terms of the economic impact of the shock and their ability to respond to it. Geographical considerations, however, also apply; for example, for those countries closest to the war and for those who it might be feared will be next if Russia is successful in taking Ukraine (eg Georgia, and outside our group, the Baltics).
However, from an investor perspective, the number of sovereign dollar bond issuers is limited. Only seven of the eight have meaningful hard currency sovereign bonds (the Czech Republic doesn’t – just two bonds, a EUR maturity in May and a JPY bond) and, of those seven, two don’t have any (Bulgaria), or any meaningful (Croatia), dollar bonds, only euro ones (although their EUR bond stocks are large, cEUR8bn in Bulgaria and EUR11.5bn in Croatia, and US$3.25bn in dollar bonds, albeit with 2023 and 2024 maturities). That leaves five with meaningful dollar bonds (Poland, Hungary, Romania, Serbia, Georgia) – our focus here. Of these, Poland, Hungary, Romania have many bonds, in different hard currencies (Hungary's hard currency bond stock is over US$20bn equivalent, Poland's over US$30bn equivalent, and Romania's over US$40bn equivalent). Serbia has EUR6.3bn in euro-denominated bonds, and one US$1bn dollar bond with a 2030 maturity. Georgia has just the one bond, US$500mn maturing in 2025.
Bonds have fallen since Russia's war in Ukraine although, with the exception of Georgia, the others have generally recovered most of their losses, with prices down only 1-4% (notwithstanding duration differences). Georgia's 2026 bond, however, remains down c11% in prices terms since 18 February, with its yield rising to 6.8% (cob 31 March on Bloomberg), after having spiked to 8.6% in early March. The yield is still, however, 300bps higher than it was before the war. Georgia's reaction however may not be surprising given its lower credit rating (which makes it more susceptible to changing external conditions). But it also reflects Georgia's greater economic dependence on Russia (as shown by our scorecard). It may also reflect concerns that Georgia could get dragged into an escalating conflict or is more vulnerable if Russia's war spreads to other countries.
To put this into a wider regional context, however, Tajikistan (B3/B-/-) has been the worst performer (price down nearly 15% on the 2027s). Its yield has risen 500bps since the war, to 15%. This is due to its greater dependency on Russia. Moody's put Tajikistan on review for a possible downgrade on 30 March, in part based on the expectation of a 50% fall in remittances from Russia this year.
Elsewhere, Lithuania 50s also saw sharp falls, with prices down 25pts (nearly 30%), from EUR90 to EUR65, albeit a long-duration bond, on concern the Baltics would be next under threat from Moscow, although the bonds have also recovered a bit (now EUR71).
Hence, in the US$ bond space in CEE-8, given the recent recovery in bond prices, even with the price movements and market volatility noted earlier (as evident by CDS), the sell-off hasn't seemed to open up much value.
Georgia ‘26s look to be the only bond that is cheap to the curve on our spreads versus ratings model across a broad sample of EM and frontier markets. Georgia ‘26s have a spread of 400bps compared with fair value of 260bps, offering about 140bps of value (and perhaps more if we adjust for its shorter duration). However, whether this offers value or signals downward pressure on its BB rating remains to be seen, although the IMF programme may provide near-term support to the bonds. Serbia ‘30s, with a spread of 213bps, look closer to fair value.
