TRANSITION REPORT 2014 Innovation in Transition

Outlook and risks

The annual growth rate in the transition region is expected to decline from 2.3 per cent in 2013 to 1.3 per cent in 2014. This reflects the impact that the crisis in Ukraine has had on the economies of Ukraine, Russia and neighbouring countries, as well as a number of country-specific factors (including the damaging floods seen in Serbia and Bosnia and Herzegovina in May 2014).

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Recovery in CEB and SEE countries will continue at a moderate pace. The lift provided by recovery in the single currency area will be only partly offset by weaker demand from Russia and the impact of the ban on selected food exports to Russia. Growth is expected to decelerate in Central Asia, due to the region’s strong economic ties with Russia, as well as various country-specific factors. Countries that rely heavily on remittances from Russia are at particular risk of a sharper economic slow-down. Growth is expected to remain robust in the SEMED region, where countries have taken steps to reduce energy price subsidies and improve fiscal sustainability over the medium term.

The transition region’s annual growth rate is projected to strengthen somewhat in 2015, increasing to 1.7 per cent. Output contraction in Ukraine is likely to be less severe in 2015. Growth may resume towards the end of the year, if the necessary macroeconomic adjustments and structural reforms are implemented and tensions do not escalate further. Russia is expected to experience a mild recession in 2015, reflecting increased uncertainty and the impact of economic sanctions. This slow-down is expected to constrain growth in the EEC region and Central Asia, where many economies rely heavily on export demand and remittance flows from Russia. Growth in the SEMED countries is also projected to strengthen on account of a more stable political environment.

The outlook for growth is subject to an exceptional degree of uncertainty related to geopolitical developments, with significant downside risks. Any further deepening of the crisis in Ukraine and Western sanctions on Russia will have direct implications for the two economies and a significant impact on investor confidence and growth in the transition region. In particular, a recession in Russia would reduce demand for the exports of many regional trade partners and weaken growth in remittance flows to EEC and Central Asian countries. A major economic slow-down in China or an abrupt correction in interest rates and asset prices in advanced markets could lead to a deterioration in the global economic outlook, potentially encouraging European parent banks to withdraw more funds from the region. This, in turn, would exacerbate the contraction of credit in the region, negatively affecting investment and consumption.