CEE Special Report | Fiscal impulse switched on

The new fund passed by the German parliament as well as relaxing fiscal rules on the European level are expected to have a positive impact on the growth in the CEE region. German growth forecast is being revised upwards. As the impulse has a more domestic character and does not originate in external demand stimulus, the pass-through to CEE may be slightly weaker compared to the global impulse. Nevertheless, the lift of market sentiment and anchoring expectations for positive development may lift the overall confidence, becoming a trigger for a higher growth path. We currently estimate the positive impact in the region to range between 0.45 and 0.6 percentage points in the first two years. As far as fiscal stimulus coming from trigerring escape clause for defense spending is concenred, we are more cautious. It will depend on the country whether it will decide to use additional fiscal space or not. Poland is the frontrunner in terms of defense spending. It allocates almost 5% of GDP for that purpose but activation of the escape clause will provide some relief for the budget in the next four years. In Czechia, Croatia or Romania we see space to increase defense spending toward 3% of GDP in few years time. Romania, however, is entering a new era of defense expenditure, boosting its economy through the development of new local production facilities and integration into EU defense industry supply chains. In Hungary or Slovakia, defense production capacity is rather limited, with a minor impact on the economy. As for the positive effect on GDP growth, the magnitude of fiscal multipliers depends on openness, business cycle (lower in expansion phase) and the exchange rate regime.

As far as growth, inflation and interets rate outlook is concerned, we consider recent annoucnments still as a risk scenario to our current forecasts. We hope, though, that higher growth path of German economy will mitigate the negative effect of tariffs on the economic performance of CEE countries. If so, we would consider it as risks for inflation to remain higher for longer, thus limiting space for monetary easing in the region. Central banks have been quite cautious recently regarding further interest rate cuts and possibly higher inflation path in medium-term will only add to these concerns.

In this report we offer overview of the impact of recent annoucnments on the region as well as provide snapshot of defense spending or prospects for defense sector on country level.