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Autumn 2020 Economic Forecast: Rebound interrupted as resurgence of pandemic deepens uncertainty
The coronavirus pandemic represents a very large shock for the global and EU economies, with very severe economic and social consequences. Economic activity in Europe suffered a severe shock in the first half of the year and rebounded strongly in the third quarter as containment measures were gradually lifted.
However, the resurgence of the pandemic in recent weeks is resulting in disruptions as national authorities introduce new public health measures to limit its spread. The epidemiological situation means that growth projections over the forecast horizon are subject to an extremely high degree of uncertainty and risks.
An interrupted and incomplete recovery
The Autumn 2020 Economic Forecast projects that the euro area economy will contract by 7.8% in 2020 before growing 4.2% in 2021 and 3% in 2022. The forecast projects that the EU economy will contract by 7.4% in 2020 before recovering with growth of 4.1% in 2021 and 3% in 2022. Compared to the Summer 2020 Economic Forecast, growth projections for both the euro area and the EU are slightly higher for 2020 and lower for 2021. Output in both the euro area and the EU is not expected to recover its pre-pandemic level in 2022.
The economic impact of the pandemic has differed widely across the EU and the same is true of recovery prospects. This reflects the spread of the virus, the stringency of public health measures taken to contain it, the sectoral composition of national economies and the strength of national policy responses.
Rise in unemployment contained compared to drop in economic activity
Job losses and the rise in unemployment have put severe strains on the livelihoods of many Europeans. Policy measures taken by Member States, together with initiatives at EU level have helped to cushion the impact of the pandemic on labour markets. The unprecedented scope of measures taken, particularly through short-time work schemes, have allowed the rise in the unemployment rate to remain muted compared to the drop in economic activity.
Unemployment is set to continue rising in 2021 as Member States phase out emergency support measures and new people enter the labour market, but should improve in 2022 as the economy continues to recover.
The forecast projects the unemployment rate in the euro area to rise from 7.5% in 2019 to 8.3% in 2020 and 9.4% in 2021, before declining to 8.9% in 2022. The unemployment rate in the EU is forecast to rise from 6.7% in 2019 to 7.7% in 2020 and 8.6% in 2021, before declining to 8.0% in 2022.
Deficits and public debt set to rise
The increase in government deficits is expected to be very significant across the EU this year as social spending rises and tax revenues fall, both as a result of the exceptional policy actions designed to support the economy and the effect of automatic stabilisers.
The forecast projects the aggregate government deficit of the euro area to increase from 0.6% of GDP in 2019 to around 8.8% in 2020, before decreasing to 6.4% in 2021 and 4.7% in 2022. This reflects the expected phasing out of emergency support measures in the course of 2021 as the economic situation improves.
Mirroring the spike in deficits, the forecast projects the aggregate euro area debt-to-GDP ratio will increase from 85.9% of GDP in 2019 to 101.7% in 2020, 102.3% in 2021 and 102.6% in 2022.
Inflation remains subdued
A steep fall in energy prices pushed headline inflation into negative territory in August and September. Core inflation, which includes all items except energy and unprocessed food, also fell substantially over the summer due to lower demand for services, especially tourism-related services and industrial goods. Weak demand, labour market slack and a strong euro exchange rate will exert downward pressure on prices.
Inflation in the euro area, as measured by the Harmonised Index of Consumer Prices (HICP), is forecast to average 0.3% in 2020, before rising to 1.1% in 2021 and 1.3% in 2022, as oil prices stabilise. For the EU, inflation is forecast at 0.7% in 2020, 1.3% in 2021 and 1.5% in 2022.
A high degree of uncertainty with downside risks to the outlook
Uncertainties and risks surrounding the Autumn 2020 Economic Forecast remain exceptionally large. The principal risk stems from a worsening of the pandemic, requiring more stringent public health measures and leading to a more severe and longer lasting impact on the economy. This has motivated a scenario analysis for two alternative paths of the pandemic evolution – a more benign one and a downside one – and its economic impact.
There is also a risk that the scars left by the pandemic on the economy – such as bankruptcies, long-term unemployment and supply disruptions – could be deeper and farther reaching. The European economy could also be impacted negatively if the global economy and world trade improved less than forecast or if trade tensions were to increase. The possibility of financial market stress is another downside risk.
On the upside, NextGenerationEU, the EU's economic recovery programme, including the Recovery and Resilience Facility, is likely to provide a stronger boost to the EU economy than projected. This is because the forecast could only partially incorporate the likely benefits of these initiatives, as the information available at this stage on national plans is still limited.
A trade agreement between the EU and the UK would also have a positive impact on the EU economy from 2021 compared to the forecast baseline of the UK and EU trading based on WTO Most Favoured Nation (MFN) rules.
ROMANIA: GDP will decline by 5.2% in 2020 and increase by about 3.3% in 2021
Romania’s economy is set to recover from a fall in output in the first half of the year due to the COVID19 crisis. Although the contraction in 2020 appears less severe than initially expected, uncertainty remains very high given the recent evolution of the pandemic and real output is not set to return to precrisis levels before the end of 2022. The budget deficit is projected to increase significantly, as the fiscal effort required to fight the crisis comes on top of past fiscal slippages.
Investment performance limits output drop
Real GDP fell by 4.5% year-on-year in the first half of 2020. Strict lockdown measures had a negative impact on consumer spending. In addition, the disruption of international supply chains and weak external demand slowed production and exports. As the import decline was somewhat less strong, the trade balance continued to deteriorate, but improved primary and secondary income balances lowered the current account deficit.
Investment surprised with a positive contribution to growth as construction activity was largely unaffected by containment measures. Romania?s economy continues to be affected by COVID-19 as some restrictions have been reintroduced in the autumn, and the resulting uncertainty is set to dampen economic growth, particularly in the fourth quarter of 2020.
Recovery expected to be gradual
Real GDP is forecast to contract by 5¼ % in 2020 and to rebound by around 3¼% in 2021 and 3¾% in 2022. Private consumption should recover gradually, in line with the eventual easing of social distancing measures, in 2021 and 2022.
Investment is also projected to rebound, albeit somewhat muted due to spare capacity and persistent uncertainty. Net exports are expected to contribute negatively to growth in 2020. After a sharp contraction in April, exports began improving in the third quarter of 2020, but losses are not expected to be recovered by year-end. As domestic demand declines, imports are also set to fall, albeit less than exports.
Exports are expected to pick up as of 2021 supported by the gradual recovery of global trade, while import growth is set to resume, reflecting increased consumer spending. Overall, the contribution of net exports to growth over the forecast horizon is set to remain negative. The current account deficit is expected to decline in 2020 only slightly compared to 2019 and increase again in 2021 and 2022.
The unemployment rate increased in the first half of 2020 but stabilised over the summer, due to policy measures limiting job losses. It is projected to reach almost 6% in 2020 and continue increasing somewhat in 2021 due to a delayed downturn reaction of the labour market. In 2022 unemployment is expected to decline again but stay above 5%.
Nominal wages are projected to increase moderately over the forecast horizon after several years of double-digit growth. In response to the COVID-19 crisis, the National Bank of Romania cut its key monetary policy rate in three steps from 2.5% to 1.5% and purchased more than RON 5 billion worth of government securities on the secondary market between April and August to support the financing of the real economy and the public sector. Inflation is projected to fall to 2.5% in 2020 mainly due to the sharp fall in oil prices and is set to remain contained throughout 2021 and 2022.
Risks to the growth forecast
Prolonged uncertainty related to the future direction of public policies in Romania could reduce confidence and hamper credit flows, negatively affecting investment and growth. A smaller than envisaged increase in pensions would not necessarily translate into heightened risks for growth thanks to positive confidence effects generated by the improved fiscal outlook.
On the other hand, the funds allocated to Romania under the Recovery and Resilience Facility are expected to provide further support to investment.
Public deficit on an increasing path
The general government deficit is forecast to increase to around 10¼ % of GDP in 2020, from 4.3% in 2019. The pre-existing expansionary trend largely driven by pension increases is set to be reinforced by the impact of the COVID-19 crisis.
Expenditure on old-age pensions is set to rise considerably, driven by the full-year effect of a 15% pension increase from September 2019 and a further increase of 40% from September 2020. Moreover, the child allowance has been doubled. Additional spending due to COVID-19 related measures, including employment support schemes and health-related spending, is projected at 1.3 pps. of GDP, out of which 0.4 pps. financed by EU transfers.
Tax revenues are set to be negatively affected by the recession. Despite an economic recovery forecast and the expected expiry of pandemic-relief employment support schemes (in the absence of the 2021 budget), the general government deficit is set to increase further, to around 11¼ % of GDP in 2021 and 12½ % of GDP in 2022 under a no-policychange assumption. This is due to the full-year effect of the 40% increase in pensions from September 2020, and an additional upward pension recalculation scheduled for September 2021.
This forecast does not include any measures funded by Recovery and Resilience Facility grants. As a consequence, Romania’s debt-to-GDP ratio is forecast to rise from 35.3% in 2019 to around 63½ % in 2022. An upside risk to the general government balance projections is that the increases in pensions and child allowances could turn out to be more moderate.
The government in the budget amendment of August proposed to increase pensions by 14% instead of 40% from September 2020 and to stagger the increase in child allowances over time. However, the parliament rejected this proposal. This forecast, in line with the standard no-policy change assumption, follows the parliamentary vote. Going forward, in the absence of a 2021 budget, it incorporates the increases mandated by the pension law currently in force.