In the Baltics – in particular Lithuania, which tops our vulnerability index and Latvia – how the governments handle emigration and immigration is a key variable that will determine whether growth in these countries does indeed decelerate sharply. Due to heavy emigration, unemployment rates have fallen close to natural rates, which could begin to reduce employment; shrinking employment puts pressure on labor markets and could be a trigger for weaker growth in the medium term. While emigration will become less of a problem in the future as local wages begin to improve, an ageing population hurts future productivity and puts pressure on government finances. On the other hand, the Baltic countries are now much better equipped to weather the external shocks than they were before the global financial crisis. There are little signs of real estate bubbles or excess financial leverage, and current account and general government balances are in surplus or close to balance.
In Hungary, populist policies are fueling high growth, raising overheating risks. Growth is supported by an investment boom, while new export capacity has come online, alleviating fears of industrial slowdown in response to decelerated growth in the region. However, Hungary’s nationalistic tendencies could be a threat to sustained growth, as they could jeopardize key EU inflows that will support major infrastructure spending in the 2021–27 program period. Romania also scores highly in the overheating index and risks a slowdown. Populist economic policies – tax relief, generous income policy, and high spending on public employment – since the end of the global recession have fueled above-capacity growth that has contributed to a significant fiscal deficit. Recent fiscal changes and a deteriorating investment environment are undermining the country’s ability to weather external shocks, thus raising the potential for a rapid deceleration of economic growth.
While France rises high on our index with several monetary risks flagged, its latest very low core inflation data, modest employment growth results and outline of accommodative fiscal policy point to a controlled economic slowdown this year. French private debt currently stands at a high level compared to the beginning of the 2000s, a prominent factor of potential overheating risks in France. Sweden also appears on the list but does not seem to be at high risk of overheating: growth is slowing this year, but respectable domestic consumption growth continues to counterbalance the negative impact of weak exports on overall economic expansion. Growth in Austria has also already started to lose growth momentum, but no abrupt correction is likely. Instead, Austria seems to be less adversely affected by the deteriorating global demand than the eurozone on the average. Incomes and thus, further, household demand will enjoy support from the continued downward trend in unemployment.