Because of the invasion of Ukraine, Europe faces the economic shock of the countries of the East

The Russian invasion of Ukraine is an act of war of unprecedented violence, the duration of which is still uncertain. However, the consequences on the macroeconomic prospects of this war for the European economy are beginning to be described and projected in detail for the coming years.

First, this war will profoundly change the old budgetary arbitrations for military spending in many European countries. Secondly, it will cause, on a strictly macroeconomic level, both a demand shock and a supply shock. In the short term, everything will translate into a high impact on inflation.

For Europe, however, inequalities will increase among its members. Countries in the East of the continent that have joined the European Union in successive waves look at the war in Ukraine with another perspective, starting from an unprecedented immigration crisis. Even the reception of refugees is certainly a more important issue than the security threats that could be inflicted by a Russian attack: Poland, Hungary, Slovakia or even Romania are considering the economic consequences of the invasion in Ukraine.

Eastern European economies are facing a high impact from transformations in their systems of trade relations. Former members of the Warsaw Pact must move further away from Russia, in favor of the European Union. Their economies will incline their dependence even more on Germany, an economy that is in itself urged to leave its ties with Moscow.

Since the conflict in Crimea, that is, since 2014, although geographically close to Russia, they had to split at greater speed from Russian economic dependence. And now, this search for a pro-European trade balance must add up to the needs, for example, of 3.8 million Ukrainian refugees who left their country and were received by their neighbors, with Poland at the helm.

Julien Marcilly, chief economist at Global Sovereign Advisory, as explained in the French economic daily, Les Echos, says that “these countries have largely moved away from Russia since 2014, that is, since the capture of Crimea and the war in Donbass. Russia is no longer a leading trading partner for Eastern European countries.” It could rise like a wall, an iron curtain, on its borders with Russia.

The eastern economies, albeit nuanced, have had a good start to the year, but as the war in neighbouring Ukraine entered its second month, they fear that their growth will be affected on multiple fronts.

Since Russia invaded Ukraine on February 24 and triggered a series of punitive international sanctions, the expected impact on exports, supply chain disruptions and rising inflation have particularly threatened these economies.

Poland is the sixth largest economy in Europe by nominal GDP (excluding inflation) and a major producer of machinery, vehicles and electronics, as well as many minerals, such as coal, copper, zinc and rock salt. While the country's economic performance in February still does not fully reflect the impact of the conflict, Liam Peach, an emerging market economist at Capital Economics, predicted that the war in Ukraine will throw a “dark cloud” over the country.

For Eastern countries, new arrivals to the Union, exports to Russia rarely exceed 3% of their foreign sales and always less than 5% when Ukraine is included. Financial ties are also weak and the crisis should not weaken banks in the Eastern countries too much.

But another determining factor will be energy dependence. “For them, the risk factor is more on the side of imports, especially gas,” European analysts agree. The problem is real for the Baltic countries, Hungary and Slovakia, which are heavily dependent on Moscow gas. But it's less acute for others. “In 2019, Russia accounted for only 3% of Polish exports and 6% of its imports, especially gas,” according to Daniel Foubert, founder of the Warsaw-based firm Excalibur Insight.

30% of the Polish gas supply consists of US liquefied natural gas (LNG) and 15% comes from European countries such as Norway, continues the Franco-Polish. Poland has built the necessary infrastructure, particularly in the port of Gdansk, to avoid purchases soon from Russia. In addition, the opening of the Baltic Pipe next autumn will allow you, like the whole region, to forget about Russian gas pipelines definitively.

A particularly complex cloud is inflation. Poland, like much of Europe and beyond these borders, are already fighting with steadily rising prices even before the invasion attributed, in many cases, to the coronavirus crisis.

However, new geopolitical uncertainty and volatility in commodity markets further tarnish inflation forecasts. In a note last week, JPMorgan said that strong underlying inflationary pressures are expected to persist in Poland, as in the rest of the Eastern countries, for at least the next few months.

Inflation is a problem in Poland, Czech Republic or Hungary. Hungary's central bank raised its rates by 30 basis points to 6.15% last Thursday and the Czech national bank is preparing to raise them by 50 basis points on Thursday to 5 percent. It must be said that prices rose by more than 10% in one year in the Czech Republic and 9% in Poland.

With this scenario, these countries are already experiencing a cycle of pressure on prices and wages. Central banks began their race to tweak rates, a prelude to tightening their monetary policy.

Something to assimilate is the rise in energy prices, a trigger for the expectation of inflation. In Poland, as early as January, the government had to temporarily reduce the value-added tax on gasoline and groceries in an effort to contain rising consumer prices. Meanwhile, the Polish energy regulator resolved a 54% increase in gas bills in December, and JP Morgan's economists said more price increases may be needed.

The dilemma will then be to raise rates in the midst of a crisis at the borders can lead to undermining the confidence of households and business leaders. For now, growth between 3% and 4% is expected this year in Central Europe. But the year 2022 will be full of events for the countries of the East, including at the economic level.

For the East, the reception of Ukrainian refugees also represents an unexpected challenge. More than 3.8 million people have so far fled the war and more than half of them have crossed the Polish border.

In a note in early March, Goldman Sachs tested that the arrival of refugees to ECO-4 (Poland, Hungary, Slovakia and the Czech Republic) will provide a “substantial boost to GDP” that will offset the short-term impacts on companies and households in conflict.

Analysts reduced their GDP forecasts for the region by 0.25 to 0.5 percentage points in 2022, while increasing them by a similar amount by 2023, as refugees begin to contribute to both domestic demand and the labor force. However, the financial assistance policies available for this containment by the European Central Bank and the Community government must also be awaited. Will there be an EU mega rescue plan like for the Covid 19 crises? At the summit in Versailles, France, there was no agreement.

Finally, and with a Germany urged to reconvert, a Berlin resistant until now to cut ties with Moscow, is where the East will add another weakness. Germany is the main customer of the Czech, Polish, Slovak and Hungarian industries. During 2019, 22% of Slovak exports went to Germany, 27% of Hungarian and Polish exports were sold to their powerful neighbour, and even 31% of Czech exports were sold.

It means that any recession in the European engine will shake their economies. Although the data on the German productive force do not reflect strong turbulence, a certain crosswind, they have already sharply dented the confidence of the German chiefs, as well as that of the Czech bosses and the rest of the East, at least the surveys of the rating agencies say.

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