The covid-19 recession in Eastern Europe would be the worst since the collapse of communism
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Richard, how the coronavirus pandemic will affect the economy in Eastern Europe and particularly in Bulgaria?
I think that we can see already that the effect is very big. I mean on the one hand the virus didn't spread as much in Central and Eastern Europe and in Bulgaria. I mean the number of cases, the number of deaths as well, is much lower than in the Western Europe and other parts of the world. And it's very positive thing of course. But the economic impact I think will be quite comparable because countries in Eastern Europe including Bulgaria introduce this quite strict lockdown at quite early stage of the development of the virus. Maybe because they are worried about the health system capacity, maybe they were other concerns as well. But the restrictions - the closing of shops and restaurants and that kind of thing in Eastern Europe, in Bulgaria is quite comparable with Western Europe in terms of the timing of the severity. So I think that the economic impact is going to be quite similar - maybe not quite as bad as in Western Europe. But I think all countries will have a very deep recession this year. I think all countries probably are already in quite a deep recession.
In an article in The Economist magazine you predicted that the recession in Eastern Europe will be worse than in the West and will be as bad as the recession following the collapse of communism. Why is that?
It's not what I said, they misquoted me. What I said was it would be the worst since the early 90s. It would be the worst recession since the early nineties but not as bad as and this is important distinction. - And it will be worse than 2008 in terms of the size of the recession. But it won't be comparable to the transition recessions. It's a different type of recession. It won't last as long for sure. And so I think it will be the worst since then. And in terms of comparing it to Western Europe I think there will be some countries where I would be worse than Western Europe. For example countries that are very reliant on tourism like Croatia or Montenegro - in those countries it will probably be worse than in Germany or Austria. But I don't think that's necessarily the case for most of Eastern Europe and probably not for Bulgaria for example.
But Bulgaria is also very dependent on the export to Germany. So we will depend on how the German economy recovers.
Yes, I think that's a very important point. A lot of what happens from now in Central and Eastern Europe would depend on what happens in Western Europe. That's because of, like you said, the exports, because that's where most of the tourists come from, because of remittance inflows, because of other types of capital inflows as well - so foreign direct investment or portfolio investment inflows. I mean Eastern Europe is very, very integrated with Western Europe in economic terms. And like you said maybe especially Germany. It's a bit different so for example the former Yugoslavian countries tend to be very integrated with Italy. And countries further north are integrated with Scandinavia. But Germany is important for everybody. So I think what happens in Germany is very important. Germany has been hit very hard by this. But by Western European standards the spread of the virus in general is much less compared to Italy or France, or UK. It's been much less in Germany. So that might mean that the lock-down measures are eased more quickly. It might be the recovery is better in Germany. We also know in Germany there's a very big fiscal stimulus to support the economy. And because of the integration that will spill-over into Eastern Europe including Bulgaria. There's a lot of uncertainty of course but I think that it's not the worst position to be and to have this integration with with Germany. In terms of recovery it's possible that would be a positive factor.
Do you have already any data - how big will be the recession in Bulgaria?
We only have GDP for the first quarter which tells us very little. Because it was only the second half of March when the full measures were implemented. Really what we will see is GDP in the second quarter. That's where we really see the big main impact. We have some data like this Google mobility data. I mean it shows you something, it gives you an approximation. We also have some of the monetary data - like retail trade data, for example, and it looks very bad. It confirms I think the view which I said before - that this will be the worst since the 90s. And I think we can already say with a reasonable degree of confidence that this is worse than 2008 in terms of the real GDP.
You mean for Bulgaria or for the region?
Both.
What role has the fact that we are out of the eurozone?
Good question. Because Bulgaria is out of the eurozone but in some ways it's in the eurozone. I mean it doesn't have a floating exchange rate. I mean we've seen for example that exchange rates in some of the Central European countries like the Czech Republic, Poland Hungary, depreciated a lot. And that's not the case obviously for Bulgaria, or for Croatia. Of course there are some very concrete advantages of being in the eurozone - the support for banks, the ability to issue public debt in their own currency. This is a huge market. But I suspect it won't be the deciding factor. I don't think it's really like a huge advantage or disadvantage. If I compare Slovakia and the Czech Republic which is a good way to compare euro versus not euro.
Because our prime minister said that it would be a big advantage if we were, not in the euro zone, but at least at the ERM II. So we are now trying to enter the ERM II and he said that it would be a big advantage for us.
I think would be an advantage. I think that's clear. But I don't think it would be the deciding factor. If you look across Central and Eastern Europe I don't think you can really argue that whether or not the countries are in the euro zone is the most important factor in this crisis in terms of how badly countries would be affected.
What you think are our chances to enter the ERM II this year?
It's difficult for me to say. My opinion would be that both Bulgaria and Croatia are still on course for the euro. I think that is where both countries are going. But in terms of the timing like a lot of things that are less sure now, are more uncertain because of this crisis. Bulgaria will join the euro but I think it's very hard for anyone to be really sure in this environment about time. And that applies to Croatia.
Which sectors do you think will be hardest hit by this crisis?
Anything which has been especially locked down or closed down and it's harder to open. For example recreational and leisure industry - restaurants and cafes, but also maybe especially museums and cinemas. In Austria those are the last things to open. Things like cinemas and museums, so everything in that sector. I think external trade, the export industry, global trade has collapsed. It also looks worse than 2008-2009. And tourism will be very badly affected this year. I think the tourism season this summer in Bulgaria and in Southeast Europe in general it's going to be very difficult, difficult tourism season.
A lot of that should come back. There's a lot of uncertainty but the tourism sector once this very acute phase of the crisis passes and people have confidence that there isn't a second or a third wave, once it passes the tourism sector can recover very strongly, very quickly. Global trade I think can also recover quite quickly. It depends on what happens in Asia, it depends on what happens in Germany. But in the leisure and recreation industry for a lot of small businesses - in restaurants and cafes and places that have had to close for a while, these often small businesses they maybe don't have resources to ride this out like big companies. For them I think that is definitely a concern.
There are also sectors that will benefit from this. I think we see that already - like everything in the digital sphere. Any businesses that can be done online, they get a huge boost from this.
When could we expect a recovery?
The recovery is possibly already here but we're recovering from an extremely low base. I think that the full recovery can only happen when life really returns to something like normal and that's when we either have full confidence among enough people that the virus is not coming back, that there won't be a second or third wave, or we have a vaccine that's available for everybody. And I think the estimates from the scientists are that it would be really the second half of next year. It's kind of a likely time frame for the vaccine. So we might be in this sort of "up and down" phase where we slowly recover but there's a lot of caution still. This can last a year with a recovery, but not a very strong, not very impressive.
How the recovery will look like?
I think it will not be V-shaped. I like this idea of this Nike tick recovery that somebody came up with. So it's kind of a V in a way but the right side of the V is quite gradual. And I think this is like the the most likely scenario. Unless the virus really comes back and there's a huge second wave I think we're past the worst. We had the low points. But there is just this huge caution what you out on the street, you feel it, people are very cautious, people are not returning completely to normal life. And I think they won't for some time.
What would be the role of the European Commission recovery plan?
We have to see what's going on. And it's interesting to discuss this from Austria because Austria is one of the countries that is at the moment against it. I think it always matters if you have France and Germany on the same side. For that reason I would be quite optimistic that it will happen in something like the plan, something like that. And in that case it's a lot of money. The projections are up to 20% of GDP for some of the Eastern European countries. I think Bulgaria is towards the top, has one of the biggest potential allocations relative to GDP. If it happens in something like the form which it is planned, and I think it would be pretty significant, it's quite a bit of extra money on top of the existing EU budget as a share of GDP. Two thirds of it is grants so it's enough to be paid back. Bulgaria looks like will be one of the countries that benefits most from it. So I think it's in a way kind of surprising development and reflects a different kind of thinking in Germany about this whole issue. It reflects I think also the severity of the crisis, it really focused the minds. And it will be if it happens in anything like the way it is planned, and as I said I'm reasonably optimistic, I think it would be an important part of the recovery.
Bulgaria cut the VAT - the value-added tax, for restaurants from 20% to 9% and many economists in our country criticized the decision saying it would open the door for many more industries to seek tax cuts. What signal could this change in our tax system sent to potential foreign investors? Because VAT is the main revenue source for our country.
At the moment the oneness is on governments to ease fiscal policy whether that's to spend more or cut taxes to stimulate the economy. I think that most governments are going in that direction. So Bulgaria is not an unusual case and that's the right thing to do. I don't have a strong opinion on the VAT cut in Bulgaria specifically. I think in general the fiscal loosening is important because the government has to step in to support the economy in such a particular and bad crisis.
Our income and corporate tax is 10% and one of the lowest in the European Union and we rely on that to attract foreign investors. But because if the VAT is cut like this and also in other industries, this would result maybe in the other taxes like income and corporate to be increased.
At the moment the foreign investors probably have even bigger things to worry about. It's a time when there won't be much foreign investment of any kind. I think that we all now have to work on the assumption maybe we're going to see very big fiscal deficits for at least a year probably two years or more in almost all European countries including Central and Eastern Europe. Public debt is going to rise a lot as a result in this crisis. So my assumption would be on aggregate taxes are going to rise everywhere to pay back this debt. Taxes will rise across Central and Eastern Europe over the next few years. Even if there were cuts now I think that this is almost inevitable given the public debt is going to rise a lot. I mean the advantage Bulgaria has is that it starts this crisis and I think this was also in the Economist article actually that the Bulgaria starts this crisis it's very low public debt. It's interesting to compare to Romania. It's very different. Romania sees a big fiscal deficits it's kind of seen as almost reckless in a way. And Bulgaria has a reputation for being very careful, very fiscally conservative and that's because of the euro accession plans and the currency regime that Bulgaria has. Bulgaria doesn't look like a country that is really in danger. That's my impression.
How the region and Bulgaria could benefit from the nearshoring? We have big outsourcing, IT and automotive industries.
I think this will go further. I think that if you look at it from the perspective of German investor or an Austrian investor with investments outside of Europe, it looks different now, the calculation is different. It looks more risky. The advantages of proximity are much greater. On the other hand for them to really bring investment back home - the labor costs are very high. It's quite easy to make the argument that Central Europe Eastern Europe can benefit from this. That the advantages of investing in Central and Eastern Europe will be higher that it were before the crisis. I think the question is - Is that like an incremental change, it just happen a bit or does it happen a lot? And I think that will really depend on the country. I think that different countries have different advantages. In manufacturing, in automotive sector I think that still the Visegrad countries really have the advantage here. I think they will maybe benefit more from that. Where in countries further east or south like Bulgaria maybe the real advantages are more like in the IT sector, more in digital economy in general, or in the services sector. I mean this is a sector that will really get a boost from this crisis. I think it's shown how much more can be done remotely than before.
Because in Germany in general outsourcing of production, the manufacturing, has gone much further than outsourcing of services so far. And that's something that might change as a result of this crisis. There might be more outsourcing of services functions to countries like Bulgaria. And in general the digital economy, the IT sector, there's already a hub in Sofia, it's already started in Bulgaria. But this sector has got a boost in a few weeks basically, that could have taken otherwise five or ten years. And I think that is a permanent change. Because we know that Central and Eastern Europe has good people, qualified people, who can work in these sectors. We know that there are already hub and including in Bulgaria, there's already an established competence in this area. and that's something I think could go much further in result of this crisis.
What are the main lessons that we in Europe should learn in result of this crisis? Is the globalization over?
I think globalization has certainly peaked. I think that we already had the reality of great power conflict between China and the USA that already existed, there was already this huge threat to globalization. And the combination of this crisis with the fact that it originated in China, that so much of the production of - for example medicines, is in China, this all goes together in the same direction. We will see a rolling back of globalization. I don't think it's the end of globalization at all but I think at least in some sectors we're going to see unwinding of these very complex supply chains. I think that's reasonably likely. And maybe what we will see more is three relatively distinct blocks in the global economy: of the USA, the EU and China. I think there's still scope especially maybe between the EU and China, there is still scope for areas of cooperation. But I think the hyperglobalisation period is passed, the peak period of that is passed. We will see more protectionist world.
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