S&P Global Ratings projects that GDP growth in CEE will average 2.0% this year and accelerate to 2.8% in 2025 thanks to strengthening consumer spending and investment, spurred by EU fund inflows. These inflows will help overfund CEE economies' modest current account deficits and maintain their generally strong external stock positions. We expect disinflation and monetary easing to continue. Despite global and regional headwinds and elevated fiscal risks, we expect our CEE sovereign ratings to remain broadly stable.

That said, uncertainty over the external backdrop has increased. This stems from global trade dynamics and geopolitical tensions, both of which will be shaped by the new U.S. administration's policy decisions. CEE is one of the most open and trade-intensive regions globally, with exports to GDP averaging over 60%.

There is a risk that higher U.S. trade tariffs for the EU and greater uncertainty over the evolution of the Russian-Ukraine war might hamper CEE's GDP growth through weaker external demand in advanced Europe; flagging investor confidence, including lower foreign direct investment (FDI) inflows; and higher market volatility. This could complicate the already challenging fiscal outlook for CEE governments and put pressure on the sovereign credit ratings (see table 1).

Table 1

Risk 1: Much Weaker GDP Growth In Key CEE Trading Partners, Including Germany

The external backdrop, including global trade settings, could change our baseline growth expectations for Western Europe, CEE's key trading partner.   Specifically, under some scenarios, the new U.S. administration's tariff policies and the EU's policy response could dampen economic activity in Europe (see "Economic Outlook Eurozone Q1 2025: Next Year Will Be A Game Changer," published on Nov. 26, 2024).

Even if CEE economies' trade links with the U.S. are limited, their indirect exposure is meaningful. CEE's high reliance on exports to Germany, whose trade exposure to the U.S. economy is much higher, could hamper regional GDP growth (see chart 1). Germany's struggling manufacturing sector has already softened GDP growth in CEE economies in 2024.

Chart 1

Risk 2: Rising Geopolitical Tensions

The new U.S. administration under President Donald Trump could test European security settings.   This will be especially true if the U.S. reduces its support for the North Atlantic Treaty Organization (NATO) or military and financial aid for Ukraine. Our baseline is that the Russia-Ukraine war will linger into 2025, but not spread beyond Ukraine's territory or result in direct confrontation with NATO countries. That said, the position that the U.S. administration takes could influence efforts to end active fighting (see "Geopolitics: How Will Markets Navigate Ongoing Geopolitical Risks?," published Dec. 4, 2024).

Heightened uncertainties could have adverse macroeconomic repercussions for CEE economies.   In light of CEE's proximity to the Russia-Ukraine war zone, adverse geopolitical and security scenarios will undermine business confidence and increase risk premiums. Possible volatility of commodity prices could also negatively affect the small, open, and energy-intensive CEE economies, even though their reliance on Russian energy supplies has fallen substantially since 2022.

Risk 3: Delayed Fiscal Consolidation Amid One of Highest Fiscal Deficits In EMEA

Electoral considerations could intensify spending pressures and derail governments' fiscal consolidation plans.   The average fiscal deficit in CEE will remain high due to softer GDP growth, public wage and pension hikes amid ongoing electoral cycles, elevated interest bills, but also higher defense spending. We project that almost all CEE NATO members will spend 2% of GDP or above in 2025-2026, with Poland and the Baltic States likely to spend up to 4% of GDP. Spending pressures will keep primary fiscal deficits in the region wide and government debt on an upward path, even if debt remains at a moderate 50% of GDP in a global context (see chart 2).

Chart 2

Weaker fiscal efforts could worsen CEE sovereign funding conditions.   CEE government bond yields are below their peak in 2022, but government debt is more costly to service. We project that interest costs as a share of GDP will be 1.5x-1.6x higher than in 2021. Interest spending will consume more than 5% of total budgetary revenue in CEE on average in 2024, reaching as high as 11% in Hungary.

Government funding costs could show elevated volatility depending on global and regional interest rate developments, as well as investors' risk perception (see chart 3). The latter is partly contingent on governments' compliance with EU fiscal rules. Hungary, Poland, Slovakia, and Romania are under the EU's excessive deficit procedure.

Chart 3

Risk 4: Weaker Take-Up Of Available EU Funds, Undermining GDP Growth And Fiscal And Balance-Of-Payment Positions

Disbursements of some EU funds are contingent on reforms and rule-of-law performance.   Delayed reforms have already resulted in the slow disbursement of EU Recovery and Resilience Facility (RRF) funding. By December 2024, less than one-third of RRF allotments to CEE sovereigns had been allocated (see chart 4). Almost all funds under the RRF are still frozen for Hungry due to what the European Commission perceives as insufficient efforts to address its rule-of-law concerns. Under the current settings, sovereigns can tap RRF funds no later than end-2026.

Chart 4

EU funds are important for CEE's external funding and investor confidence.   Following a period of external rebalancing after the energy-price shock in 2022, we project that the CEE economies will run only a modest current account deficit on average. We expect that EU funds will primarily cover these deficits, alongside FDI (see chart 5). This will allow the CEE economies to avoid or contain the buildup of net external debt. Romania is a notable exception, as government foreign borrowings are increasingly financing the country's wide, fiscally induced, current account deficits.

Chart 5

Risk 5: Monetary Policy Mistakes Amid Exchange-Rate Volatility And Underlying Price Pressure

Macroeconomic developments, as well as investor perceptions of geopolitical risks, could continue to result in exchange-rate volatility in CEE.   The Hungarian forint exchange rate serves as a good example. Even though the Hungarian economy has been running a current account surplus, the forint depreciated by over 12% versus the U.S. dollar this year, including by almost 6% in November 2024. While this currency weakness occurred in the context of broader pressures on emerging-market currencies, the forint has also demonstrated its vulnerability to investor concerns about Hungary's GDP growth outlook and uncertainty over EU fund disbursements and the fiscal path.

We expect that CEE central banks will be more cautious than usual given a relatively high exchange-rate pass-through to domestic prices and elevated underlying price pressure.   After rapid headline disinflation, price growth has picked up in recent months as wage growth remains high and tax cuts and energy price caps have been reversed. Underlying price pressure remains sticky, with core inflation exceeding food and energy inflation (see chart 6).

It will likely take longer for CEE to reach price stability targets (generally 2%-3%) on a sustainable basis compared to advanced Europe. This is not least due to loose fiscal settings, but also to the region's structurally tight labor markets amid a shrinking labor force.

Our expectation is that policy easing will continue in 2025 in most of CEE, but further rate cuts might be less forthcoming as the likelihood of monetary policy missteps is higher than before due to the uncertainty over the global macroeconomic outlook and the volatility of regional exchange rates.

Chart 6

Related Research

• Sovereign Risk Indicators, Dec. 9, 2024; a free interactive version is available at http://www.spratings.com/sri
• Geopolitics: How Will Markets Navigate Ongoing Geopolitical Risks?, Dec 4, 2024
• Global Trade: How Might Uncertain Trade Policies Affect Macro-Credit Conditions In 2025?, Dec. 4, 2024
• Economic Outlook Emerging Markets Q1 2025: Trade Uncertainty Threatens Growth, Nov. 26, 2024
• Economic Outlook Eurozone Q1 2025: Next Year Will Be A Game Changer, Nov. 26, 2024
• CEE Growth Will Decelerate, But The Outlook Isn't Bleak, Nov. 18, 2024