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Spring Forecast of Economic Trends 2022: Moderation of economic growth, high uncertainty due to the war in Ukraine

The Spring Forecast of Economic Trends was prepared in a situation of high uncertainty related to the war in Ukraine. After a deep downturn in 2020 and a strong rebound last year, we expect GDP growth of 4.2% this year, which is 0.5 p.p. lower than projected in our Autumn Forecast. We had already projected a slowdown of growth before the start of the war in Ukraine, mainly due to last year’s high base as well as increasing price pressures from high energy and commodity prices and supply chain bottlenecks. Moreover, we expect the volume of support measures that have a positive impact on economic growth to be lower this year than last year, even taking into account the measures taken until the middle of March. Economic growth this year will be largely driven by domestic consumption growth, while private consumption growth will slow under the impact of higher inflation. The easing of containment measures will lead to faster growth in the consumption of services, which was still far behind 2019 levels last year due to restrictions related to the epidemiological situation. Investment growth will remain high. We expect exports to continue to grow, albeit at a slower pace than last year, due to a slowdown in the growth of goods exports, which will be significantly affected by the consequences of the war in Ukraine, as well as a sharp decline in exports to Russia and, via the impact on the economic activity of Slovenia's main trading partners, a slowdown in the overall growth of external demand. Inflation continued to rise at the beginning of this year and is expected to remain relatively high this year, before gradually declining. The rise in employment and the decline in unemployment will continue, and at the same time demographic trends will increase the impact of labour shortages. We expect GDP growth to slow to around 3% over the next two years. The main risks to the realisation of the forecast are related to the unfolding of the war and energy prices. The downside risk also remains related to the epidemiological situation and increasingly to supply chain disruptions. Economic growth could also be higher than forecast if the situation in Ukraine stabilises and geopolitical tensions ease and will also depend on the adaptability of businesses and support policies during the war and sanctions against Russia. These are the main findings of the Spring Forecast of Economic Trends presented by the Institute of Macroeconomic Analysis and Development (IMAD).

In our Spring Forecast, which was prepared in first half of March, we expect GDP growth of 4.2% this year, slowing to around 3% in the next two years. “After a deep downturn in 2020, economic activity grew by 8.1% last year, surpassing the 2019 level. This year, economic growth will be 0.5 p.p. lower than projected in our Autumn Forecast. After last year's strong rebound in economic activity, we had expected growth to slow even before the war in Ukraine began, mainly due to last year’s high base as well as increasing price pressures from high energy and commodity prices and supply chain bottlenecks. Russia's invasion of Ukraine and the imposition of sanctions have exacerbated these pressures, and the sectors most dependent on trade with Russia and Ukraine are (or will be) even more severely affected, leading to a decline in exports to this region,” explains Maja Bednaš, Director of IMAD, on the impact on projected economic growth, adding: “We estimate that the volume of support measures that have a positive impact on economic growth will be lower this year than last year, even taking into account the measures taken in recent days. In terms of content, the support measures in the last two years were mainly aimed at mitigating the impact of the epidemic, while this year they will be aimed more at mitigating the impact of high energy prices.” Economic growth will be largely driven by domestic consumption growth. Private consumption growth will slow this year after a strong rebound last year as a result of further increases in disposable income (supported by government measures and a rapid recovery in the labour market) and the release of pent-up demand from 2020. Private consumption growth will be lower than last year also under the influence of higher inflation, which will lead to a real stagnation in disposable income. Therefore, we also expect a decline in the savings rate, which rose sharply during the epidemic. We expect the easing of containment measures to lead to faster growth in the consumption of services, which was still far below 2019 levels last year due to constraints related to the epidemiological situation. Investment in machinery and equipment will continue to increase, and with the easing of containment measures, investment in services sectors, which were most affected by coronavirus restrictions, will also increase. We expect a further increase in housing investment, and according to the valid budget documents, we also expect further growth in general government sector investment. This will also be supported by EU funds, as funding from the 2014–2020 financial perspective is coming to an end, and this is usually the time when absorption of funds accelerates, while the contribution from the Recovery and Resilience funds is also increasing. We expect exports to continue to grow, albeit at a slower pace than last year due to the slowdown in the growth of goods exports, which will be significantly affected by the consequences of the war in Ukraine and a sharp decline in exports to Russia, and, via the impact on the economic activity of Slovenia's main trading partners, a slowdown in the overall growth of external demand. Supply chain disruptions are expected to ease slowly and gradually over the course of this year and remain high in some sectors. The trend of bringing supply chains closer to European markets, where Slovenian companies would increasingly seek opportunities, could have a positive impact. As external demand continues to weaken, the projected slowdown in economic growth over the next two years will also be affected by continued price pressures, which will impact business costs and limit household purchasing power.

We expect economic growth in the euro area to slow to 3.4% this year and to 2.7% in 2023. “Assumptions about economic growth in Slovenia’s main trading partners and energy prices are accompanied by pronounced uncertainty related to the unfolding of the war in Ukraine and the related measures,” Maja Bednaš pointed out.

Labour market conditions began to improve rapidly in mid-2020, when the containment measures were gradually lifted and most activities resumed. Employment rose to its highest level last year, with a strong contribution from the employment of foreign workers, also against the backdrop of labour shortages. Given the growing demand for labour, the number of registered unemployed fell sharply last year (to an average of 74.3 thousand in 2021). “We expect employment to rise by 1.7% this year, while the number of registered unemployed will continue to fall and will amount to around 61 thousand on average in 2022 as a whole,” Maja Bednaš commented on the labour market developments. We expect labour market conditions to continue to improve over the next two years, “albeit at a less vigorous pace than this year due to somewhat lower growth in economic activity and demographic trends causing a decline in the working age population (aged 20–64),” she added. Labour market conditions could therefore be an ever greater obstacle to the growth of value added, as was the case even before the COVID-19 crisis.

This year, nominal wage growth in the private sector will be similar to last year, while the average nominal gross wage in the public sector will fall due to the cessation of allowances and consequently last year's high base. In addition, real wage growth will be dampened by high inflation.

Consumer prices rose sharply last year. Inflation is projected to remain at a relatively high level for most of this year, only approaching 2% in 2024, provided price pressures ease. At the beginning of this year, inflation continued to rise as prices for energy, food, services and non-energy industrial goods increased. “We expect inflation to hover around the levels reached for most of this year, and even higher growth will be limited by measures to mitigate the impact of high energy prices,” said the Director of IMAD. With the easing of containment measures, we expect some demand this year to be diverted from goods to services, whose price growth will accelerate. All this will lead to an overall increase in consumer prices of 6.4% in 2022 as a whole, moderating to 3.2% in 2023 and to 2.3% in 2024, while higher wages will have at least some impact on final price growth, especially in the services sector, which is less exposed to international competition. 

Since the Russian invasion of Ukraine, the greatest risks to the realisation of the forecast are associated with the unfolding of the war and energy prices. Amid significantly higher energy prices, EU Member States would be forced to rationalise energy and look for alternative sources, which would have an additional negative impact on economic activity in the short term given the EU's high dependence on Russian gas imports. The already severely weakened trade flows with Russia would decrease, which would have a negative impact on exports, at least in the short term. At the same time, inflation would remain high for an extended period of time (including next year) as oil and natural gas prices rise and are likely to remain high. Even more massive fiscal measures would be needed to help economies mitigate the greater negative impact on financial markets and the decline in consumer and business confidence, which would slow fiscal consolidation.  

The downside risk to the realisation of the Spring forecast is still related also to the epidemiological situation and increasingly to supply chain disruptions. Stricter containment measures in the face of potential new waves of infection, also as a result of new and more infectious coronavirus mutations and/or insufficient vaccination coverage, remain a significant risk to a more stable recovery in some activities. “The risk associated with potentially prolonged supply chain problems is also increasing. In particular, a shortage of certain raw materials and semi-finished products, also as a result of further disruptions related to the Russian-Ukrainian conflict, would affect exports in particular and increase the risk of greater cost pressures,” Maja Bednaš explained. There are, however, also some upside risks to the baseline projections for Slovenia and the assumptions for its trading partners. This will depend mainly on the situation in Ukraine and the adjustment of businesses to the situation, including through increased investment activity to accelerate reduction in dependence on Russian energy, and on the global ability to cope with the pandemic, as well as on the effectiveness in terms of absorption of EU funds.
 

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