The end of a golden decade for the German economy: that is how economists describe recent developments in Europe's strongest country following the news that German gross domestic product has shrunk by 0.1% in the second quarter compared to the previous one. And Germany is not the only one slowing down; other Eurozone countries also recorded sluggish growth rate, raising fears of another recession.
The slowdown can be seen in the numbers for Central and Eastern Europe as well. The Bulgarian economy grew at an annualized rate of 3.3% in the second quarter of 2019, which is pretty average for the region. But the growth engines - exports, investments and consumption, have been showing signs of fatigue, while trade tensions between the US and Europe and economic uncertainty weigh down on the outlook. There's no doubt that a potential global recession will impact Bulgaria as well. Past experience shows that outside shocks reach Bulgaria with a delay of 6-9 months. However, unlike the deceptive calm preceding the global recession that started in 2009, now the warning signs are visible.
The euro area is stumbling
The economic growth rate in the Eurozone continues to decrease. According to Eurostat, growth fell to 1.1% on an annual comparison basis in the euro area and 1.3% in the EU. All eyes are on Germany, where GDP decreased by 0.1% on a quarterly comparison basis due to a decline in exports. Meanwhile, Italy continues to stagnate and economic growth in France also slowed down compared to the first three months of the year.
According to the director of Düsseldorf-based Macroeconomic Policy Institute (IMK) Sebastian Dullien, the likelihood of an impending German recession has increased by 6 percentage points to 43% since the second quarter data were published.
"Softening global growth dynamics and weak international trade is still weighing on the euro area outlook," the European Central Bank (ECB) said in its Economic Bulletin in August. "Moreover, the prolonged presence of uncertainties, related to geopolitical factors, the rising threat of protectionism and vulnerabilities in emerging markets, is dampening economic sentiment, notably in the manufacturing sector," said the central bank. Orders of components will slip if companies expect an economic downturn, which would also negatively impact subcontractors such as Bulgaria.
The disappointing numbers from the second quarter give many experts one more reason to bet on the ECB stepping in to boost growth. A year ago, bets were on a gradual increase of interest rates in the Eurozone in the fall of 2019. However, now it seems that the odds are shifting towards a further loosening of monetary policy. This means a decrease in base interest rates (which are already negative for deposits and zero for loans) and a new quantitative easing program one year after the previous one was discontinued.
Moreover, there are other risks stemming from the ECB's potential policy turn. A further decrease in interest rates will make deposits even more undesirable, and people could start looking at other assets in which to invest their money at a profit. Real estate, for example. The deputy chairman of the Bulgarian National Real Estate Association, Irena Perfanova, warns that the continued fall in interest rates would lead to a more negative scenario around 2021-2022 than currently expected, including the danger of an impending asset bubble. In addition, negative interest rates erode banks' profitability and push them toward riskier investments, which also inflate bubbles and, in a recession, can materialize in losses.
Consumption is slipping
The labor market brought a much needed breath of fresh air in the second quarter. The number of people employed rose by 105,700 to over 3.26 million in the year to the end of June. Unemployment fell to a historic low of 4.2%. More and more people are joining the labor market from marginalized groups such as women, people with a lower educational attainment level and people on the cusp of retirement.
Meanwhile, the average wage in Bulgaria rose by 12% on an annualized basis, whereas inflation stayed at around 3%. As a result, domestic consumption grew, though at a weaker rate than that of the first months of the year. Economist Latchezar Bogdanov of Sofia-based think-tank Institute for Market Economics (IME) warns that employment will not be able to support the growth of the economy for much longer, taking into account the decreasing number of available human resources.
Trade tensions at home and abroad
One reason for the above-average growth rate in Bulgaria is the positive contribution from net exports in the second quarter. Sales of Bulgarian goods abroad rose by 3.3% on an annualized basis, whereas imports fell by 5.5% compared to the same quarter of 2018.
The decline in imports comes from a decrease in purchases of foreign goods. National statistics show that the value of imported oil and fuels from non-EU countries in April-June registered a drop of 54% compared to the same period last year. Imports of copper ores also decreased, due to both the lower prices of raw materials on the international markets and the smaller quantities purchased by companies in Bulgaria.
Export growth this year has been driven largely by the low base in 2018, when two of the biggest companies - oil refinery Lukoil Neftochim and copper producer Aurubis Bulgaria, shut down production for several months for maintenance.
The outlook for the year ahead is not great though. One of Bulgaria's competitive advantages is the low price of resources. "We are in a currency board with the lev pegged to the euro. Remuneration is rising, energy prices are going up. Opportunities for successfully competing on the international stage with our low prices are decreasing. There are other factors at play which are difficult to forecast, such as politics and weather," said economic analyst Emil Kalchev.
The textile sector is already feeling the strain. "Since the start of the 'yellow vest' protests in France, orders have stagnated. This transferred to Germany as well. Consumption in the EU is slowing down," said Radina Bankova, chairman of the Bulgarian association of producers and exporters of clothes and textiles.
According to ING economist Bert Colijn, the second half of the year won't bring an increase in industrial production in the euro area - a development that will impact both Eurozone economies and their subcontractors. An escalation of trade conflicts around the globe is also a threat to Bulgarian firms and exports. The Bulgarian National Bank (BNB) also warns of the dangers of further trade tensions in its second economic bulletin of 2019.
Bulgaria has very few monetary mechanisms in place to fight a recession coming from abroad with its open economy and fixed exchange rate. The good news is that the country has the third-lowest level of government debt in the EU, a budget surplus and many fiscal buffers, which if used reasonably can withstand significant pressure.