Europe News

'Emerging' Europe overtaking the old-school economies

Economies in central, eastern and south-eastern Europe (CESEE) are poised to overtake the continent's traditional economic powerhouses like Germany and France in terms of rate of growth and employment, according to the International Monetary Fund (IMF).

In its latest regional report on Europe's emerging economies from Albania and Serbia to Latvia and Lithuania and eastern European countries such as Romania, Poland and Hungary, the IMF said that CESEE economies were so far showing themselves to be resilient in the face of external pressures.

"Despite weaker external demand, most of the region outside the Commonwealth of Independent States (the CIS, which includes Belarus, Moldova, Russia and Ukraine) continues to record solid growth, with unemployment rates now approaching pre-crisis levels," the IMF said in its report published on Friday.

It said robust growth continued in most central and southeastern European economies, as well as in Turkey ,despite problems plaguing wider Europe such as deflation in the euro zone.

"Accommodative macroeconomic policies, improving financial intermediation, and rising real wages have been behind the region's mostly consumption-driven rebound, while private investment remained subdued. In the near-term, strong domestic demand is expected to continue supporting growth amid continued low or negative inflation," the IMF said.

Dancers of Hungary's 'Matyo Folklor Art Association' in traditional clothes, react as boys throw water, some 130 km east of Budapest on March 24, 2016.

The Fund predicted that central, eastern and southeastern European countries were expected to grow by around 3 to 4 percent this year.

Things also looked good on the jobs front, with labor markets outside the CIS strengthening "considerably in recent years." The Fund said that unemployment rates had fallen "significantly" in the CESEE economies with the most declines seen in the Baltic countries, although it noted a gloomy spot with unemployment still elevated in non-EU south-eastern countries – essentially, the Western Balkans region.

In contrast, earlier this week the European Commission cut its forecast for euro zone gross domestic product (GDP) in 2016, forecasting growth of 1.6 percent. The wider 28-country European Union (which includes some but not all of the CESEE countries) was forecast to grow 1.8 percent this year. Unemployment levels are slowly coming down but remains at 10.2 percent in the euro zone.

In contrast, the IMF said that the Russian economy, which went through a sharp contraction last year amid a drop in oil prices and international sanctions and the Fund noted that other CIS countries, such as Ukraine, were "hurt by domestic political and financial woes, as well as by weak demand from Russia."

It said that the CIS' output contraction was expected to moderate to around 1.5 percent from 4.5 percent in 2015 "as the shocks that hit the CIS economies gradually reverberate less and activity stabilizes."

Read More Russia: Why the worst is over for our economy

Not all rosy

Despite the positive growth outlook for CESEE countries, the IMF issued warnings for the group saying "downside risks have increase since the fall of 2015."

Although sources of downside risks remain largely unchanged, these risks have become more pronounced. Lower euro area and U.S. growth, tighter global financial conditions, and continued weakness in many emerging economies are creating headwinds. In addition, political uncertainty and instability risks have been on the rise across the region."

As such it called for a combination of supportive monetary policy and medium-term fiscal consolidation for many economies in the region.

Read More Why the rest of Europe should recognize Polish potential

In addition, CESEE countries were facing a "brain drain" with what the IMF said was "some of the worst declines in the working-age population in Europe, reflecting both unfavorable demographics and emigration — a trend that is expected to continue or worsen."

With a less supportive global environment over the medium-term, greater reform efforts to increase productivity, support further capital deepening, and improve labor supply may be needed to lift growth, it said.

EM an opportunity

Investors have expressed caution over emerging market assets ahead of the U.S. Federal Reserve's meeting in June at which it could further increase interest rates, a move expected to cause more capital outflows from emerging markets, like those in parts of Europe.

David Hauner, head of Eastern Europe, Middle East, and Africa (EEMEA) Cross-Asset Strategy and Economics at the Bank of America Merrill Lynch, told CNBC on Friday that he thought that a U.S. Federal Reserve rate hike could also pose an opportunity for investors to "buy the dip" in EM assets.

"We have become very used to the fact that Fed hikes are bad for EM (emerging markets) but if you look at previous cycles this has not been true so we actually think that the impact on EM, if EM continues to do better which is our baseline (scenario), will not be too bad that's why we think we should buy that correction ahead of that Fed meeting."

"What really matters most is whether emerging market growth continues to get better and that's the case, EM data is surprising to the upside," he said.

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