By Paul Hannon


The economies of central Europe are set for stronger growth this year and next as inflation cools, but Russia's invasion of Ukraine will continue to cast a shadow over their prospects in the form of higher borrowing costs, the European Bank for Reconstruction and Development said Wednesday.

The London-based development bank also noted a surge in Chinese investment in parts of Europe and North Africa last year as businesses sought to avoid barriers to their exports.

Russia's full-scale invasion of Ukraine in February 2022 pushed energy and food prices sharply higher, weakening household spending power across central Europe, while undermining business confidence. With central banks raising borrowing costs to tame a surge in inflation, economic growth across nine central European countries slowed sharply, with five experiencing contractions.

The EBRD now expects a pickup in growth as household spending recovers, with Poland set for an expansion of 2.9% this year and 3.5% in the year after.

But the impact of the war is likely to linger, as investors and lenders now perceive many countries that are in close proximity to Russia as riskier places than they did prior to the invasion.

The EBRD estimates that the spread between yields on German government bonds and those issued by the affected governments is now twice as wide as it was in January 2022, making borrowing for governments, households and businesses more expensive than it would have been had Russian troops stayed in Russia.

"There is a lasting increase in the cost of borrowing, which is related to the war," said Beata Javorcik, the EBRD's chief economist. "The war continues to cast a long shadow over Europe."

The EBRD was established in 1991 to help countries in eastern Europe and the former Soviet Union following the collapse of communism, a development that ushered in a period of globalization that included a removal of barriers to trade and the relocation of much factory work to countries where wages were lower.

Now, the EBRD is helping the countries in which it invests navigate a fragmentation of that global system, driven in part by mutual suspicion between the U.S. and China, with Europe leaning toward the former.

Last year, the EBRD detected a sharp rise in Chinese activity across the roughly three dozen countries in which it operates. Businesses from the country accounted for 39% of all foreign investment in new factories and facilities, having accounted for less than 5% in 2022.

Much of that was concentrated on a number of countries that have sought to maintain relations with both sides of the geopolitical divide. They include Egypt, Morocco and Serbia, in sectors such as electronics, metals and renewables.

To the EBRD, this appears to be an effort to avoid potential barriers to exports by making products in countries that have and are likely to retain access to wider European markets. In Morocco's case, it also has a free trade agreement with the U.S.

"You can think of this as a pre-emptive move to supply markets through foreign direct investment rather than exports," Javorcik said.

The war between Israel and Hamas is also having an impact on countries in which the EBRD invests. The development bank said it now expects Egypt's economy to grow by 3.9% this year, down from 4.5% forecast in November, shortly after the Hamas attack on Israel. That downgrade partly reflects a loss of revenue from the Suez Canal. It lowered its growth forecast for Lebanon to 0.2% from 3%.

Across all of the countries in which it operates, the EBRD expects to see a pickup in growth to 3% this year from 2.5% in 2023. However, that marked a downward revision from the 3.2% growth it expected in November, largely reflecting the weakness of demand for exports from western Europe.

The development bank said it continues to expect Ukraine's economy to grow by 3% this year, while it raised its forecast for Russian growth to 2.5% from 1%.


Write to Paul Hannon at paul.hannon@wsj.com


(END) Dow Jones Newswires

05-15-24 0114ET