EKIP– Expert Club for Economics and Politics A Different Opinion
Highlights:
- The data indicate faster growth of the Bulgarian economy towards the end of 2016.
- In December, manufacturing production grew at the fastest annual rate since 2011
- Industrial turnover growth reaches highest rate in 21 months
- Retail sales grow at a strong pace, boosted by the Christmas holidays
- Inflation in consumer and manufactured goods prices reaches record levels for the last three years
- The business climate is improving in the industrial and service sectors
In the second edition of our monthly macroeconomic monitor (you can read the first one here ), we will pay attention to the data from the National Statistical Institute for December 2016, which were published in the last few weeks. Some key sectors are recording a significant improvement in their growth rates, which is a good sign for the growth rate of the Bulgarian economy as a whole, while at the same time the level of price inflation for both consumer and manufactured goods is reaching the highest levels in the last few months. Moreover, since the NSI also published the data for December, we can follow the trends in the different sectors throughout the past year and assess their dynamics.
Industrial production shows strong improvement
We begin our analysis again with the calendar-adjusted indices of industrial and construction production. The NSI data show that while industry is experiencing one of its most productive years in recent memory, the situation in construction over the past 12 months has been exactly the opposite. The industrial sector ended 2016 on a very positive note, with the calendar-adjusted index of industrial production recording a growth of 6.95% year-on-year in December. This is the highest growth rate in this index since May 2014.
This improvement in the core index is mainly due to a significant acceleration in the pace of productivity growth in manufacturing, which jumped by more than 5 percentage points to 9.59% in December from 4.33% in November. This is a record high in the last five years – the last time manufacturing output grew at a faster pace was in early 2011. Overall, 2016 was a good year for the industrial sector, which recorded an average growth rate of 2.67% on an annual basis in the period January-December. This level is slightly below the average for 2015 (2.89%), but remains significantly higher than those recorded in 2014 and 2013.
Chart 1: Industrial and construction production indices, calendar adjusted
Source: NSI
Turning to the construction sector, we see that the situation there continues to be much more unpleasant than in industry. The construction production index fell by 9.70% year-on-year in December, after falling by 4.09% in November. The index has recorded a year-on-year decline in every month since 2016, with the lowest rate of decline in November and the highest in October. The data show that construction is the only sector whose contribution to the growth rate of the Bulgarian economy was negative at the end of 2016.
The prolonged decline in construction output over the past year is mainly due to delayed payments under EU funds, which are the main source of financing for many construction and infrastructure projects. Therefore, the negative trend is expected to reverse in 2017, when EU funding will be renewed. The construction sector is very dependent on state funding (especially in the context of growing state investments such as the energy efficiency program), which does not bode well for its long-term sustainability. Excessive dependence on state funding leads to lobbying and corrupt practices displacing free competition in the market, which inevitably causes a decline in the quality of construction output.
Chart 2: Industrial turnover index, calendar-adjusted
Source: NSI
In Chart 2 above, we can see that the acceleration in industrial production growth is accompanied by an acceleration in industrial turnover growth. The industrial turnover index increased by 12.46% year-on-year in December, which is the highest growth rate since March 2015. And in terms of turnover, the main factor for the upturn in December is the manufacturing industry, whose sales increased by 16.40% year-on-year.
This significant increase in the industrial turnover index is mainly due to the strong growth in turnover on the foreign market (i.e. exports), but it is noticeable that sales on the domestic market are also growing at a strong pace in recent years. Their growth rate doubled in December compared to November and reached 3.70% - the highest level since March 2015. As we mentioned in the first edition, the acceleration in the growth of industrial turnover stimulates production because it means an increase in demand for industrial goods, so the growth in the production index in the sector is an expected consequence of the growth in turnover. Data from the last few months show that the state of the industrial sector at the end of 2016 is not only good, but also continues to improve, which is a good sign for the growth rate of the Bulgarian economy.
Christmas spending boosts retail sales
If we turn our attention to retail trade, it, unlike the industrial sector, has seen a slight slowdown in its growth rate. Retail trade growth (excluding cars, motorcycles and fuels) fell to 5.80% year-on-year in December. This growth rate is lower than that in November, but it should be noted that it remains higher than the growth in any other month in 2016, which means that despite the slight slowdown, retail trade ended last year on a good note, similar to the industrial sector. On a monthly basis, retail trade excluding December actually grew by over 16% compared to November, which is an expected development in view of the approaching Christmas holidays.
Chart 3: Retail trade index, calendar-adjusted
Source: NSI
The slowdown in the overall retail trade index is due to slower growth in all major categories of goods included in the index, with the exception of food, beverages and tobacco sales. Non-food retail trade (incl. fuels) even recorded a slight decline of 0.63% year-on-year in December, while the pace of growth in non-food retail trade excluding fuels slowed by over 4 percentage points. In itself, this slowdown in retail trade growth is not a cause for concern, unless it becomes a long-term trend.
Keep in mind that retail trade (especially for some goods) is seriously affected by purely seasonal factors and a further slowdown in sales in the sector is likely at the beginning of 2017 in view of the fact that the months after the Christmas holidays are usually weaker than the months immediately before them, which is a completely logical trend. Towards the end of each year, people usually increase their consumption due to the holidays and the fact that they have probably received bonuses and end-of-year bonuses, which accordingly has a positive impact on the growth rates of the Bulgarian economy. Overall, 2016 was not a bad year for the sector, with an average monthly growth rate in retail trade of 3.96% on an annual basis, but it was not particularly remarkable compared to previous years. This monthly growth rate on an annual basis is higher than the average for 2015 and 2013, but lower than that in 2014 and 2012.
Price and credit growth continues to accelerate
In terms of price dynamics, December saw a significant acceleration in inflation in the producer price index in industry, while January 2017 saw a significant acceleration in consumer price inflation. The consumer price index increased by 1.39% year-on-year in January, the highest inflation rate since June 2013. Similar dynamics were observed in the prices of manufactured goods, whose index in December marked the highest inflation rate since December 2012.
As for the CPI, the acceleration in core inflation was driven by higher food inflation, which accelerated by over 2.5 percentage points to 3.79% in January, and non-food inflation of 1.20%. January was in fact the first month since February 2013 in which non-food prices increased. CPI inflation in Bulgaria followed the Eurozone trend, but remained below the average for the monetary union, which was 1.80% in January according to Eurostat data. As for the industrial producer price index, inflation there was mainly driven by a sharp acceleration in the rate of price growth in manufacturing, which reached 4.21% in December, from 0.66% in November.
Chart 4: Consumer Price Index, Industrial Producer Price Index, Loans to Non-Financial Corporations, Households and NPISHs
Source: NSI, BNB
The level of credit extended increased by almost 1% year-on-year in December, reaching the highest growth rate since October 2014. As we explained in the first edition of the macroeconomic monitor, in the context of the modern banking system and the influence that central banks have on the money supply through a policy of low interest rates and credit expansion, credit is among the factors with the greatest impact on price movements in the economy. The upward trend in the level of credit extended over the past few months gives a boost to both the demand for final consumer goods, which pushes the consumer price index up, and to longer-term investments, which in turn accelerates the demand and, accordingly, the price inflation of production (capital) goods.
The acceleration of inflation in the prices of manufactured goods could become a serious problem for enterprises in the industrial sector in terms of their capital expenditures if it were to persist as a long-term trend. All other things being equal, the increase in the prices of capital goods would at some point force enterprises to cut other types of expenditures, such as those for labor, for example, and in some cases even to suspend their plans for future investments. These consequences would in turn have a negative effect on the labor market. In addition, the level of inflation in manufactured goods of course also has an impact on the dynamics of prices of final consumer goods. Inflation in consumer goods prices, in turn, could lead to some contraction in consumption if its pace continues to rise in the coming months. This contraction would be expressed in fewer retail sales and a corresponding slowdown in the growth of activity in the sector.
Overall, prices of both consumer and manufactured goods have been falling for most of 2016, with only the last few months of the year seeing a reversal in this deflationary trend. This trend, especially for manufactured goods, was largely driven by the decline in oil and energy prices in general in recent years. However, oil prices stabilized in 2016 and this effect is now reversing. Given that the level of credit granted to both households and businesses is again growing on an annual basis according to BNB data, prices of both consumer and manufactured goods will continue to rise. Political instability in the country is one factor that could, however, have a serious negative impact on consumption and investment in the future, but at the moment this does not seem to have happened yet. Remember that higher inflation rates do not necessarily mean higher growth rates for the Bulgarian economy.
The business climate is improving slightly
Last but not least, of course, it is appropriate to pay attention to the opinions and expectations of entrepreneurs themselves, expressed in the NSI business climate index. Entrepreneurs' assessments of the current and future state of the sectors in which they operate are one of the most reliable indicators of what levels of growth of the Bulgarian economy we can expect. We remind you that in December the business climate had improved in two sectors - construction and industry, and had deteriorated in retail trade and services. In January, the picture slightly improved and we noticed an improvement in the business climate in industry and services, while the business climate index in retail trade remained unchanged, and that in construction marked a slight decline.
Chart 5: Business trends by sector
Source: NSI
The most significant improvement in the business climate was recorded in the services sector, where the index rose by 3.5 points and reached its highest level since last June. According to the NSI survey, this is due to an improvement in the assessments and expectations of managers for the business condition of enterprises in the sector, as well as optimistic assessments regarding the current and expected demand for services. Among the factors with an unfavorable impact, competition in the industry displaces in second place the difficulties associated with the uncertain economic environment. Most managers expect selling prices in the sector to maintain their level over the next three months.
From the sector with the most significant improvement in the business climate, we turn to the one with the significant deterioration . The business climate in construction decreased by 1.2 points in January, mainly due to the deterioration of entrepreneurs' assessments of the current business situation of their enterprises. According to them, the security of production with orders is decreasing compared to October 2016, but at the same time, their expectations for the business situation and construction activity of enterprises in the next six months are improving. This is probably due to the expectations for renewed and higher levels of European financing in 2017, which we mentioned above.
There is not much to say regarding the business climate in retail and industry. In retail, the index remains at the same level as in December, with entrepreneurs in the sector's expectations regarding sales and orders in the next three months remaining reserved mainly due to the uncertain economic environment and insufficient demand. Traders also predict that prices in the sector will remain unchanged in the next three months (on a monthly basis). In industry, a slight increase in the business climate of 0.9 points compared to December is noted, due to more optimistic expectations for the inflow of new orders and, accordingly, production activity in the next three months. According to managers in the sector, the main factors limiting business development are the uncertain economic environment and the shortage of labor, with the negative impact of these two factors intensifying in the last month.
Conclusion
Overall, 2016 has been a good year for sectors such as industry and retail, where growth rates have picked up significantly in the last months of the year, while construction output has been declining due to delayed funding from the European Structural Funds. Consumer and producer prices have been following a deflationary trend for most of 2016, but this trend seems to have reversed sharply in recent months. Keep in mind that too high inflation rates could pose a threat to the growth rate of the Bulgarian economy.
If inflation continues to accelerate at such a rapid pace in the coming months, this could negatively affect both industry and retail trade, in the former case through higher production costs, and in the latter through a contraction in consumption in response to rising commodity prices. At the same time, the level of credit continues to grow at an increasingly rapid pace, which is also a major factor in the rise in price inflation levels. The business climate is generally more favorable in January than in December, mainly due to expectations of higher demand in the services and industry sectors in the short term.
