EKIP– Expert Club for Economics and Politics A Different Opinion
Highlights:
- Retail data indicates that consumption growth is accelerating, likely driven by higher levels of household lending
- Industrial production and turnover decline year-on-year in January, but mainly due to base effect
- Consumer price inflation continues to accelerate, but lags slightly behind the EU average
- Producer price inflation reaches record levels for the last 4 years
- Entrepreneurs continue to cite the uncertain economic environment as a major risk factor for business development
We are sure that the most current topic for many of you right now is the upcoming parliamentary elections in a week, but political theater should not be an excuse for neglecting the... real world. And it is also useful to have at least some idea in what economic context we make our choice which political formation will govern us and, accordingly, will hinder (politicians almost never help) the economic development of the country. In the previous edition, we analyzed the latest data for 2016 and made a brief overview of the dynamics of the Bulgarian economy over the past year. Now it is time to turn our attention entirely to 2017, in the first month of which consumption growth is the main positive accent. Once again, we invite you to share any remarks, criticisms and recommendations for our analyses in the comments below.
The influence of base effects leads to a decline in industrial production
In January, the calendar-adjusted industrial production index fell by 1.19% year-on-year. This was the first annual decline since May 2016, driven mainly by a sharp contraction in manufacturing output. The production index in this sub-sector fell by 3.75% year-on-year in January, well below the EU average growth rate of 0.6%, after growing by a record 7.79% in December. This decline in itself is not a major cause for concern, as it is largely due to a base effect. In January 2016, the industrial production index was at a record high for the post-crisis years, making the base for the growth in January 2017 unusually high. The level the index reached in January 2017 is actually higher than the levels reached in January in every year since 2008, with the sole exception of 2016.
Chart 1: Industrial and construction production indices, calendar adjusted
Source: NSI
Due to the influence of base effects, there is no reason to worry about the decline in the index in January, which is likely to be only temporary. If this turns into a longer-term trend, however, and the index continues to decline in February and March, this would be an indication of a more serious slowdown in industrial production growth at the beginning of this year compared to the previous one. Such a longer-term trend is unlikely to emerge, however, given the fact that investments in the industrial sector are growing and more and more foreign-invested factories are being opened in the country.
Meanwhile, the construction production index continues to fall, both on a monthly and annual basis, and decreased by 10.34% in January 2017 compared to January 2016, but at the same time it continues to slow down its pace of contraction for the third consecutive month. As we have mentioned before, the construction sector in Bulgaria is highly dependent on financing from the European Structural Funds, which was delayed in 2016 and this was mainly due to the prolonged decline in production in the sector.
The situation is expected to improve in 2017, once EU funding is renewed. Overall, the level of production continues to fall on an annual basis, but at a relatively slower pace in recent months. We recall that the weather conditions in January were quite unfavorable in view of the heavy and prolonged snowfalls and this certainly had a negative effect on construction activity.
Industrial turnover is slowing down its growth, but there is no cause for concern for now
Chart 2: Industrial turnover index, calendar-adjusted
Source: NSI
Industrial turnover continued to grow in January, but at a significantly slower pace than in previous months. The industrial turnover index grew by 5.87% year-on-year in January, slowing by 6.51 percentage points compared to December. This was mainly due to lower sales growth in the manufacturing industry, while those in the mining industry actually accelerated their growth.
From a geographical perspective, industrial turnover growth is slowing down both within the domestic and foreign markets. Much more significant was the slowdown in the growth of sales on the foreign market, which was 9.59% year-on-year in January, compared to 27.95% in December. This slowdown in growth is not a cause for concern, however, given the fact that the industrial turnover index on the foreign market reached record highs in November and December. In this context, the slowdown in the growth rate in January is not unusual or worrisome. Industrial turnover growth rates are generally very volatile from month to month, especially on the foreign market, so unless this slowdown behaves as a longer-term trend, there is no cause for concern for the time being.
Consumption growth improves in almost all categories
In retail trade, growth accelerated in all categories except food trade in January, according to preliminary data from the National Statistical Institute. The calendar-adjusted index of retail trade excluding motor vehicles, motorcycles and fuels increased by 6.85% year-on-year in January, compared to 4.74% in December. This value is significantly higher than the average for the European Union during the same period - 1.8%. In addition, it is noticeable that while the growth in trade in this category of goods in the EU slowed down from 2.4% in December according to preliminary data from Eurostat, that in Bulgaria accelerated. Seasonally adjusted data from the National Statistical Institute also show that the turnover in retail trade excluding motor vehicles, motorcycles and fuels in our country increased both on a monthly and annual basis. The fact that consumption growth on an annual basis remains high and continues to improve is a good sign for the sector, but we should not forget that the base for comparison is relatively low, because January is usually among the weakest months for business.
Chart 3: Retail trade index, calendar-adjusted
Source: NSI
Retail trade in non-food goods (incl. fuels) significantly accelerated its growth rate in January, reaching 4.19%. Even more remarkable, however, is the acceleration in the growth of trade in non-food goods (excl. fuels), which reached its highest level since January 2015 – 10.1%. This growth rate in our country is over 7 percentage points higher than the EU average in the same category of goods during the same period – 2.7%.
A more detailed breakdown by the NSI shows that this is mainly due to the very strong growth in the trade in computer and electronic equipment. It recorded a 24% growth on an annual basis, which is the highest growth recorded among all categories of goods, while at the same time a significant increase in online orders was also noted. The growth of the calendar-adjusted index of retail trade in food, beverages and tobacco products slowed down by 4 percentage points compared to the level recorded in December, but this is a natural and expected slowdown after the end of the holiday season. According to the seasonally adjusted data of the NSI, retail trade in both food and non-food goods recorded very strong growth levels (by about 5% and 10%, respectively) on an annual basis in January, which is an indication that the improvement in the sector is not due (solely) to favorable seasonal factors. However, the business climate in the sector worsened in February (more on this below), which is an indication that consumption growth in January improved temporarily, possibly under the influence of post-holiday discounts.
Inflation reaches record levels for the last four years
Turning to price dynamics, we see that inflation continues to accelerate at a very serious pace. In February, the consumer price index increased by 1.70% on an annual basis, compared to 1.35% in January. At the same time, the producer price index in industry jumped by as much as 4.31% and after another serious acceleration, inflation in this sector reached its highest level since December 2012. Yet, despite significantly accelerating, consumer price inflation in Bulgaria remains 0.2 percentage points below the EU average, which was 1.9% in February.
The acceleration in consumer price index inflation was again mainly due to higher growth in non-food prices, which doubled in February and reached their highest level since September 2012. At the same time, growth in food prices remained relatively high (3.55%), although it slowed slightly compared to January. Transport prices increased by 6.01% in February – almost 4 percentage points faster than in the previous month, probably under the influence of oil price dynamics (more on this below).
As for inflation in the prices of manufactured goods in January, the largest increase was experienced by prices in the extractive industry. They increased by as much as 15.68%, which is a record level for the last 5 years. However, the prices in the processing industry made the greatest contribution to the acceleration in the inflation of the main index, which is natural given the fact that this is the largest industrial sector. Their growth rate accelerated by almost 2 percentage points and reached 6.20% in January, which is a record level for the last 4 years.
Chart 4: Consumer Price Index, Industrial Producer Price Index, Loans to Non-Financial Corporations, Households and NPISHs
Source: NSI, BNB
The level of credit granted is growing at an increasingly rapid pace
The faster growth in prices of both consumer and production goods for the third consecutive month was also supported by a faster growth in the level of credit granted. It increased by 2.49% on an annual basis in January, which is the fastest growth rate in almost four years. One of the factors that has stimulated the increase in lending to the real economy in recent months is the government's debt policy. As economist Georgi Angelov recently commented, recently the taking on of new debt by the government authorities has been lower than the repayment of old debt, which stimulates the banking system to seek profits by lending to the private sector, instead of buying up government securities. The level of credit granted to households is increasing most seriously. It increased by 4.07% in January, which is a record high growth rate for the last 4 years. Consumption growth in January was certainly positively influenced by this higher level of lending to households.
The credit boom in Bulgaria follows the trends in the Eurozone and the EU as a whole. In the Eurozone, household lending grew by 2.20% in January, the fastest growth rate since May 2011, and corporate lending by 2.30%. Given that the ECB, unlike the Fed, has not yet decided to raise interest rates in the Eurozone, this acceleration in lending is likely to continue, at least in the short term. This will likely also boost economic activity levels in Bulgaria, given our country's very close trade ties with Eurozone members such as Germany.
It is difficult to say at this time whether the trend of accelerating price inflation will persist in the long term, or even in the medium term, given the impact of the oil price dynamics in 2016. In the first three months of 2016, oil prices reached their last deep bottom and then started to rise until they stabilized later in the year. Due to this fact, the basis for comparison of the price indices of all goods in the production of which oil, and accordingly its prices, play a key role, is quite low. As a result, among the prices of manufactured goods, those of energy products increased by 5.34% on an annual basis in January 2017.
Although the long-awaited return of inflation is considered a positive sign by some experts, we should not forget that the acceleration in the growth of prices of manufactured goods is dangerous if it persists as a long-term trend. In fact, the increase in price inflation is never a positive development in any sector, because it is a sign that demand is growing faster than supply and, accordingly, productivity in that sector is not growing fast enough. As we noted last month, the increase in price inflation of manufactured goods could lead to an escalating increase in capital expenditures, which would force businesses to start cutting investment and labor costs. If the serious acceleration in price inflation persists even after the influence of the base effect in oil prices ceases to be a factor after March, then there will already be some cause for concern.
Entrepreneurs' expectations for business development are mostly optimistic
Regarding the state of the economic situation, the dynamics of the business climate were mixed in February, similar to that in January. Two of the four sectors - construction and services - saw a slight improvement in the business climate, while the other two reported a slight deterioration.
Chart 5: Business trends by sector
Source: NSI
The business climate in the industrial sector fell by 0.7 points in February, for the first time since October. This is mainly due to the weaker assessments of managers in the sector about the current business situation of enterprises. However, production activity is assessed as slightly improved, while at the same time it is expected to increase in the next three months. Entrepreneurs do not expect their selling prices to change in the coming months and continue to point to the uncertain economic environment as the main obstacle to increasing activity in the sector.
The situation is similar in retail trade. The business climate in this sector decreased by 1.3 points in February, due to more pessimistic assessments of traders about the current business situation of their enterprises. From the previous assessment of the situation as "good", it has now fallen to "satisfactory", but this in itself is not a cause for concern given the fact that historically this is a normal assessment for this period of the year. These lower assessments of entrepreneurs about the state of the business are an indication that consumption growth probably slowed down in February and the improvement in January was temporary. However, entrepreneurs' expectations about the future state of the business and sales volume are improving. In this sector too, the uncertain economic environment is seen as a major risk factor for the future development of enterprises, together with insufficient demand and strong competition. A slight increase in sales prices in the sector is expected over the next three months, which is an indication that inflation in consumer prices will persist in the short term, at least on a monthly basis.
The business climate in construction marked a slight improvement of 0.5 points mainly due to an improvement in entrepreneurs' expectations regarding the state of their enterprises in the next six months. This improvement in expectations regarding future levels of business activity in the sector is probably related to the expectations for the renewal of higher levels of financing under the EU funds in 2017, on which, as we noted, activity in the construction sector is highly dependent. According to entrepreneurs in the sector, the main obstacles to their business are the uncertain economic environment, followed by unfavorable weather conditions (which is a purely seasonal factor). In the services sector, the business climate also increased by 0.5 points thanks to more favorable expectations regarding the state of businesses in the next six months. Here, as in all other sectors, the uncertain economic environment is cited as the main risk factor for the development of enterprises.
Conclusion
Overall, there are no firm indications yet that the positive trends in industry will reverse in the long term, as the negative growth in the industrial production index in January is mainly due to base effects. At the same time, retail trade growth is improving and is ahead of the average values for the European Union, which is an indication that consumption in the country was strong in January. Seasonally adjusted NSI data indicate that this improvement is sustainable and is not solely due to seasonal factors. Increased consumption was stimulated by very high levels of growth in lending to households in January, which also led to an acceleration in the level of price inflation of consumer goods. At the same time, inflation in manufactured goods is reaching record high levels for the last 4 years, which could become a dangerous trend for business if it persists in the long term and leads to escalating capital expenditures.
The state of the business climate as a whole remains mixed, but entrepreneurs' expectations for the development of their businesses over the next six months are optimistic. However, the uncertain economic environment remains a major risk factor for them. Overall, in January, a positive trend can be highlighted as the fact that consumption growth in Bulgaria is accelerating and surpassing the EU average, but at the same time, consumer goods inflation is slightly lagging behind the EU average.
