A glimpse of better inflation prospects

HUNGARY - Report 28 Dec 2022 by Istvan Racz

Honestly, there was little reason to be very optimistic about Hungary, and about the whole of the CEE region, in most part of 2022. Yet in the last few weeks, a glimpse of better prospects for 2023 may have appeared suddenly.

No, we do not share the optimistic official view that a recession of the economy can be averted this time. Neither do we see the ongoing trend improvement of the non-energy current account balance that the MNB keeps talking about. Likewise, it would be hard not to agree with the official forecast that CPI-inflation is set to make another big jump upwards in December. Moreover, it would be equally difficult to argue that the European, and within that the Hungarian, energy situation is fundamentally safe and secure. And finally, it must be evident to everyone that a lot of additional effort will be needed to gain access to new development grants from the EU.

Nonetheless, we see some positive signs that simply were not there yet a month ago. Most importantly, the facts that the European market price of gas has returned to the level where it was immediately before the war, and that Urals crude oil sells at hardly more than half of its pre-war price, are new and encouraging. Continuation of this as a trend is not at all guaranteed, of course. But that Europe could come this far at least opens up the chance for disinflation on the continent, and for a substantial improvement on Hungary’s current account next year.

It is probably on this basis, and also as a result of a correctly chosen sterilization rate, that the forint has nicely stabilized lately, having returned to the EURHUF level the MNB was defending for four months before its unfortunate statement on ending the tightening cycle in late September. Holding that, or a similar, level for a few months more could be the best way to set the economy on the path of disinflation.

Regarding the latter, the headline inflation rate kept being pushed up from time to time by price reforms in recent months, as the government greatly reduced the scope for subsidized energy prices, due to their unsustainability. There still remains a considerable amount of subsidy in the system, but the scheme has become much smaller and more sustainable, especially as energy import prices are now lower.

Fiscal policy will still need to be tightened next year, but that task seems manageable, once again if the cost of energy indeed falls materially from 2022, and also because much higher than originally expected inflation can help generate revenue for the budget in short term. The amendment of next year’s approved budget has been officially promised to come very shortly. Targets to cut the deficit and to reduce the debt ratio have also been promised to stay largely unchanged. All this would follow a major fiscal adjustment effort since May this year, which has put the budget back on an improving trend. However, November saw some derailment of that process, which will need to be tackled first.

Given the recent stabilization of the forint at a favorable level, the lack of major volatility on global markets, including the kind that may be caused by negative geopolitical developments, could leave the MNB with the simple-looking task of sticking to its current sterilization rate for the next few months, and the not so simple task of reducing banking sector liquidity as and when possible. Indeed, the MNB is preparing itself exactly for that, especially as it still expects the peak of the inflation cycle in early 2023, but it does not expect any significant decrease of inflation before Q3 2023. The Bank also intends to continue selling FX to energy importers off-market at least in early 2023, hoping now that its interventions will use up less of FX reserves than initially expected.

In really great news, the government has managed to get approval for its utilization plans for EU development grants under the recovery instrument (RRF) and the cohesion policy funds in the 2021-2027 common budget. This is a major step forward, even though essentially the whole of the RRF and cohesion funds will remain blocked until the government has implemented a large number of anti-corruption measures and other reforms to enhance the rule of law in Hungary.

All this sounds positive, but there is always something that needs to give. This time around, the likely price is the recession of the economy and some erosion of the government’s standing in domestic politics. On the former, the recent robust performance of industrial exports has created hope that the recession may not last long and it may be as shallow as a ford on the river. But frankly, there is absolutely no guarantee for that to be possible, due to a weak European economy, and contractionary income, fiscal and monetary policies at home.

On domestic politics, we kept saying until now that Fidesz has little to worry about, as it has all the necessary powers to get through with what it wants, and as the opposition and popular protestations are too weak to cause any real trouble for them. This is still mostly true. However, tomorrow may be different, as the ongoing series of protestations by teachers has only become more forceful lately, and a similar problem is in the making within the health care sector, sparked by most recent reform plans coming from the government. And there may be more trouble coming, as economic hardships caused by inflation get reinforcement from the harsh facts of further fiscal adjustment.

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