A race for gas in Europe

HUNGARY - Report 23 Sep 2022 by Istvan Racz

Europe’s short-term economic success currently hinges on to what extent and at what price the western side of the continent will be able to secure the amount of natural gas it needs for the upcoming winter. This is a fundamental political, growth and price stability issue at the same time, as gas is equally used to provide heating for homes and offices, run industries, food production and services, and to produce some 30% of electricity.

Recent news has been mixed in this regard. On one hand, Nordstream’s full and final closure means the fallout of about half of Europe’s former gas imports from Russia for this year. On the other hand, storage levels continue to rise, and this, together with the prospect of EU regulatory action has helped to bring gas and electricity prices sharply down from late-August levels. At present, the key problem is the EU’s limited gas storage capacities, as Russia may cut its exports further at any time.

In Europe’s ongoing race for gas, Hungary is still positioned relatively well, for its comparatively high storage level, its sizable underground storage facilities, and the so far uninterrupted flow of imported gas from four directions, except for the fallout of a limited share of imports that should come directly from Russia through Nordstream. The current storage level is roughly enough to cover the country’s demand for gas over the three winter months.

For sure, the key risk regarding gas is a possible halt to the remaining shipments by Russia, especially if the latter gets dissatisfied with war developments or with the EU’s intended new price cap policy. Such an event would also have a major negative impact on the availability and the price of electricity. The impact of the EU’s Russian oil imports ban and of the G7’s price cap decision on global oil prices, both from December, is also a major risk factor.

Hungary is cooperating with EU policies to save gas, and it has already reduced gas consumption materially. Markedly more savings will likely occur as soon as households catch sight of their first highly priced gas and electricity bills shortly, and when enterprises need to renew their annual energy purchase contracts, typically at some point in Q4. Unfortunately, this adjustment is likely to imply a severe hit to output, employment and prices as well.

Regarding recent performance, real GDP growth fell to hardly above zero in July and the first half of August, and maybe even a bit further since then. Industrial output remains quite strong, whereas agriculture, construction and some services have weakened most recently. We expect private and public consumption to contract, and energy-intensive sectors to get in trouble in the rest of this year, due to massive increases in energy prices, and generally to rising inflation.

In August, improvement continued in the central government’s cash budget, although at a slower rate than in previous months. By Eurostat standards, a surprisingly low net financing requirement came out for H1, but we do not regard that as reliable data, because of its way of accounting for the recently paid-out massive income tax refunds. In truly good news, July was the first month this year that the central government’s debt ratio was lower than at end-2021.

The balance of payments continued to look quite bad and even deteriorated in certain respects. In July, this year’s cumulative net financing requirement remained quite high, although it did not grow further as a ratio to GDP. However, there was further deterioration of the current account. BOP weakness comes entirely from the trade balance, as relatively strong export growth is more than offset by extremely high energy import prices. Also in July, the financing side improved as FDI inflows picked up, and official FX reserves were markedly higher on a year-on-year basis.

Consumer inflation made a big jump in August, just as expected. However, the strange situation came about that KSH’s national-methodology CPI-inflation and its EU-conform harmonized indicator (HCPI) were markedly different, due to differences between national and Eurostat standards. The one that reflected the true situation better was the much higher HCPI number in this case. This statistical difference will likely disappear by September by the national-standards figure rising first to the current level of HCPI-inflation and then further, to possibly above 20% by year end.

The MNB still appears to be sticking to its undeclared objective the keep the forint stable at EURHUF 400 for now, a policy that may be upheld for the next 3-6 months in our view. In this endeavor, it has been supported lately by the fall of European energy prices and the resulting stabilization of EURUSD. So, it has proven to be sufficient to raise the base rate by another 100 bps at the late-August rate-setting meeting so far. Simultaneously, the Bank announced new sterilization techniques, the aim of which would be to achieve a better result at a lower cost. However, the Bank also said that the latter would be introduced only after due consultation with the banking sector.

The MNB has said it will go on raising the base rate each month until the point it feels that the base rate has become higher than prospective headline CPI-inflation expected for the subsequent one-year period. We expect that point to come no sooner than mid-2023. We also expect the MNB to use relative forint stability against the euro as the main transmission channel to tame inflation until the cyclical peak of inflation and interest rates is reached.

The looming threat of losing access to large amounts of EU funds has become much more specific, although not absolutely clearcut. The European Commission is proposing a 65% penalty on those cohesion policy programs where the funds would be allocated predominantly through public procurement. However, this penalty would be suspended for a probation period, under which Hungary’s access to its quotas from the 2021-2027 EU budget and the RRF would be frozen. This proposal is going to Ecofin, the EU Council’s ministerial level, which is to decide on the matter with a qualified majority by December.

Fidesz’s erosion in opinion polls has continued lately, as a natural consequence of the hardships of the ongoing fiscal adjustment. However, opposition parties are not doing any better, because of their almost complete inability to address key political issues properly and mainly to cooperate with each other. The latter has gone as far recently as opposition parties' turning against each other in some interim elections for local government positions.

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