Can Hungary resist the global trend of Covid-19?
The outlook for the Covid-19 pandemic has greatly deteriorated over the last two months. Contrary to earlier expectations that the epidemic would recede during the summer though it might return when the weather gets colder in the Northern Hemisphere, the current prospect is continuous further spreading, which could be aggravated by seasonal factors as early as next winter. The efficiency of medical treatment is improving all the time, but no magic pill or vaccine should be expected in short term. No full reopening and rapid economic recovery are likely in these circumstances.
Running counter to the global trend, the situation in Hungary has improved, with new infections, mortality and the number of active cases all having decreased markedly since early May. Only a small number of Covid-related restrictions remain in place. However, this situation is outstanding even in Europe, given the recent infection flare-ups in many countries due to an excessively early reopening and cross-border movement by tourists and guest workers. As a result, Hungary’s economic recovery will likely be constrained less by domestic factors and more by low external demand, as the renewal or tightening of lockdown rules should keep the global economy weak for a long time.
Most recent statistics suggest that the initial economic setback was really steep in Q2, though not quite as bad as we expected previously, with GDP growth probably at -12% yoy. Compared to the deep trough seen in April, May was only a little better in manufacturing, a lot worse in construction, similarly tragic in tourism, but considerably stronger in retail sales. The BOP came out of January-May with a small surplus as to the overall balance, despite a sizeable deterioration seen in the trade account, and a substantial withdrawal by portfolio investors. This was made possible by increased net transfers from the EU, heavy FDI inflows and borrowing by the MNB.
The fiscal deficit ratio appears to have substantially overshot the twice-raised annual target and probably reached the 6% of GDP level indicated by our own annual forecast in H1. This limits the potential for the government to support the economy in H2, although we still do not believe that either the amended target or the deficit figures included in the government’s risk scenarios will eventually be met. At any rate, the government’s net financing requirement for 2020 will have to exceed the amended annual financing plan significantly. In meeting the extra financing gap, the MNB’s collateralized loan facility and its program to buy government bonds as and when necessary should prove really helpful.
The inflation picture remains remarkably stable and is moving largely in a direction favorable for central bank policy. A key contributor to this has been the stabilization of the EURHUF exchange rate between 350-360, keeping the various factors that determine inflation in the right balance. The MNB carried out a major tightening in April but has continued with a cautious and gradual loosening since then.
Going forward, we expect significant recovery of output in H2 but we still expect a 6% decrease in GDP in the full year, a setback similar to the one in 2009. Fiscal policy will likely become somewhat less supportive than in H1, the key risk area clearly being the employment situation. The government’s relative self-discipline should be crucial for the health of the BOP and the success of central bank policy. As for the BOP, the trade balance will probably strengthen, and the net financing requirement should increase only moderately, due to continued strong financial support from the EU.
The MNB will most likely aim at keeping both headline and core inflation below 4%, for which purpose the current EURHUF level would be just appropriate. We expect the Bank to pump further massive amounts of liquidity into the system, mainly through its collateralized loan and credit-for-growth programs, which implies significant net withdrawals of FX swaps and the maintaining of the current sterilization instrument, the one-week deposit tenders. The Bank is likely to systematically sterilize all forint liquidity, but it is likely to aim at reducing the base rate somewhat further, to the extent it can be done without the EURHUF rate becoming too weak from the inflation point of view.
For 2021-2022, we expect a further significant, although less-than-spectacular economic recovery, with a slowly improving fiscal situation, both in terms of the deficit and the government debt ratio. Once again, a more aggressively supportive fiscal policy is likely to be avoided, in view of the government’s traditional respect for debt ratings and the necessity to keep the BOP in a fundamentally healthy state. But we admit that in the current situation, unusually high uncertainty around the further development of Covid-19 should prevent everyone from taking any longer-term forecast too seriously.
However, one factor that needs to be considered here is the parliamentary election due in spring 2022, which should make 2021 and early 2022 a campaign period, with significant consequences on fiscal policy. But the room for running campaign-style fiscal policies will be much smaller this time than on previous occasions. So far, the need for the Fidesz government to be too generous ahead of the election is not particularly great, as the government and the party have come out of the first phase of Covid-19 very well politically. But of course, the key test is yet to be passed, and that will be the success of crisis management in the forthcoming period, including employment, public services, social policies and restoring economic growth. We continue to see this as a key political risk item for the next two years.
Finally, it is hard to forecast how the everlasting conflict between PM Orbán and EU decision-makers might be solved. At stake are financial transfers from the EU, of course. In the ongoing budget debate within the EU, Hungary’s quota is set to be halved as a ratio of GDP between 2021-2027, but the new Next Generation instrument could raise it back to roughly three-fourths of the current level. However, donor countries insist on tying the availability of EU support to the introduction of rule-of-law conditions, which is unacceptable for Hungary. Eventually, a compromise is likely as always, but exactly what that will mean is difficult to see at present. This issue will remain another key risk item for the longer term, we think.
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