Critical mass of Covid vaccinations expected by end-summer
Our new quarterly forecast is published in an era of unusually high uncertainty. The key unknowns are the development and success of Covid vaccinations globally, the implementation of the new rule-of-law legislation in Europe and the outcome of the 2022 parliamentary election domestically. Given the existence of these factors, it seems too ambitious now to publish a 3-year forecast, as we usually do. Consequently, we have set our time horizon at end-2022 in this report.
Initial success in taming the ongoing second wave of Covid has been consolidated, despite a temporary uptick in daily new infections shortly after the winter holidays. The partial lockdown introduced in November has been extended, and the official plan is to stick to it until vaccinations have reached a sufficient degree to end the epidemic. Based on a reasonably optimistic scenario, we expect the latter by September this year.
The new Covid restrictions depressed economic activity in Q4 2020, but the negative impact appeared to be much smaller than at the time of the spring lockdown. The bad news is that the lockdown effect will remain present for most of this year, keeping recovery moderate in 2021. Assuming Covid remains under control later on, GDP may grow quite substantially in 2022, most likely supported by loose fiscal policy during the upcoming election campaign.
The government deficit for 2020 turned out to be markedly greater than suggested by the fiscal trend of Q1-Q3, although still relatively moderate if judged against the existing extraordinary conditions. The deficit appears to have been pumped up consciously, through large last-minute recapitalizations and debt settlements, with a view to setting aside reserves in case anything turned wrong in 2021-2022. An underlying concern may have been the EU’s potential blocking of transfer payments to Hungary during the election campaign, which we regard as a low probability, although a high impact, event.
We do not quite share official optimism regarding the rapid reduction of the fiscal deficit over the next two years, but we agree that some reduction is still likely, and that the gross debt ratio may also fall a bit from the long-time peak reached at end-2020, provided EU transfers are indeed available.
The combination of rapid industrial recovery and weak domestic demand caused the current account and net capital transfers to improve somewhat in January-November 2020. A similar trend is likely this year, supported by moderate domestic growth and an improving balance of EU transfers. The usual deficit on factor income should remain contained by limited earnings on FDI, an improvement of workers' remittances and the impact of the new EU recovery package. 2022 is likely to bring about renewed deterioration of the BOP as the economic recovery gets underway.
Domestic core inflation is quite high compared to the existing deflationary global environment, due to the forint’s officially supported significant depreciation last year. Going forward, stronger growth should reduce both the need and the scope for a further weakening of the currency, due to domestic and external factors alike. For the next two years, inflation is likely to stay largely in its current range, as the MNB is likely to stick to its tolerance range but is unlikely to get any more ambitious about pushing inflation further down from its current level.
Central bank strategy has been clearly stated in recent days. The MNB wants unchanged interest rates for now, and it intends to avoid being part of any competitive currency devaluation. The Bank is determined to continue aggressive quantitative easing and to devote this year to the support of economic recovery, before returning to more focus on equilibrium and debt reduction from 2022. It expects similar behavior from the government, including support of fixed investment, job protection and helping financially distressed households and companies this year. In this spirit, a few days ago the MNB extended its program to buy bonds issued by domestic non-financial companies.
The government is facing strong headwinds in EU diplomacy, but on our two-year horizon, there are good practical chances to get Hungary’s existing allocations from the EU budget. This is because the implementation of the newly adopted rule-of-law mechanism takes time, especially as the legal situation and the underlying procedure remains unclear, and as various EU institutions and member governments disagree on the issue. The rotation order of EU presidency and the election of the new CDU president in Germany may play into PM Orbán’s hands. The outcome of the US presidential election affects Fidesz negatively, but there is no way to tell how this effect can materialize eventually.
In domestic politics, the campaign for the parliamentary election in April 2022 is starting about now. For the first time since 2006, the stakes are very high for Fidesz, as the united opposition appears to be somewhat stronger in the polls. All this can be rightly blamed on the Covid epidemic, the management of which is difficult in any case and has not been perfect at all so far. A major risk is that vaccination may not be going rapidly enough to allow the removal of the lockdown by the start of summer. But the outcome of the election is unclear, as a re-opening of the economy from Covid before end-2021, the start of the economic recovery, and clever use of fiscal resources for campaigning purposes could greatly help Fidesz.
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