Decreasing energy import prices should break the negative trend of the BOP this year

HUNGARY - Forecast 25 Jan 2023 by Istvan Racz

This quarterly update of our macro forecast partially follows the same basic trend as the one presented in our previous forecast report, released in October. However, it includes some important changes regarding key assumptions, real and nominal growth, inflation and the forint’s exchange rate, and mainly the balance of payments. In addition, it also includes our main scenario for 2024 for the first time.

Regarding assumptions, we see two key changes compared to three months ago. The first one has to do with the energy situation, which looks substantially better than previously expected. Mainly, the EU has made great progress in reducing its dependence on energy imports from Russia. It seems increasingly certain that EU countries will be able to weather out this winter without major problems, which also improves prospects for further changes to their mix of energy supplies. Sanctions on Russian oil seem to be working, and gas and oil prices have fallen below pre-war levels. However, energy prices and supply risks equally remain high by historical standards.

The other major change is related to Hungary’s access to new development transfers from the EU. In this regard, material progress has been made, and a lot of the previous uncertainty has been removed. However, increased certainty does not mean a positive change. In practical terms, access to EU funds now seems to be further away than ever, the remaining problems being political, rather than technical. In view of this, our current BOP and budget forecast does not include any new development transfers for this year and 2024; it only counts on transfers expected from non-cohesion funds from the new budget and the remaining part of the 2014-2020 quotas. Thus, the limited chance for a positive breakthrough on the subject represents an upside risk to our scenario.

With that said, we expect real GDP growth to end up materially stronger than previously predicted both in 2022 and 2023. For 2022, this is pretty much a fact already, based on stronger-than-expected industrial output and a relatively slow weakening of domestic demand in recent months. However, we still see a recession, although a relatively mild one, for 2023, due to the combination of a really weak H1 with a stronger H2, as inflation and forint interest rates may start to decrease materially only in the latter part of the year. Nominal GDP growth should be even stronger, as the deflator is now likely to be higher than previously expected, which must be good news for fiscal policy.

Reduced energy imports prices, which we regard permanent, though with a safety margin, for purposes of this report, should help a lot in stabilizing domestic prices and the BOP. Inflation is starting 2023 from a very high level, but producer prices have started to show initial improvement, and there is a good chance for CPI-inflation to fall to nearly single-digits by year-end. H2’s massive base effects and improved exchange rate stability should significantly contribute. Unlike previously, we now expect a substantial reduction of the C/A deficit, mainly because of a much smaller energy import bill, this year.

The year 2022 saw no real fiscal tightening, but the government debt ratio still fell materially. For 2023, a very tight deficit target has been approved, but we do not believe that the government indeed could, or wants to, meet that extremely tight target, which may be aimed at keeping investors and rating agencies calm. However, we believe that some minor tightening of policy is still likely, and the debt ratio will probably drop further this year.

The MNB has recently acknowledged that the main transmission channel of its policies is the EURHUF exchange rate. Since October, the Bank has been successful in keeping the forint nominally stable against the euro, and it may continue to aim for this for most part of H1 this year. This policy should be supported by the existing high sterilization rate, a strong political mandate to reduce inflation and, hopefully by an improving BOP. In this regard, the Bank’s own balance sheet appears to be less of a concern now than it seemed previously. In H2, the MNB is likely allow some nominal forint depreciation, with a view to maintaining competitiveness. However, we do not expect any sterilization rate cut in H1, and we predict the MNB will cut its interest rate more slowly than the decrease of the headline inflation rate for the whole of this year, in order to turn the real interest rate substantially positive by year end.

In 2024, the economy is likely to recover, but GDP growth will probably remain limited, because of high interest rates, the lack of access to new EU funds, and the running out of the old EU cohesion policy quotas. However, we do not see much scope for a rapid further decrease of inflation, as the labor market will likely remain quite tight, fiscal policy will be moderately restrictive at best, income policy targets will be probably not be very aggressive, and no further windfalls from energy import prices are likely. Similarly, the current account’s improvement is likely to get stuck again, as domestic demand recovers. However, a further material reduction of the government debt ratio remains a realistic objective.

In foreign policies, we do not expect significant changes. The government is likely to remain pretty much isolated within the EU and in the CEE region, except for a limited number of friends in this second case, because of its off-trend view on a series of issues, including the war between Russia and Ukraine. We expect efforts to restore access to EU funds to continue, but some elements of the now complete-looking set of EU conditions may prove too fundamental for the government to accept. Thus, the eventual success of talks with the EU remains rather uncertain.

In domestic politics, Fidesz’s positions are currently deteriorating, and an economic stabilization success would be badly needed to reverse this trend by the time of the local government election and European Parliament election, both set for 2024. Meanwhile, Fidesz can rely on its extremely strong administrative powers and media influence, and it is likely to focus on avoiding bigger problems generated by the currently mounting economic hardships. This will not be easy, but it seems very well possible, especially if the opposition parties remain as passive and incompetent as they currently have been.

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