Fidesz restored two-thirds majority

HUNGARY - Forecast 17 Apr 2018 by Istvan Racz

The parliamentary election held on April 8 brought about almost exactly the same result as the previous one did in 2014. Fidesz once again won with a big lead, narrowly restoring its two-thirds constitutional majority, which it lost in an interim election held in early 2015. Participation in the vote was unusually high, but the governing party proved to be more efficient in mobilizing supporters. Opposition parties competed against one another, as expected. Curiously, the opposition won in Budapest, but Fidesz reached a sweeping majority in small settlements all around the country.

The election result came as no surprise to pollsters and political analysts, who only hesitated before the vote about the chances for Fidesz to reach two-thirds in parliament. From investors’ perspective, this outcome positively promises policy continuity, including the government’s strong commitment to keep public finances in order. However, the fact that Fidesz will again have the right to amend the constitution and the so-called "cardinal acts" may further aggravate the already problematic situation with regard to democracy and civil rights.

Given the most recent charges of high-level corruption and the sharp conflicts between Hungary and mainstream EU member states, international pressure on the Fidesz government is likely to intensify further. Problems will likely come early, as the EU Commission will come forward with its new fiscal proposal in early May, and as the German government wants to get through with its refugee-redistributing initiative by the middle of this year. These problems are unlikely to spread over to domestic politics in the short term, but they could cause domestic trouble around 2020, when Hungary is expected to run out of distributable EU transfers.

In terms of prospective economic policies, the government has given away little so far. However, PM Orbán has just said that government policy will focus on competitiveness issues, along the lines laid down by the MNB’s Competitiveness Report of 2016. Focus points will be increasing the supply of good quality labor and pressing demography issues.

The domestic economy appears to be healthy, as industry, construction, foreign trade and private consumption all started the year with impressive dynamism, and consumer inflation remains rather low, due to weak import prices and the continued strength of the forint. The only area where off-track results appeared is fiscal policy, where an unusually large deficit supported the economy and Fidesz's election prospects in Q1. For the rest of 2018, we expect growth to decelerate moderately, as the industrial cycle appears to have peaked, fiscal net spending will have to return to normal, and wage growth will also be significantly lower than last year.

2019 and 2020 are likely to bring about further cooling of the economy, because of the need for further consolidation in the fiscal area, the deceleration of consumption growth as the period of extreme high wage growth fades away, and as the government is expected to run out of its EU transfer quotas by end-2019. However, no drastic slowdown of GDP growth is likely, as the need for fiscal corrections seems moderate, low unemployment will likely continue to keep wage growth significant, and as investment out of EU transfers will continue for a while even after the government has paid out the last bit of Hungary’s transfer quotas.

CPI-inflation is likely to rise from its current problem-free level in the rest of 2018 and also in 2019, given the existing strength of consumer demand and the expected upward pressure on wages, due to declining unemployment. However, we no longer expect the headline rate to rise above the MNB target this year, or to exceed the upper end of the tolerance range at any time in 2019. Correspondingly, we do not expect the MNB to raise interest rates this year, and we think that only a limited amount of rate hikes is likely to come in 2019. In 2020, the rising trend of inflation should break, due to the marked weakening of demand growth expected by that time.

Price stability remains supported by the current and prospective strength of the forint, which in turn is based on the country’s robust balance of payments position. The existing significant external income surplus will likely remain in 2018-2020, despite the ongoing deterioration of the trade balance. This is mainly because of the availability of incoming EU transfers. This inflow is in fact likely to intensify in the forthcoming period, as project completion is accelerating and increasing amounts will hit the BOP as write-ups of claims vis-à-vis the EU, the latter of which should eventually be reimbursed at a later stage.

Finally, we do not expect Hungary’s sovereign credit rating to change from the current BBB-/Baa3 level in either direction over the next three years. On one hand, the existing low investment grade ratings appear to be well deserved, in view of the recent strengthening of performance in terms of growth and macroeconomic balances. On the other hand, how Hungary will overcome its increasing labor shortage and how it will be able to handle its current political collision course with the EU remain unanswered questions with crucial consequences for the country’s prospects.

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