Fidesz won easily and faces all the economic and foreign policy mess currently developing
The governing Fidesz-KDNP alliance won the parliamentary election by a surprisingly large margin early this month. Their victory was no surprise at all, but the continuation and even a slight increase of their constitutional majority was entirely unexpected. Fidesz’s win has removed a great deal of uncertainty as to the future course of government policy, whereas it maintains a number of, mainly foreign policy, conflicts that originated from PM Orbán’s domestic conduct and special attitude towards international affairs. Anyway, it is now Fidesz that will have to face all the economic and foreign policy mess stemming from the Ukrainian war, global demand and supply problems, inflation, the fiscal situation, geopolitical pressures and conflicted EU relations.
The election playing field was rather uneven for Fidesz and its opposition. A lack of transparency in the election process and even election fraud was also present but admittedly marginal as to its impact on the results. Indeed, election fraud appears to have been greatly reduced by the mass presence of opposition vote counters all around the country. So, in addition to Fidesz’s predominance in the media and its unparalleled abundance of financial resources, the opposition lost mainly on the inadequacy of its campaign message and a lack of success in winning over moderate Fidesz supporters. Yet leftist-liberal-centrist forces did better than at any of the previous two elections. Following the defeat, the opposition alliance is currently in ruins, sharp internal rivalry has returned, and so the opposition will have to reorganize itself before it can step up efficiently against Fidesz again.
The economy started the year with very strong growth, but it will likely be affected by mainly negative impulses in the rest of 2022. On the one hand, the distribution of a massive amount of campaign money in February is boosting demand, but on the other hand, the impact of the war and Chinese lockdowns on external demand and supply bottlenecks, higher-than-expected inflation and the need for a major fiscal adjustment and further monetary tightening will most certainly reduce growth substantially. We have scaled back this year’s GDP growth forecast significantly, and expect roughly the same picture for 2023, as most existing negative factors will likely remain for next year as well.
Regarding fiscal policy, the good news is that both the annual deficit and the end-year gross debt ratio proved to be better than expected last year. But the Q1 cash deficit reached about three fourths of this year’s annual target, as Fidesz was pushing the pedal very hard in the election campaign. So, a major fiscal adjustment will be indeed necessary, especially as the fiscal landmines of costly fixed retail energy prices, the legally guaranteed inflation-indexation of old-age pensions and the now loss-making central bank will also add to the government’s financial burdens. As Fidesz won the election, Hungary is now unlikely to be helped out by big EU transfers. In this report, we provide new estimates as to the likely costs and losses, and also on how much the tax base is likely to exceed budget.
In a further bit of good news, the refugee situation appears to be much less of a problem than initially expected, although risks remain significant in this regard. Similarly, Covid appears to pose less of an immediate threat than expected, as the disease has been stagnating in recent weeks, rather than picking up again in a local 6th wave as feared by experts. Although a great deal of uncertainty remains as to the long-term prospects of Covid, it seems less likely at this moment that it could be a serious threat for the economy between now and end-2023.
A subject quite rarely mentioned in government and MNB communications is the continued deterioration of the balance of payments. This trend is likely to persist for this year and 2023, mainly because of high energy prices and the decreasing amount of incoming EU transfers. We see nothing dramatic here as to the adequacy of FX reserves and Hungary’s ability to finance its current account deficit. But the negative trend underscores the importance of fiscal adjustment, and the forint may need increasing support from the central bank in the forthcoming period.
Our inflation forecast has been raised quite substantially, just as done at the central bank and everywhere in private sector analysis. We expect the current high inflation to remain for next year as well, despite assuming that the existing administrative price control mechanisms will all stay in force. International food and energy prices will likely be kept high by the war’s negative impact on global food supply and by the increasing western pressure to halt all energy imports from Russia within a relatively short period of time.
Higher inflation requires tighter central bank policy. Yet the MNB has been seen as trying to economize on the use of further interest rate hikes, shifting its perceived short-term EURHUF preference to a somewhat weaker level recently. The Bank has been helped in this endeavor by the ECB’s continued loose stance, whereas the continued strength of USDHUF, important for Hungary through energy imports, is something beyond the MNB’s sphere of influence.
The burden of domestic counter-inflationary efforts will likely be shared between the MNB and fiscal policy in the forthcoming period, the latter prospectively acting by cutting the deficit and by administrative price controls. The MNB will likely keep one eye on its balance sheet, which may be insignificant for monetary policy but important for the government budget. Financial stability will be another key area of consideration for the Bank, even though we expect some sort of an extension of the existing administrative containment of mortgage interest rates, with modified conditions, after the end-June expiry. All in all, we expect further sterilization rate hikes over the rest of this year, as and when EURHUF stability requires, and we expect the sterilization rate unchanged at a high level throughout 2023.
Among other things, Fidesz's election victory means the continuation of Hungary’s existing conflicts within the EU. The EU Commission immediately announced the start of a rule-of-law procedure against Hungary after the election, citing the incidence and the further threat of high-level corruption as the key reason. To make the situation worse, the Ukrainian war has caught PM Orbán on the wrong side of the conflict: his government has been sharply criticized by its former allies in the CEE region, who have been alienated by Mr. Orbán’s overly tolerant gestures in assessing Russia, despite the fact that Hungary essentially continues to cooperate with the West on sanctions and arms supplies to Ukraine.
Crucially, Hungary, together with Germany and Austria, are coming under increasing pressure to agree to a complete halt to energy imports from Russia. There have been a number of sharply critical accusations against Hungary in this regard, unfortunately not free of a misrepresentation of crucial facts, which we try to clarify in our report. Going forward, we expect a progressively implemented Russian energy import halt within the EU, with Hungary cooperating with the scheme. Paradoxically, the need for Hungary’s cooperation with EU energy policy and arms supplies to Ukraine appears to create new tactical chances for Mr. Orbán to save at least a part of the EU transfers, which could be lost otherwise if the rule-of-law procedure ends with a negative conclusion, as we expect to happen.
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