Golden scenario to run until end-2019, sort of

HUNGARY - Forecast 18 Jan 2018 by Istvan Racz

Our new quarterly forecast marks an unusually smooth macroeconomic path for Hungary in 2018-2019. This should come about with annual real GDP growth above 3%, relatively low, though rising, inflation, a material, though shrinking, external income surplus, and a moderately decreasing government debt ratio. Barring a major disruption in the global economy, the risk of which does exist already on this horizon but does not seem to be very high, this benign domestic scenario is likely to prevail throughout the next two years.

The factors underlying Hungary’s favorable macro performance are the ongoing forceful recovery in Europe, the availability of massive free-of-charge funding from the EU and an increasingly intensive wage convergence that can be seen happening everywhere in the EU’s new member states within the CEE region. These factors have proven, and will likely continue to be rather powerful in boosting both fixed investment and consumption, while providing invaluable leverage to fiscal policy.

Despite all the existing conflicts and problems, there seems to be a fair chance that politics will not seriously impair the prospective benign macro scenario at any point in 2018-2019. Most importantly, the existing favorable economic trend will most probably enable Fidesz to win all three elections that are due in this period, and this outcome will likely secure continuity and stability in domestic politics.

Besides, the existing serious conflicts between the Fidesz government and major Western European powers on democracy and civil rights, migration policy, etc. are less likely to lead to an open clash any time soon. This is because the migration issue is increasingly a problem for the EU as a whole, and as CEE member states, with which Hungary’s government is sharing these conflicts, are too important for the EU and NATO for the latter to launch an all-out attack against the former ones.

However, no everything-is-just-right state of an economy can last forever. The existing threats are eventually more inflation and monetary tightening in the US and mainly Europe, in addition to a continuously tightening domestic labor market and the upcoming end of the current massive inflow of development transfers from the EU. The first and second of these should mean more inflationary pressure and the need to raise interest rates possibly as soon as from H2 2018, whereas the third one will most likely lead to a significant deceleration of GDP growth in 2020. An alternative scenario would be a major equity market correction in the not too distant future, which would, of course, change the game towards even less growth but also lower inflation.

The key long-term problems facing Hungary still appear to be the same as the ones that have been with us for several years now. First, EU transfers will almost surely never recover after 2020 to their current level, and so Hungary will have to learn to live much more on its own talent and diligence than so far. Second, once all remaining free labor has been drawn into production or emigrated for a better living, growth will depend fully on productivity increases, unlike in the current model, where it is mainly a function of ever increasing employment. Third, as wage convergence between Hungary and developed economies is proceeding, performance requirements facing employees are bound to rise to significantly higher.

And here comes the problem that limits Hungary’s potential growth the most seriously. Free labor of any acceptable quality is just about disappearing completely in these days. In addition, fixed investment apparently has not been sufficient in quantity and quality to reach a major improvement of labor productivity in recent years. Finally, the government has proven to be rather unsuccessful in the area of human infrastructure, mainly in securing proper education and health care services. It appears increasingly clear that deep structural reform is needed to boost potential growth. But unfortunately, the existing prospect of a big victory for Fidesz in the upcoming election season will likely make the achievement of those reforms only more complicated.

As a result, Hungary’s bright prospects for 2018-2019 and its unsolved potential growth problem for long term are to be read and assessed together.

Now read on...

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