Goldilocks Economy Is At Threat As Inflation Rises
There is remarkably little change in the outlook we presented in our previous Quarterly three months ago. In essence, Hungary continues to follow a benign macroeconomic path, which seems very well sustainable until the end of the forthcoming election period in late 2019, but will be most certainly unsustainable on a three-year time horizon. This means a high risk of a sharp macroeconomic correction in 2020, of course.
We see strong official commitment to maintaining rapid output growth, fueled by robust wage growth and cheap credit, but a reasonably tight budget and a decreasing debt ratio, between now and end-2019, with the underlying motivation to win all three elections (parliamentary, local and EU) due in that period. However, we see no official willingness or ability to change the existing structural policy course to improve the prospective macroeconomic path in subsequent years.
For now, (almost) everything seems to be going just fine. In 2017, 3-3.5% GDP growth is essentially guaranteed by the return of EU fund distributions on a massive scale, and by an unexpected but significant upturn in European industry. These positive factors are likely to offset the negative impact of a weather-related drop in agricultural output and of the slower-than-expected pickup of consumption, the latter despite the existing extremely high growth rate of wages.
In 2018, output growth is likely to slow somewhat, as fiscal policy will have no room to be any more expansionary, and as the same large amount of EU funds’ distribution cannot have the same incremental demand impulse as this year. An added risk is a possible settling down of the currently robust European industrial cycle. But even so, the current steam should still drive the economy through 2018-2019 with a reasonably high GDP growth rate, primarily on the back of continued rapid wage growth and robust consumption growth in the wake of the latter.
In 2020, however, the existing growth trend will have to break, as Hungary will reach the end of its EU fund allocations by end-2019 if the current accelerated rate of distributions is maintained until then as planned, and no further allocations will be practically available before 2022. Given Fidesz’ existing investor-unfriendly structural policy line, Hungary’s ability to attract private investment seems clearly insufficient to fill the resulting resource gap, and so a serious break in the growth trend is essentially bound to happen at that time.
Recent news on fiscal performance have been somewhat mixed, but the underlying trend remains quite positive. The accelerated pace of nominal GDP growth and good tax collection performance is helping to keep the fiscal deficit at or below target this year, and also to maintain the targeted decreasing trend of the gross debt ratio, despite a sharp pickup of development spending, the latter mainly under EU-backed transfer programs. Here a key risk is that the government is moving too fast with EU-fund distributions, apparently paying lots of advances, which cannot be accounted for as claims on the EU, unlike the amounts paid out on completed projects. This practice puts pressure on the government’s cash budget in the short term, and poses the threat that reimbursements by the EU may not take place if the underlying projects are eventually not properly completed.
Still on fiscal policy, this January’s big hike of statutory minimum wages, in exchange for major tax cuts, has proven to be well calculated from the fiscal policy point of view, resulting in only a moderate loss of net budget revenue. However, the primary distribution of GDP shifted significantly in favor of wages, at the expense of enterprises’ operating surplus (profits and depreciation allowances), which is supposed to be negative for future growth. This is all the more so as the same trend is guaranteed to continue in 2018, due to a further hike in minimum wages planned for next January.
We see the main threat to the existing Goldilocks economy coming from rising inflation. Although headline CPI-inflation remains low, not least due to decreasing fuel prices and the strong forint, there are signs that a serious imbalance is developing in the domestic economy. These signs range from a quickly decreasing unemployment rate and extremely high wage growth to elevated levels or recent rises of various price indicators, including the GDP deflator, housing prices, industrial and agricultural producer prices, etc. Core inflation keeps rising systematically. Unlike the MNB, we expect the headline CPI-inflation rate to reach and surpass the official 3% target by Q2 2018.
The MNB is maintaining its low interest rate / decreasing sterilization / easy liquidity policy set for the time being, based on a much more optimistic view of inflation prospects than ours. However, MNB policy is not quite that loose in a broader perspective, as the Bank has allowed the forint to marginally appreciate against the euro early this year, and is likely to informally use this tool to fight inflation, as much as possible, in the forthcoming period as well. A factor helping the MNB in this regard is the strong fundamental trend of the forint, as GDP growth is more export-driven than expected this year, and the external income surplus remains substantial. But even so, we still believe that the MNB will have to raise its interest rates in H2 2018.
In foreign politics, PM Orbán continues to gradually isolate his government (and country) from the western world, the latter including the mainstream states of the EU. This process seems to be largely irreversible as far as he is concerned, although how far it can go, and over what time period, is pretty much unclear. Our current main scenario is that the EU will not take any major action directly against Hungary (and Poland) at any time in the foreseeable future. Instead, it is likely to aim at PM Orbán’s gradual weakening by the acceleration of European institutional and policy integration (the main line of EU policy anyway), by a reform of the system of EU transfers for 2021-2027, and by not rushing to help Hungary out if it uses up its existing transfer quotas earlier than the time when the setting of any new allocations would be due.
In domestic politics, however, PM Orbán still holds the support of close to 30% of the total voting population, and is set to win the upcoming parliamentary election in 2018, and the subsequent local government and EU parliament elections due in 2019. However, just as we said earlier, this is likely to happen at the expense of maintaining a set of unsustainable macroeconomic policies in 2017-2019, which will most likely lead to a major correction by 2020. The possible political consequences of any such macroeconomic correction are completely unclear for the moment, in part because there is no evident successor of Fidesz in sight, in case of the potential need for a government change.
Now read on...
Register to sample a report