Good news and more good news: GDP, the fiscal deficit and the debt ratio
Hungary and some of its neighbors are still holding out as an island of peace in the big sea of Covid waves all around Europe. In this regard, it seems to be an advantage that the country is neither a transportation hub nor a major destination for tourists, and that international travel remains subject to strict restrictions.
But this grace period cannot hold for long: the number of new infections has started to grow already, slowly and from a low level for the time being. Experts are convinced that Covid will largely follow last year’s pattern, returning in a 4th wave in September, when all travelers have returned from abroad, the school year begins, and the weather gets cooler again. A realistic hope, though, is that the relatively high vaccination level will probably limit the scope of this new Covid wave, containing the pressure on the health care sector, the intensity of any necessary restriction and the size of the economic damage.
First-estimate GDP data for Q2 beat all forecasts, including the one based on the Finance Ministry’s leading indicator, the Weekly Economic Index. Despite the massive 3rd wave of Covid just around springtime, real GDP rose markedly from Q1, but most of the big yoy jump was due to the exceptionally low base recorded in Q2 last year. As usual for preliminary national accounts data, GDP details have not been published yet, but some useful conclusions can be made from KSH’s monthly releases.
The economic recovery seen in H1 was led by the industrial sector, but retail sales also did better than it appears at first glance. Performance is now exceeding pre-Covid levels in these areas, and also in employment. Areas of continued weakness are the Covid-hit part of services, notably hotels, catering and entertainment, passenger transportation, and construction. However, a rapid recovery has been recorded recently in this latter area, as the government has given a major push to the sector by cutting the VAT on new apartments again, and by providing families with further subsidies to buy new homes. In addition, much of the positive surprise regarding GDP must have come from the services unscathed by Covid, including trade, IT, telecom and financials, on which hardly anything is reported between the quarterly national accounts data.
This year’s fiscal developments have been quite favorable. The deficit fell, as spending was switched back from crisis mode to normal, and as above-expected GDP is beneficial for revenues. This and the existing large cash reserves will allow the government to start its development programs designed for the EU’s recovery facility at its own risk, even if approval of Hungary’s RRF plan is delayed due to rule-of-law concerns. The government’s gross debt ratio fell substantially in H1. The MNB and domestic banks bought markedly more government debt than the total of net issuance, whereas other holders, especially nonresidents, reduced their stake by a large amount.
Developments in the BOP remain generally favorable, as the fundamental part is still nearly balanced. The favorable dynamics of external trade greatly supported this trend in H1. The financial account did not look as good, mainly because of the decrease of nonresidents’ investment in domestic government bonds. The latter was in some part a matter of policy, and it had no material negative impact on international reserves or government deposits.
CPI-inflation fell substantially in July, but that was due mainly to an extremely large base effect, and not really to an easing of inflationary pressures. Official and private sector forecasters equally expect the headline rate above the MNB’s tolerance ceiling for the rest of this year. Inflation appears to be fueled by external prices, labor market and wage developments, a strengthening propensity to consume and rising inflationary expectations. However, the forint’s rapid depreciation against the euro, formerly a contributing factor, has not been present since the turn of MNB policy in April.
In addition to raising the base rate by another 30 bps and pushing up the interest rate corridor fully into the positive range, the MNB also reduced the amount of liquidity generated through quantitative easing in July. The latter took place predominantly through less refinancing of SME loans, in line with the Bank’s earlier pledge to close down that program. QE activity is most likely to decrease further in August, as long-term collateralized lending to banks was discontinued from this month. However, direct purchases of government bonds are bound to stay as they are absolutely essential, and so far, no word has been said about any possible cutback of the MNB’s purchases of corporate bonds, either.
Regarding the odds for the upcoming August rate-setting meeting, we expect the continuation of tightening, but with a smaller rate increase than in the previous two months. The Q2 GDP data only strengthened the arguments in favor of further rate increases, but the July inflation number was not particularly bad, and the forint’s current exchange rate also appears to be compatible with the MNB’s stabilization efforts.
In foreign policy, Fidesz has organized a one-week visit by Tucker Carlson of Fox Television to Hungary, to demonstrate to the world and mainly to the domestic public that the party is not at all isolated internationally, and only a heavy liberal bias in Western Europe can explain its current problems in the EU. Meanwhile, construction works on a NATO military base continue in North-Western Hungary, as part of strengthening cooperation with the US on defense matters. In Central Europe, the main focus of western criticism has shifted from Hungary to Poland for now, which allows PM Orbán to take a break before the culmination of RRF talks in late September and the expected court decision on the rule-of-law mechanism in October.
In domestic politics, the only poll available from July reflects equal public support for Fidesz and for the opposition alliance, which would most probably imply a clear Fidesz win because of the way election law is constructed. The opposition’s preliminary election process has started and is expected to conclude around mid-October. This is a complicated and risky process, given the diversity of views and conflicting interests within the opposition alliance. But at the same time, it is also an opportunity, as successful implementation of the preliminaries could prove the opposition’s political maturity and serve as a confidence builder. On the other hand, faster-than-expected economic growth will allow Fidesz to implement generous pre-election handouts of public money. Indeed, Fidesz should worry mainly about inflation, Covid and the poor state of public services from an election point of view.
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