The old story repeats itself again

HUNGARY - Report 18 Nov 2019 by Istvan Racz

By now, readers may have become somewhat bored by reading all the repeated claims by forecasters that the economy is now genuinely set to lose its growth momentum, after a period of heavy resistance to the weak European business cycle. Sharing the consensus view, we still believe that sooner or later undisturbed high growth must come to an end for a number of reasons. But it seems the old story is repeating itself once again, as in recent weeks, robust growth figures have been reported for GDP, industry, construction, wages, retail sales and exports.

On the labor market, the trend of growing employment versus decreasing population remains intact, yet an important milestone has been reached recently. Following years of decelerating expansion, Q3 was the first period for ten years that the active labor force did not grow at all, despite improving employment conditions and the existing miserly system of social benefits. This suggests that raising the activity ratio has its own limits. The government has come up with new tax benefits to bring pensioners back into work, but that is likely to be a solution to only a small part of the problem.

CPI-inflation rose in October, officially blamed on the impact of swine fever on pork prices. But adjusted core inflation also picked up markedly, due to the strength of domestic demand and the forint’s depreciation in Q3. Going forward, a major uptick of the headline rate is likely to start in November, due to an unusually large base effect in fuel prices. This will most probably push the yoy rate up by about 1%-point by December and keep it there until February. Any core inflation surprise on the upside could take the headline rate to, or slightly above, the 4% tolerance ceiling temporarily.

The balance of payments clearly looks much less dramatic than a few months ago. That the net financing balance is turning into a deficit this year from a small surplus in 2018 appears to be a firmly established trend, but the pace of the deterioration looks much more normal than extraordinary now. The decrease of the trade surplus seems quite moderate, though that needs to be read together with the increasing deficit of errors and omissions.

The fiscal situation continues to look firm, on tight expenditure policy, increasing cash reimbursements by the EU and robust tax collection. The Finance Ministry has just announced measures to improve tax collection, with special attention to the VAT. The government debt ratio continues to shrink at an accelerated speed. The Treasury is maintaining a heavy emphasis on selling MÁP+, as shown by the reduction of the coupons paid on other retail bonds. They used robust MÁP+ sales to depress the yields on bonds and T-bills, earning back some of the extra cost of retail bond sales.

The MNB sold a large amount FX swaps in October in net terms, to offset the bulk of a major outflow of liquidity in that month. This was sufficient to elicit a further moderate easing of BUBOR rates. Going forward, we think that the likely spike of CPI-inflation in the forthcoming months carries some risk. However, the MNB is unlikely to tighten policy, due to its heavy easing bias and the fact that current inflation is not out of line with their existing short-term forecast.

Recently, MNB Governor Matolcsy presented a set of negative views on the euro in Financial Times, recommending the dismantling of the Euro Area and the creation of a global currency. He also raised this idea at a Eurasia conference a few days earlier. Key ministers distanced the government from these views, yet we think that Mr. Matolcsy’s article may have been more of an experimental political initiative than just a summary of his personal vision. Anyway, it seems evident that the euro’s early introduction, a national program for some CEE countries, is out of the question in the case of Hungary.

Indeed, recent diplomatic events suggest that PM Orbán, of whom Mr. Matolcsy is a close ally, is positioning Hungary within the Berlin-Moscow-Ankara triangle, in which setup the EU is just one, though currently the most important, factor. Within the EU, Mr. Orbán is apparently relying on the Macron-Leyen axis. The latter includes tactical deals but also an amount of goodwill enjoyed from Germany and its CDU/CSU alliance, based mainly on German vested interests in Hungary. On this basis, we do not expect the European People’s Party to expel Fidesz at the November party congress.

However, the EU budget for 2021-2027 is one issue for which the above-mentioned model does not work, as the interests of Hungary and Germany/France are diametrically opposed. Talks on the budget are now in a critical phase, but the positions of donor and recipient countries are so far apart that a political agreement may not be possible before end-2019 as planned. The current odds are that Hungary may lose more than a quarter of its current transfer quotas, meaning that net incoming transfers would likely fall to less than half of the present level as a ratio to GDP.

Should Hungary and other net recipients fight aggressively for more funds, donor countries would most likely go for a tightening of control over their use. The latter refers mainly to the so-called "rule-of-law provision", which is likely to be introduced anyway, but in a relatively watered-down version if recipients are ready to accept more substantial budget cuts. Taking the rule-of-law threat seriously, the government recently announced dropping plans to set up a parallel court system, to which cases from public administration would belong.

Finally, takeover by the winning opposition in Budapest and half of the major cities after the local elections of October went relatively smoothly. There were some recounts and even repeated votes here and there, but overall, the results have not been questioned. Fidesz keeps asserting its readiness to work together with opposition-led local governments, possibly waiting for the latter to develop their own corruption cases or for disagreements to emerge among opposition parties. The cohabitation of the Fidesz rule at the national level and opposition-led local governments is unlikely to be easy, but at the moment the whole process is in the phase of cautious initial positioning.

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