Monetary tightening accelerated in November

HUNGARY - Report 19 Nov 2021 by Istvan Racz

The 4th domestic wave of Covid continues to rise rapidly. Daily new infections and deaths exceed those in the 2nd wave of late 2020, and Hungary has one of the highest R0 globally. With the current speed of virus spreading, reaching the limits of hospital capacity could be only a few weeks away. Protective measures taken so far look insufficient, as the government is still hesitating to act, due to political considerations. This approach will prove unsustainable in our view, and the authorities will likely have to introduce tighter restrictions soon. However, the latter are unlikely to go beyond the ones applied in this spring’s 3rd wave, meaning that their economic impact should remain moderate.

A decent GDP growth rate was reported for Q3, though falling back markedly from the extraordinary Q2 number. For Q4, the Finance Ministry expects some slowdown because of Covid, high European gas prices and rising inflation. The weakness of car manufacturing is also a negative factor in our view. Strengths include the non-car part of industry, construction, the recovery of tourism and of consumer demand. A big fiscal stimulus is expected for Q4 and Q1 2022, with nominal wage growth rising to a double-digit rate in the new year. The government, employers and trade unions have agreed on a major increase in the statutory minimum wage and a large reduction of employers’ wage taxes.

Following several months with improving fiscal data, the Finance Ministry reported an unusually large cash deficit for October. This marked the start of the now usual year-end spending spree, which tends to occur when the deficit would shrink otherwise to a significantly below-target annual level. Crucially, the deficit is likely to remain extremely high until the April elections, because of the big campaign measures that are currently taking shape. In this period, the government and the central bank will work against each other, and it will not be before May that fiscal policy can be expected to join the MNB’s tightening efforts.

The Treasury’s heavy issuance of FX-denominated bonds gave a big boost to government debt in September. Yet end-Q3 general government data suggests that in order to reach the objective of reducing the gross debt ratio by a small amount in 2021, debt can be allowed to rise even further in Q4. Liquidity is no problem for the government, as the Treasury has unusually large cash reserves.

The debt moratorium, introduced for domestic enterprises and households in March 2020, was closed down at end-October. A limited circle of financially vulnerable people was given the right to stay in the program until June 2022. However, only a very small number of those eligible requested to stay. Banks provisioned heavily against the credits and loans under moratorium last year, but even so, the development of credit quality will remain an issue. Economic recovery and the government’s upcoming spending campaign will probably help in this regard.

Even though September data was moderately favorable, a significant negative shift in the BOP was clearly visible in Q3. The main negative factor was the weakening of the merchandise trade balance, as industrial exports were contained by the car manufacturing problem, whereas imports were supported by strengthening domestic demand, and rising energy prices caused a significant loss in the terms of trade. However, the overall balance turned back into surplus, due to the government’s sizable FX bonds issued in September.

CPI-inflation jumped to new highs in October, representing an equally great surprise to public and private sector forecasters. The problem was caused in part by skyrocketing fuel prices, but the secondary impact of sharply increasing gas prices, the imported impact of global supply shortages and the recovery consumer demand were also important contributors. This was certainly not the end of the rising trend, as most of the foregoing factors are unlikely to fade away quickly. The government reacted by introducing a three-month administrative price cap on fuels. This will help to ease the problem somewhat temporarily, but the government’s overall contribution to the inflation problem will most probably remain significantly negative.

Under mounting pressure from different directions, the MNB accelerated the pace of tightening in November. This appeared through increasing the monthly rise of the base rate, the renewed detachment of the 1-week deposit rate from the base rate, followed by a significant upward adjustment of the latter, and a marked reduction of the regular monthly liquidity injections through quantitative policies. Most importantly, the Bank has switched to a weekly review of the effective sterilization, its decisions made dependent on the momentary situation in financial markets. The latter should mean primarily the forint’s momentary position, in our view.

In foreign relations, no major events took place over the past one month. The EU’s new rule-of-law mechanism, still by far the most important subject, is coming ever so slowly closer to activation. Under growing pressure from the European Parliament, the EU Commission is just about sending out a related questionnaire to a number of member states, including Hungary. However, the Commission is not prepared to go further than this until the European Court’s verdict on the matter. The Court is actually dealing with the subject, and based on the progress made so far, its ruling is most likely to come in January. This means that Hungary should expect no sanctions before the election in April. However, fronts appear to be frozen completely with regard to the RRF, where Hungary’s access to EU funds is essentially blocked by the missing approval of its programs by the EU Commission.

The opposition’s new common candidate for PM, Péter Márki-Zay paid an introductory visit to Brussels. He attracted great interest from commissioner’s parliamentary faction heads and other politicians. Just as most of the opposition alliance’s constituent parties, Mr. Márki-Zay is presenting himself as a heavily pro-European politician whose policy platform includes the rapid introduction of the euro and cooperation with the EU in fighting corruption as key items.

The opposition has gotten ahead of Fidesz in most polls lately, possibly on the back of its primary election, the selection of the new top figure and the stormy spread of Covid, the latter always negative for the governing party. However, the opposition’s lead does not appear to be big enough to secure a safe win, considering the many ways through which the election playing field tilts in favor of Fidesz. In addition, the political impact of the government’s generous campaign measures is likely to be felt only in Q1, when most of these measures are scheduled to take place. The opposition has come forward with the idea of a referendum on the constitution soon after the election if they win. Meanwhile, Fidesz introduced a technical-looking legal amendment, which is believed will help them in the election.

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