Nearly excellent current performance, moderately positive medium-term prospects
In our new quarterly forecast, we do not take into account the possible negative impacts of major international economic, financial or political debacles such as e.g. a potential no-deal Brexit on 29 March. Even though the British parliament’s NO vote to the government’s Brexit proposal a few days ago has apparently raised the probability of such an outcome, we believe that a no-deal Brexit would be a severe crisis event, which should eventually convince decision-makers that it must be avoided even at the cost of a potentially serious loss of face. Besides, forecasting the consequences of such a crisis scenario would go far beyond the desirable scope of our current report.
Hungary’s current macroeconomic performance could be characterized as almost excellent. For 2018, annual GDP growth will likely come out at an above-target 4.5-5%, and this is combined with low unemployment, improving fiscal balance, around-target inflation and a moderate surplus on external income flows.
For the next two years, essentially all forecasters expect growth to decelerate, following the new trend of the European economy, and also due to some moderation of domestic wage growth as well as the necessary tightening of fiscal and monetary policy. However, except for the case of a major setback of the global economic cycle, Hungary’s slowdown is likely to remain moderate. In 2021, we expect domestic government policies to become more expansionary again, in view of the parliamentary election due in the following year. Growth should then accelerate in response, though probably still falling short of its current rate.
Prospects regarding EU transfers, a usual factor of uncertainty, have become much clearer recently, after a significant slowdown of domestic disbursement, carried out in late 2018. The government has committed essentially the whole of its 2014-2020 transfer quota to specific projects, and the related funds are likely to be distributed by end-2020. However, conditions appear right for a roughly proportional distribution of the actual use, and the subsequent reimbursement by the EU, of these funds over the next four years. This would mean annual utilization similar to recent levels throughout the 2019-2022 period, avoiding major setbacks to fixed investment demand and to proceeds in the BOP.
We regard the government’s ability to reduce the fiscal deficit ratio to a below-target 1.9-2.1% of GDP in 2018 as quite impressive, especially in view of the election year and the fallout of a sizeable extraordinary revenue item. The accelerated reduction of the debt ratio, supported by a big payment of EU transfers towards year end, was also promising. Fiscal policy is likely to stay in an adjustment mode in 2019-2020 but achieving its adjustment goals will be easier from the better-than-expected base of last year, probably implying a less negative growth impact as well. The EU Commission will likely remain dissatisfied with Hungary’s structural fiscal deficit. But as long as the government achieves improvements in its financial performance, EU criticism is unlikely to become seriously consequential.
We expect Hungary’s small net financing surplus to be sustained for the whole of 2019-2021. The merchandise trade balance has deteriorated, but this trend will likely be contained by slower GDP and lower energy prices. The deficit of factor incomes is likely to fall, whereas the services trade surplus and incoming net EU transfers should remain largely unchanged. All this appears achievable together with 2% nominal depreciation of the forint against the euro annually, save for the case of a major global financial market debacle, of course.
Recent global developments have played to the MNB’s hands in a significant way. The threat of further tightening by major central banks has been scaled back, and the marked correction by crude oil prices in late 2018 improved inflation prospects for short term. The headline inflation rate fell sharply, and a further decrease is likely to take place in January. However, all this left the unfavorable domestic labor market and wage inflation trends unaffected, as reflected by a further dynamic increase in core inflation in the last two months of 2018. We expect a further rise by non-fuel CPI inflation, to 3.5-4% yoy by end-2019, followed by the headline inflation rate starting from February. This problem will not go away in the following two years either, although it is likely to become much less intense if the MNB acts promptly and the economy slows down as we expect.
Breaking with its previous habit of delaying action on inflationary pressures, the MNB said in January that they would regard their preferred core inflation measure reaching 3% yoy as a sign that efforts to ‘normalize’ policy (the politically correct word for moderate tightening) are to be stepped up. This may happen already in Q1 2019. We do not expect any hike of the MNB base rate this year, but the reduction of the outstanding stock of FX swaps, an increase in the sterilization ratio, and upward adjustments of the O/N deposit rate, with a view to higher BUBOR are increasingly likely.
In these days, the government and the MNB speak a lot about competitiveness, claiming that in case further structural measures are taken, the labor market problem could be overcome, and GDP growth could be maintained at 4% for several years going forward. In fact, the government has promised the announcement of such measures already in February. However, we have no high expectations regarding these new policies, based on what we know about the current official approach to the subject. This has to do in part with the complexity of the problem, and in a great part with the government’s obvious political limitations in taking the right measures on the really important structural issues.
Politics, both foreign and domestic, are set to follow a negative trend in medium term. Internationally, Fidesz’ autocratic tendency, including the aggressive concentration of political power and the large-scale accumulation of wealth in the hands of its political family, in addition to close cooperation with Russia, are causing an increasing problem in Hungary’s relationships within the EU and with the US. We still expect this to lead to an essential halving of Hungary’s quota of financial transfers in the 2021-2027 EU budget. However, the actual impact of this reduction is unlikely to appear before 2023, the likely year in which the large-scale disbursement of development grants under that budget is to be started.
At present, PM Orbán’s express hope is that the European Parliament (EP) election, in late May this year, may lead to a shift in power towards Eurosceptic, typically right-wing populist, parties. Such a shift could provide Mr. Orbán with an opportunity to push for a better result of EU budget talks, which are set to be concluded this autumn, and to broaden his room for maneuver on other issues. We find it quite probable that Eurosceptic parties may gain more power at the June election, but most probably not to an extent which would satisfy Mr. Orbán’s hopes to any significant degree. In addition, any major gain by right-wing populists would likely be coupled with marked losses by the Christian democratic European People’s Party, which has served so far as a protecting shield for Fidesz in European politics.
Although Fidesz has a big majority in polls, in addition to its firm control of parliament, the government administration, most of the domestic media and, increasingly, the judicial system, its current situation appears somewhat awkward in domestic politics. By an amendment of the Labor Code in December, to the effect of radically impairing employee rights, Fidesz stepped to an unusually high level of confrontation with the domestic population. This provoked demonstrations, strike threats and potentially widespread public discontent, just month ahead of the EP election, which is to be followed by local government elections around October. At this moment, it is hard to see when and how the Fidesz regime could come under serious domestic pressure. However, any election result for Fidesz that falls seriously short of the party’s showing at the parliamentary election of last April could become a catalyst for the strengthening of its opposition.
Hungary continues to have a positive outlook on BBB- sovereign ratings from S&P and Fitch Ratings, and a stable outlook on a Baa3 sovereign rating from Moody’s. Based on our current macro forecast, we expect all these agencies to move Hungary up to BBB/Baa2 at some point over the next three years. Actually, we see better than even chances that one or two of these agencies will upgrade the government already in 2019. A key question deciding the issue may be what kind of weights rating agencies will attribute to current macroeconomic performance versus longer term risk items.
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