PM Orbán on a Collision Course with the EU
Following a relatively uneventful period in politics, PM Orbán has suddenly gotten onto a direct collision course with the EU, in addition to apparently alienating a large number of domestic intellectuals in recent weeks. This came after he launched an attack on civil organizations and the Central European University (CEU), changing regulation in a way that would stigmatize many of the former and block the latter’s future operation. Simultaneously, Mr. Orbán initiated a forceful campaign against the EU, erecting "Stop Brussels!" billboard posters everywhere in the country, and sending a letter to every voting citizen, with the claim that the EU aspires to cause harm to Hungary in a number of key policy areas.
Mr. Orbán apparently thought that conditions were favorable for him to move further towards his expressed ideal of an "illiberal democracy", but he may have miscalculated the odds in this case. His moves prompted a series of street demonstrations in Budapest in early April, so far the largest since he took over in 2010. The US government, which Mr. Orbán hoped would behave as a friend after President Trump’s inauguration, received his action on CEU, a university domiciled in the US, very negatively. Additionally, the EU, which for many years typically reacted to Mr. Orbán’s many hostile remarks and forceful steps to limit democracy with only soft disapproval, has condemned some of his most recent policies through the EU Commission and the European People’s Party, Fidesz’ political family.
The impact of all this on Fidesz’ reelection chances is likely to be limited, although the negative potential is not at all insignificant. Fidesz remains sufficiently popular among the non-intellectual part of the electorate, mainly due to the existing robust growth of real wages and employment, a fact the western media often forgets to mention. Opposition parties cannot make easy gains because they enjoy little trust from the public, and they did not play any role in the ongoing demonstrations. And despite some sharply condemnatory voices in European politics, the EU is unlikely to go for throwing Hungary out of the organization or even to deprive the country of its existing allocations of financial transfers.
In the event, there are likely to be negotiations between the EU and Hungary, in which the EU Commission will want PM Orbán to clarify his standpoint regarding the EU’s fundamental values and specific policies. In this process, Mr. Orbán will likely pretend retreat, as he always does whenever he feels the heat. But this time, he cannot do that without a serious loss of face. However, the latter will not reach the majority of Hungary’s electorate, due to disinformation by the now predominant official media, and also due to a lack of understanding among non-intellectuals. Even the EU itself appears to be missing any firm resolution to directly punish the Hungarian government. Instead, it is likely to move towards a "multi-speed Europe" legal and policy structure, in which they would need supporting votes from euro-skeptic governments, like that of Hungary (Poland, etc.), much less than in the current system. In addition, they are likely to aim at further reduction of development transfers in the 2021-2027 budget period, and may not rush to help Hungary out when its current allocations run out by end-2019, i.e. before funds from the next 7-year budget would be available, as is now likely. As a result, the main scenario remains that Fidesz will probably win the three elections coming up in 2018-2019, and get into a difficult economic situation shortly thereafter, as the inflow of EU transfers could fall from 6-8% of GDP p.a. to little more than zero in 2020-2021.
The downside risks attached to the foregoing scenario are no doubt significant, as any reconciliation procedure between the EU and Hungary is likely to be imperfect, and Fidesz is unlikely to suddenly turn into a lamb from a wolf. International political pressure on Mr. Orbán will probably become more intense anyway, as signaled by the current plan of EU Commission President Juncker to discuss with member state leaders who belong to the EPP if Fidesz is still a Christian democratic party, on April 29. In addition, no easy way seems to exist to calm down demonstrators in Budapest, in part because the government’s readiness to satisfy them is lacking. All this represents a set of significant, although limited, risks for Fidesz, already on a horizon shorter than the next three years.
On non-political issues, our forecast has changed relatively little since our latest quarterly outlook. For 2017, we expect moderately higher GDP growth now, in response to the likely looseness of fiscal policy this year, the degree of which was not yet clear three months ago. However, we now expect deceleration to start from 2018, as the government budget will have to tighten again to satisfy the EU’s fiscal policy rules. Even so, GDP growth will probably average 3% annually in 2017-2019, which is largely the same as we expected previously but with a different distribution between years. Meanwhile, the government budget will likely remain under control, with the deficit falling to 2% of GDP in 2018, and the trend of systematic small reductions of the debt ratio each year remaining uninterrupted.
Given the lack of sufficient fixed investment and of free skilled labor, the GDP growth rate forecast here for 2017-2019 must exceed potential growth. Moreover, we do not see a negative output gap currently, in view of the existing labor shortage, and so we see the expected rate of economic growth as inflationary. This problem is reflected by low and decreasing unemployment and high wage growth, the demand impact of which will likely remain contained by a stubbornly high domestic financial savings ratio. The net result will probably be rising inflation, which should level off at current levels in the rest of 2017, due to a base effect related to fuel prices, but rise further to exceed the MNB’s 3% target level in 2018. A factor limiting upside inflation risks in this period is that neither wage growth nor GDP growth seem to be sustainable at this year’s rate.
Following a temporary fallback in 2016, the external income surplus will likely pick up again to 9% of GDP in 2017 in response to an expected recovery of net EU transfer inflows, and this surplus is likely to erode only gradually in the following years. This should keep the forint on a fundamentally strong trend, against which the MNB’s continued de-sterilization efforts should play a crucial regulatory effect. Given the prospective loose fiscal policy and the significant inflation risk in short term, we now see slightly less interest on the part of the MNB to enforce some growth-supporting forint weakness, although the EURHUF exchange rate we forecast for end-2017 still marks a slightly depreciating forint for the year as a whole. We expect a similar trend of small forint depreciations throughout 2018-2019, achieved through the continued use of quantitative measures to reduce the amount of monetary sterilization, and keeping large capital outflows out of the currency market, by the MNB. Just as previously, we do not expect any interest rate hikes between now and the parliamentary election in April 2018. However, the MNB will likely raise the base rate to contain inflationary pressures in H2 2018 and in the following year.
An important footnote is that the forecasts presented in this report assume the availability of existing allocations of EU development grants as approved under the 2014-2020 EU budget, including the UK’s donor contributions after March 2019, which EU leaders are currently treating as a precondition for the start of Brexit talks. But given the current rate of the domestic distribution of EU funds, which we expect to be maintained in the following years as the government is currently planning, existing allocations will be used up by end-2019, leaving no further transfer funds available at least for 2020-2021. At present, we do not have any detailed forecast for those years, but should the availability of EU funds indeed follow this scenario, GDP growth would almost surely turn negative in 2020.
Now read on...
Register to sample a report