Policies for 2017 Are Taking Concrete Shape
Having achieved a deal with employers and trade unions on deep cuts in the social contribution tax (SCT) and the corporate tax, to compensate enterprises for sharp increases in the statutory minimum wage, the government has set the main theme for economic policies in 2017-2018. The agreement included a reduction of the SCT, currently at 27% of gross wages, to 22% in 2017 and further to 20% in 2018, in addition to cutting the corporate tax from the current 10/19% to a flat 9% from January. In return, the statutory minimum wage will be raised by 15% (25% for skilled workers) in 2017 and further by 8% (12% for skilled workers) in 2018.
The objectives behind these measures include holding back, through more competitive wages, the local labor force from migrating westwards within and outside the EU, generating extra consumer demand, with a view to accelerating GDP growth, providing improved incentives to companies, through a more competitive tax system, to make more investments in Hungary, and above all, to win the parliamentary election in April 2018 by forcing employers to raise wages very sharply over the next two years. Additionally, a hidden agenda may be to provide a tax haven for foreign companies by setting the lowest corporate tax rate currently available in the EU.
The economy is indeed cooling. Following weak GDP growth reported for Q3, which was only propped up by the good results of the heavily weather-dependent agricultural sector, industry and construction output shrank again on y-o-y basis in October, and retail sales growth also decelerated during the same month. The government is still distributing EU-backed development transfers much less rapidly than in 2015, but faster than the annual allocation of these funds under the current 7-year EU budget would allow. Weaker GDP growth in 2016 reflects the fact that neither the previous extremely rapid rates of auto industry capacity extensions nor the high level of EU-transfer distributions could be maintained for this year. In addition, a massively restrictive fiscal policy is reducing demand and output further.
To what extent the new wage and tax measures can boost growth in 2017 is rather unclear, because the package is controversial. At any rate, nominal wages are expected to rise by 11% in the government sector and by 8-10% in the private sector. However, this would mean no higher real net wage growth than this year, and the positive impact on employment and corporate fixed investment is also questionable. A key problem is that the measures heavily favor large companies but hit most of SMEs, compressing profits and even threatening the stability of operation at many of them.
The Economy Ministry expects the negative fiscal impact of the new measures to be surprisingly small, as the sharp hike of the minimum wage is supposed to bring in substantial extra revenue, and as it reckons with a positive effect on private sector employment. The Ministry’s forecast on the direct impact may be a bit too optimistic but is largely correct. And even though we do not agree with the official forecast of indirect effects, the new measures appear to be far from requiring any upward correction of the 2.4% of GDP deficit target set for 2017. This is all the more so as net financing data indicated a small ESA2010 fiscal surplus in the first three quarters of this year.
Consumer inflation is picking up as expected, the headline y-o-y rate set to converge with core inflation around 1.5% at year-end. However, recent events, including the new wage/tax measures, the recovery of oil prices, the appreciation of the US dollar and a downward correction of HUF/EUR, suggest that the headline rate might rise further faster than previously expected. We expect headline CPI-inflation to come close to the MNB’s 3% target by end-2017, i.e. sooner than suggested by the Bank’s September forecast. The MNB may also raise its forecast in the new inflation report (due on December 20). Yet we do not expect them to raise the base rate before the April 2018 elections even if inflation rises moderately above the target level in H1 2018.
Large wage hikes tend to be a winning strategy for governments seeking re-election, and so it may be in Hungary as well. However, the impact is unlikely to be fully positive for Fidesz, as it might lose support among the owners of SMEs, which is also a significant group. At any rate, PM Orbán has started the courting of old-age pensioners already, hinting at a higher-than-planned pension hike in 2017, in view of higher-than-expected inflation. In addition, the government has approved a special Christmas present, to be delivered to all pensioners in the forthcoming days, a small measure to use up part of the above-plan net fiscal revenue collected this year.
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