Question Marks Are Growing

HUNGARY - Report 12 Aug 2015 by Istvan Racz

Moving closer to the end of 2015, an increasingly intriguing question is how the authorities will handle the combination of decelerating output growth, weak domestic investment, rising inflation, the imminent decrease of development grants from the EU and the continued inactivity seen at domestic banks. The MNB’s most recent policy steps helped to dispel a part of the doubts, but left important issues unaddressed.

We are presenting new evidence that despite still considerable growth, the economy is definitely cooling. Latest reports on industry and construction, external trade, real net wages per employee, and hotel visits data all show a material slowdown, compared to both Q1 2015 and (partial or full) Q2 2014. A particularly striking phenomenon is a continued and even accelerating decline of bank credit to enterprises and households. We look into the reasons, the sustainability and the possible ways to handle this problem.

An inventory of cohesion policy allocations and payments under the 2007-2013 EU budget is also presented, with particular focus on how much money has been left for distribution, and how much is still due from the EU. The government is likely to distribute a record high 6.5-7% of GDP under EU cohesion policy programs this year, roughly 1% point above 2014 actuals, probably using up all its allocations under the 2007-2013 EU budget. The annual average of allocations for 2014-2020 reaches only 2.9% of GDP, and actual distribution is likely to be less than that in the initial years of implementation.

So far in 2015, the cash budget deficit ratio remained unchanged from 2014, but excluding net EU transfers, material improvement could be observed. A serious price for this was the obvious under-financing of various government services, including health care and education. The government is pre-financing very large sums of EU transfers; the key short term fiscal risk re-mains the unpredictability of when and to what extent reimbursements by Brussels will catch up with distributions by the government to local recipients.

In a slightly surprising move, the MNB cut its base rate by 15 bps on July 21 and announced the immediate end of its loosening cycle, stating that it will not use its pre-announced shift to 3-month deposits in late September to reduce the base rate, and that its cheap loan program (FGS) will be ended in December 2015. In our view, the MNB might get stuck between a pick-up in inflation and decelerating growth in the forthcoming months, in which situation no easy monetary policy response will exist. The base rate will have to be likely raised in 2016 at a time of a slowing economy. A further slide of commodity prices and the continuation of FGS in 2016 could help though.

In politics, July was just another month without major events or initiatives, resulting in a small decrease of Fidesz’ popularity in the polls, following a moderate gain in the previous two months. Key factors setting the scene were the refugee issue, a referendum initiative against the mandatory closure of supermarkets on Sundays and another one to loosen up pension rules, and the government’s apparent inability to pay health care workers and schoolteachers fully on time, within the framework of this year’s annual budget.

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