Revisions are due everywhere, from GDP to fiscal and monetary policy

HUNGARY - Forecast 18 Jul 2019 by Istvan Racz

Compared to our previous medium-term forecast, released in April, there are no fewer than five areas where material revisions seem to be justified. First, we are raising our forecast for this year’s GDP, despite maintaining the view that growth should indeed decelerate in H2 and next year. Second, we observe the recent deteriorating trend in the BOP and are adjusting the forecast downwards, to show small income surpluses and moderate financing deficits. Third, as fiscal policy is tightening further, we see smaller fiscal deficits and a more steeply decreasing government debt ratio.

Fourth, we expect slightly decreasing CPI-inflation for next year and 2021, though we remain convinced that the central bank’s target will likely be materially exceeded throughout the next two and a half years. Finally, we expect a significantly lower increase in MNB interest rates than before, as fiscal policy is assuming a greater role in maintaining macro equilibrium. However, we continue to believe that central bank policy will have to follow an explicit tightening course to avoid running above the MNB’s tolerance range.

Regarding GDP, we are raising this year’s growth forecast by almost a full percentage point, on the somewhat surprising strength of industrial and construction output. The latter is likely to hold out for the rest of 2019, whereas consumption has started to decelerate, in line with a similar trend followed by real wages. We continue to expect a more pronounced slowdown in 2020, in view of the weak European cycle and tighter fiscal policy. For 2021, we expect a moderate recovery, as government policies will likely loosen again ahead of the parliamentary election due in the following year.

Anecdotal evidence keeps gathering that especially manufacturing and construction companies are employing a growing number of foreign workers, a fact consequently missed by official reports. Technically, labor imports could raise potential growth and help contain inflationary pressures. However, any significant immigration of foreign workers would lead to a high political cost to the government, as the latter defines itself as a heavily anti-immigration force. Consequently, the medium-term outlook remains a low and continuously decreasing unemployment rate.

Current fiscal policy appears tight enough to conveniently secure an on-target or slightly better outcome in 2019. Tightness is coming mainly from expenditures, not least from holding back spending on public sector wages. In early July, parliament approved the draft 2020 budget with a deficit lower than the one planned just three months ago. All this points to a benign outlook as regards the fiscal balance and debt in the medium term. However, there is less clarity around the sustainability of the current debt issuance policy. The existing heavy bias towards large-scale sales of HUF-denominated retail bonds may lead to markedly increasing interest expenditure.

We have become somewhat less concerned about the medium-term inflation outlook, in view of tight fiscal policy, decelerating nominal wages, the relative strength of the forint and the prospective slowdown of GDP growth. Yet we still expect a progressive tightening of banking sector liquidity, in addition to a higher MNB sterilization rate in 2020-2021. Regarding the latter, the MNB has a good chance to weather the next two and a half years with relatively little increase in interest rates, mainly because of the recent turn of the global cycle and the contribution by fiscal policy.

Things did not get any better for Fidesz in the horse-trading phase of post-election EU politics, even though PM Orbán successfully exploited some tactical opportunities to minimize the damage caused by the unfavorable election result. In the medium term, criticism within the EU of Fidesz’ performance on rule-of-law issues is likely to intensify, without leading to any break-point in itself; Hungary is likely to get most of the development grants allocated to the country in the running 7-year EU budget; but from 2023, grants are likely to fall to half of the current level in relation to GDP, or to even less if political conditionality will indeed be introduced as currently planned.

In domestic politics, Fidesz’ dominance seems unquestionable until the parliamentary election of 2022, yet this year’s local government election will be an important test. For this occasion, opposition parties have managed to form broad coalitions in a number of major cities, including Budapest, which has greatly improved their chances to win. Conditions for cooperation on the opposition side have been improved by the recent shift of support in favor of hard-core anti-Fidesz parties and away from soft opposition forces. This trend is likely to continue in the medium term, and it may possibly lead to a slow erosion of Fidesz' popularity if voters believe that the government’s economic performance is weakening.

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