Stronger Economy, Weaker Politics
The optimism of official and market forecasters regarding this year’s growth prospects has been justified so far by actual data, even though the government’s 4.1% GDP growth forecast still seems to be at the upper end of existing forecasts. But growth is following a pattern different from largely everyone’s expectations, insofar as it is much more export-driven than predicted.
In more detail, domestic demand seems to be weaker than expected, as purchased consumption is still expanding at a decelerating rate, despite the increasingly robust wage growth seen in the early months of 2017. The latter was only partially offset by an unexpectedly strong pickup in fixed investment in Q1. However, industrial output jumped by a surprisingly high amount, driven by a robust recovery of Europe’s manufacturing sector. Incoming tourism also expanded substantially.
For 2017, the MNB expected markedly accelerating growth of domestic demand, leading to more adjustment in the balance of payments than in inflation. However, the external income surplus did not fall at all in Q1, and the net external financing capacity only dropped by a very small amount. This means the continuation of a fundamentally strong forint, in spite of the strengthening economy.
Headline CPI-inflation fell somewhat in May as well, once again on decreasing fuel prices. However, core inflation continued to rise, and it is running above the MNB’s latest forecast for Q2. Given this problem and the opportunity offered by export-driven GDP growth, the MNB is unlikely to be very concerned about competitiveness in the rest of 2017, and may allow a relatively strong forint, with a view to containing inflationary pressures. In our view, the MNB’s informal comfort level for the forint exchange rate may be slightly stronger than EURHUF 310 in the short term.
In fact, the MNB is already seen acting much less ambitiously to generate capital outflows than last year. Even though it continues to squeeze banks out of the 3-month deposit facility, the pace of the decrease of sterilized and total liquidity has fallen dramatically since early 2016. In fact the MNB has created substantial amounts of liquidity, mainly through swapping the forint against FX, in the early months of this year. Interest rates have not been changed lately, of course, nor do we expect any interest rate move before the middle of 2018.
The government budget is not quite as tightly balanced in cash terms as in 2016, but there seems to be still little reason to worry about the feasibility of this year’s deficit target of 2.4% of GDP. This is partly because the cash deficit of the central government was still of a moderate size in January-May, and partly because the general government budget looks much better in accrual terms. In fact, the latter had a substantially negative net borrowing requirement in Q1, and even the central government would have shown a cash surplus in January-April if adjusted for the increasing reimbursement gap incurred by the EU under its development transfer programs.
Of course, fiscal policy is much looser than it looks on the basis of official data reports. One way this is happening is that much of the sharp upturn of publicly financed fixed investment in Q1 was implemented out of funds accounted for as fiscal expenditure in late 2016. Besides, fiscal policy plans for 2018 are becoming looser almost every week. The latest announcement of a new family support plan, to raise the domestic birth rate, is estimated to cost HUF100bn (0.3% of GDP) in 2018, but this is just one example of a series of similar policy actions. However, the real significance of various spending plans is difficult to gauge, because their content and timing are often too loosely defined, or are announced to be bigger than they actually are, much in the spirit of the ongoing election campaign.
The European Parliament vote in late May, which called for the activation of the EU’s rule of law mechanism, is unlikely to lead to tangible short-term action against Hungary, except for another investigation into the domestic state of democracy and civil rights. In particular, voting rights in the European Council and the availability financial transfers from the EU are unlikely to be affected.
However, the European People’s Party’s ability and readiness to protect Fidesz within the EU is definitely weakening. The outlines of a sharper conflict in the medium term are becoming more visible, possibly affecting the rights of Hungarian guest workers in Western European states and the availability of financial transfers when the existing allocations have run out, the latter most probably already in 2020. For the time being, Fidesz does not seem to be concerned about this prospect at all, and continues to raise the stakes both domestically and in EU relations, with a view to increasing the degree of its political control and to winning over radical right-wing voters from Jobbik.
Following almost no change in opinion polls for several months, Fidesz-KDNP lost electoral support equivalent to 3% of the total voting population in May. As usual, most of the newly left ended up among undecided voters, but there were also some additions to the camps of the Socialist Party and minor liberal forces. However, this did not change the distribution of electoral support in a significant way, leaving Fidesz in a firm winning position for next April’s election.
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