The year of uncertainty: Covid, inflation and EU funds

HUNGARY - Forecast 21 Jul 2021 by Istvan Racz

Moving forward within the year, official sources are painting the picture of an increasingly strong economy with no prospective further disruption from Covid, with the likely annual GDP growth rate over 6% and with growing inflationary pressures. The policy response they are talking about is distinct tightening by the central bank but no reaction from fiscal policy, the latter maintaining a protracted, slow reduction of the government deficit and the debt ratio. Official speakers continue to disregard any negative impact on growth from Covid, monetary tightening or the potential problems around the availability of EU transfers.

This picture is generally supported, without much disagreement, by a broad consensus of multilateral organizations and private sector analysts. We also agree that the official story is by and large correct. As a consequence, we are forecasting higher GDP growth, higher inflation and interest rates, an essentially unchanged path for the fiscal deficit and debt, and a stronger forint than we did three months ago.

However, we are not quite as sanguine regarding the strength of the economy as are official speakers and the majority of independent analysts. This is in part because Covid prospects are not quite as good as generally taken into account, and in part because we see a conflict between the central bank’s tightening ambitions and growth prospects. Similarly, domestic demand appears to be too weak to support high GDP growth sufficiently, and it is a question as to what extent the industrial sector and net exports can do the job alone. The good news may be that this structure of demand works against inflationary pressures and keeps the BOP fundamentally healthy.

All this can take a significant turn next year if the government uses the extra revenue stemming from above-expected growth to boost domestic demand through the return of this year’s income tax to families, as it has announced, and to take other popular measures, as is currently being considered. These measures, and generally election campaign policies can dynamize the economy further and also add to the need for tightening by the MNB in 2022. In addition, hospitality services and related sectors are likely to go through a substantial recovery, and consumers are likely to become more confident, as the world moves further out of the Covid crisis. The MNB is unlikely to implement as much tightening as required to bring inflation back to its tolerance range.

In politics, conflicts between the government and the EU are growing even sharper, the main issue, unsurprisingly, being access to EU funds. Our main scenario is that the fiscal rule-of-law mechanism will be activated against Hungary and some other EU members, but the prospects for the outcome are not at all clear, and no conclusion is likely to come before the parliamentary election of next April. A separate problem is the EU’s extraordinary RRF instrument, for which the EU Commission is seen to block the endorsement of Hungary’s national utilization plan. Domestically, Fidesz has gained in the polls recently, most likely because of the favorable development of the local Covid situation. However, should Covid return in a fourth wave within a few months, as is now likely, that could reverse the most recent trend in opinion polls, depending on the severity and impact of that new wave.

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