The war impact cannot be properly assessed yet
Whatever used to be the state and the prospects of Hungary politically and economically, the whole story has been thoroughly rewritten by the war in Ukraine. The latter has dampened the outlook for growth, raised prospective inflation and interest rates, added further strains to fiscal policy, and made the country’s already difficult foreign policy game even more complicated. Significant new risks have been created and others magnified. Forecasting has become much more difficult than before. We intend to come forward with our next quarterly macro forecast in April, as usual.
Most importantly: being a member of NATO, and NATO's being opposed to direct involvement in the war, the probability of Hungary's becoming part of the military conflict is next to zero. This probability is further reduced, although it is not certain by how much exactly, by the government’s pronounced policy of keeping a distance from the conflict and maintaining a relatively Russia-friendly stance despite the sharply Russia-hostile western political environment. Similarly, the regular supply of imported Russian energy is likely to remain uninterrupted, due to the coincidence of everyone’s interests, unless the related infrastructure or parts of that are accidentally damaged or destroyed. In addition, Hungary’s direct exposure to Russia and Ukraine in terms of exports and non-energy imports is rather limited, although not negligible. However, most of everything else appears to be pretty much uncertain at this moment.
Regarding our usual subjects, Covid’s local 5th wave has collapsed spectacularly, and not only most restrictions, but also even the subject itself has been quickly removed from the public agenda. However, Covid is not completely out of the way yet, as a revival of the disease in western Europe and the arrival of large numbers of lowly vaccinated refugees from Ukraine will likely bring back the problem once again. Some initial signs of that are starting to be visible on the charts. Even so, there seems to be no significant likelihood of returning to tough Covid restrictions that could lead to material economic or social disruption.
Partial data on industry, construction, retail sales, tourism and bank credit suggests that robust growth continued early this year. The start of the war in the neighborhood did not immediately lead to a break of this trend. However, its longer-term impact is likely to be significantly negative, of course, reducing GDP growth prospects materially this year. A large part of exports to Ukraine and Russia is likely to be lost, higher-than-expected inflation will contain both consumer demand and business activities, tourism will probably suffer again, and supply bottlenecks may also play an important role. Financial stability problems can also arise or be aggravated both among households and businesses.
By now, employment has recovered from Covid completely, excess labor having fallen back exactly to pre-Covid levels. The labor market is quite tight again, which implies significant upward pressure on wages, also driven by rising inflationary expectations. In principle, the emergence of a new labor force if many Ukrainian refugees are forced to stay for longer could prove favorable. But of course, uncertainties in that regard are very high at the moment.
One of the key questions for this year is to what extent the government budget will be kept under control. The master plan for 2022 has been to run an ultra-expansionary fiscal policy until the election, followed by a U-turn to achieve a sizable reduction of the annual deficit ratio. The first part of that mandate has been successfully fulfilled, as most of the massive election-driven gift money has been paid out in February. However, the hard part of the mission has been made even harder by the emergence of the negative war impact, the true size of which is not known yet.
The main item of the latter will be the large fiscal cost of maintaining the administrative price freezes introduced to contain inflation. In addition, extra spending associated with war refugees may also become significant if arrivals rise further substantially. Finally, the MNB is also turning a significant loss-maker, due to the increasing sterilization rate, and that will also have fiscal consequences. On the positive side, the domestic income base, on which taxes are imposed, once again has proven stronger than expected, and high inflation is set to provide compensation for much of the likely lower real GDP outturn and the extra fiscal cost this year.
The war, high energy prices and high interest rates have reached the banking sector in pretty good shape, reinforced by the beneficial impact of MNB policies, high credit growth, a debt moratorium under Covid and the existing interest rate freeze for household’s mortgage loans. Directly, the war is seen to have a limited impact on the sector, despite the potential damage at the sizeable Russian and Ukrainian operations of country’s biggest bank and the forced liquidation of the single Russian commercial bank in Hungary. However, the financial stability of clients will likely be challenged by the impact of high energy prices and rising interest rates later this year and beyond.
The balance of payments remains set on a distinctly deteriorating trend, which is likely to be reinforced further this year. Already in the pre-war era, significant current account and external financing deficits developed, as shown by the latest actuals, from January. This problem may be aggravated further by even higher energy prices and any war-driven loss of exports. But on the other side, Hungary may make some partially compensating gains in the BOP on rising food prices and any moderation of domestic demand growth.
Inflation has continued to defeat all forecasts on the upside lately, driven by energy, food, and the campaign-mode looseness of fiscal policy. Even the MNB’s official-looking optimism has moderated substantially. Some analysts have started to predict low double-digit inflation rates at a peak later this year. But in reality, no one knows, as prospects for inflation will depend mainly on global commodity prices and on how much fiscal policy will be able to contain that impact through administrative price regulation. Anyway, the prospect for any decrease of inflation in 2022 has faded away completely.
Following a measured pace of tightening in pre-war 2022, the frequency and the size of interest rate hikes increased again in recent weeks. The Bank’s basic task remains the protection of the forint, with interest rate measures effectively driven by that objective. In this regard, MNB policy does not seem to be very aggressive, apparently aiming at containing the forint’s depreciation against the euro, rather than going for a nominally stronger currency. This suggests that the central bank indeed counts on forceful fiscal stabilization after the election, and it is also concerned about the prospects for growth and financial stability.
Maintaining its long-term foreign policy trend, the Fidesz government continues to keep a balance between its EU/NATO commitments and its usual friendly relationship with Russia. This is still working reasonably well, to the extent that Russian oil and gas are still flowing in and that Ukraine’s westernmost territories, where ethnic Hungarians live, have not been directly hit by military strikes as yet. However, the task is getting increasingly difficult, because of the sharply anti-Russian sentiment within the broad western community. The immediate cost seems to be an almost complete isolation among the EU members of the CEE region. As for the EU, there is still no word about the release of RRF funds, and it is unclear if Hungary will be able to receive EU financial support to partially cover the extra spending to host war refugees.
With only a few days left until the parliamentary election on April 3, Fidesz continues to do well in the polls. It appears that PM Orbán’s public message to remain neutral on the war, stay away from paying a price for the conflict and not risk domestic prosperity is well received by voters, even though the assessment of Russia has led to some division within the Fidesz camp as well. There can be little doubt that the government’s generous fiscal gifts helped a lot, and even the recent significant improvement on Covid may have played into Mr. Orbán’s hands. Thus, Fidesz is set to win the election clearly, although the united opposition is likely to make gains in parliament, so that Fidesz’s current constitutional majority will most probably not continue.
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