What slowdown? The economy is overheating

HUNGARY - Report 15 May 2019 by Istvan Racz

GDP growth accelerated to a new high in Q1 2019, in the face of the weak Eurozone economy. This looks like a regional phenomenon typical of Central and Eastern Europe: Poland, Romania and Hungary all reported GDP growth around 5% in the first quarter of this year. A relocation of output from Western Europe to the CEE, driven by lower production costs, is apparently taking place.

In fact, economic growth shows signs of deceleration in real wages and retail sales, merchandise exports, fixed investment spending by the central government and the hotel business. However, a recovery is seen in industry, the thrust of strengthening coming from car production. And most importantly, construction output is just exploding, with the development of roads, railways, power plants, office buildings and residential property all exhibiting stellar growth rates.

The government’s new annual convergence report is essentially a reiteration of last year’s macroeconomic policy statements. It still sees potential growth at 4% and the output gap around zero, positive employment growth sustainable despite a shrinking working-age population, and no problem in the BOP over the medium term, despite domestic demand expanding much faster than output recently. We have serious doubts, as usual.

Whether or not we believe in the feasibility of a zero fiscal balance, expenditure below 40% of GDP and a debt ratio of 56% by 2023, current fiscal policy appears quite tight, and the central government is working in a cash collection mode. There are no signs of electioneering in view of this year’s European and local government elections, except for a surge of development spending at the local government level, out of central and EU funds disbursed in previous years. The Finance Ministry is praising revenue collection, although we think that more of the recent savings came from cutting expenditure.

The government scaled back its medium-term target to sell retail bonds, but the new target is still excessively ambitious in our view. The actual sales of retail bonds recovered markedly in March, in response to a hike in the coupon rates in late February, reducing negative net sales to a small figure in Q1. The central government’s debt ratio fell in Q1, in response to the reduction of the cash deficit.

The fundamental part of the balance of payments deteriorated markedly in January-February, with the trade balance, net factor income, net transfers from the EU and errors and omissions all contributing that negative change. Our view is that investors should pay more attention to BOP developments in 2019 than at any time in recent years.

Headline CPI-inflation continued to rise in April, due to increasing fuel prices, whereas core inflation and adjusted core inflation fell moderately, owing to a sizable base effect. The MNB is unlikely to return to the revision of monetary policy before end-April, in part because the April inflation data provided it with ample opportunity to argue that its March forecast was correct. However, we continue to believe that headline and core inflation rates are equally set to rise to between 4-4.5% yoy by the end of this year.

By now, the MNB has implemented its Q2 plan to reduce banking sector liquidity by withdrawing FX swaps, but unsurprisingly without any impact on money market rates. The Bank also announced to start its program to buy corporate bonds from July but promised to sterilize the resulting extra liquidity through preferential deposits. Despite this latter detail, we regard the bond purchase program as an expansionary credit-side measure, i.e. a step to loosen policy.

Moody’s skipped one of its pre-announced review dates in early May, without touching Hungary’s Baa3/Stable rating or actually saying anything on the subject. Back in November 2018, its concerns included Hungary’s heavy dependence on the ailing German car industry, its labor market problems and the upcoming running-out of EU transfers. We think that no further rating movement from a leading agency is likely to take place for the rest of 2019.

The European People’s Party’s late-March verdict to postpone the final decision on Fidesz’ membership until after the European election did not work out well. Campaign pressures mounting on both sides have caused the EPP and Fidesz to drift further away from each other, and now it is only a matter of time that a final break will be announced. The result of the EP election will tell a lot about PM Orbán’s future on the European political scene. But most likely he may end up in Salvini’s radical right-wing bloc, in an opposition position with markedly less influence on key decisions than so far.

After a very long period of not being received in the White House, President Trump finally agreed to see Mr. Orbán in person, just two weeks ahead of the European election, at a perfect time to support the latter’s domestic campaign. This is likely to be a kind of counter-value for large purchases of US military equipment, a promise to raise Hungary’s defense spending to the level required in NATO, and the enthusiastic support from Mr. Orbán of Mr. Trump’s general policy line, starting from the very early times of the latter’s presidential candidacy. The US government’s and the Republican Party’s worries about Mr. Orbán’s domestic policies have proven to be of secondary importance only.

In domestic politics, Fidesz even increased its lead in the polls somewhat and is most likely to deliver a sweeping victory in the European election. As regards the local government elections due around October, setting up a unified opposition coalition seems to be blocked by the LMP (greens) and Jobbik (radical right) in Budapest and a number of major settlements. For this reason, election success for the opposition is likely to be only scarce and partial. Fidesz is using the State Audit Office to financially weaken some of the opposition parties and also holds the upper hand in ongoing domestic conflicts with health care workers, judges and the National Academy of Science.

Now read on...

Register to sample a report