Accelerating Growth, Weakening Trade Balance
Q3 GDP was revised higher by an unusually large amount in the second estimate, to 4.1% yoy from a preliminary 3.8%. This was followed by robust industrial and construction output numbers, and by this year’s so far strongest retail sales figure, for October. Based on all this data, we now see full-year GDP growth at 4.0% in 2017. The latter would outperform most of the existing official and market forecasts, including the MNB’s and also our own previous prediction. However, it would be only marginally lower than the government’s long-standing forecast, which most analysts, including ourselves, had thought to be excessively optimistic until most recently.
The impact of accelerating growth on macro equilibrium has been taken up so far by the external trade balance. Imports are growing materially faster than exports, and the trade surplus is decreasing now, despite the existence of a sizeable inverse J-curve effect. However, Hungary’s external income and net financing balances will most likely show continued significant surpluses this year, given that most of the decrease in net exports is offset by an upturn of incoming net EU transfers.
Inflation, on the other hand, seems to be following a relatively benign trend on the whole. Even though the yoy rate of CPI-inflation shot back up to 2.5% in November, essentially on fuel prices, it is heading towards a somewhat lower end-year figure, and its average level in Q4 may end up marginally lower than the MNB predicted in its September inflation report. What makes this possible in the face of continued super-rapid wage growth and an increasingly robust expansion of household consumption is exactly the most recent deterioration of the trade balance, in addition to greatly stable prices in the domestic services sector.
In terms of policy, the MNB is most likely to take the most recent good news on growth and inflation as a vindication of its loosening efforts so far. So at its next rate-setting meeting on December 19, the Monetary Council will probably continue its easy policy line without any correction, providing more specifics on its newly announced QE and yield-curve flattening plans, through buying mortgage bonds and offering interest rate swaps to banks. Regarding the forint, over which the MNB has direct influence through its "fine-tuning" currency swap instrument, the recent good news on growth would allow more appreciation against the euro, containing longer-term inflation risk. However, the MNB seems to feel comfortable about the most recent weaker forint level at EURHUF 314-315. This strongly suggests that the Bank remains relaxed about inflation prospects and is aiming at a big game in the form of even faster GDP growth.
Even though we admit that the recent data has provided material tailwind for MNB policies, we continue to believe that the risk of overheating is not at all negligible already in the medium term. In particular, the rapid ticking of the labor market clock appears somewhat troublesome. Following the recent trend of rapidly disappearing excess labor, the unemployment rate fell to 4% in October, despite the fact that the government released a substantial number of people from its social employment programs in recent months. The labor market is most likely to tighten further at a rapid pace if the current rate of economic growth is maintained.
We still believe that neither the 2.4% of GDP government deficit target nor the objective to reduce the government debt ratio further this year are at any serious risk. The small surplus run by the general government in January-September should provide ample buffer against unforeseen events, and Fidesz’ increasing lead in the polls should minimize the risk of election-related overspending. Even so, the government’s December cash flow may still offer some excitement. September’s VAT collection problem was nicely corrected in October, but the problem is likely to come back again, on systemic grounds, in December. As to the other problem area, an increasingly big EU "reimbursement gap", the EU Commission has given a green light to payouts to Hungary despite an ongoing audit of the local distribution process, but to date, no actual reimbursement payment has taken place on the basis of that decision.
Recent high-profile visits by the Russian president and the Chinese prime minister in Budapest appeared to have served direct economic objectives on the part of the visitors. The two projects in question are the construction of the Paks 2 nuclear power plant and the modernization of the Budapest-Belgrade railway track. The economic benefits of both projects for Hungary appear somewhat dubious, so political analysts are speculating on other background considerations. One may be that PM Orbán is seeking alternative political support as he meets increasing hostility within the EU, and another one is that he is trying to secure sizeable infrastructural development projects for the years when EU funds will no longer be available in the current quantity. All this should lead to additional criticism from other EU members and the US, as Hungary’s development of its relations in the eastward direction is thought to be in conflict with European and NATO interests in various respects.
The last 30 days was a period of no great success for PM Orbán within the EU. The European Parliament decided to support a permanent refugee redistribution scheme, which the Hungarian government received as a major offense. Besides, the EU Commission turned to the European Court on three legal issues which it had against Hungary: the recent amendment on independent NGOs, the legislation against the Central European University, and the government’s non-compliance with the EU’s refugee redistribution scheme of 2015. The EU is also moving forward with its integration agenda: following the announcement of a new European Public Prosecutors Office, they decided to launch a social pillar of EU policies, and most recently they updated a master plan on the European financial union. As PM Orbán has serious issues with all of these initiatives, he is running the risk of being increasingly sidelined within the EU. In fact, one likely reason behind moving forward with these decisions quickly is the leading EU powers’ (mainly Germany and France) wish to counter the ongoing rise of euro-skeptic parties in some member states.
Paradoxically, PM Orbán’s poor showing in EU relations does not seem to be causing him any harm in domestic politics. Whatever happens in EU politics that hurts Fidesz’ interests the party and its now predominant media presents as new evidence that the EU is indeed implementing what Fidesz calls the "Soros plan". And whether or not the latter is a conspiracy theory, it is taken well by those far-right voters, whom Fidesz is just now winning over from Jobbik in great numbers. Indeed, Jobbik – and for that matter the Socialist Party, once the leading force of the leftist-liberal camp – appear to be losing supporters in near free-fall mode in these days. And even though two minor parties from the leftist-liberal side, LMP and DK, appear to be gaining support at the same time, the net effect so far has been that Fidesz is becoming stronger from one poll to the next, heading towards winning a comfortable constitutional majority next April.
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