Adjustment, recession and disinflation
Preparing a well-argued, credible macro forecast is a highly challenging task these days because of the unusually high risk associated with geopolitical factors. Regarding the latter, we treat a further major escalation of the Ukrainian war, and a fundamental destabilization of Europe’s energy situation as high impact but low probability events, excluding them from our main scenario. However, we regard further deterioration in both areas as outcomes with significant probability, as opposed to the scenario of rapid normalization, which is quite unlikely on our forecast horizon.
Against this backdrop, the main scenario we foresee until end-2023 is one of forceful macroeconomic stabilization efforts by fiscal and monetary policies. These efforts and high inflation have already pulled the economy down to the brink of negative output growth, to be followed by a deeper recession late this year and in 2023. In the latter, the scarcity of energy supplies, as imports from Russia are increasingly falling under sanctions, will likely play a major negative role in the coming winter, the impact of which factor is rather difficult to calculate in advance.
Despite all the negative signs and prospects, very few forecasters are predicting a recession for Hungary. Compared to a number of forecasts with marginally positive growth for next year, we may appear too pessimistic for doing so. However, we stand by our negative GDP growth prediction firmly, on the grounds that the economy is most likely already in recession now, and the way it is proceeding leaves little doubt as to its short-term prospects. In fact, we claim to be quite optimistic, predicting a material recovery of real GDP between late this year and Q4 2023.
CPI-inflation has accelerated steadily in recent months, on global energy prices, a related domestic price reform and on forint weakness. However, the ongoing rapid cooling of the economy, and the recent stabilization of European gas prices seems to suggest that the cyclical peak of inflation is not very far now, save for the unexpected, although not completely improbable, case that a major turmoil develops in the European energy sector this winter. In a largely normal case, inflation may peak at some point in Q1 2023, and take a downward trend later on, substantially helped by base effects, to possibly fall to a high single-digit level by the end of next year.
The balance of payments has deteriorated by quite a lot lately, the current account deficit boosted by a widening gap on energy imports. The MNB keeps stressing that the non-energy part of the current account remains in surplus, and it is likely to improve as the economy adjusts going forward. We largely agree, yet we see the outlook better and worse at the same time. The energy balance is likely to improve already from October, but in 2023, a small decrease of the trade deficit will likely be offset by higher external debt costs and a reduction of development grants from the EU.
Macroeconomic adjustment, following a boom phase before this spring’s election, is led by fiscal policy. Fiscal adjustment is being implemented in an orderly fashion, and the deficit and debt ratios are likely to fall moderately this year. This is all the more important as monetary conditions have not really tightened, because of significant forint depreciation so far this year. But even so, we do not think that our inflation/BOP scenario will require substantial further interest rate increases in this cycle from the current very high level of the O/N deposit rate if Europe weathers the coming winter period with a reasonable level of energy prices. At any rate, the MNB will have to continue its monetary sterilization efforts and do everything possible to reduce the banking sector’s liquidity, while avoiding the possible mistake of voicing excessive optimism in an unduly early phase.
The government is making good progress towards restoring access to development funds from the EU’s new budget and recovery fund. Currently, it is implementing a long list of legal and institutional reforms, which are hoped to eliminate corruption from the domestic system of public procurement. Whether or not these agreed reforms will indeed secure that objective is a matter of belief at this point. But for now, the crucial goal is to introduce all of them by mid-November, on the basis of which the European Council could approve further talks on the use of the funds in question by Hungary. Should this happen, disbursements from these quotas could start around mid-2023, contributing, together with prospectively decreasing inflation, to an economic recovery in H2 next year.
In general, the continuation of uneasy relations between the Orbán government and NATO/EU is pretty much guaranteed. As usual, PM Orbán refrains from openly turning against major EU policies such as sanctions against Russia, but in everyday talk and action he sounds much more like President Putin’s ally. One reason for this behavior is suspected to be his desire to secure continued safe access to Russian energy, and indeed it seems that some goodwill may have been earned from Moscow in this regard. On the other side, translating this into direct economic cost in EU relations is difficult, but we suspect that apart from a likely initial go-ahead in December, it may prove quite difficult for Hungary to actually obtain the contentious development funds from the EU budget and the RRF.
We kept reporting in recent months that in domestic politics, Fidesz has suffered only limited damage from growing economic hardships, especially rapidly rising inflation. This damage is growing all the time, and by the middle of next year, Fidesz’ situation could become much more difficult than currently. However, due to the very substantial concentration of power in its hands, Fidesz appears to be well prepared to survive situations like this, even if the harsh reality of macroeconomic adjustment leads to the recovery of opposition forces. Should the economy indeed turn for the better by H2 2023, there would be a realistic chance for Fidesz to emerge from its current problems relatively unscathed.
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