Covid-19 crisis: no V-shaped recovery is likely
Under the new reality that governs the world in these days, current macro forecasts are determined mainly by the outlook on events related to the Covid-19 epidemic. There are two key factors in this regard: 1) the prospective development of the epidemic; and 2) the nature and size of policy responses.
As for the first of those, the epidemic seems to have peaked already in terms of the daily global number of new confirmed new infection cases, and fatality data has also started to shrink. In Western Europe, the disease is pulling back already in German-speaking countries and slowing down considerably elsewhere, especially in the heavily affected Mediterranean region. The CEE region, including Hungary, remains with a relatively low infection rate, due to a fortunate late start of the epidemic and to early responses, in terms of restrictions on human turnover.
Going forward, we see a good chance for the epidemic to be overcome in Western Europe by end-Q2, and globally during summer. The CEE region is likely to follow this trend, despite its improvement's being contained by the mass return of its citizens who have lost their jobs in Western Europe. The gradual removal of domestic and border restrictions started in Europe immediately after Easter, and CEE countries will probably follow suit within a month or two. However, the removal of all restrictions is likely to take 3-6 months, and there is a considerable risk of setbacks to the improvement in Covid-19 as people are again allowed to move around freely.
However, overcoming economic problems will likely be more difficult and protracted. We expect the losses of employment, output and income to be similar to those of the financial crisis of 2008-2009. The initial policy response by governments and central banks appears to be timely and significant. However, the fiscal component looks typically smaller than suggested by political announcements, and even that will be difficult to finance. High-level references to a new Marshall Plan sound out of place, given the lack of a strong sponsor who is ready to pay for everything.
Regarding Hungary, a special problem is its high degree of openness, which makes the economy especially vulnerable to the impact of falling external demand, border closures and all sorts of external supply shocks. The high degree of reliance on the car industry and other export-driven manufacturing, and on the substantial net exports of a few heavily hit services, is likely to lead to major losses of employment and GDP in 2020. The BOP, which had been fundamentally balanced until most lately, will also be hit, but cheaper energy and the relatively high import-intensity of the domestic economy will be powerful mitigating factors.
The resulting conditions of a shrinking economy, high uncertainty and financial imbalances both at the macro and the micro levels, combined with the negative impact of growing global risk aversion, has left the authorities with an unusually complicated set of problems. They are facing the task of avoiding mass bankruptcies, providing liquidity and income relief, securing funds for the economy at a reasonable price, financing a growing government deficit and, of course, maintaining an adequate level of FX reserves to control the exchange rate and domestic inflation.
The government and the MNB have started to address these tasks by introducing a debt moratorium for enterprises and households, a complex system of new central bank schemes and instruments, a selectively applied increase in interest rates, and a fiscal package, which combines a major restructuring of the spending quotas set for this year’s budget with raising the 2020 fiscal deficit target. The fiscal package has not been elaborated on in any great detail yet, but it is understood to include wage support and tax relief to protect jobs, the redirection of development spending towards crisis-hit sectors, and interest subsidies and guarantees to back lending by banks.
Our first reaction to the initial policy response is that it represents unusual solutions under extraordinary conditions, which are necessary and appear reasonable. As for the central bank’s set of measures, they appear comprehensive and sufficient, though only time can tell to what extent the MNB will be able to reach all of its somewhat conflicting objectives. However, we are quite convinced that the intended fiscal package will be far too small to address the problem. Besides working out a number of details that are still missing, the fiscal package surely will have to be extended later on. However, we feel some sympathy for the approach that the government has not given up its intention to maintain a degree of macroeconomic discipline. In both areas, decision-makers will have to maintain flexibility, the need for which both the government and the MNB acknowledged recently.
The political risks for the forthcoming period will be very high, as most probably crowds of crisis-hit individuals, enterprises and institutions will suffer and set requirements that the government will not be able to meet. Already, a great deal of contention has developed around the centralization and the distribution of scarce financial resources.
A special political problem is the Fidesz’ government’s approach to the Covid-19 emergency situation, which they used in the National Assembly to grant extraordinary rights to the cabinet, to govern the country by issuing decrees for an unlimited time. The domestic opposition as well as most developed country governments, including mainly those within the EU, appear to be regarding this action as a constitutional coup, seriously questioning whether Hungary can be called a democracy anymore. Longer-term consequences are unpredictable, even though in the short term, governments and EU institutions are too busy with other problems to deal with this issue in any serious form.
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