Covid’s second wave has peaked, no veto on the EU budget
The Covid restrictions introduced in November seem to be working, even though the health care sector is missing an outright debacle only rather narrowly. But the number of daily new infections peaked in early December and has been decreasing ever since. Improvement is only initial and limited for the time being, so the existing partial lockdown rule has been extended for another month, until mid-January. Mass vaccination is likely to happen in line with EU licensing and procurement, implying a start probably in January. Restrictions appear to be containing economic activity somewhat less than in the first wave, and they are likely to be kept in force flexibly as long as justified.
The introduction of the new Covid restrictions found the economy in an improving phase, as shown by Q3 GDP and the early data available for Q4. In October, industrial output continued its marked recovery, and retail sales also strengthened, whereas construction followed this year’s negative trend, and the hotel business exhibited a rather sad picture. Curiously, the number of job seekers continued to shrink in November, although this may have reflected employers’ efforts to retain core staff and the impact of government programs to avoid mass layoffs. National accounts data reveals that in Q1-Q3, predominantly employment and wages were protected, at the expense of falling labor productivity and profits and the deterioration of the fiscal balance.
The fiscal deficit target for 2021 has been revised sharply higher recently, to take account of the realities of the protracted Covid crisis. The new target largely corresponds to the existing trend in the budget, yet it is likely to appear considerably smaller than this year’s annual deficit. This is due to heavy net spending just before 2020, in part serving the achievement of next year’s fiscal policy objectives. The new financing plan aims at markedly less gross borrowing than last year, as it expects massive drawdowns from the current very high cash reserves. The gross debt ratio may even decrease moderately in 2021, following a big jump this year.
External accounts reflected some further improvement in October, due to more strengthening by heavily export-driven industrial output than by import-intensive retail sales. Both the current account and net external financing were essentially balanced in the first ten months of 2020. International reserves have risen significantly this year, reflecting the government’s and the MNB’s strong preference for being highly liquid during difficult times.
Consumer inflation has been following the development of Covid-19 rather closely this year, turning down at times of lockdown but picking up markedly in the summer, when the epidemic temporarily seemed to be out of the way. Following the same pattern, the headline rate slowed significantly over the last three months to November, and it is quite likely to finish the year slightly below the MNB’s medium-term target. However, core rates remain materially higher, solidly holding out in the upper half of the central bank’s tolerance range. Inflation has been depressed by weak domestic demand, low fuel prices and administrative price controls lately, but also pumped up to an extent by the forint’s significant depreciation against the euro.
Despite the recent retreat in inflation and the forint’s strengthening after the EU budget deal, the Monetary Council refrained from loosening policy at its mid-December rate-setting meeting. We have sympathy for this decision, as the potential gains from immediate loosening could be limited, whereas the risks regarding inflation, fiscal policy and capital markets remain significant.
Hungary and Poland have struck a positive but tricky deal with the European Council on the conditionality mechanism attached to the EU’s new fiscal package. The deal has given a go-ahead to the fiscal plan, secured the availability of cohesion funds in the 2021 budget and kept Hungary and Poland within the recovery package. In exchange, the latter accepted the regulation they previously opposed.
The Council has issued a political statement providing important concessions on conditionality, but it is not part of EU law, and is not binding for the Commission and for the Parliament. At this point, it is difficult to see how the new system will work, but from now on, PM Orbán will work under a permanent threat by the conditionality mechanism, even though blocking access to funds will not be easy.
Activity in domestic politics is hindered by Covid and the related state of emergency. Opinion polls show some decrease in Fidesz's popularity, probably due to dissatisfaction over the handling of Covid’s second wave. In January, the debt moratorium will expire for some two-thirds of debtors, which will likely cause a shock to the many families and small ventures in financial distress. To avoid a further loss of electoral support, the government needs rapid improvement on Covid and to secure the continuity of EU transfers. By changing the election law, Fidesz is essentially forcing the allied opposition to run together in the 2022 election, which has a certain logic but may also prove risky.
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