Election Policies and a Labor Shortage will Dominate in 2017
Fresh data reflects the continuation of weak growth into Q4 2016. Evidence of this was decreasing output in industry and construction, weakening external trade dynamics and decelerating wage and retail sales growth, as shown by the October, and partly November, statistics.
2016 GDP growth is unlikely to have been higher than 2%, and even this was on the back of support from the leap-year effect and from a highly positive weather-related supply shock in agriculture. The key reason for the marked slowdown last year was ultra-tight fiscal policy and weak public and private investment.
2017 will most probably look different, due to much looser fiscal policy before the April 2018 election. A radical policy turn already took place in December, with strong efforts to bring forward spending from 2017, reversing an 11-month surplus into a small deficit for full-year 2016. Much of the money spent in December will likely have a real economic effect only this year, and the deficit will likely grow further, to 2-2.5% of GDP in 2017.
As reported earlier, the government also wants to accelerate growth by pushing up minimum wages and reducing social security and corporate taxes. But the economy is now close to full employment, and so the result will probably be high wage growth and stagnant or falling profits, the latter reducing chances for increasing private investment.
A common view is that the use of EU grants will speed up again to peak levels after a transitional weak year, as implementation of the 2014-2020 EU budget proceeds with full steam in 2017. But payouts under EU programs are unlikely to be higher in 2017-2018 than in 2016. Should the government return to the payout rates seen in 2015, they would run out of available allocations by Q3 2019, i.e. several years before the end of the intended distribution period. The latter strategy could preempt the loss of EU funds if the UK stops contributing at some point in 2019, but it could cause a severe downturn of fixed investment and GDP growth between 2019-2022.
Given the likely lack of leverages such as an EU grant boom, sharply higher investment and another big jump of agricultural output, GDP growth is unlikely to explode in 2017-2018, as officially expected. But it will most probably accelerate to around 3% in both years, on continued rapid growth in wages and consumer demand, a big boost by fiscal policy in 2017, and the completion of major capacity extensions in the auto industry scheduled for 2018.
In 2019, growth is most likely to decelerate again, on the lack of further drivers and under the pressure of the increasingly acute labor shortage. In fact, medium-term macro prospects will fundamentally depend on the government’s treatment of this latter problem. Official responses given so far appear inconsistent and inadequate. The economy does not seem to have a negative output gap at all, and the fact that it is apparently unable to make gains in labor productivity while the available pool of labor is shrinking poses questions about its potential growth rate.
In view of the labor market problem, and also as the windfall of low commodity prices gradually fades, inflation is likely to rise markedly over the next three years, with CPI-inflation reaching 3.5% yoy by 2019. While on this we apparently do not have sharply different views from those of the MNB, we would stress the upside risk associated with the existing labor shortage, which is genuine terra incognita for both policy makers and analysts.
The MNB’s existing loosening bias will probably hold until the 2018 election unless a major unfavorable inflation surprise takes place beforehand. The Bank has largely run out of its rate-cutting potential, but it still has the option to continue non-conventional de-sterilization policies. A base rate hike before mid-2018, in view of negative real interest rates, is unlikely, because of its impact on the forint and also due to political considerations.
The strong forint will likely remain a drag on growth and a problem for the MNB, due to the prospect of a continued massive external income surplus. However, exports of domestic financial savings, driven by low HUF interest rates and likely Fed rate hikes, would only help the MNB in that regard.
An obvious alternative to capital outflows would be increasing investments in the domestic real estate market. The impact of this trend will probably be mixed but mainly negative. Sharply rising property prices are boosting development, positively for construction output and GDP. However, supply growth is limited by obvious capacity constraints, and so property prices are likely to rise further. This will force homebuyers to save more and consume less, to a great extent defeating the government’s objective to boost consumer demand.
Election-time fiscal policy is unlikely to harm the sustainability of fiscal debt. The existing fiscal framework for 2017 allows the debt ratio to fall moderately further from around 74% of GDP at end-2016, even after the recent amendments of income and tax policies. The government’s commitment and ability to maintain that trend seem equally rather strong. The existing policies of increasing domestic holders’ share and the local currency share of debt are expected to remain, despite the ÁKK’s intention to issue a €1bn bond in 2017, as a new benchmark after recent credit upgrades.
Despite some defeats in the October referendum and a crucial parliamentary vote, and also despite some alleged high-level corruption cases, Fidesz’ position in the polls seems to be unusually strong for a governing party. Rising wages and employment appear to be winning factors for the next parliamentary elections, even though there are relatively large groups (e.g. low-income households, SME owners, etc.) who are unlikely to be happy with Fidesz policies. The opposition remains weak and severely divided. With little exaggeration, Fidesz could only lose in 2018 if a major economic failure were to take place by then, but that appears to be very unlikely for the time being.
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