Election results will raise political pressure on Fidesz
In the local government elections on October 13, Fidesz reached an unexpectedly poor result, losing control over Budapest and around half of major cities, while doing very well in rural areas. This will not change the power structure at the national level, as Fidesz continues to have an impressive constitutional majority in parliament, and no further major vote is scheduled until the next parliamentary election in April 2022. However, the election success will provide opposition parties with a power base and crucially important mental reinforcement, after several years of a hopeless state of internal division and fragmentation. We expect domestic pressure on Fidesz to grow, pushing the authorities towards looser fiscal policies from 2021 and instantly reinforcing the existing trend of loose monetary policies.
Our new forecast update does not contain fundamental revisions, yet they still contain noteworthy refinements. Most importantly, we do not expect any change to the MNB’s base rate through end-2021. Basically, the downturn of global growth and the policy response by major central banks should save the need to raise the base rate this year and in 2020. In 2021, the potential for a rate hike will be seriously limited by the approaching parliamentary election of 2022. Should the global cycle turn up again by then, the MNB could still handle the situation by adjusting the interest rate corridor around the base rate. In addition, we expect the MNB to keep using FX swaps in the longer term, as those represent a near-ideal instrument to regulate liquidity and the EURHUF exchange rate at the same time.
Our current expectation of interest rate policy is based on a more benign inflation forecast than the one we had three months ago. This one is supported by weak external prices of both industrial goods and services and the continuation of tight fiscal policy, even though these factors are offset in large part by ongoing high wage growth and a weaker forint. However, the MNB is apparently happy to see CPI-inflation in the upper half of their tolerance range and is prepared to accept a depreciating forint, with a view to reinforcing growth and containing further deterioration in the BOP. Regarding the latter, we expect moderate but stable external financing deficits in 2020-2021.
A key component of our forecast remains the deceleration of GDP growth from the 5% pace of the last two and a half years to 3% in 2020. Such a slowdown has been expected by essentially everyone for a while, but in fact it had not taken place until most recently, given the spectacular resilience of industry and construction/fixed investment to the global economic trend, in addition to robust growth by real wages and consumption. However, the tide is now turning in industry, and new housing starts are bound to fall soon, due to sharply higher VAT from next January. MNB policy to keep interest rates low will do a lot to counter the impending slowdown, but much of the impact of rapid borrowing by the enterprise sector will be offset by the expected runout of development grants from the EU.
A welcome new phenomenon has been the recent acceleration of productivity growth, in response to technology investments to replace the use of the increasingly expensive domestic workforce. This is likely to slow down the further aggravation of Hungary’s structural labor shortage, but it is unlikely to break the decreasing trend of the unemployment rate. Net emigration of domestic labor to Western Europe will likely continue, albeit at a decreasing rate, and the imports of foreign guest workers should be kept at moderate levels, because of political constraints. The government is set to progressively reduce the size of social employment programs and to keep pushing up statutory minimum wages. Both steps are budget-positive and should provide forceful support to economic growth.
Fiscal policy has been tightened in 2019, and this trend is likely to stay until end-2020. The general government deficit will likely end up within target this year and shrink further in 2020. Consequently, the gross debt ratio should drop to around 65% over the next five quarters. Tightening is expressly intended to improve competitiveness by reducing the spending-to-GDP ratio, and to prepare for the decreasing availability of EU transfers, which has started already and is set to continue in the coming years. In 2021, we expect renewed fiscal loosening though, to prop up growth and to improve some government services ahead of the 2022 parliamentary elections. The intensity of that loosening will likely depend on domestic politics and on the momentary state of the global economic cycle.
The government’s cash flow is likely to be strong between now and end-2021, especially as reimbursements under EU-backed development programs should speed up in response to project completions. Signs of this are already present this year, reducing the net borrowing requirement. In addition, the Treasury will likely maintain its focus on the mass sale of retail bonds, although the size of regular sales will likely be scaled back compared to recent months, due to cost considerations. These trends should keep HUF bond yields under significant downward pressure continuously.
The government’s positions in EU diplomacy are and are likely to remain at a near-critical level. PM Orbán is apparently set to continue his distinctly euroskeptic political line, not least in response to sharp criticism from the European mainstream for his domestic conduct. The outcome of the recent European elections has run against him, and the performance of his European allies has been mixed recently. However, Mr. Orbán remains good at using tactical opportunities, keeping the government’s western relations above the acceptable minimum of workability. Fidesz is unlikely to be expelled from the European People’s Party, and the ongoing Article 7 procedure will probably remain inconclusive. However, talks on the 2021-2027 EU budget are unlikely to come out well for Hungary.
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