Everything still depends on Covid prospects
Forecasts on COVID-19 have proven to be largely wrong everywhere around the globe so far, and ours have been no exception. Unfortunately, analysts must have a view on the ongoing pandemic all the time, as everything else will greatly depend on the prospects for the epidemic. So, we are also starting our current forecast with this subject.
Since end-August, Hungary has been following the negative European trend, with rising infection and fatality numbers, combined with an increasing positivity ratio of virus tests. The government is firmly rejecting a renewed lockdown, even though health care experts, including some government advisors, are demanding a tightening of Covid rules.
Our current main scenario is the continuation of largely the existing Covid regulations, with moderate further tightening only. This implies that the epidemic may become significantly worse before it can get better, the latter possibly no earlier than springtime next year. With a bit of luck, the government could get away with this, without another major disruption to the economy, but the speed of the recovery will likely be materially impaired. The obvious risk is if existing restrictions prove insufficient, and eventually a marked tightening with a serious economic impact will be required.
The economic recovery is proceeding at quite a lively pace in industry and the labor market, and somewhat less speedily in retail sales, which remained relatively stable during the spring lockdown. However, the situation is much worse in construction, which is held back by cyclical factors and tax policy as well, and in tourism, which has been severely hit by the renewal of tough travel restrictions. This year’s setback to GDP is likely to be moderately deeper, and the recovery in 2021 less impressive than we expected in our July forecast.
Despite the recent sharp upward revision of its fiscal deficit forecast for this year, the government remains mindful of the importance of fiscal discipline. This can be only stated in relative terms under current circumstances, yet it is clearly shown by budget results and the official reluctance to initiate expensive spending policies. This attitude may have contributed to a surprise improvement of Hungary’s rating outlook by Moody’s in late September.
In Q3, the central budget’s cash balance improved due to significant inflows from EU transfers and some recovery of tax revenue. Going forward, our main scenario is a continuation of this slowly improving trend, but an important risk remains a markedly worse fiscal result if the trend of Covid-19 turns significantly more negative.
Positively, the BOP situation remains quite stable, as low import demand, the recovery of the industrial sector, a significant terms-of-trade gain in the imports of energy, and inflows from the EU are supporting the external income balance. This stability is expected to weaken over the next two years if more economic recovery takes place.
In terms of financing, both the government budget and FX reserves look all right, reinforced by successful borrowing and support from FDI investors. Indeed, a degree of cash hoarding can be seen both at the Treasury and in the MNB balance sheet, apparently for security reasons. Barring major disruptions, we do not expect any significant financing difficulties in the foreseeable future. The government debt ratio is rising sharply this year, but it will most likely return to its previous moderately descending trend by 2022, as a declared policy objective for the government.
Despite the relatively stable BOP, the forint has materially depreciated so far this year. This has a lot to do with central bank policy, though we are sure that the Bank would never admit this publicly. In our view, the MNB is using the weak forint to provide support to the economy.
The weaker forint adds to inflationary pressures, but the MNB appears to be happy with that as far as inflation remains within its tolerance range in medium term. Following a surprising sharp drop in September, CPI-inflation appears set to move towards the medium-term target, greatly alleviating the pressure on central bank policy. In 2021-2022, the MNB is likely to aim at a stronger forint trend if positive GDP growth is restored, making support through currency depreciation less necessary and creating more inflationary pressure autonomously.
Another current MNB activity is massive asset generation, to provide the economy with cheap credit and to create demand for government bonds. These policies generate large amounts of forint liquidity, which the Bank has sterilized fully in recent times to enforce its preferred interest rate for the money market. As and when its preference regarding the EURHUF exchange rate requires, it has even proven to be ready to raise the sterilization rate. Finally, the Bank recently introduced reverse FX swaps, an instrument reducing the HUF sterilization burden.
Politics is becoming a problem area for Fidesz. Covid-19 has changed the former trend of rising real wages and employment into one of economic hardship. The ongoing second wave of the epidemic may prove especially painful, as the campaign period for the next parliamentary election in Q2 2022 starts early next year.
So far, Fidesz has reacted by intensifying efforts to demolish or take over actual or potential strongholds for opposition political forces in the media, culture, education and the judicial service. However, civilian resistance has become fiercer, and opposition parties have decided to run jointly in the election. This framework, including the fight for economic recovery, has already set the political battlefield for the period between now and the 2022 election.
Foreign relations are also difficult as far as EU matters are concerned. The debate on the budget and the rule-of-law mechanism to be attached to it has not been settled yet, although a conclusion is to be reached before end-2020. Blocking the rule-of-law initiative entirely does not seem possible, and the compromises offered so far do not appear to be acceptable for Fidesz. As a result, PM Orbán is threatened by a serious loss of EU funds, a serious loss of face, or maybe by some combination of the two.
Over the next few years, Hungary’s relations with the western world will likely remain difficult. The government’s commitment to buy large amounts of weaponry from Germany and the US may help, whereas Fidesz’ strong bid to support President Trump’s campaign could backfire in the case of a Democratic win.
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