Good progress on Covid vaccination, but political risk is rising
The Covid epidemic really looks like a roller-coaster. In response to the restrictions introduced in early March, its third wave reached a maximum within a few weeks, and daily new infections turned sharply down in the first half of April. However, so far the curve has fallen just a little below the peak level of the previous second wave.
As most of its colleagues, the government keeps feeling heavy pressure to reopen each time the Covid situation starts to look a bit better. This time around, they have already relaxed curfew rules, lengthened opening times for shops and are promising further loosening within a few days’ time. The inherent risk is high, as so far new infections have picked up again every time Covid restrictions were removed.
If anything, these cycles of the disease and politics can be broken only by vaccination. The government is forcefully pressing ahead with this process. By now, Hungary has become one of the best performers in vaccination globally, as the required supply of vaccines seems available and perhaps the best model for the process has been found.
However, the pace of vaccination may slow down again within a few weeks, when the process hits the limits set by the number of those prepared to get inoculated. So far, the question how vaccination can move on from that point towards the critical level has not been answered. In view of this, we still do not believe that critical level to be attainable before late summer, even though the current pace of vaccination would allow much faster progress.
Despite growing official optimism, we expect only moderate GDP growth for this year, and recent data has appeared to substantiate our view. The only, though important, good news has been some further recovery by manufacturing, in response to external demand. However, the domestic economy remains genuinely weak, as shown by recent figures on retail sales, construction, housing, tourism, transportation and bank credit.
We still believe that the government would be able to carry out significant fiscal stabilization this year. However, they do not really want to do so anymore, as they have just raised the fiscal deficit target to almost as high as last year’s actual. The official explanation focuses on higher spending requirements due to Covid, but lower than expected growth and the financial needs of newly created foundations may also play an important role. Correspondingly, our forecast is a hardly more than marginal improvement of the fiscal balance and a similarly small reduction of the debt ratio this year.
The more relaxed approach to fiscal equilibrium is unlikely to lead to financing problems in 2021. The annual financing plan is not very demanding, households’ financial savings are abundant, and the MNB is always there to buy government bonds even in big amounts. The EU’s recovery fund, not included in the financing plan, may also contribute.
Given the continued weakness of economic growth, the fundamental part of the BOP is unlikely change much this year, the external financing balance probably remaining very close to zero. However, 2022 is likely to see much higher GDP growth and a deteriorating BOP, the latter caused especially by a bigger trade deficit and by higher local earnings on FDI into Hungary.
CPI-inflation is likely to run above the MNB’s tolerance ceiling temporarily in the forthcoming months, given the recovery of fuel prices and the related sizeable base effects. However, non-fuel inflation will probably remain much lower, especially as the MNB is expected to act to slow down the pace of forint depreciation. Thus, the headline inflation rate is likely to return into the tolerance range by mid-2021, though probably staying close to the ceiling for the rest of the year.
We expect the MNB to remain supportive of economic growth, yet we do not believe that they could give up the objective of keeping CPI-inflation within the existing tolerance range. They will be most likely able to manage this without interest rate hikes this year, whereas in 2022, they will probably have to raise the base rate or the effective sterilization rate. In any future move, the Bank will most probably share the burden of tightening between interest rates and its quantitative instruments, including FX swaps and other existing channels of liquidity generation.
Now that Fidesz has fallen out of the EPP, the doubts around the full availability of Hungary’s EU transfer quotas over the next two years have become stronger. Moreover, EU decision-makers may not like the government’s new ‘foundations business’, which is officially presented as a reform of university education. There are likely to be forces within the EU who will want to put pressure on Fidesz around next year’s election, but to what extent this could lead to actual financial penalties is currently quite uncertain. At any rate, our forecast assumes the continuation of Hungary’s full access to EU transfers, against which the case of a major financial penalty would represent a risk scenario.
As the parliamentary election in April 2022 is approaching, political risk is seen growing on the domestic scene as well. The tone of campaign talk is increasingly harsh, and the odds for the vote appear to be unusually close. Government policies may be compromised by campaign needs, which we have built into our fiscal forecast by lowering expectations on fiscal stabilization. Central bank policies are much less likely to suffer, as any politically driven compromise could earn painful penalties in the form of higher inflation and a weaker forint quickly. Should the opposition win next year, the uncertainty on what comes after would be very substantial. However, we still believe that Fidesz will have good chances to win if the government proves successful in ending the Covid epidemic.
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