Less EU transfers, more official optimism
The EU Commission’s initial budget proposal for 2021-2027, published in early May, indeed turned out to be rather unfavorable for CEE member states, including Hungary. The EU would spend substantially less on development aid and direct agricultural payments, from which CEE members draw most of their transfer revenue. Our tentative rough estimates suggest that Hungary’s gross income from EU transfers could fall by 30% in proportion to GDP. This would lead to a two-thirds cut of the speed at which the government is currently disbursing EU-related developments funds.
An important novelty is the EU Commission’s proposal to set up a mechanism to suspend, reduce, or restrict access to, transfer payments if there are serious deficiencies in the rule of law in a recipient member state that could endanger the efficient utilization of EU funds. This would be difficult to circumvent by forming solidarity blocs within the CEE region, as related decisions could be blocked only by a qualified majority vote. This proposal seems to be quite popular among donor countries, not least in view of the EU’s recent findings regarding the use of its funds by Hungary.
All this means that Hungary will have to fight an uphill battle in EU diplomacy over the forthcoming year or so. This is especially because the country-specific distribution mechanism has not been set yet, a number of donor countries do not intend to make up the Brexit gap, and Hungary will have to fight to grab funds from new or expanding spending programs. Against this backdrop, recent Hungarian diplomatic activity appeared too aggressive, blocking important EU statements and agreements, and using unusually harsh language on the EU’s various actions and institutions.
Unlike in EU relations, the Fidesz government has little to worry about in domestic politics in short term. Although the opposition claimed after the April 8 election, that Fidesz had won by means of massive election fraud, very little of this has been actually proven. We present here another piece of statistical evidence that the election result was in line with previous opinion polls. A series of street demonstrations have been held against Fidesz recently, but these have been typically non-party actions, equally protesting opposition parties’ inability to forge a coalition.
On May 8, the new Parliament held its first session, and PM Orbán has already put together his new cabinet. Importantly, Economy Minister Mihály Varga will retain his job, stressing the government’s stability and the continuity of its policies. A new administrative unit, the Prime Minister’s Government Bureau will be set up, directly supervised by Mr. Orbán and separate from the Prime Minister’s Office. We consider this, and the replacement of Cabinet Minister János Lázár by Gergely Gulyás, as a further step towards the centralization of decision-making under PM Orbán.
In contrast with the bad news heard from the EU, the government has just come forward with an extremely optimistic macro forecast in its annual Convergence Report. This has raised the rates of potential and expected actual GDP growth markedly for 2019-2022, without regard to the likely drying-up of EU inflows or to the aggravating labor market situation, while aiming at a radical reduction of the government deficit. Ministers Varga and Gulyás have both said recently that they are working on additional growth-supporting measures, but declined to specify them for the time being.
GDP growth slowed down a bit but remained strong in Q1, with a balance between a weakening industrial cycle and booming consumer demand. Double-digit y-o-y growth continued in the construction sector, but deceleration also started in March. The big question for the rest of 2018 will be how GDP will react to the upcoming deceleration of wage growth and to the necessary normalization of fiscal spending, after the generous giveaways during the election season. We do not share the government's optimism on this and we expect a moderate slowdown as early as this year.
The April CPI-inflation data was moderate bad news. On one hand, both the headline rate and core inflation picked up in y-o-y terms, the former markedly, due to rising fuel prices. But on the other hand, April is a typical high-inflation month on seasonal basis, and monthly non-fuel inflation was not outstanding compared to past years. Importantly, the headline rate was consistent with the MNB’s standing forecast for Q2. Meanwhile, the Q1 BOP reflected some weakening in net financing capacity in cash terms, potentially contributing somewhat to the forint’s recent depreciation.
The central government’s cash deficit fell in percent-of-GDP terms in April, but only a little and from a very high level. The government is still paying out EU-backed development funds hastily, although we expect this process to decelerate, given Fidesz’ comfortable election victory. But importantly, the cash deficit is also high after adjustment for EU-related payments, meaning that a correction on the spending side will be inevitable in the remainder of this year. A big question is how this can be reconciled with the government’s upcoming new growth-supporting measures.
The MNB continues to pile up its stocks of "fine-tuning" FX swaps, MIRS and mortgage bonds, with a view to controlling EURHUF and long-term government and mortgage bond yields. These activities have brought about mixed success so far. For a next step, a key question will be how the Bank reacts to the government’s Convergence Report in its June inflation report. The MNB’s March forecast expected markedly lower GDP growth for 2019-2020 than the government’s potential growth expectation. This implies further policy loosening, or the growth forecast will have to be raised.
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