Macroeconomic policy is at crossroads
GDP growth remained markedly more robust than expected in Q3 2018, due to strength of the non-government services sector. Rapid growth was also supported by construction activity, whereas industrial output was held back by car manufacturing and the weakening cycle in the Euro Area, and consumer demand was contained by the decelerating growth of real wages and retail sales.
Unsurprisingly in a fast-growing economy, CPI-inflation continued to rise and reached a six-year peak in October, just a little below the upper end of the MNB’s tolerance range set around its medium-term target. A considerable part of this increase can be blamed on fuel prices, on an agricultural supply shock and on other non-core items. However, the various core inflation measures also keep ascending and have risen dangerously close to the target. Key contributors to that have been labor-related supply bottlenecks, wage inflation and the forint’s depreciation earlier this year.
Policies have been playing a mixed role so far. The tightening of fiscal policy after the April election is starting to have a cooling effect, and so will most likely be the case with the new restrictions on housing purchases and mortgage credit. On the contrary, central bank policy remains highly supportive of growth, through this year’s depreciation of the forint and the incentives to bank lending through low interest rates.
However, the time has come when policymakers have to make a crucial choice between lower growth with more stable prices or higher growth with higher inflation. Raising statutory minimum wages by a double-digit percentage in January and maintaining the MNB’s long-time loosening bias, both to counteract the weakening macro cycle, may be consistent with the objective to keep real GDP growth at 4%, but it is unlikely to be consistent with the 3% CPI-inflation target. The problem that the desired GDP result markedly exceeds Hungary’s potential growth rate simply will not go away.
For the upward trend of inflation to be stopped, the government should raise statutory minimum wages by less than 10% in 2019, to ease the wage pressure. This would not be easy to do, given the fierce competition for workforce on the EU’s labor market. In addition, the MNB should start to tighten immediately, probably by raising the O/N deposit rate and/or reducing the banking sector’s forint liquidity further through its FX swap instrument. For the MNB, this is increasingly a credibility problem, given the increasing gap between the actual path of inflation and their forecast.
However, we expect neither the government nor the MNB to give in easily on this issue. Especially as the European economy is turning weaker and as access to EU development grants is likely to decrease in medium term, the authorities are likely to think twice before cutting back their incentives to GDP growth.
On fiscal matters, the government has apparently switched to a cash collection mode, making quite good progress in improving the central government’s budget deficit and debt ratio. This was achieved mainly by slowing down all kinds of expenditure, and by clawing back large amounts of previously distributed funds from budgetary institutions and local governments. In addition, cash reimbursements from the EU also sped up in recent months. Based on the results through end-October, we do not expect the objective of reducing the debt ratio further in 2018 to come under any serious threat.
In politics, Fidesz managed to get through the European People’s Party’s congress without being thrown out of the party family. However, the price was quite high, as Fidesz received sharp criticism, and they were forced to approve a resolution on the EPP’s basic principles, which essentially condemned all the contentious political practices which they had been accused of. Apparently, PM Orbán has been pushed back into a defensive position within the EU, which is a negative sign ahead of the upcoming budget debate. By the way, should Brexit talks not be completed by the December EU summit, it could cause major delays to the budget talks, which would be seriously negative for Hungary.
Domestically, PM Orbán has also lowered his profile somewhat recently. Fidesz’ previous harsh anti-EU campaigns have stopped, possibly on pressure from within the EU. They had not appeared very efficient anyway: a recent poll has shown that the EU is more popular in Hungary than ever. Despite some unpopular recent measures and concerns about corruption, the governing party appears even stronger than it was at the time of the parliamentary election in April, thanks to its economic success and a terribly poor performance by its opposition. We believe that rising inflation may be the first key issue to hit Fidesz’ domestic positions, should the authorities prove unable to handle the problem.
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