New game rules set by Covid-19: tighter MNB and looser fiscal policy
The negative effects of Covid-19 on the domestic economy already appear significant, and the negative potential is quite large going forward. Tourism is definitely taking a very hard hit, although it is not a major contributor to GDP in any case. Some subsectors of manufacturing, especially the production of electronic equipment, are starting to suffer from the component parts usually imported from China. At any rate, industrial output growth recovered in January, suggesting that in large part, the December setback can be legitimately regarded as an aberration. But of course, that was before the epidemic could have turned more serious as regards its economic impact on Europe.
We expect Hungary to remain among the less directly affected countries, given the less intensive inward movement of foreign individuals than is typical for most parts of Southern and Western Europe. But all that can be claimed only in relative terms: the more that other parts of the continent become infected by Covid-19, the more problems we are likely to see at home. In terms of business, Hungary will benefit from low crude oil prices, but depending heavily on exports, it will suffer from any prospective deceleration or recession in Europe and in the global economy.
Not knowing how far the virus impact can go globally makes any forecasting terribly difficult and the related risks unusually high. At any rate, recent rapid GDP growth, a healthy BOP and the decreasing government debt ratio should all help contain vulnerability if Covid-19 circumstances turn nastier than currently. However, PM Orbán and Finance Minister Varga hit an expressly pessimistic tone on March 10, hinting at the possibility of a deep recession in the Euro Area and a milder one in Hungary. In their words, this implies the need to rework the 2020-2021 budgets, to introduce a package of fiscal stimulus measures as necessary.
Somewhat curiously, the MNB, which distinguished itself previously by running very loose policies, has switched most recently into a tightening mode, swimming once again against the tide in a world where the temptation to loosen is becoming increasingly predominant. So far, the tightening of forint liquidity through FX swaps has resulted effectively in a roughly 50 bps rise in BUBOR rates. The primary objective behind this policy change is likely to be the MNB’s wish to keep the EURHUF exchange rate below the 340 line.
Following a surprisingly large jump in January, headline CPI-inflation moved downwards in February, as expected, although still remaining above MNB and market forecasts. The current weakness of crude oil prices is definitely a major windfall, and any prospective deceleration in services and industry should have an effect in the same direction. On the other hand, the labor market remains tight, despite a higher-than-expected number of guest workers, and wage growth has accelerated recently, followed by a strengthening of consumption expenditure.
The primary concern of the MNB may be further forint depreciation if the global sentiment towards the emerging world deteriorates in the existing risky environment. This could be aggravated in the USDHUF context by further negative news on the European situation with regard to Covid-19. Additional forint weakening could reinforce the already existing feeling among the domestic public that HUF depreciation is running too far in an uncontrolled manner. This could raise inflationary expectations.
The central government cash balance deteriorated significantly in the first two months of this year. This had to do with increased development spending under EU-backed programs and much lower reimbursement paid out by the EU than a year earlier. The rest of the budget actually improved further, with tax revenue growth remaining impressive and current spending growing by very little. Central government debt fell further in absolute terms in January, the debt ratio decreasing substantially on a yoy basis. The Treasury repaid additional large sums of FX debt, taking on HUF-denominated retail debt instead.
In terms of politics, recent events have markedly rewritten the international and domestic screenplays, taking much of the heat off the Fidesz government. Elements of this were the failure of the EU’s extraordinary summit on budget issues, Covid-19 events and a nasty new episode of the Syrian migrant saga developing at the Greek-Turkish border. In a nutshell, the failure of the EU budget talks maintains an extraordinary set of circumstances in European politics, keeping PM Orbán in the position of an important potential contributor to a future deal, practically meaning continued immunity from any major attacks and penalties. This is especially true as Turkey’s new migrant game has had the side effect of the Fidesz government’s distancing itself from President Erdogan and more sharing the views of EU leaders.
The Covid-19 situation is further helping to divert attention away from the usual line of political debates both domestically and in Europe. Domestically, both of the latter issues may have contributed to some further Fidesz strengthening in the polls, as they underscore the importance of relatively closed borders and the continued policy focus on the migration issue. The risks for Fidesz are very high, though, as popularity and even survival will now depend on the government’s ability to protect the nation from the epidemic and from a disruption to economic prosperity. Their early reaction to a need to change fiscal policy is probably an attempt to create political room for policy changes as necessary.
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