Positive Short-Term Performance, Vague Plans for Medium Term
This year’s growth story started differently from everyone’s expectations. A marked recovery of industrial output took place in February and March, apparently driven by the increasingly strong European manufacturing sector. However, retail sales perplexingly slowed down in Q1, despite the massive rise of employment and wages. But construction output is picking up sharply, as expected, and there are signs of an unfolding recovery of bank lending at well.
Curiously, the combination of robust industrial exports and weakening consumption growth has been accompanied by a narrowing external financing surplus, easing pressure on the MNB to keep interest rates low and intensify its non-conventional de-sterilization activities. This is because the terms of trade are deteriorating now as energy prices are starting to recover, the net inflow of EU transfers continues to be weak, and a sizeable errors and omissions deficit occurred in early 2017. The overall balance of payments remained in a moderate surplus only because the banking sector borrowed from abroad to finance its increasing lending activities.
The headline rate of CPI-inflation fell markedly in April, continuing the recent zigzags due to volatile fuel prices. However, non-fuel inflation remains on a rather stable and moderately ascending trend. Given the lack of any major upswing in consumer demand for the time being, we remain of the view that inflation will likely rise above the official target level only at some point around mid-2018, implying that the MNB does not need to be particularly worried about interest rate in short term, despite the latter being significantly negative in real terms.
The March slippage of central government’s cash balance has proven to be caused by a one-time system change in the payment of VAT refunds. In fact, there was another monthly surplus in April, which reduced the four-month deficit to lower than in any of the last 15 years. However, the medium-term trend of fiscal policy remains one of significant loosening, as signaled by the rise of the 2018 fiscal deficit target to 2.4% of GDP, the same as this year. Meeting that target would still allow a small reduction of the government debt ratio, but it will be still likely criticized by the EU Commission, which would expect a lower deficit, to set aside reserves for cyclically less favorable years.
The government’s new annual convergence report is focusing on competitiveness as a leading theme. Somewhat curiously, it claims that the best way to improve the latter is to raise wages, as it will force employers to economize on the use of labor. In its detailed forecast for 2017-2021, the report sees potential GDP growth at 3.4-3.8% annually, which is markedly more optimistic than the 2.4-3% range foreseen by the same authors for 2016-2019 only a year ago. The report does not seem to be worried that free labor may largely run out by 2020, despite it expects unemployment rates below 4% throughout 2018-2020. Neither can be seen any impact of the plan to use up all available EU transfers by end-2019 in the report’s forecast tables. In estimating potential growth rates, the government now expects much less contribution from the available stock of both labor and capital than previously, whereas it expects much higher contribution from regular increases in factor productivity.
Fitch Ratings left unchanged Hungary’s BBB-/Stable sovereign long-term FX debt rating at its first pre-announced revision point this year, on May 12. This was no surprise at all; following upgrades from all three leading rating agencies last year, we do not expect any further rating action to take place in 2017.
The conflict around the government’s political campaign against the EU and domestic civil organizations has not been settled yet. Speakers from the European People’s Party said after a meeting with PM Orbán that Fidesz would not be expelled from the party family, given its instrumental role in defending the EU’s borders (against refugees), and in exchange for Mr. Orbán’s promise to withdraw a recent legal amendment that would force the Central European University to close down its operation. Apparently, Mr. Orbán has partially retreated (though he remembers differently), which is his usual reaction, and the EPP still does not want a conflict with him, which is the EPP’s typical way.
The next event on the matter will be a vote in the European Parliament on May 17. Four leftist-liberal factions of the EP are proposing to activate the EU’s rule of law mechanism, which would put Hungarian politics under increased scrutiny and could ultimately lead, if no reconciliation takes place, to the suspension of the country’s voting rights in the EU. This could affect Fidesz’ 2018 reelection chances negatively, but could only become fact if a number of EPP members of the European Parliament supports this motion, against a much softer resolution proposed by EPP leaders. The vote may be a close call, as there are some outspoken opponents of PM Orbán in the EPP faction as well.
Domestically, the recent wave of street demonstrations has calmed down for now. The issue with civil organizations has not affected Fidesz’ standing in the polls. Although the Socialist Party’s leading figure, László Botka is reasonably popular, his party has been unable to benefit from his run-up. The Socialist Party (MSzP) is still preoccupied with fighting against the leftist-liberal Democratic Coalition. This means that the leftist-liberal opposition’s two biggest forces have diminishing chances to form a coalition against Fidesz’ for next April’s parliamentary election. Meanwhile, a new opposition party, established by young intellectuals, gained considerable support in a recent poll, which has been the most significant shift in electoral preferences over the past one year or so.
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