Surprising Weakness in Q1 GDP
GDP dropped by 0.8% qoq in Q1, a big negative surprise for both official and market analysts. Construction output fell by more than a quarter from Q1 2015, signaling a collapse of EU-backed fixed investment early this year. In addition, manufacturing growth greatly weakened, led by a small drop in car production, for which only partial explanation exists currently. This data rendered all previous annual growth forecasts outdated for 2016. We now expect 1.5% growth in 2016, down from a previous 2% forecast.
We see intensifying wage pressures, caused by a shortage of labor due to decreasing population, growing employment and the migration of workers to Western Europe in recent years. In view of this and other factors, we have doubts about the forecast in the government’s new convergence report that potential growth is to rise to around 3% in medium term, supported by further significant expansion of employment, a prospective jump in productivity growth, and the increasingly rapidly expanding stock of productive capital.
CPI-inflation rose markedly in April, the year-on-year rate returning to positive territory. But this happened mostly on fuel prices. Consequently, our inflation forecast remains 1.7% for end-2016, moderately higher than the one presented by the MNB’s inflation report of late March.
In late April, the government announced a 1.2% of GDP increase in this year’s expenditure target. We are looking at this positively, as actual fiscal policy was unnecessarily tight in Q1. The amendment would move policy back towards the roughly neutral stance of the annual budget.
The government set its deficit target for 2017 to 2.4% of GDP, up from this year’s 2% target and from the 1.7% figures forecast in last year’s convergence report. This represents a reversal of the trend of deficit cuts in recent years, and leaves little room if any for a further cut of the debt ratio next year. We share the apparently dominant market view that this move has greatly lessened the likelihood of a credit upgrade for Hungary later this year.
The MNB made another 15bps cut in its base rate and O/N credit rate, just as expected, in late April. A similar step of the same size is likely to come in May, and a further 10 bps cut of both rates is more likely than not in June. In view of weakening growth, low inflation and tight fiscal policy, base rate cuts may even continue until the 0.5% level, unless the forint weakens to north of EURHUF 320, in which case a halt to further loosening would be likely.
The EU Commission is proposing a brutal penalty for those member states that refuse to provide asylum to refugees allocated to them under a mandatory quota system. This looks like an attempt by donor countries to cut back on EU development grants to non-cooperative CEE members. The proposal is bound to spark a political rift within the EU, and represents a material ele-ment of fiscal uncertainty, neither of which are supportive of Hungary’s credit rating.
The EU’s penalty proposal is playing into PM Orbán’s hands domestically. But at the same time, the Fidesz government is increasingly coming under pressure, due to corruption charges coming from opposition parties. The latest target of those has been the activities of the MNB’s educational foundations.
Now read on...
Register to sample a report