Switching to Election Mode Again
Following a sharp upturn of GDP in Q2, industrial output, exports, retail sales and wages started Q3 with a moderate deceleration. However, the distribution of EU funds and even bank credit growth were accelerating. In H2, the recovery of GDP is likely to continue on the back of robust wage growth, strengthening fixed investment and a positive supply shock in agriculture, but the official forecast of 2.8% GDP growth for the full year seems far too optimistic. Key factors limiting growth this year are a setback in the auto industry, the tightness of the government budget and the MNB’s strong forint policy.
In 2017, the auto industry problem and the MNB’s preference for a strong forint are likely to stay, but fiscal policy will most probably loosen up, in view of the parliamentary election due in April 2018. The looser budget will likely boost construction output and fixed investment. However, this year’s rapid wage growth and agricultural boom are unlikely to be repeated. GDP growth should strengthen further, but not quite as much as in the previous election period in 2013-2014. A key risk is the EU’s dissatisfaction with the government’s new transfer distribution mechanism, which has a political context as well.
In the longer term, GDP growth will likely be supported by substantial new capacity developments in the auto industry from 2018. Brexit, though a crucial issue in long term, is unlikely to have any significant impact on Hungary before 2019. On the negative side, however, growth will likely be constrained by the increasingly scarce availability of free labor. Despite contrary claims by the authorities, we believe that no negative output gap currently exists, as employment can by now be expanded only in an inflationary way.
Surprisingly, the government’s cash budget was fully balanced in Q1-Q3, implying a surplus on an ESA2010 basis. For full-year 2016, the budget is likely to return to a deficit, but a smaller one than planned. In 2017-2018, fiscal policy is bound to be much looser, but deficits will probably remain below target. Consequently, the debt ratio should take a definite downward trend. The most likely explanation for this tightness is that PM Orbán may want to show strength in case a conflict erupts with the EU over migration policy.
The MNB continues its aggressive de-sterilization policy, together with heavy intervention to defend the currency. The net result is low interest rates and a strong forint, the latter containing inflation. On the latter, rising fuel prices and wages, followed by robust consumer spending, are generating significant upward pressure, but inflation is still likely to recover only gradually, given the strong forint, tight fiscal policy and weak fixed investment. The MNB is likely to avoid raising its interest rates until the 2018 election.
The referendum on refugees in early October was a partial disappointment for PM Orbán, who managed to keep his camp but proved unable to secure majority approval for his initiative. To save face, he is proposing a constitutional amendment to enact his migration policy, but the proposal is soft enough to avoid an open conflict with the EU. Fidesz still looks like the undeniable favorite for the 2018 election, given its current popularity and prospects for economic conditions until then. However, high-level corruption and excessive efforts to concentrate political power may become a serious issue.
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