The economy is cooling, with mixed consequences
In the following new quarterly update of our macro forecast, the key novelty is a more positive view on the forint exchange rate. We still believe that the current EURHUF rate is unsustainable from a competitiveness point of view and requires correction well within this year. But we see more support for the currency than before from decreasing energy prices, more favorable prospects for inflation and a strengthening BOP. At the same time, we find current official expectations regarding GDP growth too optimistic, seeing the potential political response to a disappointment in that area as a moderate risk to the existing set of robust stabilization policies.
Regarding the crucially important energy situation, the momentary big picture for Europe allows a deep sigh of relief, as winter has passed without major supply problems, gas reserves continue to be at high levels, and LNG re-gasification capacities and inter-connector pipelines are being expanded well above previous expectations, all this leading to lower energy prices. No doubt, Hungary is part of that positive big picture. However, a deeper look reveals a list of major structural problems. Maintaining initial savings on energy use will be very difficult, dependence on Russian energy remains high, implying significant risks for the security of supplies, and the overall dependence on the use of gas is even set to increase, because of the government’s ambitious plans to run up the production of electric vehicle batteries. In addition, Hungary’s Paks 2 nuclear plant construction project has gotten stuck because of western sanctions on Russia.
Unfortunately, the story of new development transfers from the EU has been developing exactly as we predicted, defying the more positive widespread expectation. There may have been some room for speculation lately that Hungary has been blocking Finland’s and Sweden’s accession to NATO because of hopes to eventually get some relief on its access to EU funds in exchange for its positive vote. The government keeps giving a public impression that a deal on currently blocked funds is already very close, as Hungary has essentially met all the conditions set by the EU Commission. What is badly missing though is the acknowledgement of any progress on the matter from the other side. We continue to expect no new cohesion policy or RRF transfers in 2023-2024.
However, the good news is that the BOP is still set to improve very substantially this year, even a bit more than we expected three months ago. This favorable outlook even allows a moderate amount of disappointment on energy prices. Except for the case of really powerful negative events in the global and regional environment, the same trend should continue in 2024 as well, resulting in greatly reduced net financing deficits in both years. The non-availability of new EU development transfers will have only a limited negative impact before 2025.
The favorable BOP trend we expect is conditional on the continuation of a weak economy over the next two years. We expect slightly negative growth this year and only a moderate recovery in 2024. The basis for this forecast is our expectation, right or wrong, that the authorities will stick to their restrictive economic policies throughout this year even if moderate slippage occurs against their growth objective, with a view to fulfilling their strong political promise to reduce inflation greatly. In view of that promise, and also of the global growth environment, we find the official growth forecasts too optimistic.
However, we are now convinced that reducing CPI-inflation to a single-digit level by end-2023 is not only possible but also likely to happen. The basis for this expectation includes low energy prices, restrictive income and fiscal policies that are leading to reduced consumer and investment demand, and the current strong trend of the forint, which is supported by the improving BOP and the MNB’s resolve to maintain a high sterilization rate. Regarding the forint, we still think that it will be corrected to weaker levels from its current strength, as maintaining the latter could lead to a major breakdown of economic growth, which politics would not be prepared to tolerate. We expect the first step to reduce the sterilization rate as soon as Q2, with a view to achieving that correction. But overall, the MNB is likely to reduce the sterilization rate much more slowly than the likely reduction of CPI-inflation, to the current level of the base rate by end-2023.
We do not expect much change in domestic politics over the next two years. Despite moderate losses in the polls, Fidesz is still reasonably popular, and its opposition remains incompetent, weak and fragmented. Should the current counter-inflationary policies prove successful, it could garner more support for the governing party again. In next year’s two elections, they may not do as brightly as on previous occasions, but no major defeat suffered by them seems to be currently on the cards.
Foreign policy appears to be Fidesz’s real weak point. The EU’s mainstream is unhappy with Fidesz’s domestic strategy of systematically blaming all problems on them, NATO is dissatisfied with Hungary's blocking the entry of its Scandinavian candidates, Russia is angry for Hungary's approving all EU sanctions and eventually agreeing to Finland’s accession to NATO, and a number of German companies have complained lately that the government is using administrative methods to squeeze them out of their businesses in Hungary. Essentially all western sources agree that Hungary has serious shortcomings with its internal rule of law. This will be a problem not only with regard to EU funds but also credit ratings: the latter may be lowered by some of the top rating agencies over the coming two years.
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