The General Government Reached a Surplus in H1 2017
Robust economic growth continued in Q2, with GDP growth just marginally weaker than in Q1. The leading source of strength remains an uninterrupted recovery of manufacturing and construction output. In addition, retail trade is slowly gaining momentum again, and tourist services are picking up at a spectacular speed. Foreign trade, although still growing considerably, slowed down from Q1, and agriculture appears to be rather weak, due to a classical hog cycle effect (a negative supply response to low procurement prices in previous years).
The labor market situation continued to deteriorate in Q2. On one hand, faster economic growth was achieved with less employment growth early this year, marking an improvement of labor productivity. But on the other hand, the expansion of the economically active population slowed down as well, a serious sign that the remaining pool of free labor is about to be depleted. Labor shortages have become widespread and permanent. Wage growth accelerated further in Q2, fuelling consumption and GDP, and also driving up inflation.
There are initial signs that the sizeable external financing surplus is now decreasing. The deterioration of the trade balance has been only moderate so far, more than offset by the recovery of the net inflow of EU transfers early this year. But the negative errors and omissions balance, which was already on the rise in recent years, has grown further this year. Consequently the country still has a relatively large external income surplus but only a smaller one in terms of net financing capacity. This means the forint is no longer as fundamentally strong as is generally believed.
Despite an unusually large monthly cash deficit of the central government in June, the fiscal balance seems to be in order, safely on track towards this year’s 2.4% of GDP deficit target at least, but possibly even below that level. Given the strong showing of local governments and the accelerating implementation EU-backed development projects, the general government closed H1 with a net financing surplus in accrual terms. Besides, the central government, once again unusually, generated a surplus in July, pushing back the cumulative seven-month cash deficit to normal levels.
The issuance of a small renminbi bond on the Chinese domestic market in July was a symbolic gesture driven by political considerations. The official policy to reduce the ratio of FX denomination and non-resident ownership to total government debt remains in place. The main source of government funding is currently the off-market sales of medium-term bonds to households at above-market yields, which is also a key instrument to keep MNB interest rates low. Previous considerations of a benchmark EUR-denominated issue in 2017 seem to have been dropped completely.
Inflation keeps changing for the worse. The headline rate is still held back by low energy prices and the strong forint, although pushed up by the cyclical strength of food prices. But core inflation rose unexpectedly close to the MNB’s target level in July, and the annualized rate of core inflation seen so far this year exceeds the MNB target materially. Existing inflation forecasts still look relatively benign, but we see considerable risk that these forecasts (including our main scenario) underestimate the potential impact of the existing double-digit rate of wage growth.
The MNB did nothing to stop the forint’s appreciation in the past month, logically using the strong currency to contain inflation. But at EURHUF 305, the potential for this policy seems depleted, to the extent the authorities want to maintain the industrial sector’s competitiveness, which we believe to be the case. Other than this, the MNB keeps its interest rates unchanged, as usual, and it also continues its recent policies to increase liquidity by FX/HUF swaps and to reduce banks’ access to 3-month deposits, its main sterilization instrument.
With the Austrian government joining a recent German initiative, the EU has moved one step closer to making the availability of financial transfers dependent on member states’ performance on democracy and civil rights. A recent interview by Austrian Chancellor Christian Kern signifies that criticism from within the EU on PM Orbán is becoming ever more fundamental and is shifting to the highest level of European decision makers. In response, Mr. Orbán has reinforced his support of the Polish government in a sharpening conflict between the latter and the EU, as Poland is coming under pressure from Europe for implementing a non-democratic judiciary reform. Besides, Hungary’s diplomacy has been active to improve relations with Russia and Turkey, apparently as new friends if anything goes wrong with the EU.
In domestic communication, Fidesz is exploring new depths of its favorite conspiracy theory, according to which the EU is putting pressure on Hungary only because the government is unwilling to take on large numbers of African and Middle-Eastern migrants, regardless of its performance on any other matters. To emphasize this argument, the official propaganda is making further efforts to demonize George Soros, who is claimed to be behind largely all the political events that run against the Fidesz government. Due to this communication and other domestic factors, Fidesz’ support base is shifting further towards the radical right. However, the leftist liberal opposition remains spectacularly unable to make gains on this trend. Most recently, an internal conflict erupted within the Socialist Party, threatening a further erosion of public support and reducing the potential of meaningful cooperation among opposition parties.
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