The Surplus Budget Is Back in Early 2017
Following a massive spending campaign in December, the central government’s cash budget turned back into a seasonally unjustified, significant surplus in the first two months of 2017. The monthly surplus of February was especially notable, as it had no precedent in the previous fifteen years at least, and as extraordinary items are known to have played only a limited role in it. So for now, we think that the government budget has essentially returned to its strong trend seen in the pre-December months of 2016.
But despite the apparently tight budget, fiscal policy is still likely to loosen up significantly this year, in fact more than we thought previously. BOP and national accounts figures for Q4 2016 suggest that roughly half of the equivalent of 6% of GDP spent on EU-backed development projects was paid out as advances in 2016, explaining the bulk of the December spending campaign. Most of these funds will likely be turned into actual fixed investment in 2017, making the demand-boosting impact of this year’s fiscal policy far bigger than the annual deficit target of 2.4% of GDP would suggest.
All this suggests that the likely pre-election loosening of fiscal policy in 2017-2018 can be conveniently implemented out of past savings, i.e. without knocking the debt ratio off its recent moderately decreasing path. However, long-term prospects appear less rosy, given some notable major risk factors. Out of the latter, one seems luckily out of the way now, as Hungary has just withdrawn its application to host the 2024 Olympic games. However, the construction of the Paks-2 nuclear power plant, a controversial and risky investment, is set to start now, as the project has finally received legislative clearance from the EU Commission. In addition, Hungary may lose significant amounts of EU transfers already in the current 2014-2020 budget period if the UK leaves in 2019.
The government’s issuance of a major EUR bond this year still remains an open question. However, economy minister Varga said recently that the decision would be made in the forthcoming few months, as the logic of debt policy requires any big items like this to be issued in the first half of the year. Regarding longer term, the government will have to decide how to finance the €12bn Paks-2 project. Even though the availability of an intergovernmental loan from Russia, up to 80% of project cost, has been contracted, that loan appears more costly than the current cost of alternative funding.
Detailed Q4 GDP data has brought about no major surprise as compared to the preliminary data reported in January, except for the notable weakness of fixed investment in Q4. In January, the recent sluggish trend of industry continued, whereas construction output picked up by more than expected. We have become more optimistic on 2017 growth prospects than before, expecting GDP growth at 3.3%, i.e. half a percentage point higher than our previous forecast. The reason for this revision is the unexpectedly big amount of EU advances paid out in late 2016, which are likely to boost fixed investment demand this year.
According to preliminary BOP data, the external income surplus fell to about 6% of GDP in 2016, due to the markedly lower amount of incoming EU transfers than in previous years. Even this, and the resulting upward pressure on the forint, was reduced to half by a relatively big errors and omissions deficit. However, the income surplus is likely to rise again in 2017, as the EU transfer inflow will likely pick up markedly again, even though the trade surplus is likely to drop on increasingly robust domestic demand. This implies that fundamentals for the forint are likely to stay strong this year.
CPI-inflation rose further to 2.9% in February, fully meeting our expectation and marginally exceeding the analyst consensus. More importantly, even though the bulk of the upturn was still due to rising fuel prices, the upward trend started to spread over to core inflation indicators as well. As a result, both the headline rate and core inflation are heading towards Q1 2017 averages that are materially above the MNB’s December forecast.
This will make it more difficult for the MNB than so far to maintain its loosening bias at the Monetary Council’s March 28 meeting. Yet they are likely to leave interest rates untouched and change their language towards a neutral stance only very slightly, if at all. The purpose would be to avoid any upward pressure on the forint, as the currency is appreciating from the EURHUF 311.46 average seen in 2016, and is too strong for the 3.6/4.1% GDP growth forecasts (essentially informal targets) set by the MNB/NGM for 2017.
Just over a year before the parliamentary election, Fidesz appears to be in a winning position, as the leftist-liberal opposition parties have slid into an open feud with one another, and a coalition between them seems rather unlikely. In short term, this will likely mean more stability of economic policies, but in longer term, it may lead to excessive political imbalance with unfavorable consequences if Fidesz regains constitutional majority and decides to return to the policy of far-reaching legal reforms in 2018. Sitting firmly in the saddle again, the Fidesz government has already renewed one of its previous campaigns, against multinational companies in retail trade. This story, and a parallel one in the beer industry, can shed some light on why private sector investment is insufficient in the Hungarian economy.
In foreign policy, PM Orbán has managed to get clearance for the Paks-2 project in Brussels, in return for opening up 40% of the project value for public procurement, for which EU companies will be able to compete. Mr. Orbán has also kept himself to the European People’s Party’s line at European Council president Tusk’s reelection, despite Fidesz’ close ties to the Polish governing party PiS, which moved every stone to block that decision. But despite these scores in EU relations, Hungary is coming under renewed pressure for not cooperating on the EU’s refugee relocation program, although the government is much less criticized for the existing border fence now than one or two years ago.
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