Urgent: Improve Migration Policy
The influx of Middle Eastern refugees is placing rising pressure on Hungary, and is becoming the country’s top political issue. The government has two options, neither of them favorable for Fidesz or for Hungary. The country could either defy the EU, blocking the entry of new migrants and allowing those already here to travel on to other EU states -- or it could comply with EU rules, granting asylum to political refugees, and allowing them to stay in Hungary. Choice one could bring serious conflict with the EU and its neighbors, risking financial and other major retaliation. Choice two would bring international funding and goodwill, but would raise domestic dissatisfaction.
These events underscore the dearth of EU-wide cooperation around the refugee issue. It’s true that the Hungarian government’s undiplomatic diplomatic style is playing an important negative role in the process. Hostilities between Hungary and the rest of the EU on domestic economic regulation and the treatment of foreign investors won’t help. There’s a clear need for urgent improvements on common migration policies.
Anyone who doubted that the economy was significantly cooling – among them members of the government and the MNB – has proper evidence now. GDP growth fell to 0.5% q/q, and 2.5% y/y, in Q2 2015, plainly below expectations. Growth was hampered by a slowdown in manufacturing output, and a correction in agriculture after two years of expansion boom. But it was boosted by heavy government investment in infrastructure, mainly through road construction. Our view remains that the economy is rebounding toward its potential growth rate of 1.5%-2%, and is likely to reach it by next year, and maintain it in 2017.
The government’s transaction-based net financing need came in at a surprisingly low 0.9% of GDP for H1. But this is misleading, as in MNB statistics, the government’s acquisition of Budapest Bank shares and spending on development projects that are sponsored but not yet reimbursed by the EU do not count as part of the net financing need number. The government debt ratio rose considerably in H1, and the constitutional requirement of a small decrease in the ratio can be most likely met in 2015 only if ÁKK reduces its annual net debt issuance plan by HUF200-250 billion. Avoiding the latter would require a major speed-up of EU transfer payments (no such signs seen in July-August) or the success of a HUF 200-300 billion farmland privatization plan (which may not be feasible before the end of 2015).
The MNB has told banks to stop pretending to be actively lending to enterprises, and to start actual lending. But current policies of the MNB and the government are contributing to decreasing financial intermediation through banks -- by pushing for more bank investment in government bonds, for example, and by fostering the outflow of foreign capital from the bond market and from the banking sector. CPI inflation in August was heavily influenced by a correction of vehicle fuel prices, after a sharp rise of several months. Excluding fuel prices, the August y/y rate would have been 1%, against the zero inflation measured by the headline rate. We still expect the MNB base rate to become substantially negative in real terms by the end of 2015.
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