RaboResearch - Economic Research

Hungary: Stable growth, but government policies remain unorthodox

Country Report

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Economic growth in 2015 has been robust thanks to the usage of EU-funds and strong external demand. The fiscal situation improved, although with controversial measures. In general, the government maintained its populist and nationalist policies.

Strengths (+) and weaknesses (-)

(+) Favourable geographic position and well-developed infrastructure

Due to its location at the heart of Central Europe and its good infrastructure, Hungary’s economy benefits from short transportation routes to major markets and industrial production centres. This is reflected in Hungary’s strong position as manufacturing base (especially car production).

(+) Commitment to fiscal discipline

Hungary’s government is strongly committed to fiscal discipline, as it strives to reduce the country’s dependency on external financing.

(-) Very high external debt load and FX-denominated debt

Given a foreign debt level of about 120% of GDP (2015) and considerable amounts of FX-denominated local debt (even after the FX-loan conversion), a sustained depreciation of its local currency or a deterioration of external funding conditions will significantly impact the economy.

(-) Populist unorthodox economic policies undermine business climate

The current government tends to opt for populist unorthodox ad-hoc short-term policy measures that create considerable policy uncertainty. Economic policy favours industrial production at the detriment of services and strives to replace foreign by Hungarian (state) ownership in key sectors.

Key developments

1. Economic growth decelerates, but remains relatively stable

After a year of strong growth (2.9% in 2015), the economy is expected to slow down in the coming years to about 2.5% growth per year on the back of a temporarily lower absorption of EU funds and weaker external demand. During the first three quarters of 2015, net exports were an important growth driver, while in the last quarter, government consumption and investments increased strongly. The expected lower usage of EU funds is due to the 2015 end-of-year deadline to spend EU funding from the 2007-2013 cycle. From 2016 onwards, only EU Funds from the 2014-2020 window will be available, which will likely translate in lower investments. Private consumption was strong throughout the year, supported by all-time low unemployment (5%), low inflation and the foreign exchange conversion scheme that eased the pressure of FX-denominated debt on households’ finances. Going forward, private consumption is expected to remain one of the key growth drivers. The external sector will likely remain an important growth driver too, but a major risk is that Hungary is dependent on automobile exports to Germany. The Volkswagen emission scandal in Germany could therefore also negatively impact Hungary’s car sector. That said, we expect that the current account will remain in surplus and that given its large export industry, export revenues will remain high. The government will be less able to support the economy, given their relatively high debt load and the need to keep the budget deficit below the 3%-threshold. Finally, private investments will likely remain relatively muted, due to the policy uncertainty under the current government and lack of credit availability stemming from the punitive taxes to the financial sector. The government, however, announced that it will gradually decrease this bank levy. Given the expected size of the reduction (2-3% of banks’ assets), this will significantly improve the profitability of the banking sector. Together with measures taken by the central bank that shift part of the credit risk from lending to SMEs from the commercial banks to the central bank, this will likely increase credit availability. With inflation being far below the target of 3%, further easing of monetary policy is expected that could give an impulse to private investments.

Figure 1: Growth is slowing down
Figure 1: Growth is slowing downSource: EIU
Figure 2: Reduced government credit spread
Figure 2: Reduced government credit spreadSource: Macrobond 

2. Fiscal situation is improving

The public debt burden is on a downward path, but remains relatively high (76% of GDP in 2015) compared to other emerging economies. It is expected that this positive trend will continue in the coming years, the European Commission forecasts the debt ratio to be down to 72.4% by the end of 2017. In 2015, the budget deficit was lower (2.0% of GDP) than targeted (2.4% of GDP), due to improvements in tax administration. Due to ECB’s quantitative easing programme, liquidity has increased dramatically in financial markets resulting in a search for yield. The resulting quick reduction in Hungary’s government benchmark yields, lowered the interest bill for the government. For 2016, the government aims at a budget deficit of 2%. A risk to the budget is that part of revenues is based on one-off measures, while some new expenditures (e.g. a housing support scheme) have a long-term nature. Nevertheless, besides a gradual decrease in the debt load, the debt structure is also improving. The amount of foreign currency denominated government debt is decreasing, and is now at 32% of total government debt compared to about 50% in 2011. This reduces the vulnerability of the government debt obligations to exchange-rate movements. Also, non-resident holdings of government debt have been actively reduced by means of the unorthodox monetary policy measures taken in 2014 and 2015. The central bank reorganized its open market operations, replacing its two-week bills by a two-week deposit facility and in 2015 by a three-month deposit facility. Since three-months deposits do not count as liquid assets, while government bonds do, this posed a strong incentive to banks to acquire government bonds.

3. Fidesz maintains populist and nationalist policies

The Fidesz-KDNP party coalition still has a large, comfortable majority, but lost its two-third majority after losing a few by-elections. Therefore, it has become more difficult for Prime-Minister Orban to introduce constitutional changes. The judiciary and central bank have been increasingly politicized, and have, thus, become less independent. In response to the rising popular support for the extreme-right Jobbik party, Orban moved its cabinet’s social policy further to the right. A clear example is the current handling of the refugee crisis, which was used by Fidesz to, successfully, increase its popularity. PM Orban also uses the migrant crisis to expand government power. His government wants to amend the constitution by introducing a ‘state of terrorism threat’, in which the government can temporarily suspend or change all laws, but the constitution. The handling of the refugee crisis puts another strain on the international relations of Hungary, in particular with the EU. A positive is that the government regained popular support due to the relatively favourable macro-economic conditions. Therefore, Fidesz will probably refrain from introducing even more economic populist policies like punitive taxes to various foreign-owned sectors. The government will however continue its nationalisation process of utility companies. 

Factsheet of Hungary
Factsheet of HungarySource: EIU, CIA World Factbook, UN, World Economic Forum, Transparency International, Reporters Without Borders, World Bank. 

Background information

Hungary is a small open economy with a nominal GDP of USD 119bn (2015) and about 10m inhabitants. Benefitting from its proximity to developed markets in Austria, Germany and Italy and its well-educated low-cost workforce, it has been a major recipient of foreign direct investment prior to the global economic crisis. Its largely privatized and well-diversified economy is closely integrated into Central and Western European supply chains, which contributes to close business cycle synchronicity with the euro area. Manufacturing, particularly car production (Audi, Mercedes Benz, Opel, Suzuki), and food processing constitute important export industries, as does tourism. Hungary’s rapid economic transition in the last two decades went hand in hand with a considerable increase in corporate and household indebtedness, oftentimes in foreign currencies (mainly Swiss franc), while very lax fiscal management prior to the global economic crisis boosted public debt levels. In spite of strict fiscal consolidation measures initiated since 2006, Hungary was forced to apply for EU/IMF financial assistance in 2008. Considerable public disenchantment with the austerity measures imposed by the previous government brought the centre-right Fidesz-party to power in 2010. Driven by its conviction that foreign involvement in Hungary’s economy must be reduced and the perceived influence of opposition parties on public institutions, the Fidesz-government has implemented major political and economic changes in recent years, including the introduction of a new constitution. As various policies undermined the checks and balances of Hungary’s democratic system and populist economic policies tend to target sectors dominated by foreign ownership, Hungary’s relations with the EU and USA deteriorated and its appeal among foreign investors cooled markedly. Given ongoing weak public support for the opposition parties, Fidesz will likely dominate Hungarian politics in the years to come.

Economic indicators of Hungary
Economic indicators of HungarySource: EIU 
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