Eco Emerging

Gearing towards budget consolidation

07/08/2022

Economic growth remained very dynamic until the first quarter of this year. Strong wages growth and significant government measures to back up purchasing power over this period have supported consumer spending. Inflation rose sharply in recent months but remained lower compared to other Central European countries, due to a price cap on certain food and energy related goods. Economic growth is expected to slow down significantly in 2023, owing to the deterioration in the international environment, monetary and fiscal tightening from H2 2022. The temporary suspension of European funds presents a serious challenge given that budget and current account deficits have increased and external liquidity has eroded.

INDUSTRIAL PRODUCTION AND RETAIL SALES
ECONOMIC FORECASTS

Domestic demand is holding up well

The macroeconomic consequences of the war in Ukraine are not yet reflected in growth figures in Q1 2022. Economic activity continued to grow, by 2.1% q/q after 2.2% and 1.1% respectively in the previous quarters.

It was primarily driven by strong domestic demand, currently at 7% above its pre-Covid level. The strong performance in terms of consumption (retail sales up by 9.2% compared to January 2020) can be explained by new supportive measures implemented by the government, ahead of the legislative elections last April. These included bonuses, income tax cuts, or the payment of an additional month's pension.

Other government measures aimed at supporting households’ purchasing power included a temporary freeze on 1) prices of energy and certain food items and 2) mortgage rates. Similarly, the moratorium on loan repayments has been extended until December 2022. Furthermore, the average salary increase over the past few months has been higher than inflation, thus has contributed to support the purchasing power of household incomes against a background of rising inflation (10.8% year-on-year in May). Contrary to expectations, investment remained strong in the first quarter with an increase of 4.4% in Q1 2022 following 0.2% q/q and 2.1% q/q respectively in Q4 2021 and Q3 2021. Net exports, on the other hand, were a drag on activity.

Economic indicators suggest a slowdown in activity over the next few quarters. Retail sales excluding vehicles appear to have peaked in March. Industrial production has also weakened since March, probably due to supply disruptions and rising costs for intermediate goods and raw materials. In May, the drop in new orders and the increase of delivery times, reflected by the underlying manufacturing PMI indices, suggest that the decline in industrial activity could continue over the short term. As a result, investment could suffer in coming quarters. The uncertainties related to the war in Ukraine are weighing on business confidence and will undoubtedly lead to the postponement of projects. Similarly, the recent introduction of a tax on windfall corporate profits in certain sectors could have a negative impact on investment decisions.

In terms of foreign trade, exports have increased at a slower pace in recent months while imports have remained high. Hungary’s direct exposure to Russia in terms of exports is very low, at 2.1% of GDP, but the indirect effect through trade relationship with EU is significant. In contrast, Hungary is heavily dependent on Russia for its energy supply
(50% of energy imports). At the present time, the EU embargo on Russian oil imports does not apply to Hungary, Slovakia and the Czech Republic.

The expected slowdown in activity over the next few months will nonetheless have a limited impact on growth in 2022 due to the significant carry-over effects in the first quarter, currently at 5%. Real GDP growth is likely to remain very strong at 6% this year. In contrast, it is expected to slow significantly to 2.9% in 2023 due to inflation remaining at high levels and slowing activity in the advanced countries.

Monetary tightening to combat inflation

HUNGARY : CONTRIBUTION OF PRINCIPAL COMPONENTS TO INFLATION

Central European countries (CECs) have been experiencing a sharp rise in consumer prices since end 2021, exacerbated by the war in Ukraine. The rate of inflation is higher than European Union’s average and other emerging countries in Asia and Latin America. In Hungary, it has been at its highest since 2001 (+10.7% year-on-year in May) and well above the Central Bank’s target of 3%.

However, inflation is relatively lower than other CECs owing to a temporary freeze on commodity and energy prices, initially until June and then extended until 1st October.

Food and transport were the main contributors to inflation at 4.3 points and 1.9 points respectively in May. But core inflation (+9.1% year-on-year in May) also picked up significantly, reflecting all production costs, including wages. Inflation could reach an average of 11% in 2022 and remain at high levels in 2023 due to high wage pressures.

Monetary tightening that began in June 2021 was gradual at first. The pace then has gained momentum since the beginning of this year, bringing the benchmark rate to 7.75% end of June, a cumulative of 715 bps since this cycle began. This tightening is all the more justified as the forint has depreciated by 8.6% against the euro since the end of 2021 and foreign exchange reserves have fallen significantly. The import coverage ratio was low at 3.7 months at the end of 2021, even if the floating exchange rate regime and EU membership limit the liquidity risks. Monetary tightening is likely to continue in the coming months. It is however worth noting that monetary policy is not really restrictive, as the real interest rate calculated in relation to the policy rate or the 5 or 10-year bond rate still remains negative.

Temporary suspension of European funds

Hungary has been temporarily suspended from obtaining European funds under the Recovery and Resilience Plan, worth EUR 7.2 billion in subsidies over the period 2021-2023. EU’s decision to block these funds prevents the country from having access to an important source of financing for balancing the budget and the current account.

Budget deficit is likely to exceed the official target of 4.9% this year. Over the first five months of the year, the deficit has already reached HUF 2879 billion, or 4.6% of GDP. Besides, funding costs have increased significantly due to monetary tightening and markets’ overreaction in the context of the current geopolitical situation. The average yield on 5-year bonds has reached 5.62% in June, an increase of 212 bps compared to January 2022. Against this backdrop, the recent measures announced by the government should contribute to contain the deterioration in the public accounts. Expenditure (including public investment) is expected to be reduced in the second half of 2022. In addition, a tax on companies’ windfall profits may be applied temporarily in order to support government revenues. The government debt-to-GDP ratio is expected to decline on high nominal growth but this ratio should remain above 70% in 2022.

The current account balance was structurally in surplus until 2019. It turned into deficit in 2020-2021. In 2021, the widening of the current account deficit was mainly attributed to the pronounced slump in the trade balance. The income balance, structurally in deficit, also worsened last year. Furthermore, the balance of services, in surplus, has not yet returned to its pre-Covid level. The fall in income from tourism partly explains this situation. Travel component in the balance of services was at HUF 803 billion at the end of 2021 compared to 1,324 billion at the end of 2019, or only 61% of its pre-Covid level.

This year, the current account deficit will widen due to higher energy bills and weaker exports. The trade balance stands at EUR -1,544 million cumulatively over the first 4 months of the year compared with a trade surplus of EUR 2,920 million over the same period last year. Next year, we still expect a current account deficit due to a more marked economic slowdown in Hungary’s main trading partners alongside with energy prices remaining at high levels.

THE EXPERT ECONOMISTS WHO PARTICIPATED IN THIS ARTICLE

Other articles from the same publication

Emerging Countries
From one shock to another

From one shock to another

Emerging countries have recently faced a series of unexpected and severe shocks that will significantly dampen their economic performance in 2022 [...]

Read the article
China
A difficult spring time

A difficult spring time

Economic activity contracted in April and May 2022 as a result of severe mobility restrictions imposed in industrial regions such as Shanghai. Since late May, these restrictions have been gradually lifted, and activity has begun to bounce back [...]

Read the article
India
Change of policy mix

Change of policy mix

At the end of the 2021/2022 fiscal year, India’s real GDP exceeded its pre-crisis level, and economic activity indicators were positive in April and May 2022. Activity has been supported by a recovery in domestic demand and dynamic exports [...]

Read the article
South Korea
Positive overall

Positive overall

Korea’s solid macroeconomic fundamentals have made it one of the countries that has best withstood the COVID-19 pandemic. Economic growth prospects remain relatively positive [...]

Read the article
Taiwan
Robust

Robust

The Taiwanese economy has been very resilient to the multiple external shocks of the past two years. The export sector has benefited greatly from the rise in global demand for high-tech goods [...]

Read the article
Turkey
On the razor’s edge

On the razor’s edge

The economic situation in Turkey offers striking contrasts between (i) sustained growth until Q1 2022 and stubbornly huge inflation, (ii) much greater confidence among companies than among households, (iii) a primary budget surplus and a deteriorating current account deficit due to the surge in the price of energy, and (iv) domestic borrowing conditions for the State at an unprecedented negative real rate despite massive outflows from portfolio investments. Economic policy still combines a deliberately accommodative monetary policy and a competitive exchange rate to stimulate investment, exports and import substitution. The government will now use fiscal leverage to mitigate the economic cost of inflation and is multiplying ad hoc measures to stabilise, unsuccessfully so far, foreign exchange reserves.

Read the article
Czech Republic
Weak consumption

Weak consumption

The last two quarters have been marked by slower growth in economic activity. This is mainly attributed to weaker levels of consumer spending [...]

Read the article
Brazil
A difficult calibration of the policy mix

A difficult calibration of the policy mix

Economic activity held up well in the first half of the year, but a slowdown in GDP growth is coming and expected to intensify over the second semester. The recovery of the labour market continues [...]

Read the article
Peru
From one political crisis to another

From one political crisis to another

Peruvian GDP returned to its pre-crisis level thanks to the strong upturn in activity recorded in 2021. However, the country’s capacity to rebound further is limited and short-to-medium-term growth prospects are moderate [...]

Read the article
Saudi Arabia
Fiscal reform is ongoing

Fiscal reform is ongoing

The economic recovery should be sustained in 2022 due to the sharp increase in hydrocarbon production following the OPEC+ agreements and due to stronger growth in household consumption [...]

Read the article
Angola
Persistent vulnerabilities

Persistent vulnerabilities

Following five consecutive years of recession, Angola’s economic outlook is brightening: the country should return to growth, expected to be +3% in 2022, benefiting from a favourable economic situation marked by the upward trajectory of the oil price and a resumption of national production of hydrocarbons.  The resulting increase in budget revenues and exports should support the kwanza. This dynamic is helping to ease the pressures on the country’s external financing needs and debt sustainability, which has improved thanks to the reprofiling agreement concluded with China in early 2021. Nevertheless, the Angolan economy remains prone to significant vulnerabilities. The authorities should pursue reform efforts by taking advantage of the current situation in order to reduce the country’s economic dependence on the oil cycle.

Read the article
Nigeria
Mixed prospects

Mixed prospects

The Nigerian economy is experiencing mixed fortunes. Its low level of oil production does not allow it to benefit fully from the rise in oil prices [...]

Read the article