Promising Beginning of Year in Hungary, Vulnerable Global Economy

Executive summary

Global economic prospects did not improve considerably in the last six months, which indicates that the recovery from the crises will be still long lasting. Since the middle of 2012 the international trade has been growing at an annual rate of around 3%, well behind the long term average , and growth indices do not point toward acceleration in the short term. The G20 group of the world’s major economies, and in particular the BRIC countries functioning as the engine of world economy in the last decade, faced further slowdown in growth in the beginning of 2013, causing increasing concerns especially over the outlook for China. Among developed countries, the US economy is growing at the highest rate (1.8% y/y in Q1 2013), which however represents a significant slowdown compared with 2012. The eurozone has been in recession for the sixth consecutive quarter, and the majority of forecasts for 2013 project a year-on-year decline of 0.6%: continued deleveraging, high unemployment, slackening lending and uncertain business prospects continue to restrain domestic demand through its two components, notably consumption and investments. According to projections, an increase in net exports driven by the international economic upturn along with a slight growth in consumption supported by low inflation and slowly improving income trends will help the eurozone’s economy pick up in the second half or at the end of this year. However, these processes are rather uncertain, so the eurozone’s recovery is likely to remain fragile for a long time, especially because there is still no sign of effective government intervention to support growth. The governments’ policies to reduce general government deficit have brought some progress, although to varying degrees in different countries, but no best practices for stimulating growth are available, and the negotiations on deepening integration have also slowed down.

The unconventional central bank policies had beneficial effect on liquidity in money and capital markets and therefore on asset prices, although their ability to boost growth remains questionable. The Fed’s monthly USD 85 billion asset purchase programme launched in the beginning of the year strengthened risk appetite in the markets in the first five months of the year: government bond yields declined, US and eurozone interbank and commercial bank rates stagnated or fell, equity markets soared, and there was also strong demand for emerging market assets. On the other hand, the vulnerability of money and capital market processes is indicated by the fact that even an allusion to the possible end to the Fed’s programme could trigger a major adjustment in international financial markets in the middle of May. It became clear that quantitative easing is an important financial ‘umbilical cord’, and the timing, manner and phasing of cutting it is a highly sensitive issue.

Amid abundant global liquidity, there was also high demand for Hungarian financial assets. The enhanced risk appetite which lasted until May pushed down Hungarian government bond yields to a record low, and the BUX index outperformed the regional average in the first six months, despite the surtaxes levied on certain sectors and the equity market adjustments in May. Unfortunately, the Hungarian forint hardly benefited from the favourable investor sentiment, as its attractiveness was reduced by the decline in bond yields in domestic markets, caused by the rate cutting cycle continued by the central bank in 2013, and then the rise in yields in developed markets, which started in May. The favourable international climate was ideal for continuing the regular monthly 25-basis-point rate cuts, in the last step of which the Monetary Council of the Hungarian central bank (NBH) lowered the policy rate to 4.25% in June. The rate cutting cycle was originally launched to accelerate slower than potential economic growth, but later it was also supported by the inflation rate, which had sunk to a record low since the beginning of the year. The decreasing base rate drove down the interbank and commercial bank rates in Hungary, but further rate cuts will basically depend on the development of the international financial environment in the coming period.

Investors’ demand for Hungarian assets was increased by, among other things, the sustained improvement in Hungary’s external and internal balance. The general government deficit to GDP ratio was 1.9% in 2012, and having forecast a deficit to GDP ratio of 2.7% and 2.9% for this year and next year, respectively, the European Union put an end in June the excessive deficit procedure launched against Hungary in 2004. The improvement in external balance, which started years ago, continued in the first quarter of 2013: according to the data of financial accounts, foreign debt repayments by Hungarian economic actors stood at 7.1% of GDP, and therefore (among other factors) net external debt dropped to 39.8% (a level unseen since early 2007). Continued deleveraging coupled with increasing financial savings in the Hungarian private sector resulted in a strong external financing capacity: net household and corporate savings reached 5.6% and 3.7% of GDP, respectively, while the financing requirement of general government only amounted to 2.3% of GDP in the first quarter of 2013.

On the other hand, a significant increase in net private sector savings may, through reduced domestic demand, hold back economic growth in the short term, and it also reflects the uncertainty of economic actors and business prospects, as well as the postponing of planned developments. Household and corporate incomes are on a downward trend due to the slack in the labour market, uncertainty about economic recovery and weak corporate profitability. This trend reduces and restrains corporate and household consumption and investments, also held back by the contraction of lending, which began in the autumn of 2008 and is not likely to change before the middle of next year.

The above are reflected by the level of domestic demand, which has been continuously falling, and thus slowing down or impeding the growth of the Hungarian economy, for years. Following a 1.7% economic decline in 2012, Hungary’s GDP expanded by 0.7% quarter-on-quarter in the first quarter of 2013, although it represents a 0.3% decline in year-on-year terms. On the final use side, investment shrank by another 5.6% on a year-on-year basis, while household consumption fell by 0.6%. On the other hand, data showing an increase in retail trade and improving consumer confidence indices point towards an upturn in the latter, and the increase in net wages in the beginning of the year, the improvement in the labour market, the considerable reduction in inflation and the significant ‘overhead cut’ may also help consumption to pick up. Consequently, consumption is expected to slightly expand on a year-on-year basis in 2013.

As a result of an external upswing, net exports grew yet again early this year, and trade surplus hit record high once more due to the restrained domestic consumption of import goods, which accompanied the accelerating exports. The growth in exports was attributable to an increase in manufacturing exports, although on the production side of GDP as a pleasant surprise construction and agriculture made a positive contribution to GDP growth in the first quarter, while production declined in industry and the manufacturing. However, industrial production revived in the spring months, and both Hungarian and German business expectations suggest that it will positively contribute to this year’s GDP growth from the second quarter, and so will the agricultural sector, the output of which was very low last year. Overall, Hungary’s GDP is expected to grow by about half percent in 2013, accompanied by a record low inflation rate of around 2.4% and a slightly improving labour market conditions.


Ezsébet Gém

chief economist