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Investors Will Have to Wait for Economic Stimulus

The growth rate of the Hungarian economy may fluctuate in the future as the government focuses on cutting the deficit significantly and going on with debt reduction. This announcement might come as something of a surprise, as the finance minister earlier said that improving competitiveness is the number one task for the newly elected government.

Minister of Finance Mihály Varga (left) receives his appointment document from President János Áder at the Sándor Palace on May 18.

Investors will have to wait for a large-scale fiscal stimulus package, Minister of Finance Mihály Varga said in a recent interview with news agency Bloomberg. According to the recently re-appointed minister, the current economic turmoil in countries such as Argentina, Italy and Turkey has led the Hungarian government to shift focus, and it is now concentrating on cutting the budget deficit and reducing state debt.  

The latter is one of the largest in the eastern bloc of the European Union: at the end of 2017, it stood at 73.6% of GDP, making Hungary the country with the second largest debt in Eastern Europe. Croatia tops the list with a debt ratio of 78% of GDP, while Estonia has the lowest debt ratio with 9%.

The re-defined plans of the new government is a turnaround from what Varga said earlier about bolstering economic growth. “I believe that in these turbulent times we need more fiscal room,” Varga told the news agency. “That means cutting the deficit and strengthening budget reserves.”

IMF Bailout

The Bloomberg article recalls that Hungary needed an IMF-led bailout in 2008, after the global financial crisis hit the country badly. PM Viktor Orbán stabilized public finances after he swept to power in 2010 for his second term, and when he was re-elected for a record fourth term in office this April, markets and investors had good reason to believe that his administration would “turbo charge the economy with fiscal stimulus”, the news agency wrote.

Such expectations seemed to be well-grounded as Orbán said he expects an annual economic growth of at least 4% through 2020, a bold projection that went against domestic and international analysts, as most of them said such a high growth rate is not sustainable in the long run.  

The Hungarian economy may expand by 4.1% next year, and the country is currently enjoying an upturn which allows the cabinet to cut back on the deficit significantly, while the budget remains expansionary, Varga said. As he stressed, his ministry will insist on cutting the payroll tax rate to 17.5% in 2019, raising child benefits and continuing the housing subsidy program. 

There is, therefore, limited room for further stimulus, while the upheaval on global markets and the start of the monetary tightening in the United States also reduces the room for maneuver for the Hungarian government. The tightening cycle in the States has already hit emerging assets, including Hungary’s, Bloomberg notes. The forint fell to a two-year low against the euro on May 28 as political turmoil in Italy dented riskier assets across the continent. Hungary’s ten-year bonds are on track this month for their worst performance since 2012.

The Hungarian government’s goal now, therefore, is to reduce risks. “This means significantly cutting the deficit and continuing with debt reduction,” the news agency cited Varga as saying. “That may also mean that our economic growth rate may fluctuate,” the finance minister concluded.  

EU Warning

Varga’s words on delaying the introduction of measures to stimulate the economy came only a few days after the European Union warned the country about necessary structural adjustments.

On May 23, the EU said that Hungary needed a structural adjustment of 1% of GDP this year and 0.75% next year to correct a “significant deviation from an acceptable medium-term fiscal path.

In reaction to that, Varga told government-friendly Magyar Idők that the Hungarian government thinks such worries are not grounded. Although the excess deficit procedure against Hungary, which had been on-going since the country’s EU accession in 2004, ended in 2013, and the European Union strictly monitors Hungary’s fiscal situation, there is no need to worry that the deficit exceeds or even emerges close to the 3% of GDP prescribed by the EU, the minister insisted. As he stressed then, there will not be any corrections in the budget; in order to maintain sustainable growth, the government continues to secure investment sources and scrutinizes the possibility of further tax reductions.  

Another factor to take into consideration when projecting future economic growth is the inflow of available European Union funds. On May 29, the European Commission officially proposed to modernize its Cohesion Policy, which is the EU’s main investment policy. The proposal confirms earlier speculation about the EU cutting back significantly on available cohesion funds for Hungary and other countries in the region.  

Commissioner for Regional policy Corina Creţu admitted that the EC had adopted new priorities in drafting the modernized policy, and it wants to end the practice of distributing cohesion money on the basis of GDP per capita, shifting toward criteria including youth unemployment, education, the environment, migration and innovation.  

The draft policy paper proves right those saying that the EU would redirects fund from – among others – Czech Republic, Estonia, Hungary, Lithuania, Malta, and Poland, towards southern states such as Italy, Spain, and Greece. The draft needs to be approved by the European Parliament and the European Council; if both institutions give the green light, cohesion funds available to Hungary in the 2021-27 EU budget period will be cut by 24% from what had been made available in the current budgetary period. Based on 2018 prices, the currently available amount is EUR 23.6 billion, which would be reduced to EUR 17.9 bln.

Numbers to watch in the coming weeks

The first estimates of April’s retail trade will be released by the Central Statistical Office (KSH) on June 5. On the same day, the second reading of first quarter GDP growth will be published. The day after that, KSH issues the first release of the April performance of the Hungarian industry, to be followed by the consumer price index for May on June 8.