A significant challenge continues to be the government’s deficit and debt burden. To cope with these, the cabinet introduced (and maintains) a freeze on public investments and reduced public sector spending, especially in the energy sector.
Paradoxically, higher inflation would ease the burden. According to a study published on telex.hu by Ádám Zawadoski, a researcher at the Central European University, over the past four years, the debt has grown by 2.1% annually, fueled by overspending.
Before COVID, inflation had reduced the debt-to-GDP ratio by 2-3 percentage points per year. Later, as we have seen, the inflation rose to more than 20%, which reduced the debt-to-GDP ratio by 6.8 percentage points annually. Is this a negative development? Not necessarily, but in the long term, it could be, Zawadoski says.
“It has often occurred in world history after wars and major crises since, in this way, the state can quietly ‘tax’ domestic and foreign investors without cutting spending. The prerequisite for this is that the loans of the Hungarian state are in forints, which the government consciously sought in the past,” the researcher notes.
“Perhaps this is also why the government was never in a hurry to introduce the euro since then it would not be able to inflate the debt if necessary. In the long term, however, this method is dangerous, because the government could get comfortable with this solution. It is always easier for the current government to devalue the debt by inflating the forint than to raise taxes or cut spending. And this leads to higher inflation in the longer term. We have experienced the negative consequences of higher inflation firsthand in recent years,” Zawadoski points out.
A higher GDP rate would mean a lower debt rate, and the government remains optimistic about medium-term growth. Hungary’s Minister of Finance Mihály Varga recently emphasized that GDP growth could rebound to 3-4% in 2024. Prime Minister Viktor Orbán even envisioned 6%, which was helped by robust investment activity and an improving external balance.
However, managing inflation and avoiding the EU’s excessive deficit procedure remains a priority, with further fiscal tightening likely necessary, Varga said.
Often, governmental forecasts and analysts’ assumptions differ, but on this occasion, Viktor Zsiday, portfolio manager at Hold Asset Management, commented in harsh terms on the data. In an interview with penzcentrum.hu, Zsiday said that Hungary’s potential GDP growth could not be more than 1-2% annually.
“I would be very much surprised if, in the years to 2030, we reached an average of 3%. But 6% has absolutely no basis whatsoever,” he critiqued.
A significant factor in handling inflation are the measures taken by the MNB. One of the most important actions across the last quarter has been the gradual reduction of the base interest rate, which stood at 13% for most of 2023.
In light of improving inflation trends, the MNB began cutting rates incrementally, with the base rate falling to 6.5% by October 2024. This marks a shift from the highly restrictive monetary stance the central bank had maintained in the face of inflationary pressures in 2022 and early 2023.
Despite these rate cuts, MNB officials, including Governor György Matolcsy, have remained cautious about declaring victory over inflation. The central bank expects inflation to continue decelerating, but it has emphasized that the disinflationary process could be slow and vulnerable to external shocks, especially if global energy prices rise again.
Another critical issue addressed by the MNB is the housing market. The central bank has warned that the Hungarian real estate market remains overvalued, with commercial real estate facing rising vacancy rates. Housing transactions have declined significantly due to high interest rates and inflation, but the MNB noted that risks related to mortgage lending remain contained.
The bank’s cautious stance reflects broader concerns about how global and local economic trends could impact the stability of Hungary’s financial system. Looking further, with interest rates still elevated and economic uncertainty persisting, demand for household credit is likely to continue to weaken, particularly for mortgages and consumer loans.
The government’s push to encourage savings in high-yield bonds will further reduce the attractiveness of traditional bank deposits, placing additional strain on banks’ liquidity positions.
The Hungarian banking sector has already exhibited a slowdown in lending, particularly in household and corporate segments. With high inflation and economic uncertainty continuing to dampen consumer confidence, the demand for new loans has decreased, especially for mortgages and small business loans.
The sector’s loan-to-deposit ratio has increased due to a decline in deposits, but despite these challenges, Hungarian banks remain well-capitalized, with substantial liquidity buffers. According to the MNB, the banking system is resilient and well-positioned to weather future economic shocks. Profitability, while impacted by government taxes and lower consumer demand for credit, remains supported by income from central bank deposits.
This article was first published in the Budapest Business Journal print issue of October 18, 2024.
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