Q2 Contraction Extends Hungary’s Economic Recession to a 4th Quarter

Analysis

While inflation continued its downward trend during the holiday period and enabled a further reduction in interest rates, poor second-quarter GDP data spoiled any summer party.

Hotelier Lukas Koller has been having a good season. The managing director of Est Grand Hotel Savoy, a four-star “superior” hostelry near Blaha Lujza tér in Budapest, says August in particular was a “splendid month” with major events such as the World Athletics Championships boosting occupancy to “a bit above 86%,” a significant improvement on the 73% of last year.

On top of this, room rates were raised by 16% this year. The cherry on the cake then? Not quite, as Koller cautions. “This might sound like a lot, however, it does not cover the effects of the soaring inflation rate entirely.”

Nonetheless, tourism, most especially that segment attracting up-market foreign visitors, is likely to prove one of the better performing elements in an economy which otherwise continues to suffer from the highest inflation in Europe and was, at the last count, still in overall recession.

Granted, headline inflation in July came in at 17.6%, an encouraging improvement on January’s peak of 25.7% and a result enabling the central bank’s Monetary Council to continue trimming the key overnight deposit rate by 100 basis points to 14% later in August.

However, Hungary’s Consumer Price Index is still more than three times the eurozone rate, which registered a 5.2% increase in prices in July.

Poor Q2 Figures

Whatever, any spirits raised by the inflation numbers of early August were soon dampened by the surprisingly poor economic figures for the second quarter, which revealed the economy had contracted by 2.4% year-on-year and 0.3% month-on-month, meaning the Hungarian economy had shrunk for the fourth consecutive quarter. The first estimates were confirmed in a detailed analysis by the Central Statistical Office (KSH) this week.

“This [preliminary] data caused a major negative surprise compared to the market consensus. The vast majority of the market, including ourselves, expected the technical recession to end after three quarters. We were all disappointed,” Péter Virovácz, senior economist with ING, wrote in an analysis after the data was confirmed.

Delving into the various sectors, the outstanding numbers were related to agriculture, where output surged 67.9% year-on-year, a seemingly stellar performance. However, as KSH itself was quick to note, this was largely the result of a very poor base quarter in 2022.

“Last year was purgatory for the sector, due to the impact of the Ukraine war, the related energy crisis and bad weather. So, such a huge annual improvement was always going to be on the cards,” Virovácz wrote.

Indeed, this year’s second quarter agricultural performance was, if anything, disappointing, since it represented a contraction on the first three months of 2.3%, contrary to the widespread expectation of a boom. Nonetheless, agriculture still holds out promise in the short term, Virovácz argues.

“Preliminary crop yield results suggested a nice improvement in the sector, although it seems that this will not be felt until the second half of the year,” he says.

‘Disturbing’ Contraction

In other sectors, negative results are continuing to emerge, and while the fall off in domestic demand and the yearly and quarterly drops in value added in industry (at -5.7% year-on-year) and construction (-6%) were largely expected, Virovácz deems the 2.4% contraction in services “really disturbing.”

“It seems that the start of the tourism season wasn’t enough to salvage the tertiary sector during the second half of the year. With dropping production in industry and construction and with the shrinking purchasing power of Hungarian households, retail, logistics and leisure-related services collapsed,” he reasons.

Not all analysts are so downbeat, however. At OTP Bank, senior analyst Győző Eppich notes that while many economists interpreted the second quarter results as “very bad news,” lowering their forecast as a result, “we think the data is not as bad as it first seems.”

For Eppich, the structure of the second quarter figures compared to those of the first three months “painted a more favorable picture about underlying growth,” with numerous one-off effects, both positive and negative, complicating the overall assessment.

However, after filtering out these effects, he argues that, after the sharp decline in the first quarter, underlying GDP in fact “roughly stagnated on a quarter-on-quarter basis” in the second three months.

For sure, the outlook for Hungary remains mixed. While inflation is on a downward path, the forint has seemingly stabilized in the HUF 380-385 range and both the trade and current account balances have recovered strongly this year on the back of low global energy prices. However, fiscal concerns persist, with the seven-month budget deficit at 86% of the annual target, a worrying factor in the second half of the year.

Moody’s Affirmation of Sovereign Rating Welcomed, but Controversial

In a piece of positive news for Hungary, Moody’s, the U.S.-based international ratings agency, affirmed the country’s Baa2 sovereign rating with a stable outlook in its scheduled review on September 1. The rating is in the investment grade category, two notches above so-called “junk status.”

The agency said the ratings “balances” Hungary’s credit strengths and challenges, arguing the country’s medium-term growth outlook is “solid driven” by a combination of labor and product market factors, including the availability of skilled workers, one of the highest wage adjusted labor productivities among EU countries, a solid infrastructure, one of the lowest corporate income tax rates in the EU, and its integration into European manufacturing production networks.

It also noted the country’s “robust” fiscal strength, with “a moderately high debt burden and relatively strong debt affordability.”

On the downside, Moody’s said Hungary’s main credit challenge relates to weaknesses at the institutional level, “which have been at the origin of a contentious relationship with the EU,” which, in turn, “induces uncertainty about the disbursement of financially significant amounts of EU funds.”

However, the agency expects the government to eventually secure the majority of its EU funding, although this will be what it calls a “step-by-step, noisy process.” The impact from any delay in transfers on economic growth and public finances will be “limited” and “Hungary’s economic strength is expected to remain robust in light of significant investments,” the agency concludes. But not all are so sanguine on the country’s near-term future.

“Moody’s latest decision on Hungary gives [a] false sense of security,” ING’s Péter Virovácz cautioned in his assessment of Moody’s analysis, arguing that while the affirmation of the rating came as a positive surprise, it “could lead decision-makers to become complacent.”

“We are not entirely comfortable with their argument, particularly the balanced risk assessment,” he says. Virovácz also disagrees with Moody’s assessment of the risks facing Hungary.

“We believe the risks are tilted to the downside, hence our earlier expectation of a downgrade to the outlook. In our view, the recent decision provides a false sense of security and may lead policymakers to become complacent at a time when growth prospects are deteriorating, and fiscal problems are mounting. These risks have led us to be more downbeat overall [on economic developments],” he wrote.

This article was first published in the Budapest Business Journal print issue of September 8, 2023.

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