‘Winter is Coming:’ Economy Faces Tough and Uncertain Period, Equilor Warns

Analysis

From left: Bálint Szécsényi, CEO; Lajos Török, senior analyst, and Szilárd Buró, head of financial innovation.

Turbulent months are ahead for the capital markets and the Hungarian economy, according to Equilor Investment, something an agreement on EU funds may help ease. The rapid and broad-based economic recovery following the coronavirus outbreak was primarily interrupted by the Russo-Ukrainian war and the ensuing energy crisis. All this also means that a bear market could stay with us for a long time, the consultancy says.

Erratic energy prices, galloping inflation, slowing investment, the region’s highest base interest rate, a rising wage-price spiral, and an expected slowdown in domestic consumption are just some of the factors that make the outlook gloomy.

The euro could enter the new year at around its current level to the forint. Still, it is unlikely to strengthen next year, with the rate reaching the 420 level to the forint, according to Equilor. Its analysts expect GDP growth of 5% this year and stagnation next year, while inflation could reach 13.5% this year and 15% next, they warn.

The Hungarian and European economies are facing their most uncertain winter in a decade, Equilor says. Economic indicators could be affected by average winter temperatures and, thus, the use of gas reserves. Still, in the longer term, the outcome of the Russo-Ukrainian war and the resulting energy crisis could be a vital issue, according to the company’s most recent analysis.

The development of the Hungarian economy and the forint exchange rate will be significantly influenced by the debate on the disbursement of EU funds, any resulting agreement, and, ultimately, the amount of funds disbursed.

In total, EUR 7.5 billion in funding has been suspended from operational programs. As a baseline scenario, Equilor expects that Hungary will receive the bulk of the pending amount, some 80%, but that the contested items of the 2021-2027 operational programs will not be paid. If this materializes, Equilor expects that after this year’s 5% GDP growth, next year could see stagnation, while in 2024, GDP growth could still be subdued at 2.5%.

Domestic inflation started to rise in fall 2021, boosted by fiscal easing and, on the demand side, the personal income tax rebate. The rise in world energy prices, which also started last fall, has intensified significantly following Russia’s invasion of Ukraine.

Inflation Expectations

The revision of the overheads cut will be reflected in the CPI from September and could reach 20% annually in the fourth quarter. Equilor expects annual average inflation to be around 13.5% this year, rising to 15% next year and only returning to single digits (7%) in 2024.

However, Lajos Török, a senior analyst at Equilor, thinks that the outlook has many uncertainties. He explained that the main trends could be determined primarily by the evolution of world energy prices, but there are also several risks.

In his view, it cannot be ruled out that residential overheads will have to be adjusted again from January 1, leading to a further increase in inflation from the first quarter. In addition, the system of price caps, extended until the end of the year, should be phased out soon, which could lead to a 1-2% increase in inflation, depending on current market prices.

Like the central banks of developed countries, the National Bank of Hungary (MNB) is fighting against the build-up of inflation expectations and their persistence at high levels: it has been raising the base rate in significant steps, but this can only have a partial effect due to the various subsidized loans and the interest rate freeze.

Despite having the highest base rate in the region, the forint has been in a tailspin against the euro since the outbreak of the war and has also drifted away from the region’s other currencies. This is partially explained by the relative fragility of the Hungarian economy, and partly by the withholding of EU funds, Török noted.

In addition to the interest rate hike, the MNB took other monetary tightening measures at the end of August, including an increase in the reserve requirement ratio for the banking system, a regular auction of central bank discount bonds, and the introduction of a long maturity deposit facility. The pace of the increase in the central bank base rate is expected to moderate from 100 basis points over the rest of the year.

In the absence of a shock weakening of the forint, regular base rate hikes could be completed this year, with ad hoc interventions in the first quarter. After peaking at around 15%, the policy rate could gradually decline to about 10% by the end of next year, in line with developments in global conditions, Equilor believes.

Risk Premium

In addition to accelerating inflation, Hungarian government bond prices have also been weighed down by a significant increase in the country’s risk premium. Although Standard & Poors affirmed Hungary’s debt rating in August, the outlook was downgraded to negative because of a deteriorating balance sheet and short-term country risks. With real interest rates still in negative territory, the incentive for higher interest rate hikes to increase savings and leverage is limited.

The Hungarian economy is facing several challenges. Although the debt-to-GDP ratio is not exceptional by European standards, the highest yield levels in the region could put the budget under pressure in the medium term.

In addition to the fiscal deficit, the current account deficit is also high, which could be addressed by further reducing government expenditure and lowering the import ratio. In the summer, the government opted for fiscal adjustment: special sectoral taxes were increased and extended, government spending cuts were announced, utility subsidies were linked to consumption ceilings, and preferential taxation for small businesses was abolished.

With uncertainties remaining around the increase in debt refinancing and the receipt of EU Recovery Fund resources, and with tax revenues rising with inflation, the budget deficit would have been around 4.9%. It could increase to 6.1% due to extra gas purchases, according to Equilor’s forecast.

The domestic labor market has recovered quickly from the crisis caused by the coronavirus epidemic, with the unemployment rate falling steadily to below 4% last fall. Severe labor shortages in many sectors and specializations are causing average wages to rise dynamically. The pace of wage growth is expected to accelerate towards the end of the year as companies try to offset the rising costs of inflation for their workers by raising wages.

The resulting price-wage spiral is already visible, but inflation remains primarily driven by external factors for the time being. High energy prices in Europe are likely to lead to a structural reorganization of the economy, with closures and shutdowns, especially in energy-intensive and cost-sensitive companies, which could temporarily increase unemployment by 1-2% in the coming quarters. Still, Equilor expects unemployment to remain low in the coming years, with high inflation compared to the past decade, and with moderate fluctuations due to structural changes.

This article was first published in the Budapest Business Journal print issue of October 7, 2022.

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