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EC: Hungary flies solo in 2017

The Commission said that it won’t be until after next year that we get a real feel for how the Hungarian economy fares without a heavy boost from European Union grants to local governments and firms.

Eager shoppers line up at a newly opened Pápai Hús shop in Győr in 2010. Founded in 1913, the firm declared bankruptcy on November 9, but two days later was declared by the government to be a company of ‘elevated strategic importance’. As such, it could be eligible for government support, possibly including European Union funds. According to the European Commission, Hungary will not be able to artificially prop up the economy with EU funds after 2017.

After slowing to 2.2% next year, Hungary’s real GDP growth is expected to pick up again to 2.5% in 2017, and that will be the first year when the country’s economic performance can be judged without the distortion of European Union funding, the European Commission (EC) said in its fall forecast on November 5.

The Commission’s 2.9% growth projected for this year is ten percentage points higher than it stated in its spring forecast. On top of that endorsement, the country got a boost from Moody’s on November 6.

In gauging Hungary’s economic growth, the Commission emphasized that the country’s GDP is strongly linked to EU fund absorption.

“Growth figures over this forecast horizon are heavily influenced by Hungary’s absorption of EU funds, which helped propel investment growth to 11.2% in 2014 and which, after a timid increase this year, may lead to temporarily negative figures in 2016. From 2017, funds from the current programming period of EU funding will start to positively affect investment again,” according to the November 5 document.

The growth forecast by the EC is below the Hungarian government’s 3.1% projection for 2017. According to estimates, EU funding contributed to Hungary’s GDP growth by an average 0.6 percentage points between 2007 and 2013.

As the amount of EU funding is likely to significantly decrease this year and the next, the year 2017 could be a testing period of the Hungarian growth model, Brussels-based Bruxinfo.hu wrote in a reaction to the EC forecast.  “2017 can be the moment of truth,” the portal cites an unnamed source as saying. “That is going to be the year when we will find out what performance the Hungarian economy is capable of without the large volume of EU transfers. Some say that the country should look for alternative growth resources.”

Inflation to remain near zero

The Commission doesn’t think that the general government deficit would break loose in the upcoming three years. The 2015 general government deficit is projected to reach 2.3 % of GDP, from 2.5% in the previous year. “The fiscal outlook has improved due to the robust dynamics of tax revenues and declining interest outlays,” the forecast reads.

Regarding risks, the EC mentions that the net cost of EU-funded projects could turn out to be higher than planned in 2015 and 2016, with a negative outcome of pending financial corrections. In addition, the tight operating budgets for healthcare and education sectors carry significant implementation risks.

As for inflation, the EC expects it to be around zero for this year. Looking ahead, the figure for 2016, close to 2%, could turn out to be lower than previously anticipated due to lower than expected oil prices, subdued imported inflation, low food prices, and regulated energy price cuts. As the output gap closes, inflationary pressures from the real economy will drive up inflation to 2.5% in 2017, reaching the central bank’s target of 3% only at the end of the year. These expectations are more or less in line with analysts’ views from major banks present in Hungary, including Citi and CIB Bank.

One step closer

In the meantime, Hungary got one step closer to regaining its investment grade, as Moody’s Investors Service affirmed Hungary’s long-term FX credit rating at Ba1, one notch below investment grade, and improved the outlook from stable to positive in a regular review published late on November 6.

Moody’s has cited a sustained downward trend in government debt, reduction of FX related vulnerability, and external debt vulnerability and improving growth outlook as key rationales for the outlook change.

“In our view, stable 2-3% annual household consumption growth may support medium-term GDP growth prospects. Still, the stock of externally-funded government debt remains a key source of risk,” Eszter Gárgyán, a Budapest-based analyst at Citi, said in a research note.

“Moody’s would consider upgrading Hungary’s rating if the country’s economic and fiscal metrics continued to improve, resulting in a further reduction of the public debt ratio. In particular, an upgrade would be dependent on further confirmation that economic policy-making is more stable than in the past, in turn supporting sustained economic growth, fiscal consolidation and a further reduction of external vulnerabilities,” the rating agency wrote in its press release.

Fitch comes next

Following the move from Moody’s, Hungary has a positive outlook from two major rating agencies now, the other being Fitch. This suggests that barring unexpected external shocks or adverse policy twists, Hungary has a good chance of regaining investment grade and thereby attracting new types of foreign portfolio investors as the FX portion of government debt is likely to decline sharply in 2016.

All eyes are now on Fitch’s next regular rating review, which is due on November 20. A report released on November 3 by Fitch suggests that it is very likely that the rating agency will put Hungary back on the investment map. The country remained in the BB+ (junk) category with a stable outlook at Standard & Poor’s in September.