Hungary emerged from recession in 2013 with GDP growing by 1.1%. Growth is expected to accelerate to around 2% in 2014 and 2015, primarily driven by domestic demand. Preliminary annual data indicate a government deficit at around 2.5% in 2013 but it is forecast to rebound to around 3% of GDP this year and next, the European Commission says in its latest forecast.
Continued economic growth, partially boosted by indirect fiscal stimuli
After re-entering recession in 2012, with a 1.7% decline, Hungary experienced a real GDP growth of 1.1% in 2013, partly reflecting the correction of one-off adverse developments in agriculture. In 2013 investment turned positive mainly as a result of public investment, but corporate investment also started to accelerate on the back of the acceleration in the absorption of EU funds, and to some extent the central bank’s extended Funding for Growth Scheme (FGS, providing subsidised lending to SMEs). A sharp decline in inflation contributed to increasing households’ real disposable income, but the still high unemployment and ongoing deleveraging continued to put a drag on consumer spending. Altogether domestic demand became the main driver of growth in 2013.
Real GDP growth is expected to reach 2.1% both in 2014 and 2015, driven by a further pick-up in domestic demand, while net exports are projected to provide a nil contribution. Yearly household consumption is expected to return to positive territory from 2014 due to further improvements in real disposable income, partly linked to the regulated price cuts and increasing public sector wages, but also looser lending conditions as a consequence of new subsidised mortgage schemes. However, due to an oversupply in the market, housing investment is forecast to recover only modestly. Credit supply conditions to the corporate sector will be only temporarily eased by the FGS and, together with a high absorption of EU funds, will contribute to a pick-up in investment activity as well as a slight growth in firms’ net borrowing.
Decreasing unemployment and low inflation
Despite a continuous increase in the participation rate, unemployment dropped below 10% by the fourth quarter of 2013, as Labour Force Survey (LFS) based employment increased by 1.6% in 2013. The continuous expansion of the Public Work Scheme, the increasing number of frontier workers and the whitening of the economy contributed to the improvement in the labour market. As the economy recovers, domestic employment in the private sector is also expected to pick up and the unemployment rate is projected to fall further below 10% over the forecast period.
Inflation reached a historically low 0.7% in the last quarter of 2013 reflecting three successive waves of cuts in regulated energy and other utility prices. Underlying inflation has also been on a downward trend, due to a negative output gap and declining imported inflation. However, as the output gap closes and the effect of utility price cuts fades, inflation is expected to increase gradually towards the central bank’s 3% target by 2015. The recent depreciation of the forint entails some upward risk to the inflation projections.
Risks to the GDP forecast are overall tilted to the downside. A tightening in global monetary conditions may generate significant headwinds for Hungary, most notably through the revaluation of foreign-currency-denominated (FX) debt. The main domestic risk is related to the possible adoption of a new comprehensive FX relief scheme with potential negative effects on the banking sector and investors’ sentiment. As an upside risk, stimulus measures could have a bigger-than-expected effect on investment.
Government deficit expected to rebound to 3% of GDP
Cash-flow data for 2013 point to an overachievement of the 2.7% of GDP deficit target, with the general government deficit expected to reach 2.4% of GDP, i.e. 0.5% lower than in the autumn forecast. The deficit-decreasing developments include higher tax and social security contribution proceeds (0.15% of GDP), one-off revenue resulting from the shift of the accounting method from public to total cost for national co-payments for EU funds (0.1% of GDP) as well as the end-year savings by budgetary institutions and chapters (0.2% of GDP).
The 2014 deficit is projected to reach 3.0% of GDP, i.e. slightly above the target of 2.9% of GDP. The better-than-expected budgetary outturn in 2013 has only a limited base effect, which is offset by additional spending measures, rising interest outlays and the modest nominal private consumption growth. Compared to the budgeted figures, tax revenues are projected to be lower by over 0.3% of GDP due to a lower-than-expected inflation as well as a more cautious assessment of measures aiming to enhance tax administration. The forecast is based on the assumption that the special reserve (0.3% of GDP) will not be spent.
In 2015 the deficit is expected to decrease somewhat to 2.9% of GDP. The effect of economic recovery and the assumed decline of public investment linked to the electoral cycle will largely be offset by the fall in one-off revenues from the sale of telecommunication licences.
Regarding risks, in 2013 the possibly higher local government surplus could have further decreased the deficit, but the increased arrears in accrual terms could have had an opposite effect. For 2014 and beyond, the revenue effect of the change of method for the calculation of the national co-financing represents a positive risk, while a deficit-increasing effect could result from a further slowdown in inflation as well as an increase in sovereign yields.
After a moderate decrease of 0.25pp in 2013, the structural balance is forecast to deteriorate further in 2014 by more than 1pp. and to improve slightly in 2015. The debt-to-GDP ratio is forecast to have decreased in 2013 by 2pps to 77.8% of GDP, exclusively on account of the end-year reduction in the state cash deposits. Thereafter, it is projected to increase again due to the revaluation of the FX component.