Forecast on the Developments in the Hungarian Economy in 2004-2005

In 2004 the Hungarian economy is growing at a rate of 4%; that is, by about 1 percentage point faster than in 2003. However, it became clear by the autumn and winter months that in the 3rd quarter, the temp of growth slightly decreased. The fact that the European - and within that, German - recovery has been more modest than previously expected, contributed significantly to this trend, in which the depreciation of the dollar, the appreciation of the euro and the persistently high oil prices also played an important role. In Hungary, the fact that the forint strengthened significantly even compared to the euro, posing difficulties for both exports and domestic sales; the stagnation of the purchasing power of households - which is absolutely justified from the point of view of equilibrium - and high interest rates contributed further to the trend. This slightly deteriorates the opportunities for growth in 2005 as well.

After a growth rate of 10% in the 1st half of the year, the production of the industry increased by less than 6% in the 3rd quarter. The increasingly higher basis contributed to this slowdown, since the acceleration of growth started at the end of the summer of 2003. Industrial exports significantly slowed down from 20% in the 1st half of the year to 13% in the 3rd quarter, though they are still fast. Decrease in domestic sales has become more perceptible; it was 0.5% over 9 months. The highest export growth was recorded in the manufacture of consumer durables and the second highest in the manufacture of semi-finished products. These two sectors were the most successful ones in the domestic market as well. In the year as a whole, the industry is expected to grow by 8-9%. Despite the above-mentioned problems, the high stock of orders and the fast increase in machinery imports for investment purposes support further industrial growth.

The construction industry is also growing rapidly, although at a decelerating rate. Following two arid years in agriculture, there was a record cereal harvest this year; the wheat production was two times as much as in 2003. Meanwhile, the cattle, pig and poultry stock decreased. The performance of transportation is developing significantly faster than in 2003, but it slowed down during the year. The turnover of retail trade is increasing at a rapid rate - especially compared to the stagnating real earnings - but in the 3rd quarter a slowdown was manifest in this sector as well. In tourism, the number of outbound tourists is growing faster than the number of inbound tourists, which is partly the result of shopping tourism. In domestic commercial accommodations the turnover of foreign tourists expanded, while that of domestic tourists decreased.

According to the forecast of GKI Co. in 2004 the GDP will grow by 4%, the investments by 10% and the consumption by 3%.

In the first 3 quarters, the number of employed persons in the national economy increased by 1%. It rose by 1.5% in the business sector. However, the number of employed persons in the industry decreased by more than 2%, and a significant increase took place only in the machinery industry. On the other hand, the number of employed persons considerably increased by 4, 9 and 12% in the construction, trade and real estate sectors, respectively. In the government sector the number of employed persons decreased by 1%. The situation in the labor market is in correlation with wages: in the first nine months gross earnings in the business and government sectors rose by 9.5 and 5%, respectively. Net earnings increased by 8 and 5%, respectively, which means that real earnings rose by 1% in the business sector, decreased by 2% in the government sector but stagnated altogether.

In autumn the rate of the price increase continued to moderate perceptibly; the consumer price index is expected to be around 6.8% in the year as a whole and around 5.8% in December. After the change on the finance minister's post early in the year the official target for the 2004 deficit of general government calculated according to EU methodology was set at 4.6% of the GDP. Since September, the forecast of the Finance Ministry is 5 to 5.3%. GKI Co. estimates that the deficit will be around 5.2%; i.e. in line with the new MoF forecast. The debt stock of general government will be around 59% of the GDP at the end of 2004 as well.

As a result of high interest rates and the substantial delay and a predictability of the base rate reduction by the central bank that helped speculation, the forint became extremely strong by the fall of 2004. By the end of the year the base rate is expected to be around 9.5%. That is extremely high in international comparison, and significantly higher than what the country risk would justify.

The growth rates of imports and exports (calculated in euros) are the same, and, in line with the decelerating trend of the economy as a whole, are increasing at a decelerating pace. Mostly due to the high prices of oil and other raw materials, the terms of trade deteriorated by about 1%; but the effect of the high oil price is largely counterbalanced by the extremely weak dollar. External deficit will be about the same as in 2003, but its ratio to the GDP will decrease. Capital inflow will play a more significant role in financing the deficit than earlier.

According to the surveys conducted by GKI Co., the optimistic expectations of companies deteriorated in the fall, while those of consumers remained largely unchanged. In 2005 the Hungarian economy will probably follow the growth trend of the European economy, its rate of expansion - similarly to that of the EU - will remain practically unchanged. The strong forint will continue to pose difficulties in making use of the opportunities on foreign and domestic markets, while the increase of domestic purchasing power - which is significantly faster than in 2004 - will create markets not only for domestic supply but for imports as well. Although the economy will retain the export- and investment-driven character it regained in 2004, the growth of exports and the accumulation of fixed assets will decelerate, while the growth of consumption will somewhat accelerate.

In spite of extremely high world oil prices - which must be reflected in the domestic price of natural gas and electricity - conditions for significant slowdown of inflation in 2005 will emerge. In the beginning of the year - when the tax increase of January 2004 no longer affects it - the price index will decrease rapidly and drop below 5% relatively quickly. It will decrease further until the end of the year. In the year as a whole, we expect the inflation to be around 4.8% and to reach 4.5% at the end of the year.

The growth rate of household earnings will continue to decelerate in nominal terms. Gross earnings will increase by about 6 to 7%; while due to the personal tax reduction, net wages will increase slightly more dynamically. Average real wages will increase by 3%. The growth of the stock of housing loans will continue to decelerate. The net savings of households will reach nearly 2% of the GDP. The expansion of household consumption will continue at this year's rate.

Investments will expand relatively rapidly but to a lesser extent than it was forecasted earlier. This is due primarily to the realignment of state investment financing, although it remains a question whether all PPP-plans can be realized. Business investments are somewhat uncertain as well.

The production of the industry and the construction industry will expand at a rate similar to that of 2004. Activity in the logistics, business consulting and real estate sectors will continue to increase.

The growth of the GDP will probably reach 4% partly due to the fact that in 2004 Hungary became member of the EU. Employment will decrease notably in the budgetary sector (especially in central and local administration), while in the business services sector and on the whole it will slightly increase. Budgetary consolidation will continue in 2005; however, as the general elections approach, its progress will probably only be symbolic. The deficit of general government will probably decrease to 4.9% in proportion to the GDP. This value is the same calculated on cash flow basis. The debt stock of general government - depending on the exchange rate and privatization revenue - will slightly decrease in a favorable scenario.

Imports will likely increase somewhat faster than exports in 2005. This is probable because of the expansion in domestic demand and the increasing import competition. The terms of trade will deteriorate further because of the delayed effect of gas price increase. The surplus of tourism revenue will hopefully improve. As a result, the external equilibrium will remain practically unchanged. Although the deficit of the foreign trade of goods and of the balance of current account will increase in nominal terms (the latter - together with the capital account balance - to � 6.9 billion), but in proportion to the GDP, it will continue to decrease below 8%. Net foreign direct investment will finance about half of that deficit.

On money and capital markets a further, gradual calming is likely. If monetary policy facilitates this process with continuous and perceptible signals (the balanced judgment of economic processes and a reduction of the interest rates), the reference yields of one-year government bonds may fall between 7 and 7.5% by the end of 2005. We expect a 250 forint/euro average exchange rate for next year. The increase of prices on the stock exchange will slow down but continue.

Forecast of GKI Co. for 2005

	2002. fact	2003. fact	2004. forecast	2005. forecast
	2002. fact	2003. fact	2004. forecast	October	December
GDP production	103,5	103	104	104,3	104
Of which:
Industry	101,3	105,4	105,5	107	106
Construction	112,9	101,2	105	108	107
Agriculture	87,9	96	130	98	98
Transport and telecommunication	101,6	102,6	104	102	103
Other services	104,5	102	103	104	104
GDP domestic absorption	105,4	105,4	103,7	104,7	104,3
Of which:
Household consumption	109,3	107,6	103	103,5	103,5
Accumulation of fixed assets (investment)	108	103,4	110	111	108
Foreign trade of goods
Exports	105,9	108,8	115	115	111
Imports	105,1	110,1	114	116	112
Consumer price index (preceding year = 100)	105,3	104,7	106,8	105	104,8
Combined current account and capital account balance
- billion euros	-4,9	-6,6	-6,6	-6,9	-6,9
- in percentage of GDP	-7,1	-9,2	-8,2	-7,8	-7,8
Rate of unemployment (at the end of the period, percentage of economically active persons)	5,9	5,5	6,1	6	6,1
Consolidated deficit of general government as a percentage of GDP (according to EU methodology)	9,3	6,2	5,2	4,5	4,9

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