Forecast for 2010

The speed and sustainability of recovery - especially in the EU, a market of crucial importance for Hungary - is rather uncertain, the process is unstable. Inventories have already been replenished partly. The low level of capacity utilisation holds back investments, the further deterioration of unemployment - which, at the same time, limits wage increases - hampers the rising of household consumption. Restructuring has not yet been finished in the banking sector, confidence has not fully returned, so credit is in short supply. In addition, fiscal stimuli cannot continue either, and terminating fiscal expansion and improving macroeconomic disequilibria is already on the agenda. The ECB announced that the measures to improve liquidity will be gradually withdrawn from March. The IFO survey results show that the improvement of expectations over the world economy stopped. The different forecasting institutions, which started to raise their projected growth figures since mid-2009 are now cautious and have not changed their forecasts for 2010 since February.

The 3.3 per cent contraction of GDP in 2009 will be followed by a 1.9 per cent growth in the developed economies. This rate is slow in times of recovery. The combined GDP of the EU is expected to increase by 0.7 per cent, that of Germany by 1.2 per cent in 2010. As a result of the fiscal stimuli applied in many member states, which contain expenditures on consolidating the banking systems as well, the EU's general government deficit climbed to 6.9 per cent of GDP in 2009 (from 2.3 per cent in 2008) and to 7.5 per cent in 2010. The figures for public debt are 61.5, 73 and 79 per cent, respectively. They are well above the 3 per cent and 60 per cent reference values. The US Fed's federal funds rate is 0.5 per cent; the reference rate of the European Central Bank is 1 per cent. Long-term bond yields are much higher than these levels, anticipating a rise in inflation. Until autumn 2010, neither the Fed, nor the ECB is expected to raise the rates, but both authorities would like to end loose monetary policy gradually (i.e. purchasing government bonds to keep up liquidity of the banking system). The weakening of the dollar to the euro stopped at the beginning of 2010 and the long-seen trend reversed. Following the US$1.47 exchange rate in 2008, the annual average exchange rate of the euro to the US dollar is expected to hover at around US$1.38 in 2010 with significant short-term volatility. By March 2009 the world market price of crude oil (Brent) dropped to US$40 per barrel from the US$147 peak recorded in August 2008, since then it has increased with some volatility. From the average annual price of 62US$ per barrel in 2009, it is expected to increase to 80US$ in 2010.

The contraction of the economy has lasted for seven consecutive quarters in Hungary. In 2009 GDP dropped by 6.2 per cent, consumption by 6.7 per cent, investments by 6.5 per cent, inventories were falling. In addition to the deterioration of employment, the freezing or decreasing nominal incomes, the higher interest rates on earlier borrowings, the tighter conditions for new credits; the tax restructuring effective from mid-2009 also had its role in the decline of consumption. While domestic demand was still sliding in 2009, after the initial huge drop external markets started to surge in the second quarter (compared to the preceding one). The 17.7 per cent drop in the volume of industrial production is somewhat higher than the EU average (14 per cent), but it is similar to that recorded in Germany. Last year the output of construction had been shrinking for the fourth year in a row. In 2008 the weather was excellent and the rate of growth of agriculture totalled 28 per cent, then in 2009 production dropped by 10 per cent. Whereas the GDP production of manufacturing decreased by 14.4 per cent, services shrank by only 2.3 per cent. (Within services, public services dropped only by 1 per cent). In the second half of the year the recession became deeper in retail trade. The overall position of financial institutions is relatively good.

Consumer prices were increasing faster during 2009. The exchange rate of the forint to the euro has continuously improved from its rather weak course in February-March 2009. The evaluation of the Hungarian economy has also improved: external debt has been refinanced from financial markets at sharply decreasing interest rates since June. The expiry of the IMF credit line was extended to autumn from spring 2010, which can ensure a relaxed transition to the months after the elections. The Greek crisis did not have a sustained negative impact on the assessment of the Hungarian economy. The annual figures of external and internal disequilibria turned to be rather favourable in 2009. The general government deficit was 3.9 per cent (according to the ESA methodology). Following the EUR 6.6 billion deficit in 2008, there will be a EUR2.3 billion surplus of the current and capital accounts in 2009, which is a EUR 9 billion improvement (or 9 per cent of the GDP) in only one year. This is a combined effect of the following factors: increased foreign trade surplus of goods and services, smaller repatriation of the declining corporate profits and increased EU transfers.

By March 2010 Hungarian consumer expectations have been slightly above and business expectations have approached the level measured in September 2008, the last month before the crisis. However, the improvement is slower than the deterioration was, and for the time being, one should talk about less pessimism rather than optimism. In the business sector, industrial expectations have improved most: in March the industrial confidence index not only surpassed the level before the crisis, but the long-term average as well. Industries linked to the domestic market are still pessimistic.

In 2010 the Hungarian economy will be close to stagnation, recovery with modest GDP growth is expected only in the second half of the year. Industrial production and exports will rise already in the first quarter, however, in that period unemployment will peak and consumption will hit bottom. In the second half of the year there will be some growth and inflation will be more moderate. Current external and internal equilibrium indicators may be excellent by international comparison; they can be kept under the EU average even if structural reforms that require additional expenditures are implemented. Global and EU trends mostly determine the room of manoeuvring for the Hungarian economy, so the impact of the government to be inaugurated after the elections will probably be less substantial on the economic tends in 2010 than what is generally expected (the impact on the next period can be more considerable). The economic policy of the next government cannot manoeuvre against the expectations of the international money markets and financial institutions: tight fiscal and income policies will have to be pursued and the economy has to stay on the path of decreasing external debt and sooner or later lowering rates of indebtedness. Only symbolic changes can be expected in the short run: e.g. the submission of a supplementary budget, with dozens of small changes but not touching the basic processes. Nonetheless, the government has to make the strategic decision in 2010 (when the convergence programme is updated) if it intends to introduce the euro by the end of its mandate (in 2014).

The program of joining the eurozone in 2014 requires declining government deficit and public debt ratios, for which public services should be restructured and reformed to lay the foundations for more considerable cuts on taxes. Notwithstanding, economic growth and the implied increase of tax revenues will leave the room for not cutting all government expenditures in nominal terms. (The deficit adjusted for the business cycle is already below the 3 per cent threshold). In GKI's view this economic policy option would serve the interest of the Hungarian economy. However, the "floating" economic policy, which tries to minimise conflicts, and which tries to set off the cuts on taxes with higher government deficits might also be feasible. In this case the sustained 4 per cent level of general government deficit - still favourable within the EU for years - would be justified by cuts on taxes and by obtaining the necessary financial resources with as little conflict as possible. In this economic policy, a patriotic and state-centred approach, which means public financial resources will support Hungarian SMEs, farmers and state-owned corporations, is to play a more important role (which is likely to appear also in the communication of the next government). It is somewhat strange that this policy would hardly improve the competitiveness of the corporate sector, but there is a danger that the rate of GDP growth will be lower and the quality of public services will be poorer than could be otherwise (due to the increased role of the government, less stringent efficiency requirements, besides market demand for supply decisions more attention is paid to the state than otherwise, etc.). The room of manoeuvring for this economic policy is also limited by the higher interest to be paid by the budget. In theory an economic policy with high redistribution that enhances the general government deficit and the public debt and openly confronts international organisations is also possible. However, because of the developments that would emerge even in the short-term - the depreciation of the exchange rate, high interest rates, high inflation, sustained stagnation, capital repatriation - this is not a realistic option.

Similarly to 2009, the budgetary law of 2010 reckons with a 3.8 per cent general government deficit relative to GDP. In GKI?s opinion the 2010 reserves - perhaps together with some smaller corrective measures - can cover the likely differences of government revenues and expenditures. It is possible that the international institutions - especially the IMF - would allow a 5 per cent deficit in 2010 if there are structural reform steps implemented this year, e.g. to consolidate state-owned companies (to stop the accumulation of losses). Even the target date of pushing the deficit below 3 per cent of GDP can be prolonged by one year to 2012, if there were serious measures to implement structural changes in the sub-systems of the general government in 2011 (then, the higher deficit would make the one-off budgetary impacts of the structural transition easier). Much looser fiscal policy would be hardly agreed on by the international institutions. The EU view is especially strict on this issue: generally they accept higher deficits due to new external reasons or shocks, which is not the case for Hungary. For 2011, the law on fiscal responsibility passed last year is also an obstacle, because the public debt ratio should decrease if there is economic growth. At the end of 2010, the gross indebtedness figure (ESA methodology) is expected to total about 78 per cent of GDP (but it is likely to be higher if the government deficit is around 5 per cent this year). This will not be an outstanding ratio in Europe at all! Financing the debt is possible by using the resources available in the Hungarian financial system and by further international bond issuance, but the rest of the IMF-EU stand-by loan can also be used if needed. In addition as market confidence returns, foreign investments in government bonds (denominated in HUF) will increase; also because of the still considerable interest rate premium and the lowering of risks (the process has started already).

The external balance will be rather favourable in 2010, similarly to 2009. The foreign trade surplus decreases somewhat from EUR4 billion to about EUR3 billion, but this is the sign of less severe recession. With the increase of the prices of energy and commodities, there will be some deterioration (0.5 per cent) in the terms of trade in 2010. The balance of the income account will deteriorate, but net EU-transfers will rise to about EUR2.5 billion in 2010 from EUR1.8 billion in 2009. The overall external financing need will show an EUR1.8 billion surplus (1.8 per cent of GDP). The weaker forint in 2008-2009 helped the regional competitiveness of Hungary, and relative unit labour costs remain favourable also in 2010. Foreign direct investment flows to Hungary may reach EUR3 billion. The net foreign debt of Hungary will substantially decrease in 2010.

GDP growth in 2010will be determined by more favourable external markets, investments co-financed by the EU, the gradually less pessimistic economic actors and their more favourable financial position as well as the related replenishment of inventories. However, for the whole of 2010 this implies stagnation only. The change of government implies the temporary slowdown of government decision making. Investment demand will create market for civil engineering, however, in fierce import competition, the slight increase of machinery investments and the further slight decline of consumption constrain the sales opportunities for domestic producers. In 2010 the output of industries and firms that serve foreign markets will increase most, i.e. most industrial sectors, some segments of road transportation and the tourism services in Hungary. The 3-4 per cent of growth of gross industrial production will be the result of exports only. Agricultural production will stay at the level of last year. Retail trade will shrink compared to the same period of 2009; growth is expected only in the Christmas season. The revenue of telecommunication firms is expected to decrease slightly, because of the drop in voice communication revenues. Undertakings in general, small ones in particular suffer from the lack of domestic demand and the shortage of financing sources. The micro, small and medium-sized enterprises tend to turn to the grey economy.

Aggregate domestic demand will increase by about 1 per cent in 2010. Investments co-financed by the EU that are mostly infrastructure ones, business investments will increase slightly, the number of homes completed will fall to 20 thousand from 32 thousand in 2009. Only a 3 per cent expansion of overall investments is expected. Household consumption will further decline by 1.5 per cent. Due to the oversupply of labour force and the lowering of personal income tax rates gross earnings are projected to mount by about 2 per cent. Due to changes in taxation net earnings are likely to jump by 7.5 per cent resulting in a 3 per cent growth of real earnings. Nevertheless, real income will only stagnate. Employment drops further at the beginning of the year, the support of unemployed shrinks over time, the benefits of the cafeteria system are declining because they are taxed and family allowances will not increase in nominal terms either. Taking into account the increase based on the inflation rate, the elimination of the 13th month pensions and the pension corrections, the real value of pensions will drop by about 1 per cent. The slow rate of increase of credits (the rate of which remains below that of the gross savings) implies that the net savings ratio will grow to 4 per cent. The number of employees drops by 1 per cent, the rte of unemployment goes up to an annual average of 10.7 per cent, peaking in spring at approximately 11 per cent, then declines for seasonal reasons. A moderate growth of productivity is also expected to re-start.

Because of differences in crisis management strategies, Hungary's inflationary trends have not been in line with international ones since the beginning of 2009. In the neighbouring countries and in the EU inflation virtually came to a halt, moreover, there is deflation in many countries. By contrast, inflation was accelerating in Hungary. In 2010, however, a global inflationary wave is to come, because of increasing energy prices, the additional liquidity pumped into the world economy, and the planned lifting of the tax rates to fill the gaps in the budgets. Today there are even theoretical arguments that tackling the consequences of the crisis in the global economy would be easier with a slightly higher rate of inflation compared to earlier objectives. Nonetheless, until the end of 2010, Hungarian inflation trends may again differ from international ones, because the carryover effects of the tax increases will settle in the second half of the year, causing inflation to cool. Stagnating purchasing power and the strong forint whose exchange rate is expected to be stable (and perhaps strengthening further) will also help cool the Hungarian inflation rate. In the first half of 2010 the rate of inflation will surpass 5 per cent, and will decline to 3-3.5 per cent from the middle of the year. The average annual rate of inflation will be around 4.3 per cent.

After the new government is formed, decisions would affect financial markets negatively only if they are not negotiated with the international financial organisations and if they raise the general government deficit in an unsustainable way. This is not likely. Hence, with an eye on maintaining stability, the central bank will be able to decrease its reference rate from 6.25 per cent at the end of 2009 and 5.75 per cent at the end of February to about 5 per cent by the end of 2010. The HUF/EUR exchange rate - if the economic policy mix is supported by the financial markets and the international institutions - will strengthen to HUF260 in the second half of the year, resulting in an annual average of HUF265. The HUF can be weaker and the reference rate may be reduced less ambitiously if the general government deficit is higher than what is promised; the 2011 budget proposal is not a tight budget; and the euro is planned to be introduced only in the distant future. However, if there is a sound and credible programme to introduce the euro in 2014, the reference rate could be cut more ambitiously, while economic policy should also take into account the competitiveness implications of a too strong currency at the time of joining the eurozone.

GKI forecast for 2010

	2007	2008	2009	Forecast for 2010 in
	(actual)			September	Decemberi	March
GDP production	101.0	100.6	93.7	100	100	100
Agriculture (1)	78.7	154.3	82.5	100	100	100
Industry (2)	106.0	100.4	84.1	102	102	102.5
Construction (3)	93.3	94.8	97	104	104	102.5
Trade (4)	104.0	97.0	91.5	100	100	98.5
Transport and telecommunications (5)	105.1	100.8	95.7	100	100	100.0
Financial services (6)	101.1	98.5	100.8	97	100	100
Public administration, education, health care (7)	96.1	98.5	99.0	100	100	100
Other services (8)	103.4	94.2	99.0	100	100	100
Core growth (2)+ (3)+ (4)+ (5)+ (6)	103.2	99.1	92.7	100	100-101	100-101
GDP domestic demand	99.0	100.7	88.5	101	101	101
Individual consumption	98.4	99.4	93.3	100	99	98.5
Gross fixed capital formation (investments)	101.6	100.4	93.5	106	105	103
External trade of goods
Exports	116.2	105.6	90.9	104	104	104
Imports	113.3	105.7	84.6	105	105.5	105.5
Consumer price index (preceding year = 100)	108.0	106.1	104.2	104	103.5	104.3
Combined balance of the current account and capital account
EUR billion	-5.4	-6.6	2.3*	-0.5	0	1.8
as a percentage of GDP	-5.3	-6.2	2.5*	-0.5	0	1.8
Unemployment rate (annual average)	7.4	8.0	10.1	9.8	11	10.7
General government deficit. in per cent of GDP (ESA)	4.9	3.8	3.9*	3.8	3.8 (5**)	3.8 (5**)

* GKI estimate
**If one-off consolidation costs and/or expenditures on restructuring are included
Source: CSO, GKI

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