Detailed forecast of GKI Economic Research Co. for 2012

The Hungarian economy has been the weakest for years in the region, and it fell short of its own capabilities. Now this is accompanied by a credibility crisis (perceived in the political, economic and business spheres as well). Although the growth was slightly faster than the EU average in 2011, it was lower than the regional one. This was the result of one-off factors such as the outstanding agricultural production due to good weather, and the temporary fiscal expansion (using up the assets of the private pension funds). Last year the real situation of public finances and the financing of Hungary’s debts were bad and they were deteriorating. The institutional system of the market economy was also impaired, and the tax burden increased. The withdrawal of capital is going on, investor’s sentiment of the country is negative, investments fall, and small businesses are suffering. Only the external balance is favourable. None of the main purposes of economic policy has been fulfilled. In spite of this, economic policy strives to maintain the appearance of success and continuity. Positive corrections were made only in crisis situations and many times they were no more than a mere rhetorical exercise. Actually, only the measures to reduce fiscal imbalances can be considered as significant (though short of the extent required). However, the government is gradually losing control over the economy. Together with further fiscal policy measures this could be enough to maintain solvency, but no growth in employment, investments or consumption can be expected as a result. The lack of legal certainty and predictability cripples the economy. The government’s double talk at international level is increasing the tensions with the EU and the majority of member states.

Financial trends in the EU are extremely unfavourable. The rate of inflation was exceptionally high in Hungary at the beginning of 2012, and Hungary had the highest central bank base rate (even though the rate was still below market expectations). The yields of government securities are higher than in Hungary only in Greece and Portugal (and sometimes in Ireland). Even in February and March 2012 market interest rates were so high that financing the Hungarian government debt in the long run by using these resources would entail very sharp additional restrictions. In order to finance the debt from the market Hungary would need at least 1.5 per cent potential growth rate and 3-4 per cent primary budget surplus, compared to the contraction of GDP and the 1 per cent surplus expected this year. Fluctuations in the exchange rate of the national currency are also the highest in Hungary. The loan portfolios of the banking system in other countries of Central and Eastern Europe are already increasing, except in Hungary.

The rate of growth of the world gross product will decelerate from last year’s 3.8 per cent to 3.3 per cent in 2012 mainly because of lower growth rates in the advanced European countries and, to a lesser extent, in emerging economies. Similarly to the previous year, in 2012 the GDP of US is expected to grow by 1.8 per cent. Owing to the presidential election, an expansionary monetary and fiscal policy can be expected contributing to a relatively high GDP dynamics. By contrast, the combined GDP of the EU is expected to stagnate in 2012 compared with its 1.5 per cent increase in 2011. In the first half of 2012 the entire euro zone may experience recession; however, in the second half of the year a recovery can be expected. In February and March 2012 the GKI-Erste economic sentiment index substantially increased, following an almost year-long steady deterioration down to its 2009 autumn level. The improvement in the opinions concerning the state of the Hungarian economy is especially spectacular. This suggests that the easing of the crisis atmosphere in early January, as well as the government’s promises to conclude an agreement with the IMF (which is constantly postponed nowadays) have played a role in the improvement of economic sentiment. Therefore, probably it is still too early to consider this as a turn in the expectations concerning economic trends.

The most important economic and institutional-legal changes (typically proposed by the OECD and the EU as well) are as follows:
respecting the independence of the central bank and the Monetary Council,
returning to the rule of law standards by restoring the Constitutional Court's powers and ensuring the full independence of the judiciary,
ensuring the freedom of future tax policy by amending the financial stability act,
creating the professional conditions necessary for the independence of the Budget Council,
bills and reforms should be proposed only after proper negotiations with the professional and interest representation bodies,
cleaning up the messy tax system, and eliminating sectoral levies,
launching the necessary structural changes at state companies, and stopping the escalation of nationalization and special regulations.

In legal terms, the main international procedures in connection with Hungary (IMF negotiations, excessive deficit procedure, three infringement procedures, etc.) are not directly linked. However, the IMF, the EU and the ECB rely on each other's opinion. Thus, the successful conclusion of infringement procedures is a prerequisite of starting negotiations with the IMF. However, the ECOFIN decision concerning the excessive deficit procedure (EDP) has created new conditions for the market to a certain extent by providing double support. Taking into account the current high yields, fulfilling the conditions of the EDP may be enough in itself to calm the government bond market. The Hungarian government is trying to regard the negotiations with the IMF and the EDP procedure as mere technical matters. In fact, both procedures require that the budget deficit be safely below 3 per cent of GDP, which would require serious measures (including genuine reforms). However, meeting the EU’s conditions of the IMF loan goes beyond purely economic issues, involving a continuous monitoring mechanism (which is slower in the case of the excessive deficit procedure). As a result, its confidence strengthening effect would be much stronger. A governmental behaviour may be identified that urges the start of negotiations with the IMF rhetorically, but by fulfilling the recommendations (preconditions) only partially, it actually postpones the negotiations. As far as the EDP procedure is concerned, this procrastination cannot be continued as specific steps for 2012-2013 should be presented in the new convergence programme by mid-April in order to achieve that the ECOFIN cancel the freezing of the cohesion funds in June. Therefore, the delaying tactics in fiscal affairs cannot continue.

The government may think that the fulfilment of the requirements of the EDP can avert or replace the IMF loan. In the relatively calm current international situation this may prove to be enough for the government bond market, but GKI believes that it would entail serious risks and uncertainties. The global risk appetite may deteriorate at any time, and then the IMF loan might be missing very much. Rating agencies would evaluate negatively the lack of agreement with the IMF. Therefore, the crisis of confidence could hardly be alleviated, investments would not be made, and consumption and GDP would not pick up. Meanwhile, essentially the same steps should be taken concerning the budget, but the significantly less expensive IMF sources would not be available for funding. Although the market may accept this situation, exchange rates and interest rates would only improve slightly. As a result, loans would be more expensive for domestic borrowers, and the interest burden of the budget could be up to HUF150bn higher per year, and additional restrictions should be introduced to achieve the desired balance. In addition, it is not at all certain that the EU would be an easier negotiating party than the IMF in budgetary matters. Therefore, GKI still believes that the Hungarian government should reach an agreement with the EU-ECB-IMF trio in order to alleviate the crisis of confidence and to improve the conditions for economic growth, and the sooner the better. In fact, the IMF agreement would allow for a smaller budget constraint.