GKI: Hungarian economy will expand by about 2.5 per cent in 2011

According to the forecast of GKI Economic Research Co. prepared in co-operation with Erste Bank, following the slight GDP growth of 1 per cent in 2010, the Hungarian economy will expand by about 2.5 per cent in 2011 – faster than the EU average, but more slowly than the majority of the neighbouring countries. The restructuring of taxes in 2011 brings the general government deficit under 3 per cent, however, fiscal sustainability is not ensured and the measures announced are unfavourable for economic growth.

In the third quarter of 2010, Hungary's GDP grew by 1.6 per cent, at a rate not recorded for two years. GDP growth in Hungary is at par with the EU average, yet markedly below that of Germany or Slovakia. Exports remained the engine of growth, especially those to Germany – the performance of German firms is also stimulated by the weak euro. Exports to other neighbouring countries are also on the rise that is the result of the regional division of labour of multinational companies. Domestic demand was still contracting in the first half of 2010, and – based on some partial data – in the third quarter at best it stayed flat.

The tax measures of the new government do not support growth. Reducing the corporate tax rate may improve the foreign capital absorption capacity of the country; however, it is more than offset by the weakening of legal security. The flat personal income tax rate favours high income strata that will either save more or increase spending on imported goods (e.g. by buying a new car). Nevertheless, the “crisis taxes” explicitly hamper future investments in the sectors concerned as well as the lending activity of the banks.

The expansion of tax revenues and the acquisition of the assets of pension funds together ensure that the general government deficit will be below 3 per cent of GDP. However, if the Constitutional Court or the EU rejects some laws – and, as a result, much fewer pension fund members return to the government scheme, especially those, who have higher income and thus higher accumulated assets – attaining the deficit target can be in danger. The 2.94 per cent deficit relative to GDP is formally in accordance with both market expectations and the convergence programme in force, however, in public spending an unfavourable trend is emerging in terms of sustainability. In GKI's fast estimate, the so-called structural deficit of the general government (that is adjusted for the business cycle and for one-off measures; it is monitored thoroughly by international financial markets) climbs to 4.2 per cent in 2010 and 5.5 per cent in 2011, following 3.1 per cent in 2009.

The long-term commitment to equilibrium could be demonstrated by the convergence programme, provided that structural changes of general government expenditures are announced and started. The annual average exchange rate of the forint to the euro will total about HUF270, however, if the international assessment of Hungary's fiscal policy is not favourable, the forint can be weaker. If any of the measures that aim to improve the general government position in 2011 is withdrawn, markets may respond rather severely. Hence, the exchange rate of the forint to the euro and the yields of government securities are expected to fluctuate in 2011. Even if trends are favourable, the official rate of the central bank will only remain unchanged, taking also into account the likely interest rate increases in international markets during 2011. Nonetheless, if the forint is weakening, the official rate may even rise.

The deceleration of inflation will slow down, because prices of energy and public utilities were kept under control prior to local government elections, which causes an inflationary pressure, not to talk about the extra levies. Further, rising purchasing power of households means less sharp constraints to raise prices.