Central Europe’s car making heartland remains a top pick for auto investments. When, after a dance that also took in potential sites in Romania and Russia, Daimler announced on May 4 that Poland had won the race to host its new engine plant, Hungary already had the German carmaker’s promise in its pocket for a €595mn expansion of the Mercedes production plant in Kecskemet.
Already home to car plants operated by Audi, Opel, and Suzuki, Hungary saw industrial production boosted in 2015 by their expansion, as well as the arrival of more suppliers. However, analysts warn the economy risks growing too dependent on the auto sector, noting that efforts by the government to diversify are finding the road tricky.
In 2012, the auto sector accounted for 19.2% of industrial output; that accelerated to 28.9% last year. Although the sector is a key driver of Hungary's small, export-dependent economy - accounting for 20% of total exports - its growth also increases the country’s vulnerability to external shocks. The government has pressed hard to reduce Hungary's exposure to such shocks by slashing the deficit and debt, but is struggling when it comes to cars.
“In a country where the economy is largely dependent on one sector, decrease of demand in the sector will have a negative effect on the entire economy. We saw that happen in the auto sectors of Slovakia and the Czech Republic during the 2008 crisis,” Gergely Urmossy, senior economist at Erste Bank Hungary, tells bne IntelliNews. Hungary faces the same problem, he states.
Indeed, Hungarian industrial production remained stuck in a rut in early 2016, following a slump in the automotive sector at the start of the year.
“It is never good if one sector plays a too strong role in an economy, because it increases vulnerability," agrees Zoltan Torok at Raiffeisen Bank. "It's especially true for cyclical sectors - such as the auto industry – which are highly dependent on the performance of global economy.”
It's also a double-edged sword. The analysts emphasize that the huge success of the auto industry has helped cover up the poor development of other sectors.
In September, shortly after the Volkswagen emissions scandal, Economy Minister Mihaly Varga was the first member of Hungary’s ruling Fidesz party to suggest cars may be over-running the economy. Despite the huge momentum provided by the sector, he admitted the government now needs to reduce the economy’s exposure to fluctuations in the car industry.
The announcement was soon codified in various documents, such as the government's grand reindustrialization strategy. Announced in March, the "Irinyi Plan" targets a boost in industry to make output equal to 30% of GDP from the current 23.5%. A gradual reduction in the country’s heavy dependence on car making is also included in the goals.
Hungary's latest EU Convergence Programme for 2016-2020 points out that the impressive development of the automotive sector has not been able to create high added value. The programme aims to boost innovation-focused, capital intensive sectors, which are capable of creating greater added value, focusing instead on pharmaceuticals or the production of medical instruments and machine industry parts.
Those sectors offer promise, the analysts agree. They also note a “great deal of untapped potential in the food sector.” The country’s "infrastructural development and its relatively cheap labour force give Hungary the opportunity to build up new hubs of alternative sectors,” Urmossy suggests.
However, it takes time to set up new specialised industry, while a lack of highly educated labour force - IT specialists, doctors, mathematicians – could also be an obstacle, he says. “For diversifying the economy, it is essential to rethink the strategy of the higher education system as well,” Urmossy points out.
Education is not an area in which Budapest is keen to dabble right now, as it faces a series of protests over it centralised policy. Meanwhile, officials have made it clear the focus is already turning to elections in 2018, meaning longer term plans may have to wait.
The government has not yet flagged up any major investments for this year in the sectors that are tagged to offer an alternative to the car industry. On the other hand, Budapest has welcomed several auto projects in the past few months. The list of investors is global and impressive, and doesn't look to be about to run out. China's Yanfeng Automotive Interiors, Germany’s ThyssenKrupp and Schaeffler, Japanese Mitsuba and US company BorgWarner have all arrived this year. Audi also announced in January that it will move production of its Q3 compact crossover vehicle to Hungary.
Even if the government can find its way to taking significant steps towards diversifying the economy, the “car industry will remain the leading economic sector in the country”, Torok states. The analyst adds an additional concern, noting that for now it is only the simple manufacturing that is being carried out in Hungary, with little added value. “The key to further improvement," he says, "is to bring activities with a higher added value to the country, for example, R&D.”
The Daimler investment is a case in point. The expansion of the Hungarian unit will add facilities to produce body parts, and include a paint shop and assembly unit. The Polish investment will build a brand new engine plant, which creates much greater added value for the economy.