Hungary’s economy has fallen behind its Central European peers in recent years, and the root of this underperformance lies in a sharp and protracted collapse in investment.

“While we think the worst of this slump is now over, structural weaknesses — particularly related to deteriorating relations with the EU and overcapacity in the private sector — are likely to cap the strength of the recovery,” Nicholas Farr, an emerging Europe economist with Capital Economics, said in a note on October 16.

"Elections next year present a possible fork in the road; a victory for the opposition could reduce tensions with the EU and improve the economy’s growth prospects,” Farr added.

Hungary’s economic trajectory has diverged notably from its neighbours. GDP grew by just 0.1% year-on-year in the second quarter, and the economy is only 1.4% larger than it was before the war in Ukraine. By contrast, Poland and Romania have each expanded by over 8%, and Czechia by nearly 5%.

The defining factor behind Hungary’s stagnation has been a steep drop in investment. Gross fixed capital formation has fallen by 23% in real terms since the end of 2021, while other countries in the region have seen increases. High interest rates and weak export demand have weighed on investment across the region, but these headwinds do not explain why Hungary stands out as an outlier.

“We think there are two, more important, drivers of the decline in investment. The first is a sharp cut-back in public investment,” said Farr. “One part of this is due to significant fiscal tightening in Hungary, which has taken place as other parts of the region have loosened fiscal policy (e.g. Poland and Romania). Cuts to public investment has formed a key part of this fiscal tightening; fixed investment by Hungary’s government has fallen by 2.0% of GDP since 2021.”

“The other part is due to a drop in EU funds, as a result of Hungary’s disputes with the EU over the rule of law and corruption. EU funds are primarily used to finance public infrastructure investment, and Hungary’s absorption of EU funds has fallen from ~3% of GDP in 2022 to less than 1% of GDP last year,” Farr added.

Private sector investment has also fallen sharply. Hungary’s investment-to-GDP ratio peaked at 27% in 2021, the second highest in the EU. But much of this was likely unsustainable. Business investment surged between 2016 and 2021, with machinery and equipment spending rising by 60%. Since then, it has fallen by 20%, amid signs of overcapacity, particularly in manufacturing, where capacity utilisation remains weak.

Despite this, Capital Economics believes the investment slump is close to bottoming out. The investment-to-GDP ratio has now returned to around 22%, closer to Hungary’s long-term average and in line with EU norms. With eurozone demand expected to recover, and inflation and interest rates well below their 2023 peaks, some cyclical improvement should follow.

But the rebound is unlikely to be strong. According to the European Commission’s latest Rule of Law Report, Hungary has made “no progress” on seven of eight recommendations aimed at restoring trust with the EU. As a result, funding delays and institutional uncertainty will continue to weigh on confidence and investment. Persistent overcapacity in industry also suggests that capital spending will remain subdued.

Capital Economics forecasts GDP growth of 0.5% in 2025 and 2.0% in 2026, below consensus expectations. However, the 2026 elections could prove pivotal. A new liberal political movement, Tiaza, has surged ahead of Viktor Orbán’s Fidesz in recent polls.

"A victory for Tiaza could usher in a reform drive, reverse institutional backsliding, and improve relations with the EU. That would improve the economy’s growth prospects,” Farr concluded.