Hungarian strongman Viktor Orban may have won this month’s general election by a landslide but he now faces daunting economic challenges in his fourth consecutive term, many of his own making: a slowdown in economic growth, an unfolding energy crisis, rising inflation, and bulging budget and current account deficits.
Hungary’s radical rightwing leader will have to take difficult decisions on whether to keep price caps on fuel, food and energy that put a heavy burden on public finances.
The reliance of Hungary's economy on EU funds could also put pressure on Orban to change his confrontational relationship with the EU, at a time when the Commission has won new powers to punish states with the rule-of-law conditionality mechanism.
"First we should shoot the bear, and then talk to the furrier afterwards," Orban said after casting his vote, shrugging off questions on whether he would launch austerity measures if re-elected.
The phrase austerity is missing from the dictionary of Fidesz politicians as it reminds Hungarians of the pre-2010 period, led by leftist-liberal governments that were rocked by the global financial crisis.
In the election campaign, the state of the economy was barely an issue, the last six weeks instead being dominated by the war in Ukraine.
Until recently the economy was on track for a solid 5-6% growth after a record 7.1% expansion in the previous year. But economists have been slashing their GDP estimates in recent weeks from 4-5% to 2-3% as the impact of the war begins to take a toll on Hungary’s export-oriented economy and pushes up inflation, crimping consumption.
Fitch Ratings has knocked down the 2022 GDP growth forecast to 2.3% as high inflation impacts domestic demand and the war in Ukraine hits external demand. It affirmed Hungary's ‘BBB’ sovereign rating with a stable outlook at a scheduled review in January.
The slowdown will also push up the budget deficit, by cutting tax revenues and increasing social expenditures.
The finance ministry has yet to issue any revision in its growth estimates, but the markets will take a cue from the updated convergence programme, which will be submitted to the European Union by April 30 at the latest.
In his last interview with state radio just days before the vote, Orban acknowledged that Europe faces a major crisis, the roots of which go deeper than the war in Ukraine. That war helped the incumbent politically, but now Orban faces the dire economic consequences of his loose pro-cyclical fiscal policy of recent years, not to mention the direct impact of the conflict on the European economy.
Embarking on an unprecedented pre-election spending spree before the election, the government dished out 3-4% of the GDP in tax rebates, bonus payments for the armed forces and an extra month of pensions. This drove up consumption and helped GDP, but put the public finances in disarray.
Hungary’s budget deficit ballooned to HUF2.3 trillion (€6.1bn) in Q1, a two-fold increase from the base period and 73% of the full-year target. Keeping the 4.9% deficit target will become increasingly challenging without fiscal adjustments.
In 2011, the government took over HUF3 trillion of private pension fund savings of 3mn people to reduce state debt, in what has become known as the pension grab. This time there won’t be that fiscal leeway.
Avoiding a political backlash
The first decision the cabinet must take is on the future of price controls. The government set a price cap on fuel, rolled back the price of a half dozen food staples to October levels, and fixed variable-rate mortgage loans before the election to boost its chances of re-election against the united opposition.
Price caps on both food and fuel are due to expire in May and the interest rate freeze on variable-rate mortgages will end at the end of June. Some 400,000 borrowers could see a 20-30% increase in monthly instalments if market rates return.
Speaking at an international press conference after the elections, Orban confirmed that the government will seek to extend these measures but did not elaborate. Analysts predict a gradual phase-out of price caps to avoid a political backlash. The measures have helped Hungary’s annual inflation rate stay below 10%.
There is consensus that the government will try to keep energy prices artificially low for as long as possible for political reasons. This has been a key election promise in the last two elections. Hungarian households have paid the lowest nominal price for gas and electricity in Europe since 2014 when the government froze retail prices.
But the economic fallout of the five- to six-fold rise in global gas prices is putting immense pressure on state utility giant MVM. If prices remain at current levels, MVM would need a HUF1 trillion capital injection this year.
The winding up of the retail energy freeze would be costly politically, but to take no action would lead to overshooting the deficit targets, analysts have warned. The prospect of an upward revision of fiscal targets could increase the chance of a negative outlook on Hungarian sovereign credit ratings, according to ING Bank.
The government could take a bet that prices will fall in H2, but that is way too risky, says portfolio manager Viktor Zsiday.
The size of the potential fiscal tightening will also depend on the Hungarian National Bank’s monetary policy. There are estimates that rising interest rates will lead to losses of HUF300bn-400bn for the MNB, which will have to be supplemented from the budget. Rising borrowing costs will also lift debt service costs by hundreds of billions of forint.
OTP analysts say the new government will have to carry out significant austerity measures in H2 2022 and 2023 to the tune of 3% of GDP, or HUF1.8-2 trillion.
The prime minister has confirmed that rebalancing the budget would not target households directly, which suggests that labour taxes, or VAT – the highest in Europe at 27% – will not rise.
Instead special taxes may be imposed on multinational companies and other firms, similar to the ones introduced in 2010, Orban hinted to foreign reporters, adding that such measures would depend on the EU's ability to halt energy price rises.
Based on Orban’s comments and his past policy actions, the government could seek to raise funds by levying sectoral taxes, as it did after taking office in 2010.
Twelve years ago, the Fidesz government introduced windfall taxes on the retail and energy sectors, which were later overturned by the EU. With local players carving out an increased presence in these sectors it will be difficult for the Hungarian prime minister to single out foreigner players with windfall taxes, giving exemption to his cronies, without breaching EU rules. Hungarian blue chips tumbled after Orban unveiled his plans to extend the price caps and possibly slap large companies with extra burdens.
The budget already targets HUF70bn proceeds from the bank tax in 2022, up from HUF61bn, a third coming from OTP. Hungary's leading lender is also losing HUF30bn from the freeze of mortgage rates.
Revenue from the telecom tax is set to reach HUF53bn under the current target, down from HUF59bn a year ago. MTelekom accounted for half of that amount.
The financial transaction tax that applies to retail and corporate banking and postal transactions, including transfer and direct debit orders, credit card purchases, cheques, cash withdrawals and transfers generated HUF233bn in turnover last year with a similar target. OTP’s share was HUF69bn.
Facing difficult decisions on energy
Energy prices have also sparked a new row with the EU. Hungary has vehemently opposed extending sanctions against Russia to the energy sector, saying it would significantly increase household costs. The country receives 85% of its gas and 60% of its oil needs from Russia.
Orban has partially blamed the EU for high energy prices, namely the EU's emissions trading system (EU ETS). He has proposed the suspension of that scheme and the blending regulation on the biofuel content of fuel but experts note that that would have little impact on prices. The government has also opposed the extension of ETS to buildings and transportation, which it claims would increase costs by €800 per year.
At the same time, Hungary has committed to cutting its greenhouse gas emissions by 55% by 2030 and achieving carbon neutrality by 2050, by relying on solar and nuclear power.
The government will now have to make some important long-term decisions on energy security. Despite warnings by experts, Orban seems reluctant to abandon the expansion of the Paks nuclear power plant to be built by Russia’s Rosatom.
The €12.5bn investment, which is 80% financed from a loan by Russia's Vnesheconombank, has yet to receive the final permits. The project is now in jeopardy due to the sanctions on Russian companies. Sticking with Rosatom would go against the EU’s intention to reduce energy dependence on Russia.
Desperate for EU funds
Hungary’s economic woes are growing just as its relations with the EU have worsened further. Just two days after the election the EU Commission announced that it is triggering the bloc's rule-of-law mechanism against Hungary, which becomes the first country to face proceedings. The Commission waited until after the election to avoid accusations of interfering. The government has rejected the new mechanism as a politically motivated tool.
The Commission has long-standing concerns regarding Hungary's judicial independence, conflicts of interests and systemic corruption. OLAF, the EU's anti-fraud agency, has put the country at the top of its list of irregularities involving EU funds, with public projects considered to be often overpriced. These considerations have prevented the approval of Hungary's national recovery fund, amounting to €7.2bn in grants.
Orban has accused the EU of political blackmail for holding back the vital RRF funding. In a letter addressed to Commission President Ursula von der Leyen, the Hungarian PM asked for the funding to be released and also asked for the first time for a €9bn loan under the RRF scheme to help the country handle the slowdown and higher spending needs caused by the war.
Local analysts therefore believe Viktor Orban will be forced to make some compromises with the EU to secure the much-needed EU funds.
Fitch also expects the de-escalation of the tensions as its baseline scenario, though the EU’s decision to trigger a conditionality mechanism "could signal a hardening of both sides' stances".
Fitch factors in the receipt of the €7.2bn of funding, the equivalent to 5% of 2021 GDP, into its growth forecast. It says the failure to secure the funds could cut Hungary's mid-term growth prospects by as much as 1.5pp in 2023.
If Orban wants to continue to play the troublemaker inside the EU he could therefore be forced to accept that Hungary will remain well behind its neighbours in their slow convergence with their richer partners in Western Europe. Whether Hungarian voters will be prepared to accept that will only be known in four years’ time.