Hungary's economy beat analysts' projections from quarter to quarter in 2019, posting one of the highest growth rates in Europe throughout the year despite the unfavourable external environment. The country was ranked first in the EU28 with GDP rising 5.1% in the first nine months of the year. International organisations, the government, and the central bank have upped their full-year forecasts to close to 5%.
Economic growth was supported by an increase in domestic demand, investments and exports. Growth will continue in a balanced structure with all sectors chipping in during 2020. Although the growth rate of consumption is expected to slow down it will remain one of the most important factors in GDP growth, as will market-based services.
Hungary's economic success is largely attributed to the strong performance of the vehicle and electronics sectors, which attracted the most investments in 2019. Capacity expansions in these two areas helped industrial growth to approach 6% in 2019, in the midst of trade tensions and the slowdown in global industrial production.
The output of Hungary's vehicle sector depends largely on the state of the German economy, the country's largest export market with sales expected to reach €30bn, or 30% of the total, in 2019. A slump in demand in the eurozone could hit vehicle makers and suppliers hard.
Hungary's economic growth will decelerate in 2020 but forecasts vary widely. The central bank bumped up its 2020 forecast to 3.7% from 3.3%, and the forecast for 2021 to 3.5% from 3.3%. It projected — for the first time — economic growth of 3.5% for 2022.
For 2020, the European Bank for Reconstruction and Development (EBRD) sees growth falling to 3.1%, the Organisation for Economic Co-operation and Development (OECD) to 3.3% and the World Bank to 3.5%. The most bearish forecast was made by the European Commission, which left its GDP forecasts for 2020 and 2021 unchanged at 2.8% each.
The government forecasts 4% growth in 2020 and in the following years, well above the market consensus. The bullish prognosis is based on the potential positive impacts of a fiscal stimulus programme to be unveiled in early 2020 to dampen the impact of the downturn on external markets.
The recommended measures are aimed at increasing Hungary's competitiveness as the country lags behind regional peers in this field. The government's primary goal is to have Hungary's economic growth exceed the eurozone's by at least 2pp.
The tight labour market will continue to push up wages and exert upward pressure on prices, while imported inflation will be less of a concern for the central bank in 2020. The market consensus is that the Hungarian central bank, Magyar Nemzeti Bank (MNB), will keep the base rate unchanged at 0.9% for the fourth straight year.
The MNB recently raised its inflation forecast for 2020 to 3.5% from 3.4% while leaving its forecasts for 2019 and 2021 unchanged at 3.3%. It expects the headline inflation figure to return to the 3% target in the medium term.
Core inflation excluding indirect tax effects, the indicator closely watched by rate-setters, is expected to peak at 3.6% in 2020 from 3.4% in 2019, before falling to around 3% in 2021 and 2022. The forint's weakness in 2019 has been within the comfort zone of the central bank, which sees a weak currency as supporting the government's export-oriented policies. The local currency fell 4% in 2019 and hit an all-time low against the euro at 337 in November. The market consensus is that it will remain in the 325-340 zone for 2020.
Fidesz under pressure
Hungary's ruling Fidesz party is expected to come under pressure both at home and abroad for its illiberal policies in 2020.
Opposition parties ended a 13-year losing streak at the polls (European, national and local) gaining control of a dozen large cities including the capital in the October local government elections. The recipe for success was to field joint candidates. The governing parties underestimated the viability of the "rainbow coalition", which consisted of former extreme-right, now centrist Jobbik and leftist-liberal parties.
Polls still show the dominance of Fidesz with 3mn supporters, or 52% of decided voters, while 44% of decided voters back one of the seven opposition parties. The ruling party looks rock-solid in rural areas, whereas it is losing the young, educated urban voters in large numbers.
With no election scheduled for 2020, the political landscape will be characterised by cooperation — or more likely the lack of it — between Fidesz and the opposition at local level. Analysts expect further conflicts as the government will try to take more power back from local governments. Budapest's new liberal mayor has called for an alliance of free cities enhancing corporation of cites led by opposition mayors.
This chimes with the same initiative at an international level. The mayors of Warsaw, Prague, Bratislava and Budapest, who share liberal values, have recently launched a new alliance and urged the EU to bypass national governments and fund cities directly.
The initiative mirrors the cooperation of the Visegrad 4 (V4) countries at national level, backed strongly by Hungarian Prime Minister Viktor Orban. Hungary's illiberal strongman sees the V4 as the driving force behind the EU with economic growth exceeding multifold that of the block's average.
The ruling party and propaganda media hailed the appointment of Ursula von der Leyen as head of the European Commission, but Orban's first pick for Hungary’s commissioner post was rejected.
The rule of law inquiry under the Article 7 procedure against Hungary will continue in 2020 under the rotating presidencies of Croatia and Germany. More conflicts are expected between Fidesz and the European People's Party (EPP) after the election of Donald Tusk as EPP president. The former president of the European Council sent an unequivocal message to Orban after his appointment.
Some members of the EPP have called for the expulsion of Fidesz from the party group and these voices are likely to be louder in 2020 unless Orban makes concessions. Expulsion from the EPP would be a serious blow to the Hungarian PM, who hoped that eurosceptics would make a breakthrough in the May 2019 European Parliament election, but so far has no intention of leaving the largest block in the European Parliament.
His two closest political allies within the EU, former Austrian vice-chancellor Heinz-Christian Strache and former Italian interior minister Mattheo Salvini, are no longer in power. The EPP's three-member evaluation committee led by Herman Van Rompuy will assess Hungary's judicial independence, freedom of expression, corruption and the situation of refugees during their visit in 2020. The findings of these reports could determine the future of Fidesz within the group. At present, the voting right of the Hungarian conservative party is suspended.
Budget deficit heading for a record low
Parliament adopted the 2020 budget in summer 2019 in line with earlier years. Thanks to stronger than expected growth and higher tax proceeds the cabinet will have no problem meeting the 1.8% deficit target in 2019. The deficit could fall to a record 1% in 2020. The decline is mainly supported by a decrease in government investments.
Reserves will increase to HUF500bn (€1.5bn) to widen the manoeuvre room for any negative impacts stemming from deteriorating external market conditions. The fiscal policy will accumulate countercyclical reserves in 2020 and the following years as well, the MNB said.
Hungary has pursued a tight fiscal policy and kept the deficit below 3% since being released from the excessive budget deficit procedure in 2013 after breaching the deficit rules for nine straight years. By 2023, the government expects a balanced budget.
The government's target of fiscal consolidation to eventually eliminate the deficit over the medium term would help reduce domestic demand pressures and create fiscal space that can be used during future downturns.
Such consolidation would reverse the pro-cyclical fiscal stance of the past few years and allow monetary policy to remain accommodative for a longer period, helping preserve Hungary's competitiveness, the International Monetary Fund (IMF) noted.
The 2020 budget entails a number of tax cuts. The small business tax rate will drop from 13% to 12% for 40,000 small businesses. Slashing social contribution tax from 19.5% to 17.5% will lead to a saving of HUF310bn for employers in 2020. The VAT for commercial accommodation will be reduced from 18% to 5%.
Hungary, with the highest VAT rate in Europe at 27%, has struggled with high tax evasion, but tax cuts and whitening measures have reduced the share of the illegal economy.
New measures to whiten the economy will further improve the budget balance in 2020.
The tax office plans to expand the use of online invoicing to more sectors. In the long-run, all transactions will be connected to the tax office online. The move is seen as a further step for clamping down on VAT fraud.
MAP Plus a runaway success in shift to retail borrowing
Hungary's state debt-to-GDP ratio is set to fall from 68% to 65.5% in 2020 and the country should meet the Maastricht state debt rules by 2022 when the ratio is to fall below 60%. Hungary's constitution requires the year-end debt-to-GDP ratio to fall each year until it reaches 50%.
The state debt manager AKK plans to reduce the FX share of government debt in parallel with an increase in the shareholding of retail investors.
The midterm goal is to double the stock of government bonds held by households to HUF11 trillion by the end of 2023 from HUF7.5 trillion in 2019. FX debt could drop from 17% in 2019 to 15% in 2020.
This objective is in line with plans to lessen the country’s dependency on external financing and strengthen self-financing. The domestic ownership of public debt also supports the country’s income and current account balance. To meet these goals, AKK plans to maintain a positive real-term interest in retail securities and make them more attractive by reducing commissions.
The new MAP Plus retail bond drew record demand as subscriptions exceeded HUF3 trillion in six months. Dubbed the “superbond”, it offers the highest yield of all existing government bonds, except for the baby bond.
Funding for the MAP Plus bonds came from investment funds, bank deposits and from redeeming other government securities. Only a smaller portion came from cash, which was supposed to be the top priority. Although the finance ministry has categorically denied reports of changing the pricing of the bond, the head of the state debt manager has made ambiguous statements in this regard.
The government is reportedly planning to make the baby bond more attractive to lessen demand for the new retail bond.
Overall, the positive impact of MAP Plus is that it contributes to keeping the savings rate high.
The AKK is also planning to launch a new bond targeted at retail investors with a maturity of between five and 10 years. The rollout of the new pension bond, delayed because of the superbond is expected in 2020.
Rising demand for government securities will continue to exert pressure on investment funds and banks in 2020, diverting assets toward government bonds. The success of MAP Plus has had a cooling effect on the real estate market as well.
On the institutional market, the debt manager's aim is to increase the term of the debt and to further diversify the investor base and keep the maturity of forint debt above four years
AKK is considering the possibility of issuing green bonds denominated in Japanese yen and/or in Chinese yuan, and in line with recent practice, it will manage FX debt actively, depending on the liquidity position of the central budget and the market situation.
Buoyant credit demand
The consolidated after-tax profit of the Hungarian banking sector rose 10.5% y/y to HUF560bn (€1.7bn) in the first nine months of 2019. At first glance, the bottom line of banks looks solid, but earnings were lifted by the release of risk provisions, Hungary’s central bank the Magyar Nemzeti Bank (MNB) has said, adding that in terms of efficiency and costs Hungarian banks are lagging behind regional peers.
The lending stock rose 190% to HUF30.2 trillion, while the stock of deposits increased by 14.2% to HUF38.2 trillion by the end of September.
The sharp increase may be explained by the internationally low aggregate debt of companies and the surge in new corporate investment seen in the past two years, which has seen the investment-to-GDP ratio grow jump to 30%.
The central bank sees no signs of excessive lending and is not worried about the dynamic lending activity as it comes from a low base.
Total assets of the sector stood at HUF48.2 trillion at the end of Q3, up 15.4% y/y.
Both negative real interest rates and the favourable economic outlook contributed to the buoyant credit demand, although lending dynamics may decelerate in the next few years as a result of base effects, the central bank said.
Corporate lending is also supported by the MNB's Funding for Growth Scheme launched in 2013 to help spread fixed-interest loans. Between 2013 and 2018 some 40,000 SMEs received HUF2.8 trillion in financing at 2.5%. The central bank has raised the limit of corporate bond purchase programme from HUF300bn to HUF450bn from January 1, 2020 to revive Hungary's lacklustre bond market.
The ratio of non-performing loans (NPLs) has fallen to 4.5%. The NPL ratio is under 5% at 23 of the 35 financial institutions under the oversight of the MNB.
Hungarian banks have laid out hundreds of billions of forints in interest-free general purpose loans since a credit scheme was launched in July as part of a package of family support measures rolled out by the government in the summer to halt depopulation. Banks expect healthy demand in retail lending supported by low interest rates and the increase in real wages, in addition to the government-financed programmes.