Weekly Briefing, Vol. 60. No. 2 (HU) March 2023
Mild and short recession ahead?
The business environment has changed profoundly over the past year. Skyrocketing energy prices have significantly affected the competitiveness of EU industry. The European Commission’ estimates that the EU as a whole will still have a growth rate of 0.8 percent in 2023. With the exception of Sweden, EU economies are projected to have positive growth rates in 2023, although some countries would slip into a technical recession, defined as two quarters of economic contraction.[1] At the same time, more robustness of the economy is projected to show in the figures in the second half of the year.
Introduction
The economic consequences of the war in Ukraine were estimated to be more serious for the latter than what had actually happened in the Western economies. Last year, the U.S. saw annual growth of 2.7 percent, eurozone’ GDP grew 3.5 percent higher than the previous year, while Hungary’s GDP growth was 4.6 percent. By and large, we can conclude that these economies have mastered the challenges significantly better than previously expected. Since we cannot see the end of the war clearly, economic players have had to rewrite business plans and revise investments and the above mentioned possibility of a technical recession reflects this period of rethinking and revising. (Technical recessions mean that the given economy has two consecutive quarters with negative growth rates.) An additional factor to consider is the still high inflation which is bound to swiftly decline for technical reasons in the coming months. This week, FED chairman Jay Powel warned the stock and bond markets that the FED might return to half-point interest rate raises end of March. His words immediately strengthened the American dollar[2], and weakened Central European currencies, in this way the Hungarian forint too. In case of prevailing tight money policies in the FED and the European Central Bank, Hungary might also see a new wave of imported inflation due to weaker currency. This briefing looks at the two separate but linked topics: inflation/ exchange rate and an economy policy dispute between monetary and fiscal policy decisionmakers.
Exchange rates
Since the outbreak of the war, the Hungarian currency has had a roller coaster ride. At the start of the war, the exchange rate between the dollar and the forint was 325, and just a few months later it was 435. Since then, we have seen a slow decline in the exchange rate, which was back to 359 on March 10, 2023. The main dilemma for Hungarian policymakers seems to be that it is uncertain when the cycle of monetary tightening in the United States will end. While a few weeks ago it seemed certain that the FED would start cutting interest rates, recent data on inflation and new jobs in the United States. (The annual inflation rate was 6.4 percent in January 2023, a slowdown from 6.5 percent in December 2023, though the consensus was for inflation to fall quickly. The unemployment rate was 3.4 percent in January, the lowest since May 1969. The extremely low unemployment rate indicates a depressed labor market that does not need monetary stimulus, U.S. policymakers concluded[3]) Given the uncertainty of U.S. interest rate policy, we cannot rule out the possibility that the HUF will weaken again. Another element we need to take into account is the war in Ukraine, as the continuation of the war may push energy prices up again, which would directly affect the exchange rate of the Hungarian currency’. (Since Hungary’s dependence on external energy sources is extremely high, buying energy requires large amounts of foreign currency, which weakens the forint.)
While the Hungarian central bank (MNB) does not have an explicit exchange rate target, it does want to ensure the stability of the domestic financial system. This goal and the explicit inflation target forced the central bank to raise key interest rates several times, but we must also understand that the rate hikes started long before the war, in the summer of 2021. In mid-June, the Hungarian Central Bank (MNB) raised the key interest rate for the first time in June 2021 after one year. Since then, the rate has been raised in several steps. One day before the war broke out, the interest rate was 3.4 percent. Since that day, the central bank changed the interest rate eight times, and the last increase brought the interest rate to 13.00 percent, a level not reached since 2000. (January 20, 2000: 13 percent).[4] In September 2022, the MNB announced that the period of interest rate hikes is most likely over. It is very likely that the central bank misjudged the situation and announced the end of the cycle too early, as the later inflation data. Inflation did not peak until four months later.
Disagreement between the government and the central bank
At the same time, there are disagreements between monetary and fiscal policy makers. The MNB governor criticizes the system of fixed prices and the high budget deficit, the planned battery plants. In this last case, he argues that the 18 percent of domestic value added is not enough for the Hungarian economy. He added that the cost of interest will reach 4-5 percent of Hungarian GDP next year, which is a trap for the Hungarian economy. In a broader context, he said that you can borrow money abroad or attract foreign capital, but you will not be able to catch up in this way, which is a trap.
As for the fixed price system, the MNB governor said that this system has increased the already high inflation rate by 3-5 percentage points. He also mentioned in his speech in the Parliament that the productivity of the Hungarian food industry is the second lowest in the EU and that productivity is the key to the success of a country. He added that the unimplemented reforms in education, healthcare system and services are sore points of economic policy.[5]
In his response, the prime minister said that if there were indeed external factors for high inflation, the central bank might not crack down so forcefully. He does not think borrowing at higher interest rates now is too rare, as repayments are not due until 2024 and 2025, by which time the external environment could be more positive. He added that there have been no economic policy debates between the government and the central bank since 2012, which shows stability.
In his speech to the Hungarian Chamber of Commerce and Industry, the Hungarian Prime Minister announced a new industrial policy that foresees the integration of 500 thousand people into the labor market. When the Prime Minister spoke of the need for more labor, he clearly meant the Hungarian labor force and concluded that the Hungarian economy still has significant labor reserves. He pointed out certain regions where labor reserves can be found. Debrecen, Nyíregyháza, Miskolc and Békés County were named as cities and regions with significant labor reserves. This clarification was necessary as the opposition accused the government of alleviating labor needs by allowing migration.
Another point he emphasized was that the new industrial policy will require a lot of energy and that Hungary will therefore make significant investments in the energy sector, focusing on gas-fired power plants. Two to three gas-fired power plants will be built in eastern Hungary in the coming years.[6] He also raised the issue of the paradigm shift in the automotive industry, saying that there are 300 thousand families in Hungary who live off the car industry. If we do not follow the technological change in the industry, there will be no more Audi, BMW, and Mercedes in Hungary. It is clear that the loss of these companies would harm the Hungarian economy. In this way, he also indirectly addressed the criticism of the battery plants in Hungary.
Summary
We have seen in the briefing that the exchange rate of the Hungarian currency’ has been volatile over the last year. We can conclude that this period of volatility, high imported inflation may return because the interest rate policy of FED supports financial instability in the world. In addition to global instability in exchange rate regimes, the war in Ukraine is creating tension in stock, bond markets and fueling global inflation. There is disagreement on how to address these problems. It is clear that the central bank needs to focus on inflation and take measures to curb it, while the Hungarian government focuses on GDP growth and job creation. It is difficult to achieve these two goals without friction, but it is also clear that the players want to reach a compromise on this issue. At the same time, we must emphasize that the relative position of the Hungarian economy in the European Union is very good. This debate is more about the direction of future economic policy in Hungary than about the recent political steps.
[1] https://www.euronews.com/my-europe/2023/02/13/eu-economy-to-narrowly-avoid-a-recession-as-inflation-peak-passes-brussels-projects
[2] https://www.ft.com/content/07f6217b-36db-421d-a7b8-f0b347216946
[3] https://alaskabeacon.com/2023/03/09/powell-signals-higher-interest-rates-heres-why-fridays-jobs-report-will-affect-feds-decision/
[4] After 1990, the Hungarian economy experienced the highest key interest on January 1, 1995, with 28 percent.
[5] https://www.portfolio.hu/gazdasag/20230308/ujabb-kemeny-beszedet-tartott-matolcsy-gyorgy-a-parlamentben-negativ-gazdasagpolitikai-fordulatot-hajtott-vegre-a-kormany-601518
[6] https://www.penzcentrum.hu/gazdasag/20230309/uj-iparpolitikat-hirdetett-orban-viktor-ez-var-a-magyarokra-a-kovetkezo-evekben-1134846#