Hungary grows but disturbs Europe with new anti-migrant walls

Hungary's anti-migrant policy troubles Europe but the Hungarian country's economic growth is undoubted. The ultra-conservative premier Orban has announced a new anti-migrant wall in the south and the referendum on quotas for October 2 but the economy is running, even if the foreign debt goes along with the GDP.

In 2015, Hungary's GDP grew by 2,9%: on the supply side, the slightly accelerating service sector provided a significant contribution to growth (+1,4%), to which must be added the one deriving from the good dynamics of industrial production (+0,8%) and agriculture (+0,4%). The growth in demand for private consumption and investment were the major catalysts on the domestic demand side (+1,5% and +0,4% the respective contributions). While the contribution provided by public consumption was more modest (+0,1%) due to the expenditure control implemented to strengthen public finances.

The contribution of net exports was positive (+1,5%) thanks to the acceleration of exports compared to imports. However, there were signs of a slowdown in the cyclical phase at the beginning of this year. According to the preliminary estimates published by Intesa Sanpaolo Study Centre, during the first quarter the GDP grew by 0,9% yoy. The particularly weak trend in GDP reflects the first cyclical contraction (-0,8%) since 2012. A negative contribution to the GDP trend is the weak performance of the industrial sector (+0,5% compared to the first quarter of 2015), especially in the mining sector (-40% in March) as well as in the manufacturing sector (-4,4% in March). Foreign demand also marked a decline in March (-3,4%), while in the same month the dynamics of retail sales remained on a positive trend (4,2%).

Household consumption is benefiting from the reduction in the unemployment rate (6% in February, the lowest in recent years). In April, theEconomic Sentiment Index (ESI) it remained quite high at 110,1 albeit slightly lower, and in the same month the manufacturing PMI remained above 50 at 52,2, slightly better than in March (51,7). All in all the Hungarian cyclical phasealbeit slowing down remains positive and for the whole of 2016 analysts expect a GDP dynamic of around 2,0%, thanks to the good dynamics also of private consumption, favored by the fall in unemployment, and foreign demand, especially from EU markets. On the other hand, it is expected that public spending on consumption and investment will give only a small contribution to economic growth due to the need to contain public spending.

On the supply side, the dynamics of industry are expected to remain positive albeit on a more contained trend than in 2015, while the service sector, more linked to the national economy, is expected to grow by approximately 2,4%. Inflation, equal to -0,1% on average in 2015, was equal to 0,2% on average for the first five months of 2016, recovering but decidedly weak. The trend in consumer prices was affected both by the plans to reduce the prices of electricity and gas for domestic use, and by the contained trend in the international prices of raw materials. For this year, average inflation is expected to be only slightly positive (0,5%).

In 2015, the government deficit was 2,0% of GDP, an improvement from the 2,3% recorded the previous year: the improvement is above all due to the increase in tax revenues and the lower cost of interest paid. For this year and 2017 the European Commission (EC) forecasts that the public deficit will remain at 2,0%: the drop in public investment due to the post-electoral effect, lower social spending and lower interest rates on the debt will be offset by the reduction in the tax burden on the banking sector (with the tax rate of the special tax on banks reduced to 0,15%) and by measures such as the new "housing package" which provides for a reduction in VAT to 5% for new buildings. In particular, the latter measure represents, according to the EC, an element of uncertainty for the estimate of the public deficit, which therefore remains subject to upward risks.

Public debt, equal to 78,3% of GDP in 2012, has gradually decreased in recent years and is estimated at 75,3% at the end of last year; it is also expected by the EC to further decrease in the years 2016 (74,3%) and 2017 (73%). With a budget deficit stably at 2,0% of GDP, public debt would tend to stabilize at around 50% of GDP in the long run. In the face of low inflationary pressures, and to favor the recovery of the economy, the Central Bank of Hungary (NBH) progressively cut the benchmark interest rate to 0,9% in May this year. The rate reduction phase could be over but with very limited price dynamics, monetary policy will be able to remain expansive for the whole of the current year and a good part of next also considering that the ECB could keep interest rates low for a long time to come. The reduction in the policy rate weakened the forint which reached 315,6 against the euro. In the short term, the local currency is then expected to remain subject to volatility.

In 2015, Hungary had a current account surplus of more than €4,7 billion (about 4% of GDP)thanks above all to the positive balance of the services and commercial accounts. Over the same period, there was a net outflow of capital for portfolio and other investment and, albeit to a lesser extent, also for direct investment. The capital account, on the other hand, recorded a positive balance but overall the balance of payments showed a deficit of almost 5 billion. For this year the current balance is expected to remain positive and close to 3,5% of GDP. It is also expected that the increase in imports (+1,6%) due to the strengthening of domestic demand will be offset by the increase in exports (+1,3%) favored by higher foreign demand. The country's net financial position is negative (about 70% of 2015 nominal GDP) and gross external debt is at 108% of GDPHowever, the positive current account balance could favor a gradual strengthening of the country's foreign financial position.

In the latest economic evaluations, the IMF, in addition to appreciating Hungary's good economic growth in recent years, has also positively assessed the improvement in external accounts which, since 2009, have recorded positive current account balances and external debt decreasing compared to GDP. In the medium-long term, the stability of Hungary's foreign position appears to be improving and, in the short term, there has been substantial stability in the degree of liquidity of the country. The reserve cover ratio, i.e. the ratio between foreign currency reserves and the aggregate equal to the algebraic sum of maturing debt and the current account balance which supplies the country's short-term financing needs, is estimated to be higher than threshold value of 1 (increased to 1,1 in 2016).

Based on the last Global Competitiveness Index (GCI) calculated by the World Economic Forum, between 2009 and 2015 Hungary moved from 58th to 60th place in a ranking of 144 countries: competitiveness measured by the GCI has therefore not improved in recent years. The architecture of the Hungarian economic and institutional system has several weaknesses: the same GCI index highlights the tax system and the difficulty of accessing finance as the main factors that still penalize local competitiveness. Based on theDoing Business indicator, Hungary occupies the 42nd position in a ranking of 189 countries. Although the reserve cover ratio is above the alert level and there is a significant current account surplus, Hungary presents elements of macroeconomic vulnerability due to an external debt that is still higher than 100% of GDP but which is nonetheless declining and has come down significantly from its peak of 135% in 2009. The percentage of public debt, although still significant (76% of GDP), is also expected to decline in the coming years thanks to the budget deficit projected to remain around at 2,0%. CDS have fallen in recent months in line with what has been observed for other European countries and currently the level of CDS is at its lowest since the beginning of 2015. Hence, in May, the Fitch rating agency improved the assessment of the country, bringing it to investment grade to BBB-. The other agencies, S&P and Moody's, are instead more cautious and at the moment attribute BB+ and Ba1 respectively to Hungary.