The 2024 review prepared as part of the alert mechanism states that Hungary’s macroeconomic environment is characterized by low economic activity, falling inflation, a high budget deficit and significant uncertainties, so it is questionable how intense the recovery in 2024 can be. Compared to the 4.6% expansion in 2022, GDP decreased by 0.9% in 2023 amid high inflationary pressure, tightening financing conditions and weakening global demand. According to the European Commission’s 2024 winter 2024 interim forecast, GDP growth could jump to 2.4% in 2024 and 3.6% in 2025, supported by falling energy prices, lower inflation and lower interest rates are supported.
However, economic performance remains sensitive to energy prices, potential supply disruptions and global investor sentiment, according to Brussels, all of which are seen as downside risks
so it is not at all certain that these growth expectations will be sustainable.
They point out that inflation started to decline in 2023, reaching 3.6% in February 2024, after averaging 17.2% in 2023. The recent moderation in commodity prices and the economic recession have helped to ease inflationary pressures, but high labor cost growth and price indexation in some sectors have pushed core inflation to continue to rise, reaching 7% in February 2024. Rapid wage growth is forecast to continue due to a tight labor market after nominal compensation per employee increased by 14% in 2023.
Inflation is expected to decrease further in 2024, but will remain at 4.5% – above the target level of the Magyar Nemzeti Bank (MNB) – as the revival of consumption is expected to increase the pricing power of companies.
The recession reduced tax revenues, while high inflation increased interest and pension expenses, so the budget deficit will remain high in 2023, amounting to around 6.7% of GDP. The economic policies are aimed at encouraging recovery from the recession in 2023, but the risks affecting the public finances and the need to manage them may represent a headwind to growth in the medium term – the European Commission assesses the situation.
Due to its high degree of integration with Germany and some non-EU partners, especially China, Hungary is sensitive to the spillover effects resulting from developments in these economies. The Hungarian economy relies on the import of German, Austrian and Polish products, while the main destination countries of Hungarian gross exports are Germany, Italy and Austria. International demand held up slightly better than domestic sales, new export orders remained unchanged for the second month. However, geopolitical and trade tensions pose a significant risk to the Hungarian economy due to its direct or indirect relations with non-EU partners (mainly China).
There may not be much room for spending
In recent years, the Hungarian economy has been characterized by an expansive budget policy, significant demand for external and governmental financing, and very strong price pressure, the Commission concluded.
The current account and the budget deficit have been significant for several years, with moderate budget sustainability risks in the medium term. A combination of external and fiscal deficits increased external sustainability risks, exacerbated by the economy’s high energy intensity and policies that slowed the economy’s adjustment to rising energy prices and interest rates. High inflation and interest rates burdened Hungary’s competitiveness and increased debt service costs. The net international investment position (NIIP) remained negative, although the related risks were mitigated by the significant proportion of non-collapsible assets.
After registering the largest deficit in nearly two decades in 2022, the current account improved in 2023 due to lower energy prices and weaker import demand. After a multi-year trend deterioration, the balance of the current account decreased from a surplus of 4.5% of GDP in 2016 to a deficit of 8.3% in 2022, which is due to domestic overheating and a sharp increase in the price of energy imports, resulting in a lower trade balance due to which the energy foreign trade deficit worsened by 5.6 percentage points to 10% of GDP in 2022.
High-frequency data indicated a strong improvement in 2023, according to preliminary estimates, the current account showed a surplus of 0.1% of GDP. Lower energy prices helped improve the current account balance in 2023 amid a domestic economic recession, and the non-energy trade balance rose to its highest level since 2017.
At the same time, the income balance worsened due to higher financing costs.
Based on the comparison of the balance of the general and cyclically adjusted current account, about 2.5 percentage points of the improvement in the current account in 2023 can be attributed to the economic recession that reduced import demand.
The improvement in the cyclically adjusted current account balance was primarily caused by external developments – essentially falling import prices – and not by domestic policy measures.
In 2023, the public budget deficit continued to weigh on the external balance, but the increasing net lending of the private sector reduced the country’s need for external financing. The government’s net borrowing remained significant in 2023 as well, accounting for 6.7% of GDP according to the preliminary financial accounts.
The improvement of the external balance of the economy compared to 2022 was caused by higher net lending by the private sector.
Household savings increased, partially restoring financial buffers eaten away by high inflation. Meanwhile, household investments decreased due to rising interest rates. The net borrowing of companies decreased mainly due to the reduction of inventories. Meanwhile, corporate savings fell more than investment as the recession and higher production costs reduced profitability.
According to the European Commission’s 2023 autumn forecast, the current account balance will gradually decrease in 2024-2025 as the negative output gap closes. From the point of view of sectoral savings-investment, the revival of corporate investments and the gradual decline in household savings are forecast to reduce net lending to the private sector, which is partially offset by declining net borrowing by the government.
They see it as a risk that budget spending and supporting policies, as well as a renewed rise in international energy prices, could adversely affect the external balance in the medium term.
According to the Commission, if the economic policy remains expansive, it may worsen the foreign trade balance and increase financing costs. The current account remains exposed to energy price developments, as the economy is highly dependent on energy imports, which is likely to remain in the medium term. Hungary’s updated national energy and climate plan calculates that the gross domestic consumption of fossil fuels will decrease by only 7.5% between 2023 and 2030, while there are still few opportunities to increase the domestic production of these fuels.
Furthermore, the doubling of nuclear energy production by 2030 and the significant increase of renewable energy sources are fundamental prerequisites for the fulfillment of the climate plan. Until these capacities are built, Hungary can remain a net importer of electricity. However, while the government has almost met the solar energy targets, the Paks nuclear power plant expansion project is currently in a state of flux in the case of nuclear energy.
The external deficit has been financed by recent capital inflows that have generated significant debt, which has continued into 2023. In the four quarters until the third quarter of 2023, they accounted for 6.3% of GDP, which is largely due to the growing role of foreign lenders in financing the public debt, the loans taken by state-owned development banks to finance subsidized loan programs, and the international bond issues of Hungarian banks , as they prepare to comply with the new capital requirements.
Meanwhile, net foreign direct investment (FDI) accounted for just 0.2% of GDP, as gross FDI inflows were partially offset by some large outbound transactions.
High inflation and valuation effects reduced external debt growth. In the third quarter of 2023, Hungary’s NIIP amounted to -47.6% of GDP, which is slightly above the estimated prudential level of -53%, the negative position was primarily caused by the stock of large inward foreign direct capital investments. At the same time, NIIP excluding non-defaulted assets (NENDI) stood at -9% of GDP, down from -1.2% in 2021.
This broke the long-term improvement of the NENDI stock, which stood at -52% of GDP in 2008.
The current account surpluses of the early 2010s were driven by private sector debt reduction and budget consolidation, but since 2019 they have turned into a deficit, which was mainly financed by external borrowing. Gross external debt increased from 53.4% of GDP in 2019 to 67.2% of GDP in the third quarter of 2022, but then decreased to 65.2% in the third quarter of 2023.
The increase in external debt was partially mitigated by high nominal GDP growth. In 2022, valuation effects increased external debt by 1.1% of GDP, mainly due to currency depreciation, but in 2023 this effect was partially reversed as the HUF strengthened again. In recent quarters, reserve assets were just sufficient to cover short-term external debt.
The Commission paints a dark picture
“Tighter monetary policy, lower energy prices and weaker import demand improved the external balance and reduced high inflation during 2023. However, the recession also contributed to the persistently high budget deficit, in addition to the expansionary policy that continued even in the previous years of strong economic growth. High interest rates contributed to a slowdown in real estate prices and an easing of overvaluation in 2023,” the Commission writes.
According to the report, a gradual reduction in interest rates and moderate energy prices starting in 2024 could support a gradual recovery of the economy. However, fiscal consolidation needs are restraining growth prospects, and the economy remains exposed to energy prices and external risks.
According to the European Commission, a more coherent approach to economic policy is needed to achieve fiscal consolidation and macro-financial stability, and
to create the foundations for sustainable economic growth without risking overheating of the economy, which would impair external sustainability and keep inflation and interest rates relatively high.
A large increase in the minimum wage is seen as a risk because it is based on the assumption of future productivity growth, which may not materialize due to structural factors such as low innovation, low digitization and barriers to competition in the service sector.
The costs of household energy subsidies have been passed on to companies, which weakens their price- and cost-based competitiveness.
“It seems that the support systems for home purchases remain generous and, in addition to the low supply of housing, carry the risk of an unjustified increase in real estate prices,” they write in the report in connection with the csok and csok plus programs.
In addition, frequent credit market interventions – such as interest rate caps and other attempts at state regulation – had a limited impact on economic growth, while hindering the operation of monetary policy and causing longer-term budgetary burdens through central bank losses and contingent liabilities.
In summary, according to the Commission, Hungary’s prospects are characterized by low economic activity, falling inflation, a high budget deficit and significant uncertainties regarding the strength of the 2024 recovery. The country’s vulnerabilities include very strong price pressures, significant external and government financing needs, and potential emerging risks.
The government cautions against excessive fiscal spending and the return of high-pressure economic policy, as it would only increase inflationary risks and could be counterproductive in the case of starting growth.
Cover image source: Getty Images
Tags: European Commission governments economic policy task warning risks overturning
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