HUNGARY: Recession in 2009 may be deeper than forecast

Analysis

An important indicator for the current parlous state of the Hungarian economy is industrial production: in October, it contracted by 7.2% year-on-year, the largest decline in 16 years, and by 1.9% month-on-month. The data released by the Hungarian Central Statistical Office (KSH) are preliminary and aggregate, but it is likely that the weak industrial output performance so far in 2008 is partly the result of the slowdown in Western Europe, and partly the result of the general weakening of the business cycle in Hungary.

Business environment. Businesses have repeatedly complained of domestic tax rates that are higher than in neighbouring countries (see HUNGARY: Gyurcsany's populist move is short on ideas - February 27, 2008) and of very high forint-denominated interest rates, which are also much higher than in such competitor countries as Poland, Romania, Slovakia and Slovenia.

The macroeconomic conditions for businesses are likely to remain unfavourable. The government had been trying to reduce the budget deficit further even before the stand-by arrangement with the IMF and the borrowing agreement with the EU were announced at the end of October (see HUNGARY: Crisis may be averted in vulnerable economy - October 21, 2008). The National Bank resorted to a surprise interest rate hike, raising it by 300 basis points (bp) on October 22, after the forint had suddenly depreciated by more than 10% in October. In spite of two subsequent small reductions in the interest rate, of 50 bp each on November 25 and December 9, the domestic interest rate level of 10.5% is still much too high for companies with good opportunities for growth.

Output and jobs. There is widespread agreement that the decline in industrial production in October -- when the crisis really started to bite -- is not just one bad month. Industrial production trends are not likely to show signs of significant improvement, given the substantial deterioration in the euro-area's outlook, as the countries in the zone take up a large share of Hungary's exports.

The growing number of lay-offs since October, at construction businesses, and at automobile and electronics manufacturers (including Suzuki and Nokia), indicate that a further decline in output is to be expected. However, it is also possible that some medium-sized companies are just taking the opportunity to reduce headcount, during a period in which there has been a wave of well-publicised redundancies at major foreign-owned firms and at some state-owned businesses as well.

Foreign trade. In addition to the gloomy October output figures, there are other indicators of weakness in the Hungarian business cycle. Hungary posted a trade deficit of 76.5 million euros (110 million dollars) in October, according to KSH first estimate figures. This deficit compares with a surplus of 176.7 million euros in September and 103.5 million in October 2007 (see HUNGARY: Trade gap may not be due to strong forint - September 16, 2008).

Good 2008 harvest. While there was a good agricultural season again in 2008 (unlike in 2007), and the better-than-usual agricultural output helped boost growth in GDP and exports, this very factor also reveals that the main sectors of the economy (services, industry and construction) are not doing well. The 50% growth in agriculture (the combined impact of last year's bad and this year's excellent weather) pulls the GDP index upwards by a full 2 percentage points.

Without this, there would have been a 1% contraction year-on-year in the third quarter. All the other major sectors of the economy, including industry, the construction sector and services, are in technical recession.

Quarterly GDP data. Hungary's real GDP growth slowed in the third quarter of 2008 to 1.0% year-on-year -- or 0.7% when the data are adjusted for calendar effects. That the main factor behind the limp economic growth was increased production in agriculture is not encouraging, since it is a volatile sector with output results highly dependent on the weather.

The Hungarian economy is strongly affected by the impact of the crisis in global capital markets filtering down to productive sectors; the picture is therefore even gloomier for the fourth quarter, when the negative implications are expected to be even harsher.

2009 budget. The government of Prime Minister Ferenc Gyurcsany, which is technically a minority administration, claimed a political victory recently: the new budget plan for 2009 was passed by parliament on December 15 by a convincing margin, with support from the Free Democrats, who are nominally in opposition but often back the government (see HUNGARY: New minority government lacks ambition - May 2, 2008).

The budget aims at further reducing the general government deficit (one of the conditions of foreign lending) to 2.6% of forecast GDP, from this year's revised target of 3.4% -- which Finance Minister Janos Veres now says may be undershot. Deficit-reducing measures include a cut in real wages in the public sector, and a reduction in the nominal growth of pensions. Business enterprises are also offering wage increases below the expected rise in the consumer price index for 2009 (4.5%).

However, the result has already been tensions on the shop-floor and strikes. Employees at Budapest Ferihegy International Airport have been on strike since last week and railway staff since the weekend, although Budapest bus drivers called off yesterday's stoppage, after the government agreement to increase the city transport company's funding.

Outlook. All in all, the annual change in Hungarian GDP next year may turn out worse that the official forecast, which is for a contraction of 1% year-on-year. Some are forecasting a GDP contraction as severe as 3%. If the forint continues to be weaker than in recent years, then this may support exports of industrial goods, but the main export markets (Austria, Germany and Italy in particular) are unlikely to provide any strong demand for Hungarian-made products in the months to come (see PROSPECTS 2009: Euro-area recession set to endure - November 17, 2008).