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Tuesday, December 9, 2008

The NBH Cuts Interest Rates As Hungary Enters Its Second Recession In Two Years

by Edward Hugh: Barcelona

Well, before I go any further, yes you read the header right, with the contraction of 0.1% in Q3 over Q2 (seasonally and working day adjusted data) reported by the national statistics office (KSH) today (Tuesday) the Hungarian economy has now entered its second recession since the start of 2007, since data revisions accompanying today's GDP detailed results from KSH show that they now estimat the economy contracted in both Q1 and Q2 of 2007 (by 0.2% in each case), thus satisfying the normal technical criterion for declaring a recession. Somehow I doubt the Hungarian press are filled today with headlines about this juicly little detail.

While the Q1/Q2 2007 detail is a purely technical recession, in the sense that it could just as easily disappear again in a subsequent data revision - the basis of the revision is undoubtedly the impact of movements in the seasonal adjustment parameters, produced in particular by the rather violent swings in agricultural output - there is a much bigger underlying reality to the detail, and that is that the Hungarian economy has now lost almost all growth momentum, and indeed we need to ask ourselves whether we will ever see robust output growth (neo classical steady-state-growth buffs beware) in the Hungarian economy again (Italy and Portugal would rather be the role models I have in mind here), especially with the increasing impact of ageing and declining population as we move forward in the next decade to think about, and robust growth before we enter the next decade is now an almost impossible outcome to hope for, especially when you take a long hard look at todays data in the light of what is now inevitably about to come.

Remember, the third quarter (July - September) outcome was prior to most of the "financial chaos" which has now set the scene for the growth outlook over the months to come. So it was the last of the "good times", at least for as far ahead as we can see. And that being said, if we strip out agriculture, as Portfolio Hungary notes, almost every other component of the economy went into recession in Q3, before the financial meltdown close-call.

Output in agriculture, industry and construction combined grew by 6.1% year on year in Q3, but this was largely due to the 50.8% growth achieved in agriculture. Industrial output taken separately was down by 2.2% mainly due to a 3.2% drop in manufacturing while construction output dropped by 5.0%. Services output decreased by 1.5%. On the expenditure side of GDP, final households consumption increased 0.9%, mainly due to the increase in social transfers in kind from government, up by 5.8%, while private household final consumption expenditure rose by only 0.1% year on year, and government final consumption growth remained stagnant. As we can see in the chart below, domestic private consumption growth in Hungary is now more or less done, and what growth the Hungarian economy may manage to get in the future will be all about exports.

Gross fixed capital formation maintained the negative trend of recent quarters and was down by 1.5, largely due to a drop in investments in manufacturing and in transport, storage and communications. As far as external trade goes the recent improvement continued, albeit with reducing momentum, and the volume of exports and imports were up year on year by 3.5% and 2.8% respectively.

On a seasonal and working day adjusted basis Hungarian GDP declined by 0.1% in the third quarter of 2008 when compared to the previous quarter, with agriculture being the only sector to show real growth with a 5.2% increase over the quarter. Industry contracted by 1.7% on the quarter, while the services output was down 0.5%. Household consumption expenditure declined by 0.2%, although social transfers in kind from government were up by 1.4%. More preoccupyingly exports were down by 0.3%, while imports decreased by 1.5%.

Exports Falter Again In October

In October 2008, according to first estimates from the KSH, Hungarian exports were running at EUR 6,349 million, while the value of imports was EUR 6,425 million. The current price euro value of exports was thus down by 4%, and that of imports fell by 2% over October 2007. As a consequence the October trade balance showed a deficit of EUR 77 million, and a deterioration in the balance of EUR 180 million when compared with October 2007. As we can see in the chart below, given the difficult external environment, Hungarian exports are also taking a beating at this point, but it is from a recovery in this area that the only real hope for a Hungarian recovery actually lies.

The NBH Cuts Rates

The National Bank of Hungary (NBH) yesterday (Monday) announced that it was lowering its key policy rate by 50 basis points to 10.50%. The Monetary Council was scheduled to hold a rate-setting meeting on 22 December, and yesterday's meeting was not in principle intended to take monetary policy decisions. The 50 basis point cut thus came as something of a surprise to observers. The direction of the move however did not come as a surprise since following November's 50 basis point monetary easing the market had been expecting the MPC to lower rates further in December. Despite the potential for forint instability, the financial markets seem to have taken November's cut reasonably in their stride (especially with the big guns of the IMF, the ECB and the EU lined up just in case) and the HUF has remained reasonably stable. Quite another argument would be whether these current forint values are in the best interests of Hungary's export industries, given all that has been previously said about them now being the great white hope of the Hungarian economy.

Various arguments have been advanced to explain NBH thinking at this point, among these two seem reasonably plausible. In the first place November CPI figures showed a general global decline and there are signs that we are entering a deflationary trend both in Hungary and the CEE in general. Despite the very high inflation levels that have been registered recently in the CEE, the very rapid drop in demand in some countries does not rule out the eventuality that we may see a negative price trend and even possibly outright deflation in those countries which enter the deepest depressions. Hungary's Central Bank is therefore staring to position itself, just in case.

Additionally as inflation has fallen back, serious recession fears begin to come to the forefront of bank thinking, and especially in Hungary, where fiscal policy simply cannot contemplate measures that would foster economic growth. So, to give the impression that at least someone is trying to do something about what is really a very difficult situation, the NBH starts to cut.

The impotence of the NBH is pretty much evident in this situation. The loans from the IMF and the EU were simply that, loans. They offer financial stability, but they do not address the key problem facing Hungary today, which is how to get sufficient export competitiveness to push headline GDP growth up to levels that put the economy on a sustainable path. The only way to this achieve situation is by allowing the value of the forint to fall (devaluation). Substantial internal price deflation would be too long and too painful, and carries important risks of getting stuck in a deflationary spiral. But to devalue you need a plan for the CHF denominated loans. These need to be "translated" over to forint - by decree if need be, and the West European banks who conducted all this ill advised lending need to be sent to their home governments with the begging bowl, since Hungary is surely in no position to bail them out, or shoulder the burden of the inevitable write downs.

Andreas Simor more or less accepted that the forint was the big issue in his statement before the Economic Committee of the Hungarian Parliament on Wednesday. Hungary’s scope for interest rate cuts is “limited” because of the risk of a “very significant” devaluation of the forint, the central bank President said. He stressed that the Magyar Nemzeti Bank does not have an exchange-rate target and wants to avoid forint volatility and proceed with rate cuts as the balance of risks to the economy allow.

“If we were to lower rates faster, we would risk a very significant currency devaluation,” Simor said. “We will proceed as quickly as Hungary’s risk assessment improves.”

"We have to proceed on a very narrow path, but we will proceed. As to when and at what pace? At such a pace that is in line with an improvement in Hungary's risk assessment,"

So we will not reduce rates dramatically, or substantially, even as the recession grows and fiscal policy tightens. Fine. But do tell me, just how long does it take to drain an ocean with a teaspoon?