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Sunday, March 15, 2009

Is The Condition of Hungary's Economy Really As Bad As It Seems To Be?

by Edward Hugh: Barcelona

On the face of it Hungary's situation is pretty dire. As I keep reminding readers of this blog, even Angela Merkel recently claimed that "you cannot compare the dire situation in Hungary with that of other countries" as if the worst off you could be was where Hungary is now, effectively turning Hungary into the benchmark case for economic "badness" (at least as far as the EU goes, Ukraine is obviously "another country" in this respect). I cannot agree. As I have suggested time and again on this blog, although Hungary's situation leaves little to be envious of, it is not as bad as some are making out in the current "demonisation" process, nor are the other Eastern Economies (even those in the Eurozone as I argue here in the cases of Slovakia and Slovenia) really as sound as some have been making out. Indeed in my view the Hungarian economy is not the worst case in the EU27 (I would rather suggest that either Bulgaria or Romania will be battling it out soon enough for that dubious honour). Obviously Hungary is in the midst of a major correction, and has been for nearly three years, but during that time Hungary has made considerable progress along its appointed road, and now has an industrial export sector which no one should be sneezing at. The problem is simply that Hungary (for reasons to be explained below) is now an export dependent economy, and such economies are among the worst affected in the short-term by the present slump in European (and global) economic activity.

This simple fact was brought home only last week by January's export figures, which show the dramatic nature of the recent decline in Hungary's external trade, since both exports and imports were down at a rate of around 30% year-on-year. The decrease was slightly higher for exports than for imports, and consequently the trade balance was once more negative. Exports were down by 31% compared with January 2008, showing the extent to which Hungary's export driven economy has been affected by the recession in the rest of Europe.

Imports were also down, but slightly less than imports (minus 29% in euro terms). What is quite striking if you look at the chart below is how the drop in imports has been more or less tracking the drop in exports in recent months.

Most analysts were rather disappointed by the news, since they had been hoping for evidence of a decline in Hungary's external financing requirement, with the mechanism for this being an improvement in the foreign trade balance. In reality what we have seen in recent months has been a modestly increasing foreign trade gap.

Industrial Output Down

Hungary’s industrial production has also been slumping on the back of the decline in export demand. Output fell a workday-adjusted 21 percent year on year in January, following an annual 23.3 percent decrease in December. The December contraction had been the biggest since 1991. Output however was up 2.5 percent on December's horrible low point, even despite the gas crisis.

February's output level looks to be much the same, since the manufacturing purchasing manager index, despite coming back slightly from its all-time low of 38.5 in January to hit 39.7 in February, was still well below the 50 reading which marks the frontier between expansion and contraction.

The extent of the fall in output in the industrial sector since the start of 2008 can be seen in the seasonally adjusted output chart (see below).

Inflation Slows

January's export results are doubly disappointing since, as is well known, the forint has been falling lately, and is down around 25% since last summer, although the impact of the most dramatic fall - which was in February - is still to be noticed in the export numbers (that being said I am not especially optimistic at this point).

Unsurprisingly inflation surged in February, and was up 1.0% month on month over January even though the annual rate still nudged downwards, reaching 3.0% year on year, falling marginally from January's 3.1%.

The drop in the annual rate was less the consensus estimate (2.8%) and was most obviously a result of the weak Hungarian forint which brought a halt to the disinflation process, despite the very weak level of consumer demand.

In addition recent fiscal measures -like the VAT and excise duty hike- will likely put upward pressure on the inflation path from mid summer. On the other hand the month on month number is unlikely to alarm the NBH unduly at this point, since growth and financial stability issues are much more pressing concerns. Thus, from a monetary policy perspective the release is more or less neutral, with the future interest rate trajectory depending much more on financial market developments.

Shocking GDP Numbers

Hungary's gross domestic product dropped by 2.5% year on year in the fourth quarter of 2008 following an increase of 0.7% in the thrid quarter, according to revised data from the Central Statistics Office (KSH) last week. This is the worst performance since the turmoil experienced during the early days of the transition. The downward revision from the preliminary 2.1% estimate was largely the result of a lower evaluation of the performance of the financial intermediation and real estate sectors. Looking at the chart below, the collapse in Hungarian output expansion since mid 2006 could not be clearer.

In fact GDP was down by 1.2% in the fourth quarter of 2008 as compared to the previous quarter. Agriculture and construction activity actually increased (by 4.6% and 2.1% respectively), while industrial ouput dropped by 3.4% and services by 0.6%. Household consumption was down by 1.8% and goevrnment spending by 2.5%. The quarterly impact of external trade was positive, since exports (which declined by 6.5%) fell less than imports (which fell by 7.3%).

Within gross domestic product, industrial production dropped 8.5 percent on the year and financial services declined 7.8 percent. Household consumption dropped 3.3 percent, according to today’s figures from the statistics office. So the composition of the quarterly preformance is pretty worrying as the 2.5% output decline was accompanied by a 71% leap agricultural output, a result of excellent crops. If you strip agriculture out, you find that the rest of Hungary's economy contracted by nearly 5% in only one single quarter.

Year on year household consumption was down by 4.4%, but household consumption growth has long been in decline (see chart below) and is now more of a brake on GDP than a driver.

Retail Sates Just Keep Falling

And retail sales just keep dropping. Hungary's retail sales fell by an annual 3.9 percent in December based on working day-adjusted figures following a 2 percent decline in November. Food sales were down by 1.5 percent in December from a year earlier and fell by 1.2 percent in all of 2008. Non-food sales were down by 5.6 percent in December and 2.8 percent over the whole of 2008.

And in December - using seasonally and calendar-adjusted data - the volume of retail sales was down by 0.8 percent compared to November, when they fell 0.4 percent over October. In 2008 overall retail sales fell by 2.1 percent. In fact Hungarian retail sales have now been in decline since the summer of 2006 (see chart) and I doubt we will ever see the heady levels of July 2006 (in real, price adjusted terms).

The reason for this is simple - Hungary's population is in steady long term decline 8see chart below), and less people will evidently consume less, especially when you consider that the age structure of the population is steadily changing, and there will be a higher and higher proportion of elderly people to support, which means that real disposable income for the ever smaller working population will be progressively squeezed.

Employment Falling, Unemployment Rising

Some evidence for this hypothesis can be found in the recent Hungarian employment data. Hungary's rate of unemployment rose to 8.4% year on year in the November-January period, up from 8% in the October-December period. There were 3.838 million people employed, while the number of unemployed was 351 thousand. The first thing to notice, obviously, is that unemployment is rising, which is what we would expect with the crisis taking place.

According to Eurostat harmonised data (based on a slightly different methodology) January's unemployment rate was 8.6%.

Now participation rates in Hungary are historically low - the participation rate of the population in the 15-74 age group was 54.7% in Q4, down from 55.0% in the previous 3 month period and 54.9% in the same period a year earlier, and undoubtedly changes are needed in the tax and employment law to facilitate higher participation rates, but as we have seen in Germany and Japan, in ageing populations labour reforms which raise the participation rate among older less qualified groups has not had as great an impact on real personal disposable income and consumtion as many anticipated. And the working age population is now declining in Hungary much more significantly than it has been in either Germany or Japan.

While the number of those employed, while fluctuating seasonally, has been trending down.

GKI Confidence Index Falls To New Lows

Hungary’s economic sentiment index plunged to another record in February as businesses struggled with falling orders and consumers braced against job losses as the recession deteriorated, according to the GKI institute report. The overall index fell to minus 43, the lowest since measuring began in 1996, from minus 39.8 in January. Both the measures of business and consumer confidence also fell to new lows.

The outlook for industrial production and orders led a decline in the business confidence index to minus 34 from minus 30.5 in January. Fifty-eight percent of Hungary's exports are sold in the euro region, which is in its worst recession since the single currency began trading a decade ago.

Concern about future job losses dragged the consumer confidence index to a record of minus 68.5 from minus 66.1 in January.

Short Term Outlook Bleak, But With Adequate Reforms Exports Could Drive The Economy

As I am indicating, I am not optimistic at all that domestic consumption can ever return as a major driver of Hungarian growth. However with the right mix of reforms and inward investment, the situation could be turned round, at least to the extent of keeping imminent disaster away form the door. Hungary's economy is far from being what some would call a "basket case". Clearly education quality is vital, as is the fomenting of a critical spirit which can take maximum advantage of the declining numbers of young people Hungarian society has at her disposal.

Export driven growth is far from perfect, as we are seeing now in countries as diverse (and in some cases) distant from Hungary as Germany, Japan and China, who are all suffering severe slowdowns. It is however better than the perpetual threat of sovereign default, and breakdown in the pension and health systems.

The danger at the present time is that the sharp contraction in GDP can lead to continuing budget shortfalls at fiscal level which produce cuts in public spending which themselves fuel further contraction, and so on, in a vicious spiral which only works to drive up Debt to GDP levels and spreads on Hungarian sovereign bonds.

The greatest threat from the continuing pressure on the HUF is the danger of growing defaults on CHF denominated personal loans and mortgages, defaults which themselves only pile the pressure on the banking system and intensify the credit crunch. The difficult situation this problem puts Hungary’s central bank in was made even clearer last week when bank President Andras Simor said the bank was using loans from the European Union to buy forint for euros to support the currency. Simor declined to comment on the size and timing of the intervention. But the central bank did issue a statement on March 8 to the effect that it would start converting European Union grants on the currency market to support the forint - Hungary is expected to receive more than 1.4 billion euros in EU grants this year. Obviously things have to be pretty desperate when you get to this stage, since while the bank may be able to make an impact in the short term, it is unlikely to have significant long term impact, so a solution must still be found to the CHF loan problem.

Reports in the Hungarian daily Népszabadság on Friday suggested that a solution is now being actively sought. According to reports, the basic idea is that the state would share some of the costs of conversion. As ever in Hungary, politics are in play, since the idea was originally put forward by Viktor Orbán, President of Hungary's main centre-right opposition party Fidesz.

The government itself then stepped in and Socialist Prime Minister Ferenc Gyurcsány reacted to Orbán's proposal by saying “The need to convert foreign currency loans to forint loans is rather obvious; the Finance Ministry has been discussing it for weeks,". Really, given that the country is in the middle of a very significant crisis, it would be better for everyone if all the bickering about who had an idea first could come to an end, and people put their heads together to look for the answer. Again it is "rather obvious" that the costs of conversion need to be split between the state, the mortgage holder and the bank, but in what proportions, and through what mechanism. Come on, enough studying, let's have some answers and go to work on the problem, then the forint can quietly be left to find the level which is most appropriate for attracting investment into Hungary's export sector, so when Europe's economies start to recover the export sector can be up and running, and ready to sell. The author of the "creative destruction" hypothesis, Joseph Schumpeter was himself, after all, a Hungarian.