Hungary may present new austerity measures in Q2 to get rid of EDP - JPMorgan

EDP may be lifted, but it will come at a price

“The government remains committed to keeping the fiscal deficit below 3% of GDP and has a good chance of exiting the EU’s excessive deficit procedure this year," said Nóra Szentiványi, economic and policy research analyst at JPMorgan in London.

Government officials confirmed to JPMorgan that the 2012 fiscal deficit was comfortably below 3% of GDP (2.7% of GDP excluding inflows from private pension funds; to be confirmed by Eurostat in April) and will remain below the 3% threshold in 2013-14.

“We see risks to the 2013 budget (e.g.: delays in the e-toll system and in linking cash registers with the tax authority, lower VAT revenue due to household energy price cuts, hike in higher education subsidies, minimum wage hike, and weaker GDP growth)," Szentiványi said.

Yet, she noted that sizeable budgetary reserves (HUF400 billion or 1.35% of GDP) “should be able to counter much of the likely slippage."

The analyst forecasts a 3% of GDP deficit for this year, slightly above the official 2.7% of GDP target.

Szentiványi reminded that the European Commission’s autumn forecast suggested that an additional fiscal effort of 0.5% of GDP would be required in 2014 to keep the deficit at the 3% of GDP limit.

“In our view, the government would be prepared to announce additional deficit reducing measures in 2Q13 in order to obtain a positive ruling from EU Finance Ministers with regard to the EDP. Any new deficit reduction between now and the spring 2014 elections is highly likely to come from the revenue side, via further increases in the tax burden on the corporate sector," she added.

Optimism reigns in the government

The Hungarian government expects GDP to expand 0.9% on annual average this year, while official projections for 2014 are even more optimistic at 2.5-3%. JPMorgan’s estimate is stagnation for 2012, followed by growth of 1.5% in 2014.“After a 1.2-1.4% contraction in 2012, the recovery this year is expected to come from the agricultural sector (base effect from a poor harvest least year), expanding car production and a pick-up in other FDI," Szentiványi said. She reminded that officials anticipate a FDI to recover, with increased inflows from CIS countries, the Middle East, China (e.g.: Huawei, Wanhua) and India and that following large automotive sector investments in recent years, recent FDI projects have been concentrated more in the services sector, e.g.: logistics and IT centers.Szentiványi also noted, however, that “despite a handful of large investment projects, the fundamental case for investing in Hungary has, on the margin, become less attractive." On this note, she added that the sharp rise in the tax burden on the corporate sector (sectoral taxes now amount to 2.5% of GDP) “is leading to a build-up of cost pressures."

The analyst pointed out that wage growth in Hungary also picked up sharply last year due to increases in the minimum wage and guaranteed wage for skilled workers.

“The job protection action plan launched at the start of the year is expected to lower the cost of employing labour, but the increase in production costs due to high taxes will depress corporate profitability."

What could the NBH be up to?

“With fiscal policy constrained and the economy still in recession, the government has shifted its attention to easing policy through the monetary channel," Szentiványi said. She expects the NBH to ease further “through a combination of rate cuts and targeted measures to boost lending to the corporate sector."

On the whole, she does not think the NBH will do “anything too extreme to unsettle financial markets, but will not shy away from being more active."

Prime Minister Orbán is due to reveal his choice for NBH governor in early February, according to media reports, just under a month before Simor’s mandate expires (3 March).

The analyst expects the appointment to be “someone who supports the government’s policy agenda and is willing to introduce new schemes to kick-start lending."

Beyond continued policy rate cuts, loan facilities at below-market interest rates (say 3%) targeting the SME sector appear the most likely to Szentiványi.

“The design of the loan facility could be similar to the UK’s funding for lending scheme. In other words, the next round of unconventional measures in Hungary is actually likely to be in the mainstream of European measures to stimulate the economy," she said.

In her view, government bond purchases on the secondary market would only be used to stabilize the market in the event of a sharp move higher in yields.

Szentiványi noted that views within the government regarding the most appropriate exchange rate policy differ (Economy Minister Matolcsy favours a weaker HUF than Minsiter Varga, for example). “Past experience suggests that exporters are more sensitive to unit labour costs and external demand than the exchange rate. In our view, the level of the forint is unlikely to be constraining exports at the moment," she concluded.

This is where rate cuts could stop

“The NBH’s tolerance for some HUF depreciation is likely to have increased due to the moderation in the FX debt stock and the decline in banks’ FX swap exposure. [...] On the whole, the vulnerability of the economy to exchange rate weakness is still significant, but has been reduced," Szentiványi said.

In her view, the allocation of FX risks among various sectors of the economy has also improved. “FX debtors can shield themselves from FX weakness via the exchange rate cap, which fixes monthly repayments on FX mortgages at an advantageous exchange rate for five years."

Participation stood at just 23% of eligible households at end-November due to the perceived complexity and poor communication of the scheme, while banks are also not incentivized to involve customers, the analyst reminded.

“Significant HUF weakening would thus hurt the government’s popularity, although further household energy price cuts could be used to compensate for such an eventuality. The government is targeting participation of 80% and is working on a media campaign to boost take-up. The window for opting in is also likely to be extended for another seven years to match the 11-12 year average maturity of the outstanding FX mortgage stock," Szentiványi said.

She recalled NBH stress tests as suggesting that “EUR/HUF 305-310 would not pose major risks to financing stability, although concerns about a non-linear move triggered by the FX swap market could become a concern."

Szentiványi thinks the MPC would likely pause its rate cutting cycle if EUR/HUF were to move above those levels.

IMF deal before elections now looks very unlikely

The analyst said that an IMF program for Hungary before the spring 2014 parliamentary election has become a “very low probability event."

She pointed out that the government has built up “strong buffers" and can “comfortably meet" its financing need without an IMF/EU loan.

“The key sources of liquidity reserves are FX funds that were drawn down but not used from the 2008 IMF/EU programme, the single Treasury account deposited with the NBH in forints and unsold pension fund assets."

Szentiványi estimates that government buffers denominated in FX amount to roughly EUR 4 bn, while buffers in HUF stand at around EUR 3 bn.

“This is enough to meet sovereign FX debt obligations through the elections. The benefits of an IMF agreement to the government have become less clear with the difference between the interest on an IMF loan and market FX financing at100-150bp. Further, it was argued in our meeting that the refinancing risk arising from drawing on new IMF/EU loans would in itself increase the risk premia on Hungarian assets."

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