Economy
Hungary cenbank confused a number of investors - Morgan Stanley
One of our favourite quotes in Hungary was that there is a high degree of confidence among observers that the authorities will surprise them from time to time, but they are now so used to it that they have come to expect this modus operandi. In other word, there is 'predictability in the unpredictability'
, Diana said in a CEE trip note on 18 May.Fiscal policy: Reaping the rewards of whitening
In a broad sense, the surprising turnaround in fiscal policy in Hungary (additional fiscal easing in 2017, mostly via VAT cuts) is easy to understand, Diana said. He reminded that the fiscal deficit was better than expected in 2015, and the revenue data showed a strong start to 2016.“The emergence of the underground economy (also known as 'whitening') has surpassed the Economy Ministry’s rosiest expectations and therefore there is now some wiggle room to spend some of this windfall," he explained.
For example, the EcoMin was able to improve tax collection by an estimated HUF 170 billion (0.5% of GDP) simply on the back of the new e-cash registry.
The easier fiscal stance is clearly also related to the 2018 election, and therefore we should think of next year's budget as an election budget.
The government plans to cut VAT on poultry, eggs and milk to 5% and on restaurant and internet services to 18%, which combined would add about 0.2pp of GDP to next year's deficit. This is on top of a generous scheme to offer families which plan to have three children over the coming ten years (regardless of how many they have already) a one-off grant of HUF 10 million to buy a new property, a policy which is aimed both at reviving the construction market as well as encouraging higher fertility rates. Diana highlighted that probably as a result of the government's new stimulus programme, building permits in 1Q jumped by almost 39%Y.Diana noted that the new deficit target for 2017 is 2.4%, but that the 3.1% growth target is possibly optimistic and the inflation target of just 0.9% is likely too low. The target represents deterioration from this year's planned 2% deficit and probably implies deterioration in the structural (cyclically adjusted) deficit, too, he warned.
Even so, we would not expect the EC to take a hard line and place Hungary in the Excessive Deficit Procedure again. The main consequence of an easier fiscal stance is a potential delay to the upgrades, but our view is that while the authorities remain hopeful on the upgrade front, they would not necessarily be overly upset by a delay.
Diana added that it likely would seem a price well worth paying, in order to gain some fiscal leeway. In his view, relaxing the fiscal stance in 2017 seems optimal from the government's point of view, as the next general election will take place in 2018.Monetary policy: Deciphering the NBH's communication
“It is not surprising that given the recent change in tone by the NBH there has been a great deal of confusion among local observers about what the NBH's reaction function is and what the bank is trying to achieve.“A popular view among some observers is that the NBH is providing some hints that the yield curve should be steeper, and is therefore trying to encourage bond market outflows by non-residents.
The ultimate goal is that HUF would weaken and therefore monetary conditions would ease. "
Diana noted that the recent decision to end the IRS programme (a surprise even to the government, he thinks) would fit into this view nicely. “After all, the IRS programme was instrumental in achieving one of the NBH's perceived objectives - a flatter yield curve and lower funding costs. Therefore, ending this programme may indicate a bias for a steeper curve," he explained.Popular as this view may be, Diana does not think it is correct.
It is hardly rational for the NBH to hurt its own bond market simply to try weakening HUF, particularly in light of its close cooperation with the government. Rather, we think the NBH is engaging in an 'expectation management' exercise.
“When it feels that there is 'too much' consensus around the Hungarian macro story versus Poland or Romania for instance, it thinks of those as 'hot money' inflows that keep HUF stronger than it would otherwise be. At that point, the NBH therefore chooses to engage in expectations management by suggesting that there will be less support for the HGB market going forward. Seen in this light, the yield on the 10-year Polish government bond should represent some sort of 'floor' for the Hungarian 10-year yield."
Diana believes that the NBH is
fully aware that verbal intervention suffers from diminishing returns, yet the central bank is in our view adopting a rather short time horizon to formulate its policies, and it is not necessarily concerned about the medium term.
“This emphasis on short-termism and expectations management can be thought of as the most recent chapter in the NBH's creative monetary policy saga," he added.We continue to think that, although the central bank's bias is clearly in favour of a weaker HUF, the authorities are not likely to go to any particular lengths to achieve this, other than to keep rates low for long and intervene verbally from time to time.
Diana noted that there is probably also a view (though it differs from the published NBH BoP forecasts) that the current account surplus is due to narrow substantially over time as domestic demand and oil prices recover, and therefore FX appreciation pressures should abate on their own. However, he continues to think that “an FX floor is a very low-probability scenario, and parallels with the Czech situation of 2013 are fundamentally misguided." He reminded that the Czech National Bank was trying to exit core deflation and avoid a consumer depression, and it explicitly stated that it did not mind expanding its balance sheet (i.e., printing more CZK).“None of the above apply to Hungary: There is no core deflation, domestic demand is recovering and the NBH is clearly on a mission to reduce its balance sheet."
As regards the self-financing programme, on a structural basis Diana does not share the view that the bond market remains unsupported, the NBH wants to cause outflows on a sustained basis and that the bank will simply stay away from it all.
“After all, the central bank has been clear that the principles behind the self-financing programme will continue, even if the IRS programme has come to an end," he noted.
Diana reminded that “there is still a great deal of liquidity in the system that the NBH can use to try and divert flows into the bond market. And while banks already have a huge share of bonds as a share of their assets, the NBH probably believes they can increase their holdings in the future, provided that their assets grow (i.e., they lend more)."
The economist added that for background, there is still about HUF 2 trillion worth of net excess liquidity mostly parked at the 3-month facility.
“While this excess liquidity should halve by 2017 as FX swaps expire and FX debt is repaid with HUF issuance, we think the system will remain in excess liquidity, thanks also to the continued (albeit slower) inflow of EU funds."
Views on BUBOR: Tinker and regulate
Diana reminded that following the conversion of FX loans in HUF, these have become variable-rate loans which track BUBOR, so this rate has a direct and growing impact on the economy. First and foremost, the NBH has been clear about the fact that it wants an active, liquid and competitive BUBOR market.“This has nothing to do with the level of BUBOR itself, but it's rather a point about market structure. The NBH will revisit the issue in September, and indicated that it is set to introduce compulsory dealing in the BUBOR market if it is unhappy about its functioning at that point," the analyst said.
He thinks that moral suasion and pressure (the NBH is also the regulator) could work on their own, of course, but another way that the NBH could also encourage more transactions in BUBOR is by limiting the amount of liquidity banks can park in the 3M deposit facility, which is now used by the majority of banks, to a greater or lesser degree. Banks could then redeploy part of the extra liquidity in the bond market or on the interbank market, which presumably would push BUBOR lower, he added.
“A lower BUBOR would be a welcome side-effect but not the main aim of the policy: If the NBH thinks that materially lower rates are needed, it will simply embark on another easing cycle, we think. At present, we stick with our forecast that the bank will cut rates by a further 20bp from here(10bp x 2, in May and June), though it is also possible that it chooses to cut only once, by 15bp. After rates have troughed, we think that the NBH will keep them on hold throughout the forecast horizon."
