Economy 13 March 2020, 1:05pm

Hungary's Orbán cabinet steps on slippery path but it has no other option

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Hungary's Prime Minister Viktor Orbán has pained a grim picture of the impacts of the coronavirus, or COVID-19 outbreak. He said we would delude ourselves if we thought the impacts of the virus will be gone in the short term. He also said the budget plans for 2020 and 2021 will have to be revisited, adding that economic stimulus packages worth billions of euros will be required. Finance Minister Mihály Varga's remarks made in the evening about Hungary possibly going into recession assign the PM's words even more weight. Let's see what kind of wiggle room the cabinet has and where can it find additional resources if need be.

Everyone is groping in the dark for now

The year-opening event of the Hungarian Chamber of Commerce and Industry (MKIK) on Tuesday hosted Prime Minsiter Viktor Orbán, Finance Minister Mihály Varga, and central bank (MNB) Governor György Matolcsy who addressed the potential economic impacts of the coronavirus outbreak. The matter keeps analysts busy around the world, and an increasing number of governments try to come up with economic stimulus measures to mitigate the outfall from the epidemic.

the head of the central bank, as well as government officials, particularly viktor orbán, sounded most pessimistic regarding the outlook.

Matolcsy, for instance, said that whereas the health impacts of the coronavirus may be gone within a year, its economic effect will be felt for years to come. He stressed, however, that Hungary's immune system is now stronger than before and it is also better than that of some (western) European countries.

Varga highlighted that the coronavirus will deal a blow primarily to tourism and the relating industries.

PM Orbán was the most specific of the three of them and he pained the grimmest picture of what Hungary could be facing. Although he first said "the coronavirus should not give you the jitters", while a few minutes later he said there is no best-case scenario here, we need to prepare for a global pandemic which will remove everyone from their comfort zone already in the short term.

We need to revisit the 2020 and 2021 budget plans. We need to set up economic correction funds to the tune of billions of euros, and everyone will be expected to contribute

, said Orbán.

In line with the above, but tainting the already gloomy outlook even darker, FinMin Varga told InfoRadio in the evening that Hungary's economic growth might stagnate or even contract this year.

According to the Finance Ministry, in the worst-case scenario, the EU's economy could shrink up to 2.6% this year, Varga said, adding that it has "buckled" already in the recent period. This would also deeply affect the Hungarian economy, which would stagnate or shrink slightly under such a scenario, Varga said.

IN CONCLUSION, HUNGARY'S GDP GROWTH WILL BE BETWEEN 3.7% GROWTH AND MINUS 0.3%,

depending on how hard the coronavirus hits, how long the epidemic lasts and how deep it goes, Varga said, adding that entrepreneurs also have a negative outlook and are uncertain if they will weather the current storm.

Shock

Given that due to a large number unknown factors there are no in-depth estimates regarding the economic consequences of the epidemic, there's also a lack of public forecasts for the Hungarian economy. That's why it is shocking to see the FinMin finds even recession in 2020 possible. This scenario is probably contineng of a Europe crippled by hosts of quarantines. Regardless how scary this may sound, it is not a low-probability scenario. If new developments in the outbreak in the following weeks raise chances of the gravest economic scenarios, some serious redesigning work will be timely, because budget plans will become obsolete even without the implementation of stimulus packages.

And in that case, of course, efficient economic stimulus packages will be needed even more. This begs the question: how much Hungary can spend and what it should spent it on?

The PM asked the MKIK to come up by end-April with targeted measures that could be needed in specific sectors. He stressed that the cabinet, in assistance with the central bank, is "ready to help". In view of this, the earliest we can expect an announcement of those measures is May or June, probably before the summer recess in Parliament.

this is partly due to uncertainties. the cabinet does not want to take concrete steps before quantifying the possible outcomes.

Is there room to manoeuvre ?

A static snapshot of the budget should not give the cabinet a headache. The adopted 2020 budget law targets a 1% of GDP deficit, i.e. there's still a wiggle room of 2% of GDP before hitting the Maastricht threshold. Considerint the dynamic tax impacts of an economic stimulus expenditure package, this gives the cabinet room for the adoption of a scheme of well over HUF 1 trillion.

Additionally, the 2020 budget was planned with ample buffers. There's HUF 378 billion in the Country Protection Fund and general reserves of HUF 110 bn, although half of it may be tapped only in the second half of the year.

Additional manoeuvring room could be that owing to a robust base, this year's figures could have improved further since the adoption of the 2020 budget, and the carry-over effect could be felt also on the revenue side of the budget. This could add up to a few tens of billions of forints, but since then the cabinet has announced a couple of new spending items (e.g. a bonus raise for teachers). We should note at this point that originally the cabinet designed this year's budget with GDP growth of 4.0%, but then it has revised it downwardly to 3.5%. (Also, Finance Minister Mihály Varga delivered the shocking news late on Tuesday that in a worst-case scenario, the Hungarian economy could even contract.)

at first glimpse, if the government uses up all its wiggle room, it will have about HUF 1.0-1.5 trillion to spend, which might just be enough to meet the "several billion euros" worth of spending orbán has estimated.

Orbán could be emboldened in his plan by the European Union's several suggestions that when it comes to combating the coronavirus it will apply a softer and more lenient approach on fiscal spending. Once that approach is enshrined on paper, the only restriction the Hungarian government will have will be domestic debt rules. However, they are so flexible that they would not tie the cabinet's hands at all, in case there is a real intention to see through the economic stimulus plans.

Plans to open budget taps gets a boost by the current global stance on the matter, as several countries, including the United States and Japan, are now planning to launch stimulus programmes.

The government has announced earlier this week that it is allocating over HUF 8 bn for defending against the coronavirus. This, however, is the cost of protective measures, additional funding for the health care system, the tests and doctors' overtime. Mitigating the economic impacts of the outbreak, i.e. economic stimulus is a whole other issue. Orbán referred to the latter when he said this could be the biggest slice of budget expenditures and could amount to "several billions of euros".

The static picture above is tarnished by the possibility of a recession. If an economy that shrinks by 0.3% is working under a budget that was planned with 4.0% GDP growth, the elbow room narrows drastically. The fiscal situation is aggravated even further by the fact that in recession inflation is also lower, i.e. the difference between the two growth paths could reach 4-5% of nominal GDP. The tax impact of such a gap may be large enough for the targeted 1.0% budget deficit to swell to 3.0%.

Consequently, the more a stimulus package was necessary to maintain growth, the smaller the budget resources for it would be. In an extreme scenario, the budget shortfall would need to be flirting with the Maastricht cap if the cabinet wanted to carry out a fiscal stimulus of any meaningful impact. In that case, the central bank's unconventional toolkit may come to the rescue again.

It's important to highlight that the coronavirus outbreak (now a pandemic, according to the World Health Organisation) and particularly the measures implemented to fight it have a peculiar impact on the economy. Managing the supply and special demand shocks is possible only via targeted means that requires extra care.

What kind of means could be deployed to stimulate the economy?

So, what kind of measures can we expect Hungary to implement in a bid to stimulate economic growth? Orbán said there could be targeted measures aimed at specific sectors. For now, everyone is talking aout tourism and catering, but it remains to be seen how the manufacturing sector, for instance, will respond to the persistent disruptions in supply chains. The latter is, theoretically, more resilient to shocks, thanks to low indebtedness and the delayed occurrence of deferred demand.

The classic logic of economics tells us that the following measures may be used to stimulate the economy:

Tax reductions
Investment incentives (this is probably why the Orbán regime will not want to tighten the purse strings on public investment projects)
Ensuring cheap financing artificially
Promotion of consumption

As for tourism, the first tool that pops into our mind is a targeted VAT reduction, either at accommodation services or catering. The VAT on accommodation services has been lowered to 5% from 18% on 1 January 2020, so there's not much to do there. The same goes for restaurants where the VAT on locally consumed meals and non-alcoholic beverages was reduced in two stages to 5% by January 2018. The other tourism services may be included in that, but it remains a question how effective a VAT cut could be here.

There are other ways to lower taxes, though, given that there coporations are subject to various taxes. The biggest burden is the 9% corporate income tax that the government may also choose to lower in a targeted fashion for select sectors.

Revving up public investment projects cannot really work in the case of tourism. While it would stimulate the economy as a whole it cannot be labelled as targeted.

Another tool could be offering cheap funding, in which the MNB could lend a helping hand. For instance, it could launch targeted loan programmes, even with 0% interest rates. The central bank had already started down this road. The question is whether it wants to go another round and whether such a scheme could be restricted to given sectors. Theoretically, bond purchases also fall into this category, but Hungary's corporate bond market is too shallow to achieve meaningful results with this. (Using this logic, however, easing the conditions of the Bond Funding for Growth Scheme (BGS) might be contemplated.)

At first sight, incentivising consumption does not seem to be a likely choice at this point, because the measures would be targeting exactly those industries and businesses that are in trouble now. Nevertheless, propping up domestic tourism via certain measures might be an option. The cabinet might come up with benefit packages (e.g. vouchers) similar to fringe benefits (or cafeteria as they are called in Hungary) that would help accommodation service providers and catering units weather the storm.

Who will be hurt by the measures?

The PM's remarks suggest that not everyone will benefit from the measures, there will be losers too. This suggests that due to risks to economic growth Orbán does not think he has such a wide fiscal manoeuvring space as we have estimated from a static snapshot on the budget. Instead, the future plans could be aimed at creating this wiggle room while accepting a potentially sharper deceleration. When a prime minister tells an audience of entrepreneurs that "everyone will need to contribute" and "you'll need to get out of your comfort zone", it does not really spell budgetary profligacy.

It may easily happen that some sectors get classified as "endangered" and they will be able to enjoy the benefits of the package, while some other "less important" sectors could be facing even larger burdens. In an extreme scenario the cabinet might even impose crisis taxes and special levies on certain sectors, just like after 2010. This, however, is likely be only a measure of last resort, and if the necessary manoeuvring room can be safely created, drastic tools as this will not be deployed.