Economy 11 January 2023, 5:35pm

Hungary seen plunging into a recession, lacking EU funds this year - UniCredit

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A London-based economist at UniCredit expects the Hungarian economy to contract on annual average in 2023, even if growth picks up in the second half of the year. In a quarterly research note on Central and Eastern Europe, they said Hungary will not receive EU cohesion funds this year, and that the country might lose its coronavirus recovery funds altogether. They expect inflation to peak this year but believe it could still be above the central bank's target even in 2025. The forint could remain above 400 against the euro, and analysts expect further weakening.

Key estimates

UniCredit expects the Hungarian economy to shrink by around 1% this year due to weaker domestic demand, fiscal and credit tightening, a temporary halt in private and public investment, destocking and weaker demand from the eurozone. They forecast GDP growth at 3.5% for 2024, when financial conditions could loosen while investment, output and exports recover

The bank projects inflation to peak above 26% in the first quarter of this year, remain in double digits in 2023 and well above target in 2024. As a result, they expect limited rate cuts, to 12% in 2023 and 7% in 2024. Large energy bills are likely to slow fiscal adjustment and keep the EBB negative in 2023-24.

UniCredit's analysts, however, expect FDI to recover once the recession is over in Europe, with EU funds being released in 2023.

We do not expect any disbursements from the RRF in 2023 (and probably in 2024), as the needed reforms are likely to prove a tall order.

They expect EUR-HUF to move above 420 and Hungarian Government Bonds (HGBs) to rally amid disinflation. At least EUR 3bn in REPHUN left to issue.

Let's see the details!

Before COVID-19, the Hungarian authorities ran the economy hot by doling out cheap credit and cutting taxes in the hope that supply would rise rapidly to keep inflation in check. The most impressive FDI pipeline in CEE ensured just that, until the pandemic.

Supply-chain bottlenecks, bullwhip effects and higher costs have affected output and exports since 2020. The combination of lower exports and large energy imports widened the 2022 trade deficit to around 5% of GDP, its highest level since the global financial crisis.

With FDI stalling ahead of an expected European recession and inflows of structural and resilience EU funds curtailed, the extended basic balance is negative and needs to be funded through portfolio inflows. The NBH’s straight-talking governor, György Matolcsy, called Hungary “one of the five most vulnerable economies globally”, highlighting current funding risks.

UniCredit's economists expect the extended basic balance (EBB) to register a deficit of around 5.4% of GDP in 2023 , which might close in 2024. The trade deficit is likely to widen to around 5.6% of GDP in 2023 due to a higher energy bill and narrow to below 2% of GDP in 2024. Timely planning could cap the energy bill in winter 2023-24, they added.

The analysts pointed out that having staked its energy dependency on Russia, the Hungarian government had to make a quick U-turn last autumn and purchase large volumes of natural gas from the West as Russia continued to cut exports.

However, the prices paid for this hasty reconfiguration were higher than those shouldered by Hungary’s western neighbours, which have been actively switching away from Russian energy since last spring.

"If the European economy undergoes only a shallow and short recession, as we hope, we expect Hungary’s exports to re-accelerate in 2H23 and especially in 2024, while FDI projects might restart," they said.

The economists reminded that the Hungarian government continues to add to an impressive pipeline of foreign-investment projects. China’s CATL plans to build an electric-battery factory valued at EUR 7.3bn (4.3% of estimated 2022 GDP).

Together with BMW’s factory and other smaller projects, CATL’s plans should further boost the city of Debrecen’s status as the capital of electric mobility in CEE.

"These projects should reduce unemployment in Hungary’s northeast, where it is highest in the country. By 2031, Hungary could become the second-largest European player in terms of electric mobility, behind Germany, according to the Financial Times," UniCredit said in the note.

While Hungary’s FDI future seems bright, the outlook for EU fund flows is less rosy, the bank added.

The analysts still expect the EU to release EUR 6.3 bn in structural funds that are awaiting more-transparent allotment procedures.

However, actual inflows could be delayed to 2024 due to the long process between tenders and reimbursement.

In addition, they expect Hungary to receive little to nothing from the RRF, despite the green light it received in December. PM Viktor Orbán explicitly opposes some of the 27 milestones the EU requested to strengthen the rule of law in Hungary.

We think that a U-turn is not in sight.

As regards inflation, a supply shortage coupled with robust demand has put more pressure on consumer prices in Hungary than anywhere else in EU-CEE, the analysts said. Hungary’s government imposed price caps, which led to shortages and are likely to be lifted in 2023. The most visible and consequential one, on fuel prices for households, was lifted in December.

In our view, central bank officials are right to point out that price caps raise inflationary expectations by hinting that prices will increase further. Retail gas and electricity prices should also be raised if the government wants to reduce subsidies and the budget deficit.

Assuming only small increases in retail energy prices, UniCredit sees inflation peaking above 26% in 1Q23. They expect disinflation to pick up in the second half of this year amid large base effects and weaker domestic demand, but pressure on prices for food and energy will keep headline inflation above 10% throughout 2023. According to the bank's forecast, the inflation target will also be missed in 2024 if companies that faced price caps recoup margin losses from 2022-23.

If inflation evolves similarly to what the bank's analysts forecast, they expect official interest rates to remain higher in Hungary than in the rest of EU-CEE, with the policy and the overnight deposit rates lowered to 12% by the end of 2023 and to 7% a year later. They do not think high interest rates will affect existing mortgage and SME loans, which are ringfenced but might curtail new lending in 2023 and 1H24.

Having expanded strongly ahead of the 2022 elections, fiscal policy will remain procyclical, the economists said.. Fiscal tightening started in September 2022, limiting last year’s budget deficit to around 6% of GDP. However, the speed of contraction suggests that the government might have accumulated arrears. "If this is the case, we expect the budget deficit to amount to around 4% of GDP in 2023, when energy subsidies will remain large. A further adjustment in 2024 to around 3% of GDP would keep public debt above 70% of GDP by the middle of the decade."

Given the expected technical recession in Europe, coupled with procyclical fiscal and monetary policies, we expect Hungary’s GDP to fall by around 1% in 2023, even if the economy starts to rebound in 2H23.

UniCredit believes that the main drivers of weaker economic activity will be

more circumspect consumers due to inflation outpacing wages in 2023;
lower public investment due to the planned fiscal adjustment and small EU transfers;
destocking in the private sector as global supply chains become unclogged;
weak private investment and exports in 1H23 and
a negative credit impulse.

The bank's analysts expect GDP to grow by around 3.5% in 2024, helped by better private investment and exports, credit impulse and real-wage growth.

For Hungary, 2023 could be a year of hard choices,

they said.

"Having seen his country as a platform linking East and West, Mr. Orbán might have to prove his allegiance to European institutions and priorities if the EU continues to support Ukraine in the Russia-Ukraine conflict.

We think that a separate position could further isolate Hungary in the EU, ultimately working against the
country’s political and economic interests.

The bank pointed out that the forint is vulnerable to swings in risk appetite while Hungary’s EBB remains negative.

We expect EUR-HUF to return above 420 this year, partly offsetting a terms-of-trade shock caused by rising energy prices and unit labour costs.

Lacking FX reserves for interventions, the central bank will have to keep interest rates high and sterilize liquidity, the analysts said. The NBH managed to block more than half of the excess liquidity in minimum reserves and longer-term deposits, thus reducing the amount it must sterilize daily. At the same time, the government’s intervention to cap interest rates paid by banks to domestic depositors weakens the effectiveness of monetary transmission.

Even without large inflows from the EU, the risk of a currency meltdown is very low,

they noted.

The NBH can access EUR 4bn from a repo line with the ECB and is likely to benefit from swaps with the ECB if further economic and/or geopolitical risks arise.

Disinflation could help HGBs rally in the spring of 2023, but UniCredit remains wary of the maturity profile of public debt in 2024 and beyond.

"Large retail-bond redemptions in 2024-25 and limited buybacks in 2022-23 could force Hungary’s Government Debt Management Agency (ÁKK) to pay higher yields than the rest of Central Europe in 2023-25."

The ÁKK issued USD 4.25bn in REPHUN on 4 January. UniCredit expects at least EUR 3bn in REPHUNs to be sold this year.