IMF presents long list of risks facing Hungary
Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. In the context of the 2022 Article IV consultation with Hungary, the Fund has already released a Concluding Statement, which is now followed by a Staff Report, which is a deeper analysis, detailing the risks to the Hungarian economy.
Escalation of war and sanctions is the key risk
On the top of the IMF's risk assessment matrix we find, unsurprisingly, the Russia-Ukraine war and its intensifying spillovers.
"Further sanctions resulting from the war and related uncertainties exacerbate trade and financial disruptions and commodity price volatility," the IMF warns. The latter, it adds, would likely "intensify terms of trade deterioration, external imbalances, and inflationary pressures."
Addressing commodity price shocks, the IMF staff says a combination of continuing supply disruptions (e.g., due to conflicts and export restrictions) and negative demand shocks causes recurrent commodity price volatility and social and economic instability.
Recommended policy response
- Fiscal policy should remain tight while making room for additional support.
- The vulnerable Central bank should stand ready to smooth excess exchange rate volatility and tighten further to reduce second-round effects on inflation.
A recession still looms
Another key risk is abrupt global slowdown or recession. Concerns about this have moderated over the past few weeks, as the world market price of natural gas dropped sharply and winter weather was particularly mild. However, the IMF warns that the fallout from the war in Ukraine is exacerbated by a gas shutoff by Russia, resulting in acute gas shortages and further supply disruptions, which triggers an EU recession.
In Hungary, a possible gas and electricity shortage would negatively affect industry in particular and could lead to massive job losses. The banking sector would also be affected by the deteriorating credit quality of companies. And financial markets could quickly reprice Hungarian assets in such a scenario.
"Gas and power shortages in industry will lead to output and job losses. Increased credit losses effects banks. Fiscal borrowing costs soar. Financial markets reprice risk assets," the IMF lists the possible consequences.
Recommended policy response
- Pace of fiscal tightening could afford to slow if inflationary pressures do not increase.
- Encourage greater price-induced demand reduction by further relaxing utility price caps, implement national emergency contingency plans, and extend targeted support to industry to avoid widespread closures and spillovers to financial sector.
IMF Staff also warned that a sharp tightening of global financial conditions combined with volatile commodity prices could lead to "spiking risk premia, widening of external imbalances and fiscal pressures, capital outflows, and sudden stops."
The Fund considers this a medium risk, saying that despite relatively low reliance on external financing, market pressures on yields and currency will raise fiscal and external imbalances.
Recommended policy response
- Tighten monetary policy further and intervene in the FX market if necessary to prevent market disfunction.
- Allow demand to adjust and reduce the current account deficit.
- Tighten fiscal policy.
Remaining on global risks, the IMF notes that a de-anchoring of inflation expectations and stagflation would affect Hungary, as well.
"Central banks tighten monetary policy more than envisaged leading to weaker global demand, currency depreciations in EMDEs, and sovereign defaults. Together, this could lead to the onset of stagflation," it warns. As for the impact of the risk, it warns that higher rates for longer will prolong the recovery and make fiscal adjustment costlier.
Recommended policy response
- Tighten monetary policy further and intervene in the FX market if necessary to prevent market disfunction.
- Ensure fiscal policy supports monetary policy, which may require further adjustment.
Deepening geo-economic fragmentation is also in the high risk category. "Broadening of conflicts and reduced international cooperation accelerate deglobalization, resulting in a reconfiguration of trade, supply disruptions, and lower potential growth," the IMF warns.
The impact would be that reduced FDI and contribution of auto industry value chains would lower actual and potential output employment, and energy supply security would weaken.
Recommended policy response
- Prioritize structural reforms and investments that support potential output and productivity.
Domestic risks: EU funds needed, inflation has to drop
One of the domestic risks listed by the IMF is an incomplete or untimely delivery of Next Generation EU funds and cohesion funds.
Unmet conditions to unlock funds lead to delays or incomplete disbursements of EU funds. Confidence effects raise financial market pressures via lower asset prices, higher risk premia and greater exchange rate depreciation.
The impacts, according to the Fund, would be: (i) reduced or delayed investment, (ii) delayed FX inflows, (iii) increased external borrowing needs and costs.
Recommended policy response
- Accelerate pace of investments and reforms to unlock EU funds and reassure markets through demonstrated commitment to strong economic relations with EU.
- The central bank should stand ready to tighten or intervene in FX markets if conditions become disorderly.
Hungary's inflation is the highest in the European Union, but more entrenched inflation, when core inflation is more persistent, remaining elevated for longer, is a risk the IMF highlighted.
As for the impact, the IMF warns that wage pressures would intensify and feed into a wage-price spiral. Real household incomes would erode, credit risk and non-performing loans would rise, deteriorating bank balance sheets.
Recommended policy response
- Further tighten monetary policy to slow demand and anchor expectations.
- Fiscal policy should also further tighten to complement monetary policy in dampening demand and slowing inflation.
The last risk mentioned is widespread firm closures due to high energy prices. "Persistence of high energy prices reduces firms’ ability to meet operating costs," the IMF says. As the impact it notes that "firm closures result in lower output, higher unemployment, and lower wage growth amidst persistent high inflation."
Recommended policy response
- Extend targeted and temporary support to firms while encouraging energy savings.
Cover photo: Getty Images
