Here's the potential damage an escalating tariff war could cause in Hungary

Global risks: tariff war, US spending

The IMF has recently published the results of its staff report on its regular Article IV consultation with Hungary. The organisation views the budget situation as particularly risky and does not anticipate a significant reduction in the deficit over the next five years. According to the IMF staff, Hungary's GDP could grow by 0.7% in 2025 and accelerate to 2% in 2026. However, they emphasise that there are downside risks to this forecast.

One such risk is a renewed escalation of the trade war. Although the United States has recently reached agreements with several trading partners, the threat has not completely disappeared. In April, the IMF set out an alternative scenario in its World Economic Outlook (WEO) publication. The main elements of this scenario are:

• Renewal of the US Tax Cuts and Jobs Act (TCJA). Scenario A assumes renewal of a broad set of provisions in the TCJA for a period of 10 years, including individual and business taxes, the child tax credit, and expensing of investment, totaling about 11% of GDP over 2025–34. The accompanying deficits are back-loaded, reaching about 1.4% of GDP by 2027. Because the renewal comes after a historical inflation surge, the layer assumes a small additional temporary increase in US inflation expectations.
• Lower productivity in Europe. The recent slowdown in productivity growth in the euro area deepens as a result of lower innovation, technological shifts, and lack of access to equity funding. Total factor productivity growth declines by 0.2 percentage point per year over five years, relative to that in the reference forecast, starting in 2025. The decline is concentrated in the tradables sector.
• Weaker domestic demand in China. Consumption and investment fall relative to those in the reference forecast by 0.7 and 0.5%, respectively, in 2025. The decline builds over 2026–27 and fades after that.
• Trade war. The scenario assumes a ratcheting up of tariffs in response to the April 2 announcement. First, it incorporates an additional 50 percentage point increase in tariffs on all China-US trade in both directions relative to the reference forecast in this report. Second, countries other than China respond tit for tat to the April 2 announcement, raising tariffs on imports from the United States by the same rate. Third, the United States responds by doubling the rate announced on April 2 to all countries other than China. As a result, there is an increase of about 18 percentage points in the effective tariff rate on both US goods imports and US goods exports, relative to the current reference forecast.
• Increase in global uncertainty. Uncertainty over macroeconomic policies increases. The resulting shock is equivalent to a three-standard-deviation increase in the global economic policy uncertainty measure in Davis (2016), about 50 percent larger than the spike observed in 2018–19. Regions more directly exposed to tariff measures, or where trade represents a larger share of activity, experience a somewhat greater uncertainty shock.
• Tighter financial conditions. The combination of shocks in the scenario triggers a tightening in financial conditions. Asset prices decline globally in 2025, with the largest decline in the US (about 5 percent on average for the year) and in emerging markets (about 3%). Sovereign and corporate premiums in emerging markets excluding China increase by 50 basis points; corporate premiums in advanced economies and China increase by 25 basis points. The tightening in financial conditions lasts for two years.

Given that an agreement has been reached between the EU and the US on trade, the above scenario may currently seem pessimistic.

How would this affect Hungary?

The IMF recently published an analysis examining how the above stress scenario would affect the Hungarian economy. Based on modeling,

Hungary’s level of GDP would be around 2 percent lower than in the baseline by 2026 under a scenario of further escalating global trade tensions.

Scenario A (see above) assumes economic divergence across the main global players, higher trade tariffs, heightened uncertainty, and tighter financial conditions. In this context, Hungary’s real GDP growth would be lower by 1.2 pp in 2025 and 0.8 pp in 2026. The higher impact compared to the euro area reflects Hungary’s greater trade openness.

Under the scenario, corrective fiscal measures may be needed,

the IMF stated.

Fiscal deficits would be around 1% of GDP per year larger through 2030 than in the baseline, i.e. the originally estimated 4.7-4.4% shortfall would be much higher, while the public debt ratio would be 5% of GDP higher by 2030, exceeding 80%.

Financing larger deficits would require additional borrowing and could pose potential liquidity risks

given banks’ high sovereign debt holdings and FX borrowing that is already above the authorities’ self-imposed 30% of total debt threshold," the IMF said.

Staff would recommend offsetting most of the impact through corrective measures and delivering a high-quality fiscal adjustment.

Implementation should be smoothed over the medium term, to avoid an immediate procyclical response. Targeted fiscal support to affected households would be needed and should be financed by reprioritizing spending,

the IMF staff stessed.

The shock is expected to be modestly disinflationary, potentially creating room for the MNB for easing faster than under the baseline, subject to exchange rate developments.

"The direct effects of reciprocal tariffs on inflation are likely outweighed by lower global commodity prices and reduced activity in Hungary.

Assuming forint pressures remain contained, inflation would move to target faster than under the baseline allowing the MNB to maintain a looser stance than under the baseline.

"Exchange rate flexibility would help absorb shocks, but if volatility causes disorderly market conditions, the central bank should take steps to restore market functioning. Reserve coverage is expected to stay in the adequate range if current account deterioration and capital outflows remain limited."

The IMF expects the banking sector to remain adequately capitalized, though.

"Some lessons can be learned from the MNB’s 2024 stress tests modeling an escalation in geopolitical tensions, which showed that banks’ aggregate capital ratio would remain adequate following a much more severe shock to growth.

If risks to financial stability begin to materialize and the banking system appears poised to tighten lending beyond what is justified by the broader economic conditions, the MNB could consider lowering the countercyclical capital buffer.