What is Fidesz's game plan now that Hungary's economy is passing from seven years of plenty to seven years of scarcity?
April 28. 2022. – 08:18 AM
Prime Minister Viktor Orbán is a prisoner to many promises; if he could, he would retain the fixed utility costs, the single-rate tax, and price freezes, but something has to be done about the ballooning deficit and severe inflation.
"It was Orbán and his associates who did the cooking – they should be the ones who have to eat it."
This assessment was perhaps the only positive (albeit schadenfreudian) thing that could be plucked from the comments of the many disappointed voters on April 4th [the day after Hungary's elections]. But the claim is flawed on multiple levels. For instance, Covid – which has been the source of many problems for Hungary's economy – global inflation, and the Russian-Ukrainian war are all examples of external factors which Hungary did not have a hand in. In any case, the allegation suggests that the Hungarian government has put itself into a rather difficult situation, so it would be only fair if they found the way out of this pit.
There are plenty of things for which the Hungarian government should be held responsible. These include the wave of uncollateralized handouts (presumably for vote collection) following the seven bountiful years (loads of EU funding, international liquidity surplus, low interest rates, and moderate raw material prices), such as the tax rebate. And let's not forget the numerous market distortions – such as administered prices – that put the budget, various companies, and sectors in a difficult position. But in hindsight, it seems a mistake to have exhausted all the ammunition during the good times (the famous "high-pressure economy"): the many loans, debenture programs, grants, and long-term contracts that were often given to politically loyal companies.
What exactly is this pit they must climb out of?
But what is the pessimistic diagnosis and what measures will the new administration take against it?
- As Chief Economist at ING Bank Péter Virovácz points out, the inflation rate stood at 8.5% in March 2022. Moreover, rather than being limited to just one or two products, inflationary pressures are particularly wide-ranging. "Given the current data, we believe it increasingly unlikely that any plausible tightening measures by the central bank will bring inflation to the 3% target in 2023."
- The forint is weak – sometimes drastically so – and although this has its positive aspects, such critical levels (for a while, the euro was worth over 400 forints) are dangerous. Granted, at the time of this article's writing the euro is "only" 380 forints.
- Lajos Török, senior analyst at Equilor Zrt., also notes that 73.3% of this year's predetermined deficit had already been reached by the beginning of April. The central subsystem's deficit for the first three months of the year was 6.2 billion euros. This means that either corrective measures are necessary or the deficit target (currently 4.9%) needs to be raised again.
- On top of that, the situation following the Russian aggression is also hurting the growth prospects of Hungary's economy (consider, for example, direct trade, Russian customers in the automotive industry, or the decline in Hungary's attractiveness to tourists given its proximity to the war).
- To this previous point we can also add – with a little political criticism – that Hungary's isolationist foreign policy can also undermine the ability of its economy to collaborate, trade, and attract capital. The most immediate of such issues: when will we receive RRF support and RRF loans from the EU?
- The many market-distorting measures (e.g. interest rate ceilings, fuel price caps, cuts in utility costs, fixing food prices) also reshape much of the economy: at times they contribute to the fight against inflation, at times they hinder it. But they also cause losses for the public and private companies concerned, and they hamper energy transition and efforts to reduce our dependence on Russia.
Such are the difficulties. However, there are some notable wins: GDP growth remains high, as does the pace of wage growth. Employment figures are also very good (i.e. unemployment is low, and the structure of the labor market has improved).
What action will the new government take?
Considering the way Fidesz-KDNP has been operating so far, along with their first statements following a successful election cycle, it seems that Prime Minister Orbán does not want to tamper with public subsidies. In addition to the often mentioned utility charges, it seems that the newly introduced food, fuel, and interest rate limits will remain in place.
And yet, neither is he planning any major structural adjustments to the tax system (such as progressive taxation). Rather, he will continue to try to operate with low personal and corporate taxes and high sales taxes (which, incidentally, don't appear to be taxes but just "prices"). And he will almost certainly try to patch up the budget with special revenue-generating measures, particularly sectoral surtaxes.
But Orbán has left himself an escape plan all the same. The Prime Minister indicated who the culprits would be well in advance: if Brussels presses for severing energy ties with Russia or it continues the push to go green, the cuts in utility costs will be difficult to maintain.
The gist of the message is that Hungary was heading in a good direction, but due to current circumstances, the only way the utility cost cuts and our European commitments (net-zero emissions by 2050) can coexist is if the EU helps. Otherwise, it will be Brussels' fault.
It's possible to infer well in advance how things will play out if surtaxes are introduced. The crosshairs will be set on sectors where there's a lot of foreigners, profits are being made, mobility is limited (e.g. factories), and associates of the System of National Cooperation won't be extorted (it will be harder to give them new contracts anyway because of the almost certain drop in investment).
In other words, banks and retail chains should brace themselves, telecommunication and energy companies might be spared, and the construction and insurance industries are likely to be out of harm's way.
It should be added that surtaxes always produce complex effects.
If the government appoints a commissioner for retail chains, a banking commissioner, or any sort of official, these individuals will be able to put forward new tax proposals with almost zero willingness to compromise.
With regards to retail chains, there's a belief that if this – indeed, predominantly foreign – sector, which comes with a very low profit margin and a high degree of technical professionalism, strongly opposes the taxes, then we Hungarians will gladly buy the chains from them. Whether this could lead to strong public discontent is another question. Just imagine what would happen if instead of Aldi or Lidl shoppers had to go back to Hungarian chain stores.
Banks and energy companies
Even domestic banks can expect to see a new tax. The sector has had high margins. But at the same time, it would be prudent for the state to set the tax so as not to overburden it. For example, lending activity shouldn't become limited. If the tax penalizes lending (e.g. a tax on the balance sheet total), banks will tighten up, which would be a disaster for Hungarian businesses.
In the energy sector, many companies are already suffering from the utilities war (MVM) and the fuel price caps (Mol). It would be difficult to continue burdening them – even if the latter does manage to win big on the Brent-Urals price spread (while the oil is still coming, Russian sourcing is particularly profitable). Of course, there are other players in the sector (Opus Global), but Fidesz has not been known for heavily taxing its own oligarchs, and this could now also be an obstacle in the telecommunication sector.
At best, the state would have to create a predictable market environment. If this isn't possible in such turbulent times, then at the very least it should ensure that banks and businesses can bear their losses (i.e. forgone profits). After all, as long as the market can withstand the externalities and as long as it is not expensive for the state to distort the market, the government has little interest in putting K&H, Erste, UniCredit or Raiffeisen, for example, in a difficult position in the banking market. However, Bankholding or Gránit Bank, for example, may have greater lobbying power.
The interesting thing about the banking market (unlike chains, for example) is that the owners are not that noteworthy from a foreign policy point of view either: the Germans are always harder to butt heads with, but the Italian, Austrian and Belgian governments have yet to brandish significant lobbying powers in Hungary.
Despite the administration's economic distortions (limited prices for gasoline, chicken frames and electricity), inflation remains a serious problem. According to Péter Virovácz, the average annual inflation rate is very likely to remain somewhere in the 8-9% range throughout 2022. The Hungarian National Bank may continue to raise interest rates in the coming months, but the rates can also be driven up or down based on how the war in Ukraine unfolds.
"So, despite the fact that fuel prices and some staple food prices have been frozen since February, inflation has not been curbed. March's runaway energy and raw material prices and the continued weakness of the forint's exchange rate will result in additional inflationary pressure. Prime Minister Orbán indicated that he will do whatever he can to ensure that the price-freeze measures can be sustained. As a result of this and current inflation figures, the likelihood of seeing double-digit inflation in Hungary this summer is expected to have declined.
Profits gained from reserves
Lajos Török says that despite all the difficulties, the Hungarian National Bank is not in such a terrible position. There are some assets on which the central bank is losing. However, the bank can be said to be "winning" on the foreign exchange reserves it has sold (redeemed). This is because the forint's weakening implies the revaluation of Hungary's foreign exchange reserves. Of the 38 billion euros in foreign exchange reserves, roughly 5 billion euros is in gold. If the central bank sells 1 billion euros when the value is 10 forints weaker than its cost value, this means a 10 billion forint profit for the central bank.
Update: In the section above, we had written earlier that the full revaluation of foreign exchange reserves is a gain for the central bank. To clarify, only the realized (sold) foreign exchange reserves can generate a profit. There have been examples where, for example, someone sold gold and bought it back at a higher price in order to show the profit. But merely revaluing foreign currency on the books does not result in profit.
The matter really isn't so clear-cut
But, for a moment, let's look beyond the fact that distortion lowers prices. If Hungarian households have to pay less for gas, electricity, milk and diesel, and if their loan installments are limited (i.e. interest rate ceiling), then there is more left over for other things – meaning that protecting people's pocketbooks has a significant inflationary aspect to it.
Moreover, a more far-sighted economic policy could even consider such aspects as the fact that if the Hungarian public were to also pay market prices for electricity, gasoline or gas:
- we would save more energy;
- it would trigger a reduction in Russian energy dependence;
- it would be worthwhile to undertake environmental projects (e.g. insulation).
However, this article is primarily concerned with macroeconomic issues, not environmental progress. The last time we saw this equilibration challenge was in 2011-2012, when the government looked at the problem arithmetically, came up with a nice 3% deficit target, and kept stacking the sums until it worked out.
If the government puts puzzles together like this, then Fidesz does not tend to proceed in a systematic manner but in a more ad hoc way. What do we mean exactly? Well, let's consider the fuel price cap, for example. It went something like this:
- 480 forints for gasoline will be good.
- But who would want to sell at a loss – who would be willing to run a gas station like this? Okay, let's oblige them to remain open.
- But what if this bankrupts Hungarian families who run the stations? No worries, we'll just make sure that the wholesale price is also limited.
- But then so many foreigners will come here to fill up that the security of supply will be at risk. Fine, foreign truck drivers won't get the same price as Hungarians.
- But the retailers still won't be able to make ends meet. Okay, then we'll cut taxes and give the smaller gas stations another 20 forints per liter.
Make no mistake, it is still better for the government to fix and patch-up a bad policy than to forcefully leave bad regulations in place. But these issues were foreseeable, and if the idea of consulting with experts weren't so alien to Fidesz, such struggles could be avoided.
There is some potential
Fidesz also has a lot of "potential", it's just that making use of it seems to be out of character for them.
According to János Kocsi, an expert at Amundi, domestic consumption could remain strong, partly due to employment being at an all-time high and partly due to government measures.
While public investment is expected to slacken, household investment could still rise thanks to favorable income developments and government stimulus programs.
But then what do we mean by saying that uncharacteristic measures may also be necessary?
If the ruling party were more willing to compromise on European values (real competition, anti-corruption, more neutral public media, tackling homophobia, cutting down on the persecution of NGOs), it would presumably be easier to get funding and loans (RRF funds). It could even bring in votes for them. The fact that Fidesz lost the traditionally right-wing area of Buda during the election should serve as a warning to the party. There are certainly many conservatives in these districts, but there are also many self-made successful, "western-minded" voters here who were no longer enticed by what the ruling party had to offer.
Similarly, there is a lot of potential for reining in pointless and overpriced investments, which can be done relatively painlessly. Even with a saturated labor market, Hungary's economy is attractive, with many investors arriving from Germany, Austria and even South Korea. The construction industry has absorbed much of the workforce, and nowadays, it's quite possible to earn a lot in Hungary even with minimal qualifications.
And of course there are downside risks. For obvious reasons top players here include anything that is Russian, gas, oil, nuclear, and even some lesser known topics like the Russian bank IIB or the Egyptian rail project.
There are risks and opportunities, but we really have to act. The government sector deficit for 2021 was roughly 10 billion euros, or 6.8 percent of GDP. We would like to see that number decrease this year, and yet, after just three months (i.e. one quarter), we are already at two-thirds of last year's level, or three-quarters of this year's planned level.
Fidesz absolutely abhors the terms "adjustment" and "curtailment", but they are inevitable. At most, the establishment will find another way to refer to them. And if it's presented well, some voters might even jump on board.
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