MOST LIKELY REGIMES AND THEIR PROBABILITIES
18-Month: Fidesz-MPS 70%
Five-Year: Fidesz-MPS 45%

FORECASTS OF RISK TO INTERNATIONAL BUSINESS
Turmoil Financial Transfer Direct Investment Export
Market
18-Month: Low C B+ B
Five-Year: Low B- B B-
( ) Indicates change in rating. *  Indicates forecast of a new regime.

 

KEY ECONOMIC FORECASTS
Years Real GDP Growth % Inflation % Current

Account ($bn)

2007-2011(AVG) -0.6 5.4 -3.52
2012(F) -1.2 5.4 1.95
2013-2017(F) 1.8 3.6 -2.10

IMF Deal Essential, but Far from Assured

Populist economic policies implemented by Prime Minister Viktor Orbán’s government have tarnished Hungary’s reputation among investors, while political reforms seen as undermining the independence of state institutions have drawn heavy criticism from the European Commission, creating both an urgent need for a new lending agreement with the IMF and an obstacle to securing it.

Orbán’s government has requested a three-year precautionary loan of at least $19.7 billion from the IMF, which, if obtained, will ease pressure on the forint, creating some room to lower interest rates and enabling the government to exchange expensive short-term debt for more affordable loans with longer maturities. But even if Budapest meets all of the conditions for restarting talks, which include significant revisions to several recently approved pieces of legislation, securing a loan agreement will not be easy.

In late April, the government unveiled a package of tax increases and spending cuts totaling 2.3% of projected GDP. The measures include new taxes on telecommunications services and financial transactions, along with reduced outlays for drug subsidies and spending cuts at ministries. While that might be enough to satisfy the EC, the IMF has indicated that negotiations for a loan will include discussion of Hungary’s 16% flat tax on income, a centerpiece of the governing Fidesz party’s economic program and, according to Orbán, a non-negotiable issue.

Economic realities may force Orbán to reconsider his position. The government’s budget deficit projection for 2012 is based on assumed real GDP growth of 0.1% this year. However, preliminary figures indicate that the economy contracted by 0.7% in the first quarter of 2012, and the recently announced spending cuts and tax increases are likely to delay a return to positive growth. By stubbornly defending the flat tax, Orbán will not only deny his government a useful tool for boosting revenues, but will also risk creating conditions of prolonged economic stagnation.

The abandonment of the flat-tax scheme will not be popular, but the prime minister has limited options in that regard, and given his party’s current dominance and the fact that no election is required until 2014, it is probably in his interest to act sooner rather than later.

Slow Recovery with a High Risk of Reversal

The economy is forecast to contract by 1.2% in 2012, and assuming the conclusion of a lending deal with the IMF and the release of the EU cohesion funds, a return to positive growth is likely in 2013. However, any rebound will be weak, and if those assumptions are not borne out, another contraction would be likely in 2013.

A conservative monetary stance by the MNB will help to limit the risk of inflation stemming from currency volatility, but increases in consumption taxes implemented to contain the budget deficit will push inflation above 5% in 2012.

Planned tax cuts are likely off the table for the foreseeable future, and the potential for fiscal moves to boost growth over the medium term will be limited by a persistent risk of currency volatility that necessitates the maintenance of a tightening bias by the MNB. In any case, concerns about fiscal stability and debt sustainability will undermine economic potential, resulting in average annual growth of just 1.8% through 2017. The anticipated relaxation of fiscal discipline once the immediate crisis is over will contribute to currency weakness that complicates efforts to contain inflation, which is forecast to average 3.6% per year through 2017.

The size of the current account deficit will in large part be determined by fluctuations in the income deficit, which will narrow as levels of profit repatriation decline over the medium term. In general, the current account deficit will remain well below the historical trend (in GDP terms) throughout the five-year forecast period, averaging about $2.1 billion per year, or about 1% of GDP, through 2017.

Economic Forecasts for the Three Alternative Regimes

  Fidesz-MPS Center-Right Coalition MSZP-led Coalition
  Growth

(%)

Inflation

(%)

CACC

($bn)

Growth

(%)

Inflation

(%)

CACC

($bn)

Growth

(%)

Inflation

(%)

CACC

($bn)

2012 -1.2 5.4 1.95 -2.3 6.2 1.25 -4.5 6.5 0.75
2013-2017 1.8 3.6 -2.10 0.7 5.9 0.50 1.4 4.4 -2.30

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