1. EXECUTIVE SUMMARY
2021 promises to be a tough year for Prime Minister Viktor Orban, who recently became the longest-serving prime minister in the history of Hungary. He is likely to face an economic and health crisis, which threatens to hurt the popularity of his Fidesz party, which has ruled the country with a supermajority in parliament since 2010. The risk of losing popularity at home comes at a time when Hungary's illiberal strongman is becoming increasingly isolated in Europe after his threat to torpedo the EU's budget and recovery fund. 2021 will be about preparing for the crucial 2022 spring general election as polls show a united opposition neck and neck with Fidesz. Local governments will continue be squeezed by the central government, leading to conflicts.
Hungary is on track for its steepest recession in 2020 and it will take until mid-2022 to return to pre-crisis levels. Hopes of a V-shaped recovery were dashed in the autumn as the second wave hit the country harder than the first wave. The economy could contract 6-7% in 2020 and bounce back by only 3.5% in 2021, which is much lower than projected in the summer when the 2021 budget was approved.
Budget and debt outlook
For nine years, Hungary managed to keep its deficit target below the 3% required by the Maastricht rules, but in 2020 the government deficit skyrocketed and is set to reach 9% of GDP. To finance the ballooning debt, Hungary ratcheted up bond issues and tapped the FX markets after a long hiatus. The rising financing need of the budget is expected to boost state debt to near 80% of GDP, erasing the gains of five to six years of steady declines. In 2021 Hungary plans to rely heavily on retail investors to finance the deficit, which was recently revised to 6.5% of GDP from 2.9% due to the deteriorating macro outlook and rising social spending.
The majority of sectors were affected negatively by the pandemic. Tourism, accounting for 10% of GDP, collapsed overnight as foreign guests disappeared. Industry has shown resilience with the solid performance of the key vehicle and electronic sectors. The government continued to push on with a generous subsidy scheme for foreign companies to boost investments and maintain headcount, but the jobless rate has doubled from the earlier 3% low. The application for wage subsidies was cumbersome. The ruling Fidesz party has rejected providing cash grants directly to citizens as this is in a conflict with the work-based society ideology touted by Orban.
Investors who bet on the weakening of the forint made huge gains in 2020. Stocks underperformed for most of the year until a massive rally in the final months of the year closed the gap with developed markets.
2. POLITICAL OUTLOOK
Unlike the attacks on his main foe, Hungarian-born billionaire George Soros, or illegal immigrants (which for most Hungarians are invisible threats), Orban is faced with a real enemy that he cannot control, that is, the coronavirus pandemic. The biggest political risk for Hungary's strongman is an economy falling into a deep recession that could erode his solid voter base.
Before the crisis, Hungary's economy posted growth of near 5% for years, consumer confidence skyrocketed and retail sales showed a 5-6% yearly expansion on the back of double-digit wage growth since the mid-2010s. The economy thrived on the abundant liquidity of global markets and from the inflow of EU funds. But the golden years came to an abrupt end in the spring of 2020. Now the government is working to mitigate the negative impacts of the crisis in the hope of extending its mandate beyond 2022.
Hungary's parliament gave unlimited powers without time limit to Orban's government to rule by decree in the spring. This triggered widespread criticism abroad, even though in practice it meant little change in the day-to-day work of the parliament as Orban has a supermajority behind him.
The first wave cost relatively few lives in Hungary and in the CEE region thanks to swift action by governments to close their borders and issue lockdown orders, and citizens complying with the rules. Orban took credit for "winning the first battle", while opposition parties were left scrambling after initially crying wolf, when parliament took back control in mid-June. Orban could use that as a rebuke to his critics, who accused him of abusing his power.
In retrospect, Hungary's leader may have become complacent as the numbers stayed in his favour. The summer months passed by without the government making preparations for the second wave. After restrictions were eased in June, Hungarians flocked to the countryside and domestic tourism thrived.
The political cucumber season came to an end in mid-August when photos were published showing Hungarian Foreign Affairs and Trade Minister Peter Szijjarto in the Adriatic on board a luxury yacht owned by an oligarch who had won one state contract after the other. Just a few days before the story broke Orban urged Hungarians to stay in the country for the holiday. The way to keep the pandemic under control is "more Balaton, less Adriatic" he said. At the same time, around mid-August, tens of thousands of Hungarians were spending their holidays in Croatia, which at that time had a safe country rating even as new infections were on the rise.
The government waited until September 1 to enact further restrictive measures for inbound travel, but this may have come too late. Daily infections began to creep up from September and accelerated in the weeks that followed. Hungary had the most lenient rules in place in Europe at the end of October as football matches were held in front of tens of thousands of fans and mass protests took place. By November the pandemic spiralled out of control with 5,000 new cases per day, compared to just a few hundred a month earlier. The death toll was in the hundreds, making Hungary one of the worst-hit countries per 100,000 inhabitants.
Under pressure from its own health experts, the government introduced tough curfew measures on November 11 to curb the pandemic, weeks after similar measures had already been put in place in neighbouring countries. The prime minister apparently rejected calls for tightening, saying that the country must continue operating, citing the results of a national consultation survey.
The mismanagement of the pandemic in the autumn has given new momentum to the opposition, which is trying to exploit Orban's conflicts in the EU to their own advantage. Even as the government claims victory in the month-long EU budget debate, the prime minister failed to block the rule of law mechanism coming into force. He may have gained some time, but he will be under closer scrutiny, analysts said, adding that Orban has also become more isolated in Europe after threats to veto the budget and the recovery fund.
Fidesz's family party in the European Parliament (EP), the European People's Party, has long tolerated the democratic backslide in Hungary but 2021 could see Fidesz being thrown out of the largest EP fraction.
At home 2021 will be about preparations for the elections in the following year. Polls show a united opposition neck and neck with Fidesz. The ruling party will likely work to drive a wedge to weaken the cooperation of the rainbow coalition. Portraying the opposition as puppets of Soros or Brussels bureaucrats is also likely to feature in the toolbox of Fidesz communication spin doctors.
Recent polls show that opposition parties have already benefited from the sex scandal involving senior Fidesz MEP Jozsef Szajer, a founding father of the conservative party, and corruption cases.
Tensions between the central government and local governments will escalate in 2021. Municipalities, which are at the frontline in the fight against the pandemic, are squeezed by funding cuts and a fall in revenue. They were also banned by law from taking out loans. A government decree approved before Christmas halved the local business tax of SMEs for a year. The tax cut does little to help troubled business owners but is a huge blow for municipalities as the tax is a major source of revenue for them.
3, MACROECONOMIC OUTLOOK
The pandemic interrupted a period of strong economic growth in Hungary, with GDP hovering near 5% in the past few years, accompanied by prudent fiscal policy and falling state debt. The country's fundamentals were strong when the crisis hit in the middle of March. Economic activity still expanded in Q1 with an annualised 2.2% growth, but output fell by a record 13.6% in Q2 and by 4.6% in the third quarter, bringing the Q1-Q3 figure to -5.6%.
In July 2019 lawmakers approved the 2020 budget targeting growth of 4.6% and a 1% budget deficit. With the restrictive measures in place, Hungary’s economic activity is likely to weaken again in Q4 on a quarterly basis following a historic 11.6% rebound in Q3. The dip in Q4 could have a negative carry-over effect into early 2021.
Hungary is on track for its worst year since the 2008 economic crisis with a 6-6.5% recession. Economic activity may begin to normalise from 2Q21 as the vaccine becomes widely available, the Hungarian National Bank (MNB) said in its latest report in mid-December.
The MNB held onto a positive growth scenario until the summer but its latest forecast is in line with the market consensus and the cabinet's projection of a 6.4% drop. In 2021 the central bank sees a 3.5-6% growth, a rather wide range, reflecting high uncertainties surrounding the recovery. GDP could accelerate to 5-5.5% in 2022 and slow to 3-3.5% in 2023. Hungary's economy could reach pre-crisis levels in the second half of 2022. Without the government measures taken to manage the negative impact of the pandemic the economy would have contracted by 12% in 2020, according to the latest forecast by the finance ministry.
The government left the 2020 and 2021 GDP forecasts unchanged, predicting a 3.5% rebound after a 6.4% recession. In 2022 output could grow 5.4%, which would be an all-time high. In 2018 the economy expanded by 5%, which was the highest growth figure in the post-transition period.
Credit rating agencies Moody's, S&P and Fitch affirmed their sovereign ratings on Hungary in 2020, unchanged from 2019. Hungary's rating did not reflect the country's market assessment, government officials said before the pandemic. Unlike previous years, rating decisions were not much commented on during the year.
Fitch said the impact of the pandemic is set to cause Hungary's economy to contract by 5.9% in 2020, followed by a 5.4% bounce-back the next year and a 4.3% expansion in 2022. S&P sees a 4% contraction in 2020 then a pick-up of 4.5% in 2021. Recovery will depend on the rebound of domestic demand and the impact of the fiscal and monetary policy stimulus. Moody's projected a similar economic trajectory with a 4.8% drop and a 4% rebound in 2021. In the bi-annual autumn economic forecast, the European Commission saw Hungary's output down by 6.5% in 2020 due to large exposure to highly cyclical industries such as vehicle production, which was badly hit in Q2.
Hungary's inflation rate peaked in the summer, but receded in the autumn months, considerably easing pressure on the central bank in its monetary decisions. The MNB has recently revised the 2020 headline CPI to 3.4% for 2020 ,below the 3.5-3.6% range in September. Inflation could peak around 4% in Q2 due to the low base but it is likely to be 3.5-3.6% in 2021 before returning to the central bank target of 3% in 2022.
The MNB expects rising unemployment until the beginning of 2021 and employment could again pick up in mid-2021. Full employment, which is around the 3% level seen before the crisis, could be reached in 2022. The double-digit wage growth of recent years will slow to 7-7.5% in 2020-2023.
Pricing decisions are expected to continue to exhibit high volatility in the coming quarters, while in terms of underlying inflation, a prolonged economic recovery is likely to cause disinflationary effects to be persistent. CPI is expected to rise to "around 4%" temporarily in the spring of 2021. and average 3.5-3.6% in 2021. Core inflation excluding indirect tax effects — a bellwether of underlying inflation — will fall to 2.8-3% in 2021 from 3.7% in 2020.
Hungary's recovery will also be backed by significant inflows of EU funds. The country has been one of the biggest beneficiaries of EU money in the last two budget cycles. Claims by Orban during the heated EU budget veto debate that Hungary's economy can function without EU funds were questioned by many. Hungary could be eligible for €43bn from the EU budget and the recovery fund.
Hungary has pursued a tight fiscal policy and kept the deficit below 3% since being released from the excessive budget deficit procedure in 2013 after breaching EU deficit rules for nine straight years. At the height of the pandemic, Orban still stuck to the 3% target, calling it a red line that must not be overstepped, but as the crisis evolved, he changed course. As the economic outlook worsened, the deficit targets were revised multiple times from 1% to 2.7% then to over 6% and now the 2020 year-end target is around 9%.
In his annual hearing in the budget commission in November, Finance Minister Mihaily Varga confirmed that the economy will shrink 6.4% in 2020. Budget revenues are seen shrinking by as much as HUF1.7 trillion (€4.8bn) due to the lower tax proceeds, while pandemic-related health expenditures surged.
In mid-December, the finance ministry amended the 2021 budget goals from the original 2.9% deficit ratio to 6.5%. The deficit is expected to be close to 9% of the GDP. The pandemic had created a shortfall in tax revenue of around HUF1.4 trillion (€3.9bn), while expenditures on pandemic defence added up to HUF1 trillion and stimulus measures came to HUF3.7 trillion. The 2021 budget, approved in July, forecast a 3% recession in 2020 and 4.8% growth next year. As it turned out both projections were overly optimistic.
It is not just changing macro outlooks, but also new expenditure elements in the budget that made the government amend the target. Extra benefits for pensioners and salary increases in healthcare will add up to HUF400bn, in addition to the extension of family support schemes and investment subsidies. The net impact of the government's home renovation scheme and the reduction of VAT for new homes from 27% to 5% will be less severe as they are likely to induce growth and provide additional budget revenue, analysts said.
The state debt manager AKK adjusted its 2021 financing plans to the revised deficit targets. The majority of the funding comes from the retail sector and from forint wholesale bonds. The original plan was drawn up with a HUF1.5 trillion cashflow-based deficit, which was lifted to HUF3.3 trillion, only HUF300bn lower in nominal terms than the revised planned deficit in 2020.
Hungary's debt manager will seek to capitalise on growing demand from retail investors, a key strategy pursued by the AKK in recent years. It calculates a net HUF1 trillion increase in household debt in 2021.
Hungary's constitution stipulates that year-end state debt relative to GDP must decline each year until the ratio reaches 50%, but not under an emergency situation. The debt ratio is expected to rise temporarily in 2020 back to 80% again. Gross debt calculated according to Maastricht criteria peaked at 83.5% in 2010 and fell below 70% at the end of 2018. With the deficit going through the roof this year, it will erase five to six years of achievements in debt reduction.
Under the 2020 financing plant, the AKK was mandated to issue a €1bn FX bond in 2020, but as the financing needs of the budget grew it raised the target to €4bn. Hungary issued €2bn of Eurobonds in April, a €1.5bn green Eurobond in June, and the equivalent of €500mn in Samurai bonds in September. In November just before Orban unveiled his first veto threat to the EU budget, the debt manager took out €2.5bn in long-maturity FX debt.
05. REAL ECONOMY
Hungary’s economy was affected by the pandemic due to its large exposure to highly cyclical industries such as the automotive sector as well as tourism and transport.
Tourism, accounting for 10% of GDP, collapsed overnight as foreign guests disappeared. Overnight stays by foreigners were down by 75% by October and hotel revenues by more than 50%. The country's capital is taking the largest hit as Budapest depends heavily on foreign guests. The second wave has also led to a significant drop in non-residential consumption. The worsening labour market situation and precautionary behaviour of households are also weighing heavily on the retail sector, which underperformed in Q3.
Industry has shown resilience with the solid performance of the key vehicle and electronic sectors, which account for half of all industrial output. The growth trajectory of the sector is more favourable than it was during the lockdown in spring. In April the headline figure showed a 37% y/y decline, including an 80% plunge in the output of the automotive industry. It is telling that the sector accounted for only 10% of the total industrial output for the month compared to 25-26% on average.
Hungary's industry managed to recover from the plunge and has reached pre-crisis levels. October data shows that the onset of the second wave has not yet had a significant impact. Industry could be among sectors making a positive contribution to Q4 GDP, by as much as 1-1.5pp. This is in part due to massive investments in the manufacturing sector. The government made it a priority to provide state subsidies to companies making new investments on the condition that they maintain headcount.
There has also been a clear shift to focus on electromobility. Over the past three years, investments in this field totaled over €3.5bn. East Asian companies operating in electric vehicle (EV) battery production are heavily present in Hungary.
Hungary has become one of the leading international centres of business services in the CEE region over the past decade. Companies in the sector employ 64,000 people.
Hungary is also luring investors with the lowest corporate tax rate in Europe, at 9%.
The MNB estimates that the contribution of net exports to growth will be negative, due to the performance of services exports, but Hungary's trade surplus remains firmly in the black. Hungary's industry is slated for a 14-16% expansion in 2021 after a 5.5-6.5% decline in 2020.
The pandemic has pushed back Hungary's high-flying construction sector to 2018 levels, with a HUF4 trillion output. The sector posted growth between 20-30% during 2017-2019 on the back of massive EU inflows and a surge in residential construction. The sector was already in a slowdown phase before the crisis after the VAT on residential construction was raised to 27% from 5% from 2020.
Developers cut back on new projects but ongoing development continued despite the pandemic. Industry association Evosz expects a 10% contraction in 2020 and a 5% recovery in 2021. Industry players are cautiously optimistic about the sector's outlook after the government reintroduced the preferential 5% VAT from 2021, in addition to the launch of a major subsidy for home renovations.
Hungary has seen a surge in unemployment during the first wave from a record low jobless rate near 3% up to 6%. In the summer months, the labour market consolidated. Companies began to lay off staff from November again. The temporary wage subsidy programme that helped many companies expired in August
Companies complained that the application for the furlough programme was cumbersome. The scheme was extended for companies in tourism, catering, and transport, but hundreds of thousands of people were left without any help.
The ruling Fidesz party has resisted providing cash grants directly to citizens, which goes against the work-based society ideology propagated by Orban. The government has also rejected calls to extend the shortest jobless benefit in Europe. With these moves, Fidesz risks turning many middle-class voters against the government, analysts say.
6. MARKETS OUTLOOK
The global market sell-off in equities sent the the benchmark BUX index of the Budapest Stock Exchange (BSE) to 30,000 points in March from 46,000 at the beginning of the year. For much of the year the index hovered in a tight range, After the first news about the vaccine and US elections, the index broke out of the range and rallied from 32,000 to 42,000 points in six weeks. After a 18% rise in 2019, the BUX index is likely to finish the year down 8%.
The EUR/HUF rate kicked off 2020 below 330, but at the height of the pandemic the value of the forint plummetted to a record low of 370 against the euro. The central bank's intervention and the roll-out of the one-week deposit facility ended the slide. The Hungarian currency was one of the weakest performing EM currencies this year, losing 10% versus the euro, after a 4% drop in 2019, due to the ultra-dovish policies of the central bank, which officially does not have an exchange rate target. The forint's weakness for much of the year has been within the comfort zone of the central bank, which sees a weak currency as supporting the government's export-oriented policies.
The MNB is widely seen as maintaining its loose monetary policy in the coming years to support economic recovery. The base rate at 0.6% is not expected to change next year, but the one-week deposit rate at 0.75% could change in the light of the market environment and inflationary trends. Economic research institute GKI expects the Hungarian currency to weaken in 2021, albeit at a slower rate. It sees the annual average EUR/HUF rate at 360 in 2021, after 351 in 2020. The official EUR/HUF rate of the MNB was set at 365.3 on the last day of the year. This meant that the forint shed 10.5% of its value in 2020. In 2003 and and 2011 it depreciated by 11%.