We continue to believe that despite the year-to-date cash-flow based deficit reaching 81% of the full-year deficit target by May, the budget situation still looks manageable. However, we can pinpoint some key slippages, namely less inflow via indirect taxes on the revenue side and higher debt servicing costs on the expenditure side.
Despite the year-to-date bleak performance, the government is committed to the 3.9% Maastricht-deficit criteria, but a slight adjustment might be needed to ensure that the target is met. The need for an adjustment significantly increases next year as both sides of the budget are more uncertain based on our gloomier outlook versus the government’s.
In addition, the revival of the excessive deficit procedure in 2024 should alert policymakers that fiscal discipline should not be up for debate.
After extreme scenarios have been priced out, the central bank started effective normalisation in May, by cutting the rate of the O/N quick deposit tender by 100bp to 17%. The normalisation process started by emphasising the separation of market stability (ensured by the overnight tools) and price stability (cured by the base rate).
In this regard, a cut in the base rate is not on the table yet, as the merger of the effective rate with the base rate must happen first. We expect this convergence to be finalised by September, following which we see the first cut in the base rate in December.
However, as highlighted by the NBH, positive real interest rates are needed to support the disinflationary process, at which point we believe Hungary can turn its back on the era of negative real rates for good.
We believe that labour shortage has evolved from a cyclical to a structural problem, which entails a long-term inflation risk, hence the need for a tighter monetary policy stance in the future. In this context, we have not seen widespread layoffs, which could explain the resilience of the labour market that, in our view, will continue.
The story is different for real wages. Amid sky-high inflation, March is the seventh consecutive month in which real wage growth has been negative, but we expect a turnaround in the fourth quarter. In our view, this is more likely to boost savings as households have already tapped into their savings to offset the impact of inflation. Therefore, this positive income shock implies less upside impact on inflation and more downside on GDP growth, in our base case.
Last year's energy crisis eroded the country's trade balance in goods, leading to a year-end current account balance of -8.2% of GDP.
As the energy issue appears to be easing this year, pressure on the current account from the import side is softening significantly, with the trade balance posting positive readings for the past three months. In addition, inflation has weighed on consumption and high interest rates held back investments, further reducing import demand.
Conversely, the export side carries huge growth potential, as new export capacities have improved significantly recently due to EV battery plants, while car manufacturers are dealing with large backlogs. With all these factors combined, we expect the current account to close this year with a balance of only -2.2% of GDP.
