Statement by the Monetary CouncilPrint
The current annual rate of economic growth in Hungary is approximately 3%. Although it is below both the growth rate that has been experienced over the past years and the rate of potential growth, it exceeds the annual average growth rate in EU member states considerably. No significant pick-up is expected to materialise either this year or in 2004. In fact, in order that the current rate can be maintained or perhaps slightly increased, EU economies would have to improve their current flat performance and economic growth would have to start to pick up speed.
Signs indicating recovery include the fact that the growth rate of US economy, relying fundamentally on increased productivity, was in excess of 7% in Q3. Hopefully, this will also boost economic growth in the EU. However, there are some uncertainties surrounding this expectation. For the time being, the most that we can expect is that recovery in EU economies will provide better external sales opportunities for Hungarian economy, which in turn may lead to growing exports and industrial production.
There are also promising signs in Hungarian economy. There has been an increase in both producer and consumer confidence indexes, and investment also seems to have taken off. However, both increasing consumption, unsustainable over the long term, and households’ demand for investment are expected to subdue markedly in 2004. Nevertheless, even if there is an upswing in the business cycle, growth rate is hardly likely to exceed 3 to 3,5% in 2004. It is true, that yet again expansion in investment and exports will be the engines of growth in circumstances more favourable now than in the past period.
Hungary’s EU accession in May 2004 will not trigger more rapid economic growth automatically. EU membership is a historic opportunity. Whether we make the most of it depends mainly on domestic economic policy.
The European Central Bank anticipates a further pick-up in the business cycle in 2005, which is also expected to create favourable conditions for maintaining export-driven growth in Hungary. Yet, the rate of growth is unlikely to exceed 3.5 to 4% in 2005. The reason for this is that restoring macroeconomic balance, which has deteriorated significantly, will take long years, and 2005 will be one such year. This will only allow very little room for growth in internal demand.
As to the labour market, unambiguous signs of corporate wage adjustment to disinflation, expected to materialise since the year-end 2001, have still not materialised. Companies seem to have adjusted by reducing labour usage, i.e. by reducing the number of the average worked hours and shedding manpower. Although upward trends in the rate of unemployment came to a halt in early 2003, this was mainly due to a dynamic increase in employment in the public sector. There are no such signs in the private sector. This year’s slowdown in nominal wage adjustment is highly likely to be transient. Owing to global competition, adjustment in manufacturing is expected to remain slow despite recovery in the global business cycle. This allows for the possibility of improved profitability in the sector, on the decline since 2000. As far as market services are concerned, consumer demand, considerably lower than in the past years, and the wearing off of the effects of the minimum wage raises over the past 2 years are expected to contribute to more moderate wage inflation.
To a major extent foreign investors judge Hungary on the basis of developments in the external balance. As a result of growth fuelled by domestic consumption in the past two years, the current account deficit has increased considerably – in 2003 it is expected to reach 6.4% of GDP. The current account deficit is indicative of the country’s external borrowing requirement, in other words, it is a total of domestic economic agents’ savings and investment balances. A high external borrowing requirement is to a major extent due to the fact that, although the net general government borrowing requirement has decreased in comparison to 2002, it is still high in 2003. A change in households’ saving habits also contributed to the increase in the current account deficit. In the past decade, the population has been in a net saving position. However, as a result of preferential credit facilities and the fast income increase characteristic of the past few years, households’ propensity to save has declined and currently the sector’s borrowings grow by nearly as much as its claims. Contributing to offsetting the deterioration in the position of general government and households was considerably lower borrowing abroad on account of weak corporate sector investment activity.
Although high deficit indicators have given rise to worry among economic agents, it is important to emphasise that the MNB has been expecting deterioration of the current account balance for quite a time. The Bank’s projections have increased only slightly since the beginning of the year. However, in a future perspective the Bank maintains that, if fiscal consolidation continues at the required pace, the deficit will slowly decline. Hungary’s participation in the co-ordinated conduct of economic policy in the European Union from next year and the Government’s commitment to the adoption of the euro as of 2008 provide a guarantee for decreasing government financing needs year by year. The expected drop in the external borrowing requirement is further supported by the fact that the tightening of housing loan subsidies are expected to dampen the expansion of household borrowing. If the European business cycle recovers as expected, the business sector’s net borrowing requirement may increase, but this will be financed in an automatically more healthy structure. This means that, although there are considerable risks, prospects are essentially indicative of a shift towards sustainability.
As of 2004, a different methodology will be applied in the compilation of the balance of payments statistics. In order to comply with the international practice, reinvested earnings of non-resident businesses will be recorded differently. Reinvested earnings will be recorded as deficit increasing items among income transfers within current items, but it will also automatically increase the balance of foreign direct investment, and thus finance the increased deficit. This methodological change is expected to increase the stated deficit by approximately 2% of GDP and, accordingly, the inflow of direct investment. The higher value does not, in itself, represent any change in the actual macroeconomic equilibrium position.
The Hungarian economy continuously imports capital, non-resident investors play a major role both in the foreign exchange and the government securities markets. Consequently, the country’s economic stability depends to a major extent on international capital market developments. The risk perception of the Central and Eastern European region has recently deteriorated. In addition to Russian political events, this is due to the fact that investors do not consider the speed of fiscal consolidation satisfactory in some countries of the region, and therefore they are afraid of a delay in the introduction of the euro. The recent worsening of risk perceptions has also affected the Hungarian markets, leading to wide fluctuations in forint yields and the exchange rate. In order to avoid overshooting caused by excessive market reactions and closing of positions caused by technical reasons, the Bank maintained the liquidity in the government securities market by conducting open market operations. The Bank does not have a specific yield target for the long end of the yield curve – the intervention was not justified by the level of yields but by negative developments in market liquidity.
Maintaining convergence investors' confidence is fundamental for preserving macroeconomic stability, which can only be achieved by meeting the convergence criteria in 2006 by ensuring that fiscal and monetary policies are implemented in a consistent manner. Progress with convergence is the best guarantee of reducing Hungary's vulnerability to capital market speculation.
In its inflation forecasts, the MNB has assumed that the government deficit would exceed the originally planned 4.5%, although it would be substantially lower than in 2002. Consistent with the Government's plans, aggregate demand will be further reduced by 1% as a proportion of GDP; however, the government deficit will likely exceed the plan in 2004, due to the high 2003 base. The adoption of the euro in 2008 will require undertaking a substantial fiscal adjustment, which can be implemented conduct a tight and consistent economic policy during the remaining period. In order for Hungarian firms to be competitive on the markets of the European Union, the fiscal adjustment programme has to be implemented in a way that the overall tax burden does not increase and the redistributing role of the government declines continuously. In this context, savings from staff reductions in the general government sector in 2004 are a positive sign. In the absence of the necessary reform of the general government sub-systems, growth in the Hungarian economy may lag behind its potential growth for a sustained period.
Prospects for inflation in the next two years are shaped by opposite trends. Over the short term, the Council expects the rate of inflation to pick up. This results form the fact the MNB has only partially succeeded in offsetting the inflationary pressure resulting from the rapid increase in domestic demand in the past two years; however, the fast rise in real wages in the past years has also been a contributing factor. Looking ahead, the Council expects domestic demand and primarily consumption to slow considerably, which may help ease inflationary pressures in the next two years. Another factor supporting the disinflation process, the forint has strengthened in the past few months and has risen near to its level in the period preceding the depreciation in June.
Despite the favourable long-term outlook for inflation, the change to the tax regime in early 2004 will likely lead to a one-off increase in price levels. The increase in indirect taxes on final consumption may raise the 2004 consumer price index by 1.6 percentage points to some 6.6% on a yearly average. However, this increase in prices on account of the tax regime change is not expected to have a lasting inflationary pressure – excluding the one-effect of the changes to taxes, inflation will likely be around 5%. This can only be met, if the transient increase in prices is not built in inflation expectations and the price and wage agreements for 2005 are concluded in a forward-looking manner, taking account of inflation by eliminating the effects of one-off measures. It is not necessary for monetary policy to react to the transient increase in inflation by tightening conditions, if it does not lead to an increase in expectations and does not put the end-2005 4% inflation target at risk.