Emerging Market Correction and Pressure on the Forint

Unfortunately Hungary's coming correction seems to be getting very near now. Portfolio Hungary reports this morning on the latest readings on the Calyon Risk Aversion Barometer. Caylon reported on Monday that global equity gyrations continue to dictate the direction of emerging market currencies, with risk aversion remaining high and European equities closing lower again on Monday. Indeed many currencies remained under pressure throughout the trading session yesterday. Budapest Economics also said yesterday that the HUF continued to be the most vulnerable currency in the region, with the currency temporarily hitting 259 against the euro yesterday, although it did finally manage to stabilize at slightly stronger levels by the end of the session.

Mitul Kotecha, head of global FX research at Calyon, confirmed the Budapest economics view, saying Hungary's forint appeared to be highly exposed to rising risk aversion. “Reflecting the vulnerability to risk aversion, correlations between the Calyon Risk Aversion Barometer and some emerging currencies are quite high at present," Kotecha is quoted as saying, adding that Hungary's forint “appears highly exposed to rising risk aversion, with the 1-month correlation between the Barometer and EUR/HUF at a strong 0.85." Of course, the HUF is also suffering from deteriorating domestic fundamentals, an aspect which of course he did not ignore.


Stefan Wagstyl, picks up the theme to some extent, and has another long and relevant piece in the Financial Times this morning, reflecting just how a change in tone is taking place even as I write.

The turmoil in financial markets is turning into a nerve-racking test for the economies of central and eastern Europe and the former Soviet Union. Economists have said the fast-growing region faces a slowdown following the financial shockwaves reverberating around the globe. But the precise impact is uncertain, especially on weaker economies.

The differences are registering in the financial markets. As investors reconsider their strategies, they are becoming more risk averse. Some have turned against emerging markets, including the ex-communistregion. Others are discriminating more between countries.

The spread on five-year credit default swaps (a measure of risk) has widened by 26 basis points for the Czech Republic since last June and by 44 basis points for Poland. But for Serbia and Ukraine the increase is 151 basis points; for Kazakhstan it is 218 basis points.

Given the recent unprecedented credit-fuelled growth surge, this slowdown could be welcome in countries trying to cope with inflationary pressures, including Ukraine, Kazakhstan and Russia, and those facing labour shortages, such as Poland.

The benefits could be even greater in economies facing yawning current account deficits, notably the Baltic states, Romania, Serbia and Bulgaria. As Leszek Balcerowicz, the former Polish central bank governor, told a business conference this month: "We should welcome some amount of a slowdown, especially in the Baltic states, which have been growing the fastest . . . We don't have the information that would make us predict a hard landing. Based on the current information a soft landing in the countries which have been growing fastest is more likely."

I am not as optimistic as Wagstyl is here that we will see soft landings. The existence of virtual currency pegs - which will need to be broken during the correction - virtually guarantees an abrupt change, as does the level of household debt in non local currency .

Wagstyl had an earlier FT piece where he drew attention to the way in which ageing populations and labour shortages were playing their part in this emerging crisis.

Fuelled by strong economic growth and soaring foreign investment, employment is increasing in availability just as emigration has sucked around 5m workers from eastern to western Europe. According to Eurostat, the EU’s statistics agency, labour costs are growing at their fastest rate since the end of Communism – with a 30 per cent increase in nominal costs in Latvia in the year to last September and rises of more than 20 per cent in Romania, Estonia and Lithuania. In Poland, the largest new member, the rise was just under 12 per cent.

In real terms, average gross wages in Poland rose more than 7 per cent in the first nine months of 2007 and in Romania by nearly 16 per cent, according to the Vienna-based Wiiw research institute.

While unemployment levels in western Europe have stayed at around 8 per cent since 2002, in the east they have slid from 14 per cent to under 9 per cent. In the region’s booming capital cities, almost everybody who wants work has a job. Leszek Wronski, head of the central Europe division of KPMG, the accountant and management consultant, says: “We have a job market controlled by employees.”


Even if labour markets ease a little, there will be no return to the super-abundance of workers of five years ago. The region’s populations are ageing even faster than in western Europe and, with the added effects of migration, the number of working-age people is falling in the Baltic states and central Europe. Eurostat predicts that the population of the new member states will decline from 103.6m in 2004 to under 100.6m in 2015, with particularly sharp drops in working-age people.

However, for governments and companies alike, rising labour costs and growing skills shortages raise big questions about the region’s future competitiveness. Everything from decisions on investment location to education, migration and population policies is coming under scrutiny.

So even while he doesn't directly go into how long term fertility may be playing a role in the drama we are watching unfold before our eyes, his mention of "population policy" seems to be a euphemism for this very topic. And if fertility isn't an important determinant in what has been happening, I would be grateful is someone could explain to me why we aren't seeing similar sorts of labour shortages in places like Thailand, Turkey, Chile, Brazil or Argentina, all of whom are growing - or have been, Turkey has slowed recently - very rapidly at the present time.

Back on the 28 August 2007 - just after the financial "turmoil" started - I posted the following, in a piece which still looks extremely good when looked at in the cold light of today, on Global Economy Matters:

"But any looming "credit crunch" is also likely to affect the so called "risk appetite" (that is the willingness to invest in riskier areas or activities) and the place where this is most likely to be felt is in the emerging market area. Those emerging markets which are considered to be most vulnerable will undoubtedly have the hardest time of it, and this brings us directly to Eastern Europe I think and to economies like those in the Baltics, Latvia, Estonia and Lithuania), to Hungary, and then maybe (if there were to be contagion) to the larger economies like Poland and Romania. Alarm driven reports about the dangers of a hard landing in the Baltics have been floating around for some months now (I say alarm driven not because the danger isn't real, but because most of the reports are quite superficial, and don't really appreciate the magnitude of the problem). Whatsmore, as the Bank for International Settlements pointed out in the June edition of its quarterly review , in 2006 Eastern European economies accountedfor a staggering 60% of new emerging market credit:"

At the start of September, and as part of an in depth analysis of Turkey, I posted the extract you will find below. The issue here is foresight, and our ability to see things coming. What is happening now has been obvious for some time, completely obvious, even if many people have had difficulty in seeing it. I completely resist the idea that economics cannot be scientific. I think it has to become much more of a science. But if we are to get from here to there we first need some paradigmatic models which enable us to see things coming rather better than we appear able to do right now.

In a much quoted paper - published back in 2004 by two UCLA economists (Schneider and Tornell) - it was argued that:

"In the last two decades, many middle-income countries have experienced boom-bust episodes centered around balance-of-payments crises. There is now a well-known set of stylized facts. The typical episode began with a lending boom and an appreciation of the real exchange rate. In the crisis that eventually ended the boom, a real depreciation coincided with widespread defaults by the domestic private sector on unhedged foreign-currency-denominated debt. The typical crisis came as a surprise to financial markets, and with hindsight it is not possible to pinpoint a large "fundamental" shock as an obvious trigger. After the crisis, foreign lenders were often bailed out. However, domestic credit fell dramatically and recovered much more slowly than output."

In starting off with this quote I really want to draw attention to two things.

First off, the way in which the current sub-prime liquidity problem in the banking sector of many developed economies is now steadily extending itself into a credit crunch in several emerging market economies. We are now beginning to see a clear and all too familiar pattern. There has been a lot of talk about the Asian crisis, and evidently there are some similarities with the pre 1998 situation, especially, as I shall be arguing over the coming days, in the emerging economies of Eastern Europe.


Secondly there is the "typical crisis came as a surprise to financial markets" argument, since it puzzles me why exactly this should be, or better put, why it should be assumed as a "stylised fact" about currency crises that such major events are in principle not forseeable. I find this very hard to accept. Are we really so inept we are not able to see trouble coming when it finally does come? Is economic theory really so useless in the face of complex "on the ground" facts. Something inside me resists this view. We ought to be able to see things coming, even if we need to distinguish between the where and the when. What I mean is that it should be possible, if the theories you are working with are worth any sort of candle, to pinpoint the areas of likely vulnerability. On the other hand, given that often seemingly random events precipitate the ultimate unwind, it is pretty well impossible to say in advance which random event will turn out to be the detonator on any given occassion.

The sub prime debt issue in the US is a good case in point here, since only at the start of August the Federal Reserve were assuring everyone that problems associated with the US housing market were well under control, while obviously they weren't and aren't, and equally obviously, now, such problems will be seen from the vantage point of hindsight to have played a key role in the events which are now unfolding before our eyes.

So even with this caveat, and with due regard for the well known problem of human fallibility, lets see if this time any of us are able to do just that bit better than normal, and in attempting to see things coming lets see if we can learn something which may make us better able to handle and foresee macro economic problems in thefuture.

For a fuller analysis of the specifics of Hungary's present crisis see "Just Why Is Hungary So Different From The Rest of the EU10?", "Hungarian Central Bank Leaves Interest Rates Unchanged" and "The EU Comission Warns Hungary on 2008 Budget Deficit".

For e theoretical exposition on why fertility matters to the EU10, see Claus Vistesen "Catch Up Growth and Demographics - Evidence from Eastern Europe".

Hungary Retail Sales November 2007

While the Hungarian government - according to Portfolio Hungary - was busy trying to refute a statement attributed to Prime Minister Ferenc Gyurcsány by both the Associated Press and Neue Züricher Zeitung, suggesting the PM expected GDP growth to drop to around 1% in 2008, KSH was quitely publishing yet another piece of evidence not only that he might have done well to say what is being clained he didn't, but that in fact he could quite reasonably have suggested the number might be significantly less (ie that any forecast at this point needs to be hedged by the recognition of considerable downside risk). The data in question which were quitely coming out of Portfolio Hungary related of course to retail sales.

Hungarian retail sales dropped by 0.4% month on month in November, double the rate in the previous month (-0.2%), according to data adjusted for calendar and seasonal effects published by the Central Statistics Office (KSH) this morning. There has not been a single month to date in 2007 when the KSH did not report a m/m decline.

Here are the charts for the index itself and for the monthly y-o-y change. I think - in conjunction with what you can find in the other posts on this blog - that they speak for themselves - and in a pretty eloquent way.

Hungary Government Debt To GDP Ratio

According to the Government Debt Management Agency (ÁKK) yesterday Hungary's government debt rose HUF 880 billion or 6% year on year to HUF 15,585 bn in 2007, and Hungary's government debt as a proportion of GDP fell 1.3 percentage points to 60.6%.



As reported in this post, the budget deficit for 2007 was probably in the region of 5.7% of GDP.

March 9 Assigned to Referendum

Hungarian President László Sólyom has this week assigned 9 March as the date for the proposed referendum. Portfolio Hungary give the results of an IPSOS poll 48% of those polled said they would turn out at the referendum, which was forced by the main opposition party Fidesz to abolish the doctor visit fee, the daily hospital stay fee and university/college tuition fee.

52% of the respondents said a victory of the ‘yes' votes should prompt the government to cancel these measures, while 36% of them said the cabinet should resign in this case.

The researcher said 69% of Fidesz voters and 45% of Socialist Party (MSZP) voters said they would cast their vote, but the majority of both group would say ‘yes' to all three questions.


Since the measures the opposition party want to overturn are really at the heart of the austerity package being implemented, I'm not really sure how Ferenc Gyurcsány could survive a defeat (which doesn't mean to say he won't be able to). The quantities of money - estimated to be only several hundred million euros - are not that important, but they are important symbolically - since they involve a recognition of the fact that with rapid demographic ageing Hungarian really can't afford a 2 star welfare system, let alone a 5 star one. This is a tragedy, but that is the way it is, and money can't be whisked up out of nowhere to change things. Of course it would help if people started - at the official level - to face up to the rather dire mix of macro economic policy problems Hungary is now drifting rather perilously into.

According to Reuters:

BUDAPEST, Jan 23 (Reuters) - Hungary's President Laszlo Solyom has set March 9 as the date for a referendum proposed by the main opposition centre-right Fidesz party on abolishing doctor and hospital visit fees and university tuition fees.

The referendum, dubbed by Fidesz as a vote of confidence on the government, aims to overturn some of the key economic reform measures of the ruling Socialists, whose popularity has been hit by the unpopular measures. "This is about the future, not the past," Fidesz Deputy Chairman Zoltan Pokorni told a press conference on Wednesday.

The Socialists popularity has fallen to about 13-16 percent, according to polls, while support for Fidesz is about 34-40 percent.

Polls also indicate the referendum questions would pass easily but turnout, traditionally very low at referendums, may be a problem.

Political think-tank Political Capital said if turnout is high and the vote is valid, it may weaken Prime Minister Ferenc Gyurcsany's position but does not mean that the government will fall or that he will be replaced.

"The Socialists, taking political rationality into account, wouldn't have to automatically replace their prime minister, but in case of defeat, Fidesz would clearly talk about the complete failure of the government and their programme, which would make political stabilisation difficult," Political Capital said.

The Socialists' ratings suffered after they took action to lower the budget deficit to about 5.7 percent of gross domestic product in 2007 from over 9 percent a year earlier through tax and price hikes coupled with spending cuts.

The Socialists have dismissed calls for the government to quit if defeated in the vote.

Doctor visit fees generated about 22 billion forints ($125 million) in 2007, helping reduce overall healthcare costs.

EU Comission Warns Hungary on 2008 Budget Deficit

The EU commission published this morning its convergence programme assessment for Hungary and warned that slower-than-forecast economic growth over the next two years may adversly affect deficit-cutting plans and told the government to take further measures if needed. According to economics Commissioner Joaquim Almunia:

Hungary must take adequate action to ensure the correction of the excessive deficit as planned, where necessary through additional measures.

I think this point is absolutely obvious, and I realise that in many ways this is a routine document, but I do feel that the way the Commission is expressing itself seems to suggest that they are completely out of touch with the real tightrope Hungary is being forced to walk at the moment. Here is the relevant part of the full text:

Thanks to the consolidation measures and structural reforms, Hungary is set to considerably outperform its 6.8% of GDP deficit target for 2007. It also improves the target for 2008 to 4% of GDP compared to the previous programme which, in view of the better-than-expected outcome in 2007, is both feasible and desirable. However, the lower deficit targets are combined with higher-than-previously-planned expenditures on the back of better-than-expected revenues, which cannot be counted on after 2008. Moreover, from 2009 the achievement of the budgetary targets is subject to increasing risks, linked mainly to possible expenditure overruns if the wide-ranging reform agenda is not fully carried out. Ensuring the adjustment is durable requires a strengthening of fiscal governance and the completion of structural reforms. This is also crucial in order to improve the long-term sustainability of public finances, for which Hungary remains at high risk, and to move towards lasting convergence.

In view of the Commission assessment and of the recommendation under Article 104(7) of 10 October 2006[3] and given the need to ensure sustainable convergence, the Council should invite Hungary to: (i) rigorously implement the 2008 budget, take adequate action to ensure the correction of the excessive deficit by 2009 as planned; where necessary through additional measures; and allocate the better-than-expected revenues to further deficit reduction, also given the insufficient margin in 2009 in view of the risks, thereby also contributing to accelerating the pace of debt reduction towards the 60% of GDP threshold; (ii) ensure permanent expenditure moderation by continuing to enhance fiscal rules and institutions and by adopting and swiftly implementing the remaining streamlining measures announced in the fields of public administration, healthcare, and the education system; (iii) in view of the level of debt and the increase in age-related expenditure, improve the long-term sustainability of public finances by making adequate progress towards the MTO, and continue to reform the pension system as announced after the initial steps taken in 2006-2007.

As I indicated in this post yesterday Central Bank monetary policy is effectively stuck, and from now on will be driven by the need to try to protect the value of the forint against the currency risk involved in all the non-forint denominated external borrowing. A difficult external environment will make increasing exports very hard, tight internal monetary conditions will weaken internal demand, and if additional fiscal tightening is brought into play then there will be no platform to put under the downward spiral in the economy.

This is now a difficult situation indeed. Hungarian economic growth was only 0.9 percent in the third quarter, the slowest annual rate in the EU. The government expects expansion to accelerate to 2.8 percent this year and 4 percent in 2009, but this forecast now seems hopelessly optimistic.

Prime Minister Ferenc Gyurcsany has already carried out a campaign of cutting public sector jobs, raising taxes and reducing subsidies to slash the EU's widest budget deficit. Hungary was aiming to narrow the budget shortfall to within the 27-nation bloc's requirements by next year from an estimated 5.7 percent of gross domestic product in 2007, but again, and as the EU commission recognises, this now seems very optimistic indeed.

On the other hand, there is one growing source of funds for Hungary at the present time, the European Union itself. Portfolio Hungary reported today that:

According to preliminary data, Hungary received over EUR 1.1 billion worth of funds from the European Union in 2007, more than 1% of gross domestic product expectedly generated last year.

The result of the warning was not hard to predict since the forint weakened to 258.45 per euro by 12:24 p.m. this morning in Budapest from 256.94 late yesterday.

As I said in my January 2008 forecast on Hungary only a couple of weeks back:

I will be very surprised if we see calendar year 2000 as high as 1.8%, but more to the point 2.6% seems to be assuming a strong rebound, an assumption for which there is no real substantive evidence. In particular even to get what growth we have been getting in 2007 the Hungarian govenment has been running a deficit of around 6% of GDP. This is going to tighten yet further in 2008, so there is no supportive fiscal environment. And as I keep arguing, it is very hard to see a supportive monetary one. The IMF in their October World Economic Outlook also put a similar figure of 2.7%, while the EU commission in November 2007 came in with the same 2.6% as the OECD.

I think I am reasonably confident in holding to my recession forecast for 2008, although of course, "recession" does not mean negative growth for the whole year (technically it is simply 2 consecutive quarters of negative growth), so we might then go on to see what, between 0.5 and 1% growth over whole year 2008 (and the only really doubt is whether the contraction starts in Q4 2007, or in Q1 2008). But it is what happens in 2009 and 2010 that matters really, and at this point so many variables are in play (and interrelated ones to boot) that I can only say I envy those who have the courage - or the temerity - to stick their necks out). And of course, if we get a large correction in the value of the forint, then all those carefully weighed and weighted forecasts will, without a shadow of a doubt, go straight and directly off into the bin.

Hungarian Central Bank Leaves Interest Rates Unchanged

In what was hardly a surprise move Hungary's central bank kept its benchmark interest rate unchanged today, after surging food prices and rising oil costs helped keep inflation at an unacceptably high level. The 12 members of the central banks monetary policy committee left the two-week deposit rate at 7.5 percent today. The council even discussed the possibility of raising the rate, to 7.75 percent, for the first time since February 2007. The decision was ``relatively clear,'' central bank President Andras Simor said afterwards at a press conference in Budapest.

Future rate cuts now hinge on the so-called second-round inflation effects, including wage cost growth, and on international market developments, the bank said in a prepared statement. The mention of intenational market development could be read as meaning that after what happened to global stocks today the external environment can no longer be considered to be benign, and the forint may need defending with interest rate policy. But here we are effectively caught in a policy trap, since in order to export we precisely need a more competitive exchange rate, but the level of swiss franc indebtedness makes this virtually impossible to contemplate at present.


Forward-rate agreements show investors have scaled back expectations for rate cuts in the next six months. The spread between the six-month forward rate and the base rate fell to seven basis points from an average of 40 basis points in the past six months. A basis point is equivalent to 0.01 percentage point. The three-month money market rate is 7.5 percent, the same as the central bank rate. That compares with a difference of as much as 24 basis points on July 23, also a sign of reduced expectations for lower rates.

Hungary's inflation rate rose to 7.4 percent in December from 7.1 percent in November.

Update Tuesday 22 January

Well the interpretation Andras Simor put on the debate and the decision confirms my earlier impression, the central bank has now withdrawn the easing bias, and is prepared to raise interest rates to protect the forint, even if internal demand in Hungary gets strangled in the process. Portfolio Hungary quote Eszter Gárgyán of Citibank as follows.

“Risks from domestic influences on the CPI outlook have been apparent in recentmonths, while the unwinding of global risk aversion has pushed risk premiums higher and depreciated the forint. We believe global market turmoil is likely to persist in the coming months, limiting the scope for monetary easing, as the exchange rate is still the key transmission mechanism to inflation."

She also makes the strong point that the MPC's statement “no longer hints that the next step will be a cut, as in previous months, due to deteriorating global sentiment, indicating that external factors are likely to remain the driver of Hungarian interest rates in the coming months".



My only minor quibble with this view is that more than of inflation the exchange rate is the key transition mechanism for what is known as translation risk, ie the danger that unhedged borrowers see a sudden and unsupportable rise in their borrowing costs. My guess is that the stranglehold on internal demand will be strong enough at some point to invert the inflation into deflation, unless there is a significant weakening in the value of the forint, which would, of course, also imply significant private debt default. No easy answers here.


This piece from Bloomberg this morning is just an initial warning shot. Mortgage backed coverd bonds in the East European context can't possibly sustain a AAA rating, and once market participants wise up to this, and the implications of that fact, then watch out. (Some explanation of what covered bonds are all about in the context of the Spanish cedulas hipotecarias can be found here).

Standard & Poor's may trim its top ratings on as many as 22 asset- and mortgage-backed securities insured by Ambac Financial Group Inc. as the effect of the bond insurer's downgrade spread to emerging markets.

S&P placed its AAA credit ratings on 18 securities backed by future cash receivables, three Mexican residential mortgage- backed securities and one bridge loan transaction on review for a possible downgrade, according to an e-mailed statement.

Ratings on securities issued by Banco Itau Holding Financiera SA of Brazil's Diversified Payment Rights Finance Co., Banco de Credito del Peru's CCR Inc. MT-100 Payments Trust, and Hipotecaria Su Casita SA's Construction Loan Trust, among others, were affected, the company said.

S&P is reviewing Ambac and MBIA Inc., the largest of the so- called monolines, casting doubt on the ratings of the $2.4 trillion of debt guaranteed by bond insurers. Ambac's Ambac Assurance Corp. was lowered two levels to AA and may be reduced further, New York-based Fitch Ratings Inc. said on Jan. 18.

Of course, this afternoon we have also seen another example of central bank reaction in the form of the emergency cut announced by Governor Ben Bernanke. The difference in approach and room to manoeuvre couldn't be clearer, as can be seen from the following quote from the Bloomberg article announcing the cut:

Policy makers set aside concerns about inflation to lower borrowing costs for the fourth time since September after unemployment hit a two-year high and U.S. stocks slumped. Chairman Ben S. Bernanke shifted the Fed's stance to a more- aggressive approach in remarks this month citing a need for ``decisive and timely'' action.

Now a couple of things need to be said here. Firstly, and for the sort of reasons I have been explaining on this blog the Hungarian Central Bank now doesn't enjoy the kind of liberty of action which the US Fed does, although it might be a useful exercise for people to ask themselves sometime how it was that we got here. So Hungarian monetray policy is in a bind.

Secondly , concerns about inflation have not eased everywhere, and I'm not talking about the eurozone in this context, since I think with the general slowdown inflation there will fall into line soon enough. However I do think that this is where we might look for the real "de-coupling" and fissures which are developing in the global economy - the distinction between those emerging economies which can grow rapidly - due to their favourable age structure - without provoking excessively high levels of inflation, and those which can't. Obviously Eastern Europe is in the front line here, and beyond Eastern Europe points further east passing through Ukraine and Russia and then onto China (where of course the now famous - or infamous one child per family policy was introduced some 30 odd years ago now. How important will this decision prove to be for China's growth capacity? Well we are all about to find out, as they try to stage manage their growing inflation problem by raising interest rates even as the US lowers.

So, as the rebalancing continues, and money keeps arriving willy nilly the "emerging economies" this is where I think we might see the tear in the sailcloth. Indeed, as I suggest here, we migh already be seeing in, as in countries like Romania and Hungary monetary policy moves away from internal demand management and onto protecting the value of the currency.

Hankook Tyre's Q4 2007 Results

It is hard to know how to interpret the following news release from Bloomberg:

Hankook Tire Co., South Korea's biggest tiremaker, reported a 72 percent drop in fourth-quarter profit because of a loss of about a 20 billion won ($21 million) at its new plant in Hungary.

Net income dropped to 7 billion won from 25.3 billion won a year earlier, the Seoul-based company said in a regulatory filing today. The loss at the Hungarian factory was from start- up costs, spokesman Calvin Pak said in a phone interview without elaboration.

Start-up costs can, of course, be playing a significant part, but I suspect that there is more here. The thing most of the commentators seem to be missing is the corrosive effect that the endemic inflation and the rising currency values will more than likely have on the future path of inward investment. I have the impression that the Hankook plant was really Hungary's showpiece in greenfield investment project until only recently, and this sort of news isn't going to make it any easier to sell more such projects, whatever the actual explanation for Hankooks initial results.

Hungary Construction November 2007

Well, only yesterday I was saying:

But when we consider that government spending can be down, domestic demand can be down, construction can be steady to down and exporst can come under very heavy pressure from the external slowdown, it is hard to see where Hungary is going to get GDP growth from this year. There seem to be no counter-cyclical measures available here at all.

and just today, as if to echo my worst fears we get the news that in November 2007 Hungary's construction output plummeted 22.7% year on year, according to both unadjusted data and figures adjusted for working days, according to the Central Statistics Office (KSH) this morning. This compared with a 20.1% and 21.0% yr/yr decline in the previous month, according to the equivalent data. That is to say that the situation got worse in November. We also know that industrial output slowed in November, so my advice is watch out for the Q4 2007 GDP data.



There was a 2.2% fall from October, according to data adjusted seasonally and by working days (ie this is not attributable to seasonal factors), following a 2.9% m/m seasonally adjusted growth in October. In the first 11 months of 2007 construction output was down by 12.8%. The stock of new orders at the end of November was down by 32.6% year on year, so don't expect any early improvement here, since if this is any indicator the first half of 2008 can be significantly worse than the first half of 2007. Also of note is the fact that in the civil engineering sector the stock of orders was down by 54.3% year on year, against a year on year drop of 51.9% a month earlier. As I said yesterday, fiscal tightening means the government cannot react to try and offset the huge drop in demand. With monetary policy also effectively at a standstill Hungary is entering recession with no counter cyclical remedies whatsoever available. Very difficult is what I would say.

Hungary Fiscal Deficit 2008

Hungary's Finance Ministry announced today that he expects the public sector deficit to reach HUF 27.5 billion in January and total HUF 1,111.2 billion in 2008, which would correspond to 4.0% of gross domestic product. State secretary István Várfalvi told a press conference this morning that the ministry expects a budget gap of HUF 581.5 billion or 2.1% of GDP for the first quarter. Hungary posted a surplus of HUF 48 bn in December 2007 (see this post here, which in addition to details contains some argumentation), against the ministry's forecast for a HUF 14 bn deficit. The annual cash-flow deficit (excluding local governments) amounted last year to HUF 1,291.4 bn or 5% of GDP, in line with the preliminary figure announced on 8 January, the ministry confirmed.

The original target was for a gap of HUF 1,668 bn, so the actual figure was HUF 377 bn lower than planned and down by HUF 750 bn from the gap registered in 2006. According to Finance Ministry estimates, GDP growth was 1.5-1.7% last year, while the country's external financing requirement dropped to 4.5% of GDP, ministry official Katalin Haraszti said. The government's forecast in the last update of its Convergence Programme, which was sent to Brussels on 1 December, was for a GDP growth of 1.7% and external financing requirement of 4.1% of GDP.

Basically, if external events do not intervene, we would have to expect pretty low growth this year due to the ongoing and systematic squeeze on government spending, plus the contraint on monetary easing which the central bank is under, which in part is driven by a need to contain inflation, but also now increasingly will e driven by a need to protect the Forint given the high level of swiss franc denominated external debt.

But when we consider that government spending can be down, domestic demand can be down, construction can be steady to down and exporst can come under very heavy pressure from the external slowdown, it is hard to see where Hungary is going to get GDP growth from this year. There seem to be no counter-cyclical measures available here at all.

Hungary Wages and Employment November 2007

Hungary's monthly average gross wage rose more than expected in November, making it even more difficult for the central bank to justify cutting what is currently the European Union's second-highest interest rate. Average monthly wages rose at an annual rate of 9.3 percent to 205,193 forint ($1,180), according to data released by KSH - the Budapest-based statistics office - earlier today.



Central bank policy makers, who will next discuss interest rates on Jan. 21, last month said the increase in inflation expectations, as reflected in wage developments, was a risk to price-growth targets. The central bank has kept the benchmark two-week deposit rate at 7.5 percent since September after two cuts earlier in 2007.


Private sector wages - excluding bonuses - rose 8.5 percent from a year ago. The pace of increase slowed from 9.7 percent in October. Public sector wages, on the other hand, increased from an 8.5% rate in October to a 14% annual rate in November, hence the jump in the average monthly figure.



At the same time net real wages (subtracting changes in the CPI from net wage increases) after falling sharply earlier in 2007 have now significantly stabilised.



Hungarian trade unions and business leaders on Dec. 21 agreed to increase wages by between 5 percent and 7.5 percent this year, following staements from the central bank that the agreed figure would be pivotal for rate policy. Central bank President Andras Simor four days earlier said an agreement of 6 percent would be consistent with rate-setters' forecasts. Basically the central bank will now probably adopt a wait and see approach, looking carefully at January's inflation and wage increase data before taking any decision on rate cuts. This, of course, is a big problem, since stagnant internal demand, and a deteriorating external environment mean that the Hungarian economy badly needs some stimulus.


On the other hand, despite the fact that unemployment has remained reasonably contained, employment creation is weak to negative, with the number of Hungarians in full time employment running at 2.75 million in November, 2.3 percent less than a year earlier. The government has shed 5.7 percent of its jobs in a year, reducing the number of public workers to 729,600. The apparent inconsistency between falling employment and steady unemployment is doubtless partly to be explained by the ongoing ageing of the Hungarian labour force.

Analyst Opinion

Raffaella Tenconi, Dresdner Kleinwort, London, as quoted in Portfolio Hungary

“The pick up in gross earnings was mostly the reflection of a negative base effect and a pick up in public sector wages. Private sector earnings rose by 7.6%yoy, down from 9% in October. Public sector income grew by 14%yoy, up from 8.5% in October."

“Earnings growth dropped by about 3 percentage points between October and November of last year as a result of changing in the timing of some bonus payments. Construction, real estate, renting and business activities remain the sectors experiencing the fastest wage growth within the private sector."

Excluding one-off payments, wages rose by 6.1%yoy, down from 6.8%. Private sector wages continued to grow rapidly, at 8.5%yoy, but moderating from 9.7%yoy in October.

“Net earnings (ex. tax payments) growth continued to recover, although adjusted for inflation earnings continued to fall in the private sector."

“Total employment fell by 2.3%yoy in October. Private sector jobs contracted for a fifth consecutive month and we expect this process to continue in coming quarters."

“It remains difficult to ascertain how much of the ongoing wage growth is due to the continuing whitening of the economy (more people declaring their full earnings) and how much is due to sticky inflation expectations."

“The outcome of the wage negotiations proved in line with the NBH assessment, but it remains to be seen whether these recommendations will be followed. Certainly, a weak labour market should keep wage pressures at bay. All in all, we expect the MPC to maintain a cautious stance in coming months, the next 25bps cut could come in late Q2 at the earliest."

Also we need to keep a close eye on what is happening in the stock markets at the moment. Yesterday Bloomberg ran this story:

Central European shares fell for a sixth day, led by OMV AG and PKN Orlen SA, the region's biggest refiners. Austria's ATX extended its drop from a July record to more than 20 percent, a common definition of a bear market.

The NTX Index of 30 companies in the region fell 4.2 percent to 1,716.37 at 1:08 p.m. in Vienna, heading for the lowest close in 10 months.

Austria's ATX Index lost 4.5 percent to 3,833.1, bringing the drop since closing at a record on July 9 to 23 percent. A bear market is widely defined as a decline of 20 percent or more in a 12-month period. Austria followed Poland, Singapore, Hong Kong, Sweden and Japan in entering a bear market after last year's U.S. subprime-mortgage collapse.

The Austrian banks are the most exposed should there be any large correction in central and Eastern Europe.

Update, Thursday Afternoon:


The same tonic continued today. According to Bloomberg:

Central European shares dropped for a seventh day, sending the NTX Index to a 10-month low. The Czech benchmark index entered a bear market, falling more than 20 percent from last year's high.

Komercni Banka AS, the third-largest lender in the Czech Republic, and PKN Orlen SA paced declines.

The NTX Index of 30 companies in the region lost 0.7 percent to 1,720.62 at 1:27 p.m. in Vienna as 18 stocks retreated, 11 rose and one was unchanged.

The Czech PX Index sank 1.6 percent to 1,545.50, bringing the drop since reaching a record on Oct. 29 to 20.2 percent. A bear market is widely defined as a decline of 20 percent or more in a 12-month period. In the region, the Czech Republic followed Austria and Poland, in entering bear markets after the collapse of the U.S. subprime-mortgage market last summer.

Poland's WIG20 Index retreated 0.8 percent and Hungary's BUX Index dropped 1.3 percent. Austria's ATX Index added 0.1 percent

As I say, this all needs watching very very carefully at this point. Could the correction be starting even as I write?

Friday, 18 January 2007: the sell-off continued for another day today, although Hungarian stocks actually rose slightly.

As Bloomberg report

Central European shares declined for an eighth day, the longest losing streak in two months. Erste Bank AG, Austria's biggest, and Komercni Banka AS led losses.

The NTX Index of 30 companies in the region declined 1.6 percent to 1,694.69 at 10.32 a.m. in Vienna, heading for the lowest close in more than 10 months. The measure has lost 8.2 percent this week.

Austria's ATX Index dropped 1.7 percent, the Czech PX Index slid 3.3 percent and Poland's WIG20 Index retreated 1 percent. Hungary's BUX Index added 0.3 percent.

Benchmarks in Austria, Poland and the Czech Republic dropped more than 20 percent from last year's highs this week, the common definition of a bear market, amid concern that the U.S. will enter a recession.

Erste Bank slid 2.1 percent to 39.05 euros today, while Komercni Banka, the third-largest in the Czech Republic, slumped 4.3 percent to 3,496 koruna. Raiffeisen International Bank Holding AG, Russia's biggest foreign lender, lost 1.6 percent to 79.68 euros.

Telekom Slovenije d.d. fell 1.9 percent to 340.20 euros. The shares have dropped 10 percent since Jan. 14, when the Slovenian government extended the auction of a 49.13 percent stake in its national phone company for a third time, with two bidders left.

Hungary Inflation December 2007

Hungarian inflation accelerated in December as oil and energy prices increased, producing what I think is a real problem as it makes it much more difficult for the central bank to seriously start reducing what is the European Union's second-highest benchmark interest rate. The inflation rate climbed for a third succesive month to 7.4 percent from 7.1 percent (even as domestic demand remains decidedly weak), the Budapest-based statistics office said today. Prices rose 0.4 percent from the previous month.



Core inflation, excluding volatile food and energy prices, rose 0.6 percent from the previous month and 4.8 percent from a year earlier. The full-year average inflation rate was 8 percent, compared with the central bank's November estimate of 7.9 percent.

Grain producer prices in the first 11 months were 67.8 percent higher than a year ago, while fruit costs rose 41.4 percent, according to the statistics office. Food prices account for 22.4 percent of the consumer-price index. The cost of vehicle fuels rose 2 percent in a month, while food prices were up 0.8 percent from November. The cost of cooking oil surged 9.2 percent, cheese was up 2.8 percent, baked goods and milk rose 2.4 percent each.

So even after economic growth slowed to 0.9 percent in the third quarter - the lowest pace in the EU, according to revised figures released on Dec. 7 - the pace of inflation will probably convince policy makers to put off cutting borrowing costs.


The ever interesting Dániel Bebesy, of CIB Bank, Budapest is quoted by Portfolio Hungary as follows:

“The breakdown reveals that food prices still remained elevated and explained the difference compared to our forecast. Nevertheless the 0.8% m-o-m increase is definitely smaller than during the previous two months. Consumer durables showed deflation again, and service prices hardly changed in December both are clearly positive for the NBH."

“Short based core inflation data however showed a 0.6% m-o-m rise, excluding processed food prices the figure came around 0.4% slightly higher than during the previous months, which might indicate slight pass through from rising food prices, and call for cautiousness."

“December CPI data does not clear the picture, regarding the monetary policy outlook the January data will be much more important. The forecasts are spread out in a wide range, our forecast is still below 7.0%, lower than the consensus."

“The timing of the administrative energy price hikes can be decisive. The service sector usually adjust its prices during the fist couple of months of the year, price increases should remain moderate showing no pass through from food price shock to reassure the NBH. Sharper than expected food prices mean that the 6.3% NBH CPI forecast for Q1 looks optimistic and likely to prompt the NBH to stick to its cautious monetary policy."

The bank's rate-setting Monetary Council on Dec. 17 left the benchmark two-week deposit rate unchanged at 7.5 percent, the EU's second highest behind Romania, as policy makers pledged to keep inflation expectations from rising to prevent the effects of surging food and fuel costs from spreading across the economy.

``In this situation, we have to return to our primary goal of reaching price stability,'' Gregor Simor said on Nov. 28. ``We have to follow monetary policy that will lead to this, and until we reach price stability, we basically can't pay attention to the growth aspect.''

So basically we all get to sit nervously biting our nails to see what January brings, and what else might happen in the meantime.

Hungary Budget Deficit 2007

Hungary's budget deficit as calculated by European Union standards was probably 5.7 percent of gross domestic product last year, the narrowest since 2001 according to Finance Minister Janos Veres in a press conference in Budapest this morning. The shortfall, which compares with an original deficit forecast of 6.8 percent of GDP for 2007 and 9.2 percent deficit in 2006, is a first estimate at this point. The final figure will probably be between 5.5 percent and 5.8 percent, Veres said.





Now while this improvement in Hungary's finances is very welcome, I think we should all be bearing in mind that the very low GDP growth reading we have been getting in 2007 were in the context of a still very accomodative (to the tune of possibly 5.5%) fiscal stance. This support is going to be gradually withdrawn, and the Bank of Hungary will have great difficulty easing interest rates and thus loosening the monetary stance, even while the external environment (think exports) is deteriorating quite rapidly. I therefore fail to see where all the short term optimism - ie that things are going to get better, rather than notably worse, comes from quite frankly.

``Budget policy was influenced by disciplined spending and the fact that there was extra revenue from a whitening of the economy,'' Veres said. ``There was more revenue from taxes and social security contributions than we planned.''

Hungary has budgeted a deficit of 4 percent of GDP for this year, still exceeding the EU's limit of 3 percent. The country will be ``near'' the 3 percent mark by 2009 as a result of ``disciplined'' budget policies, Veres said. It is precisely this kind of fiscal tightening, which is undoubtedly necessary, which makes me question the unrealism of some of the estimates we are seeing for future growth.

Better than expected revenue in 2007 totaled 362 billion forint ($2.1 billion), including 152 billion forint from higher income taxes and social security contributions as a result of wages rising more than expected. A crackdown on tax evasion yielded 80 billion forint more than planned in revenue, more than half of it collected from personal income tax. Interest expenses were 105 billion forint less than planned because Hungary was able to borrow at lower yields than the government had expected.

Hungary Industrial Output November 2007

Hungarian industrial production grew in November at a slower annual pace, raising concern about the recovery of the European Union's slowest-growing economy. Production rose 5.5 percent from a year earlier and 0.1 percent from October, the Budapest-based statistics office said. The annual rate compares with 5.9 percent in the previous month.



This fits in with the general slowdown picture we have been getting, and does not constitute a positive feature towards the outloook for Q4 2007 growth.

As Daniel Bebesi from Bank, Budapest says:

“The November data showed that the sharp drop in October was not an outlier, and this does not bode well for Q4 GDP growth at all."

I couldn't agree more. He also says this:

“In 2008 we expect slight pick up in case of the domestic sales and moderate decline in case of the export. A possible sharper slow down in the euro zone could severely endanger any kind of growth recovery in Hungary"

German output is evidently very important for Hungary, and we just learnt that manufacturing industry in Germany contracted in November from October, and in general the German economy is slowing considerably (please see this post today here). My feeling many optimists are trying to be positive, but are living in a parochial world which is completely out of touch with broader macro economic trends, and also fails to see why we should not be quietly waiting for some sudden "turnround" here. Things are going to get a good deal worse before they start to get better, and we should be recognising this openly now. The limit is what happens to the current account deficit when the demand for foreign currency loans peaks, and these inflows no longer compensate for the external investors pulling there money out. This is when push will really come to shove.

Hungary Producer Prices November 2007

Hungary's industrial producer prices inflation rose to 0.7% month on month in November from 0.3% in October, and to 0.4% from -1.4% year on year, the Central Statistics Office (KSH) reported on Friday.



Domestic price inflation was also higher, 0.9% m/m (vs. 0.8% in Oct) and 5.4% yr/yr (vs. 4.0% in Oct). Producer prices in the manufacturing industry climbed further up by 1.3% m/m against a 1.1% increase in Oct. Export sales prices in November fell by 3.6% yr/yr against a fall of 5.7% in the previous month and +2.7% in Nov 2006. In monthly terms the KSH reported a 0.6% rise, following a 0.1% fall in Oct and -1.6% m/m in Nov 2006.

Food price inflation rose to 11.5% yr/yr from 9.9% in the previous month.