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Tuesday, February 19, 2008

Hungary Construction Output December 2007

Output in Hungary's beleagured construction industry plummeted by 20.8% year on year in December, according to both unadjusted data and data adjusted for working days, the Central Statistics Office (KSH) reported earlier today. This follows (or was up from) a 23.7% yr/yr decline in November and a 2.1% fall in Dec 20006.

The KSH reported a 2.1% rise in construction output month-on-month from November, according to seasonally and working day adjusted data. The compares with a 2.5% m/m fall in Nov and a 0.1% drop in Dec 06.

For whole year 2007, construction output was down by 14.1%, which was a much worse deterioration than the 2006 one, when output contracted by 1.5%.

Of course to some considerable extent this data is already behind us, and has been already reflected in the Q4 data reading. In other words, this data is already factored in to our view, and at best only confirms what we thought we already knew. The construction slump, as can be seen from the chart above, does now seem to have bottomed, and even eased slightly over November. But this unfortunately tells us little about whether or not the turn will now be upwards. This looks rather unlikely, since domestic credit and demand are unlikely to support a quick turnaround. What we will need to do now is look carefully at the data moving forward for signs of what it may tell us about the future.

In conclusion on the construction front, another indicator of the future is the stock of orders, and in the case of new buildings this seems to have improved slightly during December, since at the end of the month there were HUF 426.2 bn, up 9.4% yr/yr (in current prices, so remember inflation), which compares with a rise of only 3.2% in November. Public spending of course is totally mired in the fiscal problems the stock of orders for civil engineering was down by 53.2% yr/yr, against a drop of 53.4% in November and a 35.9% decline in Dec 06.

As an indicator of what might happen to future credit expansion in Hungary, a piece of research out today from Erste Bank may prove indicative. The loan-to-deposit ratio in the banking system in the Eastern Europe economies they studied. The chart below shows data from 2006, but it continues to be valid and reflects the way in which Hungary is way out above other countries in the region. Romania broke out of the middle of the group during 2007, with its loan/deposit ratio reaching 122% by year-end, thus becoming jointly with Hungary the most exposed economy in the region on this measure. Of course, one of the main drivers of the strong demand for loans was the more than 80% increase of FX lending, which is presently being driven by the cheaper money in Euro and Swiss francs.

Looking at the degree of leverage which is being attained, I smell covered bonds here, which is another name for offering investment grade to instruments which are way too risky for this (especially given the currency risk, which ultimately boils down to the willingness of the ECB to bail Hungary and Romania out at the end of the day by throwing them a euro lifeline. I seriously doubt that this is going to happen, and for the sort of mess your banking system can get into if you try to overleverage asset backed securities when you have little in the way of deposits, take a look at Spain, and the quagmire the Spanish banking system is steadily sinking into.

Of particular note is the following statement from Erste Bank:

In many CEE countries, the low penetration of loans provides the basis for the strong lending growth rates in the coming years. The main drivers for the loan growth in most of the countries are mortgage and consumer loans - a consequence of decreasing unemployment rates, rising GDP per capita and subsequently growing demand for consumer goods and housing

This quote really reflects very well the consensus MISREADING of this whole situation, and I'm afraid this isn't a nice friendly parlour room chat where you can try to be cleverer than me, and I can try to be cleverer than you, and may the best man win. This is about the real world facts of life, out there in the big wide world, and if we have learnt anything since the inflation fire started to rage in Latvia back in the spring of 2007 it is that this catch up growth just isn't going to be sustainable for underlying demographic reasons (read labour shortages and inflation reasons, see this post from Claus for more details). Not for one or two more years, let alone for ten (just see the kind of inflation numbers that are now starting to come in from Russia and China), so this whole pack of cards is just set to collapse if this is what people are expecting.

One of the problems I am having with the Hungarian data is that all the numbers simply don't seem to add up, and I am having difficulty seeing how with an ageing and (eventually) contracting workforce they are ever going to add up. Take savings.

If we look at public sector debt, this reached 65.9% of GDP at the end of 2007. No matter how successful the fiscal adjustment package has been, the public sector deficit was still large enough to make debt to GDP increase.

And if we look ahead to 2008, and the reality that GDP growth is likely to undershoot substantially government forecasts, while spending is more than likely going to overshoot, and interest payments are unlikely to drop much, even if the don't actually rise (it depends how long the HUF manages to hold the trading band) then it is more than likely that debt to GDP will rise again in 2008, in my humble opinion. In fact this opinion is not so radical as it sounds, since even the Hungarian cabinet expects debt-to-GDP to rise this year, and the question really is whether we should regard the Convergence Programme's 65.8% of GDP projection as reasonable, or whether we should begin to entertain the idea that there is going to be strong downside risk to this projection, in which case we might like to ask ourselves how the credit rating agencies will react to this eventuality (assuming we get through unscathed to that point).

Of course, according to the most recent Convergence Programme (as agreed with the EU Commission), government debt should have decreased (by 0.2 percentage point to 65.4%), and it is not yet clear what has caused the 2007 increase. So there is already slippage in the works.

If we come over now to the private savings balance, net lending of households (i.e. their net financial saving) was equivalent to 1.7 per cent of 2007 GDP according to preliminary financial accounts data published this week by the NBH. Obviously Hungarian household savings remain very weak. Household sector net lending amounted to HUF 372.6 bn in Q4, or 5.4% of GDP (unadjusted) and only 1.5% of GDP on a seasonally adjusted basis, which means internal savings are far from sufficient to cover the financing need of the state and corporates.

The low net household propensity to save is connected with the fact that alongside the gross accumulation of saving, they are also plunging rapidly into debt. This rising private indebtedness is strongly associated with the growing popularity of foreign exchange (and in particular Swiss France loans), with the balance of forint denominated loan transactions (allowing for repayments) well into negative territory. The problem is, as I say above, just how this process can ever square itself. Obviously Hungarian households badly need to save more and borrow less to get the savings rate - and the long term accumulated household wealth level - up. But if this happens, then there will be effectively no recovery in domesetic demand. Which means we are left with exports.

But here again we hit a snag, since even if Hungary finds some way to break the vicious circle of inflation, the HUF value and export competitiveness, there is still the question of the relation between dividend payments on equities (the income component on the current account balance) and the good and services trade balance. As we can see, there is a pretty steady relation between the increasing deficit on income and the increased surplus on trade, which passes through the increasing profitability of the companies who are exporting, and the dividends they pay to their shareholders, so away you toil on one front to run up a nice attractive looking trade surplus, only to find that a large chunk of what you thought you had gained suddenly leaks out again though the back door.

Just one more of the things that I don't see how can possibly be squared in the longer term.

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