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Tuesday, December 09, 2008

The NBH Cuts Interest Rates As Hungary Enters Its Second Recession In Two Years

Well, before I go any further, yes you read the header right, with the contraction of 0.1% in Q3 over Q2 (seasonally and working day adjusted data) reported by the national statistics office (KSH) today (Tuesday) the Hungarian economy has now entered its second recession since the start of 2007, since data revisions accompanying today's GDP detailed results from KSH show that they now estimat the economy contracted in both Q1 and Q2 of 2007 (by 0.2% in each case), thus satisfying the normal technical criterion for declaring a recession. Somehow I doubt the Hungarian press are filled today with headlines about this juicly little detail.

While the Q1/Q2 2007 detail is a purely technical recession, in the sense that it could just as easily disappear again in a subsequent data revision - the basis of the revision is undoubtedly the impact of movements in the seasonal adjustment parameters, produced in particular by the rather violent swings in agricultural output - there is a much bigger underlying reality to the detail, and that is that the Hungarian economy has now lost almost all growth momentum, and indeed we need to ask ourselves whether we will ever see robust output growth (neo classical steady-state-growth buffs beware) in the Hungarian economy again (Italy and Portugal would rather be the role models I have in mind here), especially with the increasing impact of ageing and declining population as we move forward in the next decade to think about, and robust growth before we enter the next decade is now an almost impossible outcome to hope for, especially when you take a long hard look at todays data in the light of what is now inevitably about to come.

Remember, the third quarter (July - September) outcome was prior to most of the "financial chaos" which has now set the scene for the growth outlook over the months to come. So it was the last of the "good times", at least for as far ahead as we can see. And that being said, if we strip out agriculture, as Portfolio Hungary notes, almost every other component of the economy went into recession in Q3, before the financial meltdown close-call.

Output in agriculture, industry and construction combined grew by 6.1% year on year in Q3, but this was largely due to the 50.8% growth achieved in agriculture. Industrial output taken separately was down by 2.2% mainly due to a 3.2% drop in manufacturing while construction output dropped by 5.0%. Services output decreased by 1.5%. On the expenditure side of GDP, final households consumption increased 0.9%, mainly due to the increase in social transfers in kind from government, up by 5.8%, while private household final consumption expenditure rose by only 0.1% year on year, and government final consumption growth remained stagnant. As we can see in the chart below, domestic private consumption growth in Hungary is now more or less done, and what growth the Hungarian economy may manage to get in the future will be all about exports.

Gross fixed capital formation maintained the negative trend of recent quarters and was down by 1.5, largely due to a drop in investments in manufacturing and in transport, storage and communications. As far as external trade goes the recent improvement continued, albeit with reducing momentum, and the volume of exports and imports were up year on year by 3.5% and 2.8% respectively.

On a seasonal and working day adjusted basis Hungarian GDP declined by 0.1% in the third quarter of 2008 when compared to the previous quarter, with agriculture being the only sector to show real growth with a 5.2% increase over the quarter. Industry contracted by 1.7% on the quarter, while the services output was down 0.5%. Household consumption expenditure declined by 0.2%, although social transfers in kind from government were up by 1.4%. More preoccupyingly exports were down by 0.3%, while imports decreased by 1.5%.

Exports Falter Again In October

In October 2008, according to first estimates from the KSH, Hungarian exports were running at EUR 6,349 million, while the value of imports was EUR 6,425 million. The current price euro value of exports was thus down by 4%, and that of imports fell by 2% over October 2007. As a consequence the October trade balance showed a deficit of EUR 77 million, and a deterioration in the balance of EUR 180 million when compared with October 2007. As we can see in the chart below, given the difficult external environment, Hungarian exports are also taking a beating at this point, but it is from a recovery in this area that the only real hope for a Hungarian recovery actually lies.

The NBH Cuts Rates

The National Bank of Hungary (NBH) yesterday (Monday) announced that it was lowering its key policy rate by 50 basis points to 10.50%. The Monetary Council was scheduled to hold a rate-setting meeting on 22 December, and yesterday's meeting was not in principle intended to take monetary policy decisions. The 50 basis point cut thus came as something of a surprise to observers. The direction of the move however did not come as a surprise since following November's 50 basis point monetary easing the market had been expecting the MPC to lower rates further in December. Despite the potential for forint instability, the financial markets seem to have taken November's cut reasonably in their stride (especially with the big guns of the IMF, the ECB and the EU lined up just in case) and the HUF has remained reasonably stable. Quite another argument would be whether these current forint values are in the best interests of Hungary's export industries, given all that has been previously said about them now being the great white hope of the Hungarian economy.

Various arguments have been advanced to explain NBH thinking at this point, among these two seem reasonably plausible. In the first place November CPI figures showed a general global decline and there are signs that we are entering a deflationary trend both in Hungary and the CEE in general. Despite the very high inflation levels that have been registered recently in the CEE, the very rapid drop in demand in some countries does not rule out the eventuality that we may see a negative price trend and even possibly outright deflation in those countries which enter the deepest depressions. Hungary's Central Bank is therefore staring to position itself, just in case.

Additionally as inflation has fallen back, serious recession fears begin to come to the forefront of bank thinking, and especially in Hungary, where fiscal policy simply cannot contemplate measures that would foster economic growth. So, to give the impression that at least someone is trying to do something about what is really a very difficult situation, the NBH starts to cut.

The impotence of the NBH is pretty much evident in this situation. The loans from the IMF and the EU were simply that, loans. They offer financial stability, but they do not address the key problem facing Hungary today, which is how to get sufficient export competitiveness to push headline GDP growth up to levels that put the economy on a sustainable path. The only way to this achieve situation is by allowing the value of the forint to fall (devaluation). Substantial internal price deflation would be too long and too painful, and carries important risks of getting stuck in a deflationary spiral. But to devalue you need a plan for the CHF denominated loans. These need to be "translated" over to forint - by decree if need be, and the West European banks who conducted all this ill advised lending need to be sent to their home governments with the begging bowl, since Hungary is surely in no position to bail them out, or shoulder the burden of the inevitable write downs.

Andreas Simor more or less accepted that the forint was the big issue in his statement before the Economic Committee of the Hungarian Parliament on Wednesday. Hungary’s scope for interest rate cuts is “limited” because of the risk of a “very significant” devaluation of the forint, the central bank President said. He stressed that the Magyar Nemzeti Bank does not have an exchange-rate target and wants to avoid forint volatility and proceed with rate cuts as the balance of risks to the economy allow.

“If we were to lower rates faster, we would risk a very significant currency devaluation,” Simor said. “We will proceed as quickly as Hungary’s risk assessment improves.”

"We have to proceed on a very narrow path, but we will proceed. As to when and at what pace? At such a pace that is in line with an improvement in Hungary's risk assessment,"

So we will not reduce rates dramatically, or substantially, even as the recession grows and fiscal policy tightens. Fine. But do tell me, just how long does it take to drain an ocean with a teaspoon?


kisvakond said...

Hungary needs foreign investment. Who would buy Hungarian assets for hard currency in the expectation of a substantial devaluation?

Edward Hugh said...


"Hungary needs foreign investment. Who would buy Hungarian assets for hard currency in the expectation of a substantial devaluation?"

Unfortunately this argument is circular, since who would invest in a Hungary where domestic demand is shrinking, and relative prices mean exports are too expensive.

Of course, there is another route, which is three or four years of quite sharp internal price deflation, with wages falling significantly. This is where we are headed if no one does anything, and my argument is that from a macro economic management point of view this road is more difficult, and certainly much more painful for the general population. There are a whole batch of tecnical issues involved, like how does a country with an external financing need run a Japan style ZIRP if we get stuck in long term deflation. Where we are going now it would be better to have never entered.

And maintaining the CHF parity where it is doesn't get you off the mortgage crisis hook, since if your wages fall 20 to 30 percent this has the same effect on your personal finances and your ability to pay the mortgage as does a single, one off, devaluation.

"Who would buy Hungarian assets for hard currency in the expectation of a substantial devaluation?"

This is really a valid point, since this is why it is better to devalue NOW then there won't be a further devaluation to come. As it is any intelligent investor simply knows that devaluation is inevitable (no matter what the central bank and the politicians say, even the IMF can get it wrong, look at Argentina in 2000, they had to devlaue in the end), and thus will wait till AFTER the devaluation, which is what, by its own strange logic, also makes a devaluation inevitable. The only thing which would convince would be to see those export numbers shoot up, and at the moment we are going in exactly the opposite direction, and quickly.

Edward Hugh said...


"There are a whole batch of tecnical issues involved, like how does a country with an external financing need run a Japan style ZIRP if we get stuck in long term deflation."

My guess is that the only rational explanation for the recent jittery nervousness on the rates front at the NBH is the sharp fall in inflation, and the even sharper fall in domestic demand which is now coming next year. GDP can easily shrink by 5% next year, and this can head you strait into a very deep deflation mire, and frankly they don't know what to do about it, which is why they have the jitters.

Edward Hugh said...

Incidentally, for once Ukraine are getting ahead of the field, and my bet is the Russians (and who knows, even the Chinese) may not be far behind. The Hryvnia is down around 30%, mind you their correction is very very sharp, but then so was their inflation.

All those extra wages everyone was paying themselves on the basis of the current account deficits has now to be "bled" out of the system, the easy way or the hard way. Obviously everyone wants to attract investments and to start boosting exports as the global economy recovers in late 2009 or early 2010. It's just that some are positioning themselves, and others evidently aren't.


Ukrainian industrial production fell at the fastest pace registered anywhere in Europe in November, falling for a fourth consecutive month, led by steel, machine building and oil refining. Output shot dopwn an annual 28.6 percent, following a 19.8 decline in October, according to the Ukrainian Statistics Office last Friday. Steel production slumped 48.8 percent, oil refining and chemical output fell 35.2 percent and machine building by 38.8 percent.

The Ukrainian economy, which has been expanding at an average annual pace of 7 percent since 2000, is now “in recession,” according to Finance Minister Viktor Pynzenyk speaking on December 10. Econoic growth will probably slow to between 3.5 percent and 4 percent this year from 7.6 percent in 2007, First Deputy Economy Minister Serhiy Romanyuk said on December 3, while the economy may contract by 5 percent next year, according to Oleksandr Shlapak, the president’s deputy chief of staff, at the end of November.

Ukraine’s national currency, the hryvnia, is heading to its worse year since 1999. It lost 34 percent in October and November and has been sliding further this month. The government of the nation of a 46 million people relies on a weakening hryvnia to boost exports, said Finance Minister Viktor Pynzenyk yesterday.

kisvakond said...

Understand. What I mean is the National Bank can't really communicate anything else than exchange rate stability.

Edward Hugh said...

OK, now I follow you. I think, btw, that most cbs have a huge communication problem right now, for all sorts of different reasons (in each case). Eg the ECB are relcutant to bring rates down too far at the moment, even though the old excuse - inflation - is rapidly disappearing out of the window. But then, they can hardly say we are willing to accept 2 million more unemployed in the eurozone to help the US get the CA deficit down, any more than the US Fed can say they would like a weaker dollar (in part to avoid deflation), but they would.

Have a good xmas,