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Friday, January 23, 2009

Why Dominique Strauss-Kahn Had To Make A Flying Visit To Budapest

"All public sector employees received a one-off compensation of 20,000 forints in November in line with a government decree based on an agreement between the government and unions to keep real wages in the public sector steady in 2008," said KSH statistician Erika Molnarfi. "In January-November, real wage growth in the public sector was 0.2 percent,"

Well, now we have the November wages and employment data to hand, and basically it isn't too hard to see what all the fuss was about last week (as described in this post), since while the Hungarian government may have had an agreement with the trade unions to keep real wages steady in 2008, the IMF certainly thought they had signed up to an 8% wage cut. Leaving aside all the wrongling about who did in fact promise to do what, the fact is that either Hungary devalues sharply or wages are cut significantly, there are not too many other alternatives to hand at this point, and if you are going to cut wages and prices to restore export competitiveness, then I can see no special advantage in starting in January rather than November, especially when the problems are pressing ones. But then again, maybe it is significant that the forint is now falling significantly, since this, of course, is the other way of doing things.

Hungary's headline gross wage growth picked up slightly in November due to the one-off bonus payment to public sector workers, but the pace of wage growth in the private sector eased. Gross wage growth in the private sector eased to 6.7 percent in November from 8 percent in October, while public sector wages grew by 13.5 percent after a 10.2 percent rise a month earlier. This means that real public sector wages were up 9.3% in November, just when they were supposed to start going down.

Ex-bonus private sector gross wages, a number watched closely by the central bank when setting interest rates, grew by 7.1 percent year-on-year after an 8 percent increase in October, which means they were up 3.5% in real terms. Not really indicative of any substantial correction taking place.

Update: Monday 26 January

The above view of why Dominque Strauss-Kahn Had to fly to Budapest last week is confirmed by the latest interim review of the stand by arrangement which has now been posted on the IMF website.

In exchange the government pledged - among other things - to abolish the 13th-month salary of public sector employees. However, responding to a public uproar and a looming strike it decided to offset the lost salary nearly fully for about 70% of the employees and partly for the rest. While the IMF staff deemed that the 2009 budget adopted on 15 December was “consistent with the size of the fiscal adjustment envisaged under the programme", it noted that “the recent agreement on public sector wages puts this adjustment at risk."

“On the revenue side, the budget does not envisage any noteworthy tax policy changes except for tax simplification. However, on the expenditure side, the budgeted decline in nominal wage bill is lower than envisaged under the programme, reflecting an ad-hoc allowance that fully offsets the loss of the 13th month salary for about 70% of civil servants and provides a partial offset for the remainder. The allowance (amounting to 0.4% of GDP) will be financed mainly by reducing reserves and by unidentified cuts in defense and education spending," the IMF said. Staff expressed concern about “the negative signal conveyed by this measure regarding the government's commitment to the programme, noted that the reduction in reserves significantly raised the risk of not achieving the targeted fiscal adjustment, and suggested the need for compensating measures to protect fiscal reserves and reduce fiscal risk."

Recession Going To Be Deeper Than Expected

Perhaps it was this realisation that lead National Bank of Hungary Governor András Simor to state last Wednesday that the Hungarian economy would probably contract more than the NBH thought two months ago (which was for an annual contraction in 2009 of 1.7%), suggesting that recession could be significantly deeper than most analysts are currently projecting. Many (like Prime Minister Ferenc Gyurcsany ) are talking about a contraction of 3%, but I fear it may be considerably larger than this. If we look at the PMI, then there was an average reading of around 41 in the last three months of 2008, so when we get the Q4 GDP readout we should be able to calibrate this a bit, and see what we may be in for in Q1 2009, as and when we see the January PMI. I also think many are being mislead by anticipating a recovery in H2 2009 (in Hungary and elsewhere) and I think this is very unlikely. I think the most we can hope for from the fiscal stabilisation programmes is that they do just that, stabilise, and stop the recession deepening. Recovery may appear, at the earliest, and in the best cases in 2010. The CEE generally will be well behind this particular curve, and Hungary even more so.

Not surprisingly, the forint was down again today, depreciating at one point by as much as 2.7 percent to 291.25 per euro and rebounding to 289.87 as of 4:43 p.m. in Budapest. The currency has lost 3.6 percent this past week, extending this year’s decline to 8.4 percent, making it the worst performer of Europe’s emerging markets.

At the start of the week the NBH cut its benchmark interest rate for the fourth time in eight weeks and has made plain that it is set to reduce borrowing costs further as its recession deepens. The two- week deposit rate was cut to 9.5 percent from 10 percent. Policy makers also discussed lowering the rate to 9.25 percent or even 9 percent, central bank Vice President Ferenc Karvalits said.

The Hungarian government is also now preparing to redraw its budget because of a deepening recession, and this will probably mean increasing its deficit goal for this year.

“It’s obvious that we’re examining the budget deficit target,” Deputy Finance Minister Laszlo Keller said at a press conference in Budapest .

The earlier target of 2.6 percent of gross domestic product is now evidently threatened by the severity of the present recession, which is cutting revenue and raising social costs at one and the same time. The government may cut the deficit from last year’s 3.3 percent of GDP less than previously planned, to perhaps 2.9 percent, as a result of only partially compensating for the missing revenue with tax increases and spending cuts.

As a result it shouldn't surprise us to learb that yet another downgrade may be looming over Hungary, as reported by Hungarian daily Magyar Hírlap. The issue is clearly the rate of debt accumulation. The European Commission's latest forecast estimates that Hungary's government debt will rise to 74% of GDP by 2010 from an anticipated 73.8% in 2009.

“The debt-to-GDP ratio is projected to increase by 6 pps. in 2008 to around 72% as the international loans are drawn on, chiefly to build up reserves. The debt ratio should increase further - although at a slower rate - throughout the
forecast horizon, mainly as a result of the lacklustre nominal GDP outlook."

Hungary had its foreign-debt rating cut by Standard and Poor's in November, citing strains on the country's ability to service its debt amid a drain on capital. The rating was lowered one step to BBB, two levels short of junk, or non investment grade. It has a ``negative'' outlook, meaning the grade is more likely to be cut again than raised or left unchanged.

Also in November Moody's downgraded Hungary's local and foreign currency government bond ratings to A3, outlook negative, from A2, outlook stable, and the country's foreign currency bank deposit ceiling to A3, outlook negative, from A2, outlook stable. And Fitch downgraded (to BBB from BBB-plus) citing the severity of the recession and the ongoing post-crisis correction to macroeconomic imbalances and associated risks to the public finances and from foreign currency mismatches in the private sector

The difficulty is to see how this dynamic can change, especially if the forecasts do prove to be overly optimistic and if we hit price deflation (ie falling prices) which is what we should expect if the government follows the IMF plan as agreed.

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