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Thursday, February 28, 2008

Hungary Unemployment November to January

Hungary's 15 to 64 unemployment rate jumped to 8.2% year on year over the November 2007-January 2008 period, reaching a 10-year high, and up from 7.8% in Q4 over the October-December period, the Central Statistics Office (KSH) reported on Thursday. The KSH calculate three month moving averages. Given that the move from the previous 3 month average has been so significant, we can assume the move in January was equally so.

The number of registered unemployed in the January data was up to 342 thousand from the 327 thousand recorded in the previous month's data. Of course some increase in unemployment is normal at this time of year, but it is the comparison with the numbers from a year ago which you can see in the chart that is telling.

The current unemployment rate compares with the 7.5 percent level which existed a year-ago and is the highest since the first quarter of 1998, according to the statistics office. The number of Hungarians employed fell to 3.87 million from 3.94 million in the same period a year-ago period. 45 percent of those who are unemployed have now been unemployed for more than a year.

The KSH said the number of unemployed was 342,600 and the number of employed totalled 3,873,300 in the period examined. The latter figure compares with 3.909 m in Oct-Dec 2007 and 3.939 m in the same period of 2006/07. The number of unemployed rose by 14,800 from the previous 3-m period and was up by 25,100 from the reading in the same period of 2006/07.

The increase is largely due to both private and public sector lay offs (employment is DOWN 66,000 y/y) - even though the impact of this is not fully reflected in the unemployment rate as the economically active population also declined by 41,000 y/y signalling that many of those who lost jobs withdrew from the labour market, in many cases via early retirement schemes."

This drop in both the participation and activity rates is preoccupying, since with Hungary's population declining and ageing it is very necessary to put a significantly higher proportion of the available working age population to work to make the health and pension systems (even when reformed further) sustainable.

Monday, February 25, 2008

Hungarian Central Bank Removes Trading Band

(Updated) The Hungarian central bank unexpectedly allowed the forint to trade freely on currency markets this morning, according to official explanation "to help Hungary's euro adoption preparations".

“The abolishment of the exchange rate band is an important step towards the adoption of the euro in Hungary. A floating exchange rate regime creates more favourable conditions for the central bank to achieve its inflation target, and via this to meet the nominal Maastricht criteria and to enter the ERM-2."

“Given the openness of the Hungarian economy, the exchange rate will continue to play an important role in forming inflationary processes. If other developments in the economy fail to counterbalance, a sustained and considerable change in the nominal exchange rate will be reflected in the central bank's inflation prognosis and as such will exert an impact on monetary policy."

The forint's trading band is going to be scrapped with effect from tomorrow, with the bank adding that the decision was made jointly with the government. (So all those who were forecasting "not under this government they won't" got this one wrong too). The forint climbed as much as 2.3 percent in the trading session which followed the announcement, rising as high as 258.5 per euro at one point, and trading at 262.15 as of 7:05 p.m. in Budapest, which was up from 265.14 on Feb. 22. It was the currency's biggest daily gain since June 28, 2007, and in fact the forint has been falling of late, dropping 3.4 percent this year, the third- biggest drop among the nine European emerging-market currencies which are openly traded. The euphoria however may be short lived, since Hungary continues to face substantial economic problems, inflation is continuing above the central bank target, and under the stagflation dynamic which the economy now seems to have fallen into we are far more likely to see increased downward pressure emerging now that the theoretical safety net effectively provided by the band has been removed.

Hungary set the existing trading band seven years ago as part of its preparations for adopting the euro. Under the system, the forint was allowed to trade between 240.01 and 324.71 per euro. As can be seen this was a rather theoretical limit, since the forint was in fact trading well into the upper half of the band. Now of course the sky is the limit, in either direction.

The central bank has missed its 3 percent target for inflation in both of the past two years, and the current forecast is that consumer prices will rise by 5.9 percent this year and 3.6 percent in 2009.

The biggest challenge facing policy makers at present is to turn round an economy that expanded by a year on year rate of only 0.8 percent in the fourth quarter of last year - which was the slowest pace in the European Union. Annual inflation was running at 7.1 percent in January, down from the annual rate of 7.4 percent attained in December.

This development certainly makes my "three tipping points" argument advanced some ten days ago look not too bad at all, since this unexpected movement coincides exactly with the second of the forthcoming critical moments I identified, namely the rate-decision announcement from the central bank (although it appears from statements from central bank sources that the decision was taken on Sunday in consultation with the government, and thus policy deliberations at this weeks meeting already had the decision as a backdrop).

Portfolio Hungary quote Nigel Rendell, Royal Bank of Canada, London as follows:

“By scraping the HUF band the central bank hopes that an appreciating currency will do the trick. However, the risk remains, particularly against an uncertain global environment, that the HUF rally runs out of steam. This would leave the NBH in a very difficult situation, particularly if there are disappointments on the inflation side."

Basically I think this is the point, when the HUF rally runs out of steam the NBH is going to be in a very difficult situation indeed, and it will run out of steam when Hungarian housholds let up on their frenzy to borrow money in Swiss Franc denominated loans, a decision which may be made easier for them now that the band has been removed and the currency risk is evident to all. A difficult decision, but then maintaining the band was only encouraging people to keep going on contracting the loans.

Statement wat NBH's post-meeting press conference were hawkish, trying to create the impression that that rates would be raised if upcoming macro data (e.g. CPI, wages) failed to indicate a lower risk of second round effects - ie that rate policy is going to be driven by macro data. This is really near bravado on their part, since the reality is, and they must know this, that the decision to remove the band means that it is policy towards the HUF that is now going to be the main focus of interest rate decisions.

The interesting question is what happens next? Clearly, simply indicating that they want the currency to rise on its own won't get the currency to rise. It had been falling in recent weeks, and this is the tonic - in the absence of future rate rises from the bank - that we could expect to see continue. Really this decision has been taken - as I am suggesting - to avoid taking another one, which is whether to raise or lower interest rates. It seems the bank would like to give the impression that it wants to be firm on the rates front (which would imply rate rises) since otherwise talk of upward movement in the forint doesn't make sense, but that it could only get the government to agree to scrapping the band by holding fire. In fact the few that the HUF is about to weaken significantly seems to be strongly held by one group of analysts. Citigroup's Budapest-based Eszter Gargyan for example, who is cited by Bloomberg as saying.

``Rate hikes in the coming months cannot be avoided...Those who favored keeping rates on hold wanted to see the initial market reaction before taking further policy action, but the'' central bank ``is likely to act if the forint fails to strengthen.''

JPMorgan analyst Nóra Szentiványi is saying she expects a 50 base point rate increase spaced across the next two meetings assuming there is no HUF rally (which she doubts there will be).

Skandinaviska Enskilda Banken (SEB) have also stated that it is their view that the forint will remain vulnerable to any reduction in risk appetite, given the macroeconomic situation in the country and rising political risks in the run-up to the referendum on 9 March. (Hard to say whether they are reading me, or I am reading them at this point, since our views coincide entirely in this regard).

On the other hand, the economy itself continues to head downwards, and with more fiscal tightening on the agenda and a more difficult extrenal environment as the eurozone economies themselves slow it is hard to see where growth can come from, and the economy seems in bad need of some sort of stimulus shot or other. So we really now move over to the political front, and need to ask ourselves how much more of this type of medicine with no tangible results is the Hungarian voter actually going to put up with without making some sort of protest. Which brings us back to the third tipping point, the proposed referendum for March 9th.

The History of the Band

The HUF trading band system was effectively created as part of what has become known as the Bokros package, which was announced in the spring of 1995. The key component of this package for our present purposes was the shift to a crawling peg exchange rate regime with a narrow (+/-2.25%) fluctuation band.

In May 2001 the HUF band was widened to +/-15% from the original +/-2.25% (at EUR/HUF of around 273.50), but the crawling peg devaluation system remained in effect. The expansion of the band was followed by a considerable HUF strengthening.

The crawling peg devaluation system was abandoned on 1 October 2001, and the central parity of the band “settled down" at 276.10, allowing an effective fluctuation in the HUF between 234.69 and 317.52. In January 2003, the (NBH) thwarted a "hot money" attack against the top end of the currency band, by buying EU 5.2 b in the open market and slashing interest rates. In late May, the bank annouced that it had resold EUR 3.8 bn and stopped currency market interventions.

In early June 2003 the central bank and the cabinet devalued the central parity rate by 2.3% to 282.36 against the euro from 276.10. While this did not constitute an official forint devaluation, it still triggered a massive slide of the HUF to below 270 vs. the EUR. By this action the central bank effectively allowed the HUF to fluctuate in a band ranging from 240.01 to 324.71.

The official rationale behind the parity shift was that an overly strong forint (below 240 vs EUR) was not in the interest of economic policy The move - as iw wryly noted by Portfolio Hungary (to whome many thanks for the background information which forms the basis for these notes) was later called a mistake by both the NBH, government officials and economists.

Finally, on Monday 25 February 2008 the band was scrapped.

Friday, February 22, 2008

Hungary Retail Sales December 2007

Hungarian retail sales fell for the 11th consecutive month in December following the impact on consumer demand of government austerity measures to reduce what is still the European Union's largest budget deficit. Retail sales declined at an annual rate of 4 percent, following a 4.2 percent drop in November, the Budapest-based statistics Office said this morning.

Looking at the above chart, we could say that the drop in the rate of change in y-o-y retail sales has now bottomed - ie the rate of contraction is no longer accelerating - but sales continue to cntract nonetheless (as can be seen in the chart for the index below), and there is no reason to expect any short term improvement in this contraction process. If Hungary is to turn round its economic growth problem it will need to export far more, but to do this it will need to become far more competitive, which means that it needs to do something to stop inflation, Hungarian enterprises need to improve substantially their productivity and the central bank needs to address the issue of the overly high valuation which the HUF now has.

A large part of the problem here is inflation, and the fact that consumers have had less cash to spend following government inspired increases in taxes and utility bills in an attempt to narrow the budget shortfall. This has helped to drive up the inflation rate its highest level in six years.

Central bank policy makers, who will meet on Feb. 25 to discuss interest rates, held the benchmark two-week deposit rate steady last month at 7.5 percent, citing the surge in food and energy costs which the suspected could create inflationary pressure. Obviously an unholy row has broken out among analysts at this point about whether to raise rates (the inflation expectations argument) or cut them (the weak internal demand argument). This debate has in part been provoked by the fact that the central bank last month considered a rate increase for the first time since February 2007. Few analysts, however, seem to be looking at any of this in the longer term, and asking themselves - by looking at countries like Japan, Italy and Germany, with their ageing and nearly contracting populations - just how realistic it is to expect Hungary's ageing (and declining) consumer and working population to go back to fueling a consumer or property boom, or to be able to achieve the sort of increases in aggreagte productivity necessary to achieve a respectable growth rate via export driven demand (especially given the "leakage" in the current account via dividend payments on prior investments). Basically Hungarians do not save anything like enough to fund their economy at its current GDP level, let alone propel a great forward leap. This situation is in no small measure connected with population ageing in a context of low accumulated collective wealth (Japan, Germany and Italy do not have the massive monthly outflow on the income account). Thus, if people don't ask themselves just how it was (and why) that Hungary got into this mess, there is little hope of them being able to advise on how to get out of it.

Wednesday, February 20, 2008

Hungary Real Wages December 2007

Hungary's monthly average gross wage rose at a slower pace than expected in December, reducing pressure on the central bank to raise the European Union's second-highest interest rates. The average monthly wage rose an annual 4.3 percent to 210,287 forint ($1,164), the Budapest-based statistics office said today.

Central bank policy makers, who will next meet to discuss rates on Feb. 25, said last month that the increase in inflation expectations, as reflected in wage developments, constituted a risk to price-growth targets. The central bank has kept the benchmark two-week deposit rate at 7.5 percent since last September.

This lower-than-expected figure would seem to reduce the likelihood of a rate increase at the next meeting. Interestingly, such an increase has been priced in by the market at this point.

As a result the forint fell to 266.83 per euro at 9:32 a.m. in Budapest, from 264.77 late yesterday. The yield on the benchmark three-year bond rose to 8.33 percent from 8.28 percent, reaching the highest in 16 months. Forward-rate agreements show that investors now expect the benchmark rate to rise to 8.25 percent within the next six months.

In December, wages at private companies were 3.2 percent higher than a year earlier, while salaries among public workers rose 7.2 percent. Take-home wages across the economy averaged 126,259 forint, 2.2 percent more than in December 2006.

Bonuses seem to be a significant part of the story here, since regular private-sector wages, a figure that doesn't include bonuses and is one of the central bank's most closely watched indicators, rose by 3.2 percent from a year ago. The pace of increase fell from 8.5 percent in November, to the lowest rate since July 2006. The drop in bonuses is only to be expected given the economic slowdown which is taking place. Base salaries may well prove more resistant to this.

Real net wages fell by 5.2% year on year in December, reversing the trend to smaller drops in real wages that had been registered in previous months. Retail sales results for December are due out on Friday, and obviously the only thing left that is like to support domestic consumption is that increasing borrowing in Swiss franc loans.

The number of Hungarians employed in November was 2.69 million, 2.3 percent less than a year earlier. The government shed 6.4 percent of its employment in a year, reducing the number of public workers to 715,600.

In other news in today, the Government Debt Management Agency (ÁKK)seems to be having increasing difficulty rolling over short term debt, and yields are rising rapidly. They received only HUF 25.9 billion worth of bids on HUF 20 bn 6-month discount T-bills at todays auction, and the average yield was set at 8.07%, up 22 basis points from Tuesday's benchmark fixing and 65 bps higher than at the previous auction of this instrument two weeks ago.

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.

Sunday, February 17, 2008

Stagflation in Hungary

Lars Christensen, analyst at Danske Bank, in Copenhagen, is arguing that the Hungarian economy may now be trapped in a version of stagflation. This point of view, at least in terms of its practical implications, is not that far from the one I am arguing on this blog. The gist of his argument is as follows:

“This morning we got more evidence that the Hungarian economy is sliding into stagflation - high inflation and very low growth. Inflation was 7.1% y/y in January - in line with the consensus expectation, but lower than our expectation of 7.4% y/y - while GDP growth slowed further to 0.8% y/y in line with the consensus expectation collected by Bloomberg (0.8% y/y), but below Reuters' consensus expectation of 1.5% y/y. We expected 0.6% y/y."

“Even though the numbers were more or less in line with expectations it is hardly good news, and the fact that inflation remains well above the central bank's (NBH) inflation target of 3% at the same time as growth being very subdued presents a serious problem for the NBH."

Essentially he is saying that the recent macro numbers coming out of Hungary confirm what we - at least those of us who are watching carefully -already knew, namely that the Hungarian economy is effectively bogged down in some variant of stagflation and there are very few signs that growth is likely to pick up anytime soon. With the global credit crunch slowing global growth and insidious inflation eating away at cvompetitiveness Hungary's export growth is unlikely to prove spectacular in the coming quarters, and domestic demand is very unlikely to rebound simply of its own accord, especially given the tight monetary and fiscal conditions now in place.

Christensen had the bright idea of putting together quarterly CPI and GDP growth rates on the same chart, and the result gives a very clear indication of the measure of the problem.

Basically - as I say in my post on the recent inflation numbers - it is now clear that the Hungarian economy will be in and out of some sort of recession during 2008 (and possibly 2009, see my stagflation post here, and my "why is Hungary so different" one here).Thus while we can expect inflation to come down significantly at some point (indeed we may even see its reverse face - price deflation - but this very much depends on what happens to the value of the HUF between now and when we might get through to such an eventuality), the question is really when the Hungarian inflation number will start to drop back significantly? This is the "stickiness question". Where we go from here is very hard to predict, since it depends on a number of factors which are also hard to predict, like the resistance of wage and price pass-through (wage stickiness) to the general economic downturn in Hungary. I have not yet seen any attempt, theoretical or otherwise, to get to grips with this hard chesnut, but the success of inflation forceasting would seem to depend on it. In theory, with unemployment rising and the economy barely growing we shouldn't be seeing the current high levels of inflation, but we are. So how much longer can this process last, and how much structural damage will be wrought to the Hungarian economy in the process?

As Chrisiansen says whether the central bank should react to the continued high inflation and the risk of a further weakening of the forint on the back of the global credit crunch and hike interest rates, or whether it should try to spur growth by cutting rates is now the central question.

For the time being it seems likely that the NBH will remain cautious and keep rates unchanged. However, in the event of the forint weakening significantly - and this seems to be an evident risk - there is no doubt that the NBH will act by raising rates, even though, as I am arguing this will produce a deepening of the internal recession and a short term political crisis. The relative value of the HUF is a hurdle which has to be crosssed at some point or other if you really want to recover export competitiveness, so, as always, my opinion is that now is as good a time as any to cross the hurdle, although those with high credibility "sunk costs" - such as the political administration and the NBH - will doubtless see things differently, which is why we may now enter the sort of inevitable "tug of war" period during which considerable harm and little good may be done before we all arrive at the sort of consensus we could well have reached today, if we hadn't being - as is only unfortunately all too human in these situations - busily trying to hang on to our reputations rather than facing up to reality.

Thursday, February 14, 2008

Hungary January 2008 Inflation

Hungarian inflation eased back ever so slightly in January as utility prices rose at their slowest pace in 17 months. Hungary's consumer prices rose by 1.0% month on month and by 7.1% year on year in January 2008.

Annual average inflation was 8.0% in 2007.

Seasonally adjusted core (ex-fuel) inflation was 0.6% q/q and 5.2% yr/yr which compares with growth of 0.6% and 4.8% in Dec 2007. while the so-called "core-core" (ex fuel & food) slowed to 5.0% YoY from 5.8% YoY in December. This means that the core - or undelying - rate actually rose slightly in January (driven in part by the presence of food) while the core-core eased without it. Where we go from here is hard to predict, since it depends on a number of factors which are also hard to predict, like the resistance of wage and price pass-through (wage stickiness) to the general economic downturn in Hungary. I have not yet seen any attempt, theoretical or otherwise, to get to grips with this hard chesnut, but the success of inflation forceasting would seem to depend on it. Basically, it is clear that the Hungarian economy will be in and out of some sort of recession during 2008 (and possibly 2009, see my stagflation post here, and my "why is Hungary so different" one here).Thus we can expect inflation to come down significantly at some point (indeed we may even see its reverse face - price deflation - but this very much depends on what happens to the value of the HUF between now and when we might get through to such an eventuality), the question is really when will the Hungarian inflation number start to drop back significantly? This is the stickiness question. In theory, with unemployment rising and the economy barely growing we shouldn't be seeing the current high levels of inflation, but we are. So how much longer can this process last, and how much structural damage will it entail?

Hungary Q4 2007 GDP Growth

Hungarian economic growth, which was the slowest in the European Union in 2007, not surprisingly continued to slow in the fourth quarter, growing by a mere 0.1% quarter-on-quarter over the October-December period, according to seasonally adjusted first estimate figures released by the Central Statistics Office (KSH) on Thursday. The KSH also reduced the Q3 growth figure to +0.2% zero from +0.3%. At this stage it is worth pointing out that this is a preliminary - flash - release, and carries a margin of error of 0.2% - larger than the growth rate itself, and that the economy could just as easily have contracted as expanded. To really know the answer to this question we will have to await the detailed release in early March, and then (see what just happened to the Q3 data) subsequent revisions when Q1 2008 data are released.Nonetheless, as can be seen from the chart below, the steady disintegration of the Hungarian economic growth process is clear enough.

Economic growth year-on-year in Q4 was a measly 0.7% (using seasonally and working day adjusted data), while the comparative figure for Q3 was still only 1.0%. Analysts had been forecasting 1% year on year for Q4, so they have largely been caught on the (over optimistic) upside.

Annual economic growth in the whole of 2007 came in at 1.3%, the KSH added.

The consensus forecast among analysts in a Portfolio.hu poll earlier last week was for a yr/yr growth of 1.0% in Q4 (the outcome was, remember 0.7%). As recently as last October's World Economic Outlook forcecast the IMF - to take but one example - was expecting Hungary to come in with a 2.1% annual growth rate for 2007, but economic growth for whole year 2007 actually came in at 1.3%, according to the latest KSH data. The 2007 growth rate was the slowest annual growth since 1996, and the important point to grasp is that this situation is unlikely to improve in 2008, in fact it is most probably going to deteriorate, with growth of less than 1% being the most likely outcome as I explain here, and in more theoretical detail here). And, of course, the results we have been getting do tend to lend weight to my view.

As indicated above since the seasonally adjusted numbers have an associated degree of uncertainty which is higher than the actual estimated q-o-q GDP growth rate (the KSH tends to carry out several subsequent adjustments), we cannot exclude the possibility that at this point the Hungarian economy is already in recession. According to the technical definition, recession is when GDP drops in two consecutive quarters. Hungary's lacklustre economic growth compares, of course, with third-quarter expansion rates of 6.4 percent in Poland, 6 percent in the Czech Republic, 14.1 percent in Slovakia, 4.5% in Estonia, 9.6% in Latvia, 8.1% in Lithuania, around 6% in Romania and 5-6% in Bulgaria we could draw the conclusion that "Hungary is still the very sick man of central Europe and by some distance" (Neil Shearing, Capital Economics, London), but I would raise a rather different issue, namely: just how much can we learn from following Hungary about what might happen in the other "high-risk-of-correction" EU10 economies - the Baltics, Romania and Bulgaria, basically - one the "correction" takes place. This I would say is the importance of what is now happening in Hungary, the chink of light it throws - for those who are able to see - on what might get to happen next elsewhere.

The response in the government bond market was predictable on Thursday, lower demand and higher yields. As a result the Government Debt Management Agency (ÁKK) decided to sell HUF 10 bn less 3yr bonds and HUF 5 bn less 10yr bonds than they had originally intended. Accepted yields on the 3 yr bonds ranged between 7.89% and 8.05%, while on the 15yr ones they were between 7.20% and 7.27%.

Meantime, while the HUF firmed to some extent on Thursday, the downward trend continued on Friday, with the currency closing at 253.59 to the euro.

While the currency has now climbed back a bit off the December 7th low, it once more turned South on Friday, so while the initial hurdle I wrote about in my earlier blog post has now been crossed, the situation needs constant and almost daily monitoring, until we arrive at the next hurdle, the next central bank rate setting meeting on Feb 25.

Wednesday, February 13, 2008

The Pressure on the Forint Eases Slightly

Hungary's forint firmed slightly today after standing up to several waves of pressure, settling around what still amounts to a one-week low against the euro. The mildly favourable retail sales data that came out in the US during the afternoon eased some of the pressures on emerging market economies and in the collective upswing the forint managed to get back below the 262 to the euro level. Just enough to knock out stop-loss levels, but hardly anything to get excited about. The forint had been as far down as 266 to the euro earlier last week - amid a spate of rumours which included the idea that the prime minister was about to resign, and that the central bank was about to announce an emergency rate cut (or was that an increase, I never was sure which possibility was most in people's minds at that point). Indeed it was clear that a general downturn in global risk appetite which struck all across emerging market instruments was hitting Hungary's long-unsteady markets the hardest.

Hungary's economy has slumped to decade-low in growth following a government belt-tightening campaign aimed at straightening out its public finances.

Danske Bank Analysis

Portfolio Hungary reports this morning on the view of Danske Bank analyst Lars Christensen. Christensen's argument is that it is only a matter of time before the forint follows the leu, the kronur and the rand in weakening significantly. In particular he argued that the forint is not sufficiently protected by adequately high interest rates.

Since the outbreak of the global credit crunch in August 2007 many currencies in EMEA countries which have been running large current account deficits and/or have accumulated large ratios of foreign debt have been under significant selling pressures. According to Christiansen:

“Most notable has been the weakening of the Romanian leu, Icelandic kronur and the South African rand, which have all weakened around 15% since the beginning of August. The lira has more or less been flat against the euro since early August and the forint has “only" weakened around 5%".

“While we clearly see a risk that these currencies can weaken significantly more, there is also a risk that this weakening will spread to other EMEA economies with similar problems. In particular, the Turkish lira and the Hungarian forint stand out,"

“While high interest rates in Turkey give some protection, it is hard to use the same argument for the forint and hence we believe that it is only a matter of time before the forint follows the leu, the kronur and the rand and weakens significantly."

(The base rate is currently 13.75% in Iceland, 11.00% in South Africa, 9.00% in Romania, 15.75% in Turkey and 7.50% in Hungary.)

As he points out, imbalances have been reduced in the Hungarian economy on the back of last year's tightening of fiscal policy, but the markets have also 'rewarded' the Hungarian government for this by not selling the forint as much as the continued large imbalances and large foreign debt could 'dictate'.

Also, he suggests that as the global credit crisis drags on there is an “increasing risk that we will have a repeat of the forint 'crisis' of 2006", when the HUF fell sharply from around 250 against the euro to 285 in a comparatively short space of time. And, of course, the global financial environment at that time was significantly more benign than the one we have at the moment. So a forint at 280 or below to the euro hardly seems an imporobable level at this point in time, and indeed Lucy Bethell from RBS was arguing exactly this earlier in the week.

In particular, Christiansen stressed that any “slippage" on fiscal policy in Hungary would hit investor confidence hard and this would also “likely lead to downgrades of Hungary's credit ratings". And this is just why tomorrows Q4 2007 preliminary GDP data will be so important, since if the figure slips to any great extent on the downside this is bound to place strong question marks around Hungary's 2008 budget targets which are - let us remember - based on government estimates of GDP growth in the 2.8 to 3% range.

And before we leave Christiansen's analysis, I would like to draw attention to one point: the comparison with Turkey. Back in August 2007, just after the credit market crunch started to close its grip, I wrote a long post (and an even longer analysis) of Turkey, where I tried to argue that even though Turkey's economy would come under pressure just like those of its East European neighbours, the underlying soundness of Turkey's demography, and hence the element of homeostatic regulation which it would enjoy following from any significant downward correction, meant that it could well emerge with a lot less medium-term damage from the coming global storm than the rest of Eastern Europe. This view is now about to be tested, as indeed is the whole consensus thesis that demography and fertility don't matter to economics. As I wrote at the time:

There are good theoretical reasons - at least if you take demography seriously there are - for imagining that the Turkish economy might well prove to be more robust than some of the Eastern European ones will under the strains the various economies are under and about to receive. These latter economies, despite their apparent vibrance are actually much more fragile under the surface, and it is for this very reason that the observed response differences bear examination day by day.

I Suppose That's The Hill Sergeant, and I Guess You Are Going To Make Me Climb It.

The most probable scenario we now face is for the forint to experience a succession of waves of attack, and a systematic attempt to knock it of the perch on which it is so delicately poised. All free-market economists of course believe in the workings of financial markets as a regulatory mechanism, but we don't have to believe they are fair, kind or forgiving.

There seem to be three critical tests facing the forint in the short term. The first is the GDP and inflation data coming tomorrow. Starting with the Q4 2007 GDP data, my opinion is that this will surprise on the downside, and possibly give every indication of just how unrealistic most of the 2008 GDP forecasts for Hungary currently are. The second is the inflation data, and here the Hungarian central bank is now almost certainly in a heads I lose, tails I lose situation. If the CPI - Hungarian inflation was running at an annual rate of 7.4% in December - surprises on the downside this may encourage currency dealers to feel that the central bank will bow to political pressures and reduce interest rates - a move which the collapse in Hungarian internal demand suggests is badly needed.

But the reduction in yield differential this would produce would make forint denominated assets less attractive, suggesting that the currency would face a more testing time and that an acceleration in capital exit would probably occur. If, on the other hand, the data surprises on the upside - which after today's December agricultural PPI data (38.1% y-o-y) seems more likely - then this may lead people to feel that the central bank will have no alternative but to increase rates. Indeed many market analysts have now reached the conclusion that such rate rises are more or less inevtiable. The latest of these has been Gillian Edgeworth of Deutsche Bank, who today projected a total of 100-bp rate hikes in the next six months (over the course of the next six policy meetings.), and in this she has joined a fine galaxy of observers including Goldman Sachs and Citigroup - who are projecting a 50-bp hike at the 25 February policy meeting, while Citibank analyst Eszter Gárgyán is on record as saying she does not believe that even a 50-bp hike could be enough to stop the weakening of the forint. I am not sure how much of the macro-economics of what is involved in all this these forecasters understand, but I am quite happy to say that the sort of monetary tightening that Gillian Edgeworth is contemplating is just not posible at this point in the game, since, apart from the fact that it would send Hungary off into one whopping and unholy recession (especially if it was accompanied - as it would have to be - by a continuing tightening of the loan conditions on Swiss Franc mortgages, due to the hightened currency-risk default issues), the political dynamics would not accept it. You can only ask people to accept so much belt tightening before they rebel, and we are already over 18 months into this round, so tolerance must be wearing thin, and another year of monetary tightening is most definitely out at this point. If you have any doubt whatsoever on this, look at what has happened in other countries in other epochs.

So, given that not all market analysts are competely devoid of foresight, any move to press the tightening trigger can also produce a similar conclusion a rate cut would, vis-a-vis the desireability of ditching Hungarian assets, since more monetary tightening would only close even further the noose which is currently extending its grip over the increasingly stagnant internal economy. Such are the difficulties which confront you when you back yourself so tightly into a monetary and fiscal policy tight-corner. Perhaps the best policy for the national bank to adopt at the present point is to try sitting tight and doing nothing - like an embarassed child trying to avoid attention - muttering something in sotto-voce about upside-downside inflation risk and global conditions, while secretly hoping the whole damn business would go away. Which, of course, it won't. Such an attitude would only be to sit back and wait for the inevitable to happen, rather like the condemned man awaiting the executioner. But Hungary still has what euro-pegged countries like the Estonia, Latvia, Lithuania and Bulgaria (who really are now merely condemned to sit there and wait while the barber passes by them one by one - what's it to be sir, a haircut or a shave?) and that is liberty of action, in which case it should use it, whatever the difficulties.

The second hurdle, or critical point, the forint will have to get over - assuming it survives tomorrow - will them be the meeting of the central bank itself on the 25 February, and again rate policy decisions either way can have unpredictable effects, and once more it is likely that an attack will be mounted, regardless of the decision taken, given (as I argue above) there are sufficient reasons for doubting that either policy option is a good one. What all this amounts to is that the Hungarian central bank has now run out of policy options, and it is just a question of time before we get to see what the financial market participants decide to do about the situation.

Finally, and assuming that the currency passes muster relatively unscathed in the first two initial skirmishes, the cherry is most decidedly and firmly likely to be planted on the top of the cake if the proposed referendum on some of the more controversial measures in Hungary's adjustment programme actually gets to be held on March 9th. Since a vote to abandon the contested education and health service charges - which seems on the face of it to be the most probable outcome - would virtually present a frontal challenge to the whole "adjustment" process, it is hard to see how the Gyurcsany government could continue under the circumstances (even if there would be no formal obligation to resign). This kind of situation is, of course, "more power to my elbow material" for those market participants with an acquired taste for warm, freshly-spilled blood, and really if we got through to this point, without anyone having the presence of mind to take the bull by the horns first (by which I mean making a virtue out of a necessity, and openly accepting that policy is now in a no-exit bind, and that a significant drop in the value of the forint is both inevitable and desireable, depite the fact that there will be a lot of renegotiating and cleaning up to do in the aftermath), then the outcome may well not be a pleasant sight to watch.

Tuesday, February 12, 2008

Turning The Screw

Well it never rains but it pours as they say. Hungary's situation is dire, and deteriorating by the day, and what do the EU Commission do? Warn Hungary that even more budget cuts may be needed.

``From 2009, the budgetary outcomes could be worse than expected,'' EU finance ministers said in a report endorsed today at a meeting in Brussels. ``Lower-than-projected GDP growth could lead to a higher deficit.''

Government by report. The thing is I am absolutely sure that on the substantial point the finance ministers are right, that Hungary's budget situation can deteriorate substantially in the mid to longer term, but is now actually the moment to be turning the screw like this, when each day is bringing yet another piece of bad news.

Yet of course the EU ministers may not be in possesion of the full facts here (or perspectives) since they may still be looking at those rosy forecasts of expansion to accelerate to 2.8 percent this year and 4 percent in 2009 which the Hungarian government keeps sending them (this is why I am so critical of research institutes like GKI, since by offering pie-in-the-sky forecasts you alert noone to the full reality of the situation). My own guess is that 1% growth would be a good result for whole year 2008, and after that we will see the extent of the damage before we start thinking about 2009, although lets wait and see what is in Q4 2007 GDP this week, before we start wandering too far forward. In this sense again the EU are right to warn that it is very risky to prepare budget forecasts on unduly optimistic scenarios.

But what gets me is their lack of ability to respond to situations as they happen. Hungary needs some sort of plan, some sort of support, and indeed the whole EU10 situation needs thinking about, and out loud. Isn't that what transparency is meant to mean? At the moment, as I said earlier in the week, Hungary is simply in a now way out policy double bind, trapped on both the fiscal and the momentary front, while in the meantime internal demand wilts on the vine. And all the EU finance ministers can tell us is that Hungary may need new spending cuts to meet its deficit target if economic growth falls short of government forecasts. Pah!

Meantime news on almost every other front is unremittingly bad.

Portfolio Hungary informed us yesterday that Hungary's equity funds were badly hit by massive capital withdrawals in January, with with withdrawals from one individual large index-driven fund hitting 20 billion HUF. Net sales were overall positive across the equity sector but investors increasingly placed their money in low-risk money market and guaranteed funds, not only new funds, but also capital retrieved from bond and balanced fund redemptions.

At the same time the political instability is growing, as the jitter level mounts, with Albert Takacs departing the Ministry of Justice and Law Enforcement today, to be replaced by former Finance Minister Tibor Draskovics, according to the Hungarian daily Népszabadság. Now I am not a political commentator, so I really don't know how to interpret what is happening here, but then I have to say that with all the strain that is being put on the system, these kind of "events" are really par for the course, and that it was only last week that the press was full of speculation that the Prime Minister himself might resign.

And to cap it all, Portfolio Hungary this afternoon published the results of their latest analysts poll:

Extremely feeble economic growth and higher-than-expected inflation will be characteristic of Hungary in 2008, Portfolio.hu's poll of analysts showed on Tuesday, indicating a gloomy market ahead of key data due out on Thursday. The consensus forecast shows that Hungary's GDP growth remained around its lowest level in a decade in the fourth quarter of 2007 and while inflation is coming down gradually, it will still be above the central bank's medium-term target by end-2009.

Friday, February 08, 2008

Is The Next Move At The NBH A Rate Hike?

Well markets are certainly simmering at the moment. As I keep arguing monetary policy in Hungary is now in some sort of a trap, caught between the rapid internal contraction, and the need to let the currency slide to do something to address the competitiveness of exports on the one hand, and the problem of inflation and the need to defend the forint to protect unhedged swiss franc domestic borrowers on the other. That fiscal policy is also caught in another kind of trap only adds to the sense of drama that is unfolding.

As I report in an update on this post, the market seems to be virtually pricing in the idea that the next move in interest rates at the central bank will be upwards. As Gábor Orbán, portfolio manager at Aegon is arguing, given the way which inflation expectations are rising over the relevant policy horizon, credibility maintenance would seem to demand a rise. Put another way, any loss of this sort of credibility could now easily provoke a rout.

In fact yields in the fixed-income market have gone up strongly in recent days, and based on the yield of the 3-m discount T-bill - which rose today by 12 bps to 7.72%, certainly make it look like the market has priced in a 25-bp rate hike by the central bank. This is a very drastic change in a very short time, and even as late as mid-January investors were pricing in a moderate rate cut for late spring. However in the short term, a lot of investors in the currency markets seem to be betting on the likelihood of a rate cut to keep the forint weak. If this bet doesn't come off, and people need to reset their positions, this in itself could precipitate a bout of instability with unknonw consequences. Meantime over the week the forint fell by 3.5% versus the euro and by 5% to the USD.

Another symptom of the present atmosphere is the way in which rumours are circulating with such frequency. This is very typical of the kind of situation which Hungary is now in. On Wednesday the rumour had it that Finance Minister János Veres and Prime Minister Ferenc Gyurcsány were about to announce their resignations, today the rumourology was suggesting that the the NBH was planning to hold an extraordinary press conference on Monday to address the current situation - and possibly to announce in true US Fed style an "emergency rate rise". Of course the NBH has issued a denial, and the rumour was very unlikely to be true, but it does indicate just how much people have now got the jitters. It is one of these bouts of jitters - either in Hungary or in the Baltics - that is in fact likely to push the whole edifice clear off the cliff face.

Meantime the Monetary Council of the NBH will hold a non-rate-setting meeting on Monday as scheduled, and hold a first reading of the cenbank's Inflation Report to be released two weeks later. So for the time being things are likely to calm down again. The next "hot spot" will come on Thursday when Hungary's preliminary fourth-quarter GDP data will be released as will the January inflation figures. Any realisation of the anticiipated downside risk on the former and upside risk on the latter (or, worst of all case scenarios, the two together) will be the next excuse for another bout of nervoes market sentiment which could then well run all the way up to the 25 February policy meeting and Inflation Report. And if none of this is good enough to get the rilers really riled, well then we will have the lead in to the March referendum for people to occupy their time and energy with.

Thursday, February 07, 2008

Industrial Output December 2007

Hungary's industrial output grew by 5.3% year on year in December, according to both preliminary data (both unadjusted figures and data adjusted for working days) released today by the Central Statistics Office (KSH). In November industrial output yr/yr grew by 5.5%. According to figures adjusted seasonally and by working days, there was a monthly rise of 1.1% in December from November, against a 0.2% m/m increase the previous month.

KSH also reported thatHungary's industrial output grew by 8.1% yr/yr in the whole of 2007.

This result was not unexpected, but it does mean that industrial output was by and large flat across the fourth quarter. Also exports are now growing at a slower annual rate by the month. Output growth has basically been on a downward trend since the summer of 2007, and December's growth rate is the lowest y-o-y since March 2005. This environment is not likely to change anytime soon, so it looks like industrial output will continue to fade over the coming months adding to downside GDP risks and the pressure on the HUF

Wednesday, February 06, 2008

Financial Turbulence Starts To Hit Hungary

Rather mixed news this morning on the Hungary financial markets front. Hungary's benchmark stock index, the BUX Index, fell 1.62 percent at 9:10 a.m. The index of 16 companies traded on the Budapest Stock Exchange fell 378.82 to 23,016.97. Among the stocks in the index, none rose, 11 fell and 5 were unchanged. Declines in the BUX Index were led by Otp Bank Nyrt, Mol Hungarian Oil And Gas Nyrt and Magyar Telekom Telecommunications Plc.

To the gloom which is growing here we could add the prediction from 4Cast this morning that energy and forex pressures will force the Central Bank Monetary Council to hike rates by 25 basis points in February.

“Though the call is finely balanced, the fact that market prices an absolutely zero chance for a hike offers a good opportunity to open bearish positions that could be closed with minimal losses if we happen to be wrong," said Gábor Ambrus, analyst at 4Cast is quoted as saying.

Ambrus stressed that forecasting Hungarian rates has been “one of the most challenging tasks lately", with rate calls over the past year undergoing serious revisions even the week ahead of meetings. I think one of the important points to notice here is the mention of "forex pressures". In my opinion it will be the need - at least as long as they are able to - of the central bank to try and protect Hungarian households and corporates from "translation risk" arising from a falling forint that will increasingly drive short term monetary policy. This of course puts internal demand in a real straightjacket. It also builds up future risk, since - as indicated yesterday - the differential between forint mortgage loan interest rates and Swiss franc ones will only encourage further borrowing in the Swiss franc, borrowing which at some stage will undoubtedly unwind, since with the forint where it is it is hard to see substantial export growth. Basically a very, very difficult situation. To which must be added the looming political instability.

This issue is rapidly being brought home on the sovereign debt front, with Fitch following colse behind the warning from Standard & Poor's last week about risks of pre-election fiscal laxity in Hungary. Fitch Ratings added its voice to this growing chorus yesterday (Moody's were also busying themselves warning on Bulgaria, and Fitch itself recently lowered the broad credit rating outlook across a wide range of Eastern European countries citing specifically the deteriorating global conditions and the dependence these countries' have on external financing to keep the boat afloat). This time it was Ed Parker, Head of Fitch's Emerging Europe Sovereign Group in London who fired off the warning shot, indicating that Fitch are unlikely to be moving the Hungary sovereign rating upwards any time soon, point out that the ratio of direct capital inflows was likely to drop in 2008 from the 54% level achieved in 2007.

Unsurprisingly Parker mentioned the general elections which are set to take place in 2010, saying the run-up to elections creates uncertainties about the results of the consolidation, which may be exacerbated by risks attached to growth and inflation. But of course he could well have added that this uncertaintly will only be heightened if the planned referendum in March goes forward.

Fitch was the last revised its credit outlook on Hungary on 5 November 2007. At that point it affirmed Hungary's Long-term Foreign Currency Issuer Default Rating (IDR) of 'BBB+', its Short-term Foreign Currency IDR of 'F2', its Long-term local currency IDR of 'A-'(A minus) and its Country Ceiling of 'A+'. The Outlook on Hungary's Long-term IDRs was revised to Stable from Negative.

Hungary is looking at a possible downgrade to the outlook on its debt if the Socialists-led government decides to remedy its unpopularity by opening the money sack in the run-up to elections, Kai Stukenbrock, S&P's primary ratings analyst for Hungary, said last week.

Fitch was the last credit rating agency last year to revise the outlook on Hungary. On 5 November it affirmed Hungary's Long-term Foreign Currency Issuer Default Rating (IDR) of 'BBB+', its Short-term Foreign Currency IDR of 'F2', its Long-term local currency IDR of 'A-'(A minus) and its Country Ceiling of 'A+'. The Outlooks on Hungary's Long-term IDRs have been revised to Stable from Negative.

Update Wednesday afternoon:

And of course it never rains but it pours. Lucy Bethell, a currency strategist at Royal Bank of Scotland in London has argued today that Hungary's forint may fall to an all- time low against the euro in 2008 as appetite for emerging- market assets wanes and the country's economic outlook worsens. Earlier today she suggested that the currency may trade as low as 290 during 2008, and the forint declined by 0.2 percent to 260.15 per euro as of 12:11 p.m. in Budapest. Bethell's end-of-year forecast is 280 per euro.

``Having seen the leu and then the rand weaken in reaction to global risk-aversion, the forint looks next in the firing line,'' Bethell wrote in a report yesterday, and Hungary's ``external financing needs are comparatively heavy'' at about 12.5 billion euros ($18.3 billion. ``The stock of international investment in local debt has already increased this year, leaving investors vulnerable to a gradual deterioration in risk appetite,'' Bethell wrote. ``With tight fiscal policy already priced in, it won't take much to dent the market's confidence.''

The forint is the worst performer against the euro this month among 26 emerging-market currencies, falling by 1.2 percent. A decline in the forint to 290 per euro would exceed the previous record low of 285.15 in June 2006, when Standard and Poor's cut Hungary's credit rating one step to BBB+ and the government announced measures to cut the budget deficit.

Clearly everyone has the jitters at the moment. Speculation following a rumour which went the rounds of financial the markets that Finance Minister János Veres and Prime Minister Ferenc Gyurcsány were about to announce their resignation lead thre forint to continue down to above 263 to the euro - a low that has has not been seen for more than 18 months now.

Responding to a question from a journalist, government spokesman Dávid Daróczi said speculation about such resignations was “absurd". Nonetheless it is difficult to see where the government can go, if the March referendum goes forward, and if the vote is to suspend the health and other charges, since this would be tantamount to a vote of no confidence in the whole fiscal adjustment process. With Hungarian monetary policy caught in a vice of having to try and protect the value of the forint due to the translation risk threat, and fiscal policy in real difficulty as internal demand slides downwards with no ability to ease, and indeed reduced revenue possibly coming onstream at some point if unemployment continues to rise, even while export opportunities decline in a more complicated external environment, policy has few real options at this moment, and the government must know that.

Second Update Friday Afternoon

The anti keeps going up and up. Gábor Orbán, portfolio manager at Aegon and a former member of the central bank's (NBH) staff in its Economics Department, has upped his inflation forecasts, saying higher CPI numbers make a rate hike inevitable. Portfolio Hungary cite him extensively:

“We have raised our forecast on annual average inflation to above 6% and 4% for 2008 and 2009, respectively. Since the inflation course is well above the 3% goal even on the horizon relevant for monetary policy, we give a greater chance for a rate hike than unchanged rates from now on," Orbán said.

“As the market, especially foreign punters, are just marinating these news, we should breace ourselves for serious negative reactions on the bond market," he added.

Orbán said he upped his CPI projections mainly over the impacts of the electricity market's liberalization. The restricted nature of the market liberalization may lead to a 30-40% hike rise for industrial users this year, which through production costs will exert an impact on consumer prices, as well, he noted.

If this increase affected every company (and they managed to fully pass it on to consumers) core inflation would go up by 1.0-1.5 percentage points, so the consumer price index would come in 0.8 ppt higher (at end-2009).

“In its February inflation prognosis, the NBH cannot escape but to take into consideration the aforementioned inflationary impacts. We believe the (February) rate decision will be basically determined by the end-2009 inflation, which could be around 3.5%, but most definitely, and in its trend, too above the 3% objective. [...] After the debate of the February Inflation Report, chances for a rate hike decision at the policy meeting have grown considerably," Orbán said.

The reaction of the market will be a “hump" in the yield curve, as rate hike expectations are getting priced in, which would hit the medium segment the hardest, he added.

If monetary tightening failed to materialise, it would lead to substantial forint depreciation through the consequent credibility problems and the revaluation of the central bank's inflation preferences, Orbán said. Such a step would also lead to a significant and lasting increase in the yields of longer bonds.

Altogether, we should not expect the long end of the curve to “get away with it", so yields in that segment look set to increase - if only transitionally - anyhow. Orbán projects that the forint's easing to the euro - a consequence of monetary tightening, political, growth and balance woes - and a deteriorating CPI outlook will push the fundamental value of the 10-year bond to above 7.4% transitionally and that of 2-yr and 3-yr instruments to above 7.5%. In the general negative sentiment market quotations could remain well above these levels, he added.

Tuesday, February 05, 2008

November 2007 Trade Statistics Revision

According to KSH this morning:

In the period of January–November 2007, the volume of exports augmented by 16, that of imports by 12 percent as compared to the same period of the previous year. In forint terms, exports rose by 10 percent, imports were up by 6 percent. The growth rates in euro were 17 and 12 percent. The trade deficit amounted to HUF 73 billion (EUR 295 million), which is lower by HUF 528 billion(EUR 1956 million) than one year earlier.

Portfolio Hungary comments:

Hungary posted a trade surplus of EUR 60.6 million in November, according to revised figures released by the Central Statistics Office (KSH) on Friday. The final number was revised downward from prelim EUR 70.1 m.

The January-November cumulated trade deficit was EUR 295.4 m, while the preliminary balance showed EUR -285.9 m. In the same period of 2006, the trade gap was EUR 2,251.2 m.

In the same period of 2006, the trade gap was EUR 2,251.2 m.

Nevertheless, there was a considerable fall in the growth rate of both exports and imports in Nov.

Exports grew by EUR 6,443.1 m or 8.1% yr/yr in the 11th month of the year (up from a prelim growth of 7.9%) versus a 17.4% expansion in October.

Imports were up 5.5% or EUR 6,382.5 m (revised upward from prelim 5.2%), against a 13.5% increase in Oct.

As they note, the fading momentum can be primarily attributed to a downturn in the European business environment, which is also underpinned by the fact that parallel to the deceleration of growth, the gap between export and import growth has also shrunk - it dropped to 2.6 ppts in Nov, down from prelim 2.7 ppts, and 3.9 ppts in Oct. And remember this is back in November, the situation since has only deteriorated.

All of this takes me back to yesterday's post about the GKI institute forecast, and about how sensitive Hungarian growth is now going to be to external factors, since at the present point in time it has to be largely export driven. Another of the Institute's with an optimistic view - Ecostat, who are still forecasting 2.3 - 3% growth for 2008 - make a good point despite the rosy conclusions they draw:

The engine of Hungary's GDP growth on the production side is primarily the export performance of the manufacturing industry. Some 80% of Hungary's exports are generated by large enterprises, the performance of which hinges on the external business environment, especially that of Germany. If the euro zone expands at a smaller-than-expected rate due to US recession and turbulences on the money markets, the domestic outlook worsens with it, especially because diminished export demand can be offset by domestic purchasing parity only to a smaller extent

I think this is the whole point, and since the outlook in Germany is worsening by the day, this is why I think 2% or 3% growth estimates for 2008 are living in cloud cuckoo land. After seeing the trade revisions and the bank lending numbers for December I am still holding my breath as to whether Hungary will have had its first quarter of negative growth in Q4 2007.

The strategic importance of Germany for Hungarian exports is evident from the following chart which I have prepared from KSH data. What is not clear is the extent to which these products which go to Germany are subsequently processed for re-export (the Bazaar Economy hypothesis of Hans Werner Sinn). Also, while I find the level of EU10 interconnectedness revealed by the chart to be fscinating, I am not at all sure why, for example, Hungary should be exporting roughly the same proportions to the Czech Republic or Slovakia as it is to the much richer and larger UK or France, unless these countries all form some sort of dis-aggregated supply chain system to service the huge German export machine. Doubtless this will all now become much clearer as German exports ex-EU10 start to seriously slow, but all of this is surprisingly reminiscent of patters I have observed between Japan and China, Singapore, South Korea and Taiwan, where at the end of the day the whole edifice is incredibly sensitive to movements in final demand in the US and Europe. Just a hypothesis to follow up and test a bit at this point.

Hungary Bank Lending December 2007

Portfolio Hungary publish some interesting figures today, based on data from the Hungarian central bank. Hungarian households were saving more in December, and Hungarian bank deposits increased. The usual pre-Christmas “loan fever" failed to materialise and this may well find its subsequent reflection in the December retail sales numbers.

Revised statistics from the central bank also indicate that the volume of Swiss frank-based lending was higher last year than previously thought. According to Portfolio.hu's calculations, more than 75% of new loans taken out by households were foreign currency based last year - HUF 1,480 bn (EUR 5.9 bn), up 40% year on year (the volume of yen-based loans has not been published yet).

The volume of new mortgage loans totalled HUF 134 bn in December, unchanged from the previous month, and this volume can be attributed to a steady and stable demand for CHF-denominated loans, since foreign currency ratio remained at a steady 93% within this category. Across 2007 in its entirety domestic households took out HUF 1,420 bn worth of new mortgage loans, 30% more than a year earlier.

The reason for the popularity of the CHF loans is of course obvious, since they are much cheaper, and the total cost of housing loans (weighted by the amount of new business) came to 12.5% yr/yr at HUF-denominated and 6.5% at CHF-denominated loans. This situation, of course, effectively runs a coach and horses through the monetary tightening policy being operated over at the Hungarian central bank.

Monday, February 04, 2008

GKI Economic Research, Getting Hungarian Economic Growth Wrong

The Hungarian economic expansion, which was the slowest in the European Union in the third quarter of 2007, will recover less than previously expected according to the Budapest-based GKI research institute today. The institute suggest that the Hungarian growth will accelerate to 3.2 percent from an estimated 1.5 percent last year. The institute prepares monthly forecasts in cooperation with Erste Bank AG. This is definitely the highest estimate I have seen of what we can expect in Hungary this year, and seems to put it mildly, wildly optimistic. Still, it is a movement back towards reality when compared with last month's forecast, which suggested we would see growth of 3.5 percent in 2008 and an estimated 1.7 percent in 2007.

The downward revision is due to a revevaluation of the potential for Hungarian export growth, the institute now estimate will slow to 13 percent this year, down from an estimated 16 percent increase in 2007. Previously the institute predicted the 16 percent rate would continue in 2008. But there are a number of reasons for thinking that increasing exports will prove to be a much harder task in 2008 than it was in 2007. One of these is the external environment which is darkening by the day. All the main global forecasting agencies - the IMF, the OECD, Consensus Forecasting - are lowering their estimates for global growth, and this is bound to have an impact on Hungary, which is now, remember, an export dependent economy, since both domestic private demand and government spending are likely to remain flat at best.

In addition, cost pressures in the Hungarian export sector are now likely to mount. As explained in this post, the export sector component in the PPI is now showing signs of trending upwards, as wage increases - which the GKI estimate as rising at a 7.5% rate in 2008. A rise of this order - which would no longer be simply wage "whitening" - will prove very hard to absorb in the much more competitive external environment of 2008, especially if the forint remains at the current comparatively high levels as the institute forcast.

Hungary's main destination countries for exports by order of importance are Germany (the leader by a long margin), Italy, France, Slovakia, Austria, Romania, United Kingdom, Poland, and the Czech Republic. Among the Western European countries here, only France looks like it is seriously resisting a growth slowdown. It is not apparent what is going to happen in Eastern Europe at this point, but the risk of a significant correction exists if the credit crunch continues to bite, and the strong level of interlocking and interdependence means that if one country falls the rest will more or less inevitably be affected.

All of the above suggests that extreme caution is called for when looking at export prospects in 2008, and any economy which needs to depend on exports will be vulnerable, even if it were solid enough in its own right, which Hungary manifestly isn't.

As regards other elements in the forecast, GKI have contruction pencilled in for an 8% rebound. This is also hard to regard as credible, although of course EU funds for civil engineering projects will make some difference. But residential construction is not likely to trend upwards in any way shape or form in 2008, given tightening credit conditions and general risk aversion. If we look at the most recent construction chart there is very little evidence of activity having bottomed out yet, and while it doubtless will do so at some point, we need to know when this happens and at what level of activity befoe we can start assessing realistic levels of construction output growth for 2008.

On retail sales GKI are estimating a 1.5% increase, but again there is no sign yet of the downward movement in retail sales has come to an end, even if the rate of contraction may have stabilised somewhat, so the same applies as in the case of construction:

As regards industrial output, GKI see this rising by 7.5% on the year, but again we need to ask what would be driving this? Clearly for GKI the driver would be exports - since it is very unlikely to be internal demand, and especially given the fact that the current forint value and the strong internal inflation make imports more and more attractive. Again looking at the monthly chart there is no real basis for the optimistic GKI forecast, since the rates of expansion have been - as one would expect - slowing since the summer.

When it comes to inflation, which during the course of last year accelerated to the fastest in six years in Hungary in part due to the price impact of the government measures, GKI seem much more realistic, and while they feel inflation will slow this year as the effects of administrative price rises work their way out of the system , they forecast that the average inflation rate will be 5.7 percent this year, down from last year's 8 percent. This number is higher than both the central bank's 5 percent forecast for inflation and the government's 4.8 percent estimate, and indeed is up from last months GKI estimate when they predicted 5 percent increase in consumer prices.

But they do not seem to draw the conclusions which flow from their own forecast here, since this inflation will continue to eat away at export competitiveness, and will effectively box-in the central bank when it comes to monetary easing, and both these factors are strong GDP growth negatives.

Actually I will say one thing for GKI research, they do keep their previous monthly reports online, so you can go back and compare. Thus I find that in February 2007 they were forecasting 2007 GDP growth at 3%, so in the sense they are over optimistic they are at least consistent.

As for my own case, personally I was estimating back in autumn 2006 (see comments) that Hungary would have a very significant slowdown in 2007 (and I think this has been borne out) and I am quite happy - at least until we see the results of Q4 2007 GDP (after which my best guess is that we may need downward revisions) - to stick with what I was saying at the start of January 2008:

My own view is much more nuanced. 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.

Saturday, February 02, 2008

Hungary Producer Prices, Wages and Unemployment December 2007

Hungarian producer prices are still pretty tame, although they have started to creep up again from the very stepp defaltion - especially in export prices - they underwent in the middle of 2007. One thing which it is difficult to evaluate from outside Hungary is the extent to which this upward trend in producer prices is a result of the process of "wages whitening" - whereby wages which were previously paid but remained undeclared now come above board - having run its course. Evidently during a period of time industry was able to absorb what appeared to be comparatively high wage rises since the changes were more on paper than real, but now if wages continue to rise in 2008 the pressure will be on producer prices - and hence on export competitiveness.

Accordingto KSH Domestic Hungarian domestic sales prices rose by 0.6% in December 2007 compared to November, and by 6.2% compared to December 2006. Export sales prices - as expressed in HUF - were up by 0.2% as compared to November and fell by 2.1% compared to December 2006. Industrial producer prices involving both domestic and export sales increased by 0.4% compared to November and were up by 1.6 compared to December 2006. In the whole year 2007 domestic sales prices rose by 6.4% while export sales prices fell by 4.8%. As a consequence total industrial producer prices were up by 0.2% as compared to 2006.

In November 2007 gross earnings were still rising at roughly a 9% annual rate, and public sector earnings turned upwards to a 12% rate. This is the pernicious effect of all that inflation which the central bank has so far proved incapable of purging from the system. The big danger is now that these wage increases, which are understandable in the context of the ongoing inflation, are now past on to some extent to producer prices. If this happens it will be very difficult to get export growth at the kind of rate necessary to jump start the Hungarian economy out of the marshland in which it is currently bogged down.

The number of those employed in Hungary has now been dropping steadily since the middle of last year.

This pattern has of course been reflected in unemployment, with the numbers of unemployed steadily rising.

At the same time the unemployment rate has been rising steadily. This whole process (coupled with the tendency in retail sales and VAT) is going to put increasing pressure on government deficit targets in 2008 as income is reduced and expenditure comes under upward pressure. Hence, I suppose, the EU Commission warnings, although even these may be based on growth, and hence income and expenditure numbers, which are far too optimistic.