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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.

1 comment:

Anonymous said...

I largely this this stagflation is a result of the cost-push of government policies on taxes. And their current proposal to respond to the IMF loan and GDP shortfall will only compound this.