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Sunday, August 31, 2008

Have Hungarian Retail Sales Now Passed Their Historic "Peak"?

Hungarian retail sales fell again in June - by 0.3% month on month - following a 0.2% drop in June, according to data adjusted for calendar and seasonal effects supplied this week by the Central Statistics Office (KSH). What many observers seem to fail to be taking note of is that this now means that Hungarian retail sales have now been dropping steadily since they reached a historic high in August 2006. Even more importantly - as will be argued in this post - there are important theoretical grounds (in the context of Hungary's declining and ageing population) for postulating that the 2006 high may NEVER be hit again, and this is the point most of the consensus analysts who are predicting a "rebound" in domestic consumption fail to take into account. Of course at some point (although not in the immediate future) we may see the long predicted rebound, but the secular trend now seems well established, and I see no good economic arguments which would lead us to think it will reverse. Wishful thinking is, of course, another matter entirely.

According to working day and seasonally adjusted data retail sales fell by 1.9% year on year in June, as compared with the 1.6% rate of decline in May.

But this trend is now long term. Retail sales in 2007 declined by 2.9% in annual terms, which compared with an annual increase of 4.4% in 2006 and 5.6% in 2005. It is hard to give an exact estimate for 2008 at this point, but between January and June the KSH registered a 2.2% year on year decline. The Q2 decrease was 1.7% yr/yr, following a 2.9% drop in Q1, but the data are very distorted this year by the calendar effect of Easter, so a 2% drop on the year seems to be a realistic guess at this point.

Sales of cars, car parts and fuel totalled HUF 205.1 billion in June, down 3.0% yr/yr against a decrease of 1.0% in May, while retail sale of cars and car parts alone plunged 6.2% yr/yr in June, following a decline of 1.3% in May. Fuel sales were up by 0.5% yr/yr in June, up from a fall of 0.8% in May. Over the Jan-June period there was a 0.1%year on year increase.

"Peak" Retail Sales

So the question we are faced with now, is whether or not we are faced with "peak" retail sales, with the index having hit a ceiling in 2006? The level of 137.5 I have put into the annual index for 2008 is a conservative one, given that the index for H1 was 137.6 and the trend is down.

The theoretical basis for this assumption is on reasonably solid ground, and there is evidence to show the phenomenon exists in other ageing economies. In Italy, for example:

Now Italy's population is not in fact contracting at this point, although the natural population change is negative, and has been for some years. But Italy has immigrants, and thus the population is still increasing (For a fuller discussion of the situation in Italy, see this post here). This is NOT Hungary's case.

Germany provides us with another case where retail sales clearly seem to have peaked. In this case the peak (which seems to have been in 2006) is all the more striking since unemployment has been falling strongly in Germany over the last two years, and up till very recently the country was cleary enjoying an economic boom.

(Note, the index reading for 2008 which is included in the chart is an estimate - and probably a conservative one, since sales are still falling - based on the first six moths of the year).

But as well as falling, Hungary's population is also ageing, and we know from basic life cycle theory (Modigliani) that saving and spending patterns change across the life cycle, with the propensity to borrow against future income to buy now declining significantly after 50, and since it is increasing consumer credit that drives retail sales growth in the dyamic internal consumption economies, then it is highly likely that ageing will now act as a drag on sales growth. As we can see in the chart below, Hungary's median population age has been rising steadily, but the rate of ageing is now about to accelerate quite sharply, with the only real substantial unknown between now and 2020 being life expectancy, which may accelerate more than anticipated (in which case the population ageing will be even more rapid).

Conclusion: It's All About Exports Now

Apart from retail sales, another indicator of domestic demand which is worth thinking about is housing construction. Let's look at the chart.

As we can see the number of new buildings peaked in 2004. Since that point the sector has struggled. Obviously the absence of new households can be offset to some extent by holiday homes, but this has limits, and in the present credit crunch environment is unlikely to be as important as many anticipated. Despite the general economic slowdown there was a rebound in housing activity in 2007, but in the wake of the US financial turmoil of August 2007 this now seems to have faded. It will be many a long year (if ever) before we see construction on the 2004 scale in Hungary again, since housing is, above all, about demographics.

So what does all this mean for Hungary? Should people simply pack their bags and leave. No, not at all. What it means is that it is all about exports now, as far as the Hungarian economy goes, and the sooner Hungarian civil society (together with the civic institutions - parliament, central bank etc) faces up to this, the better.

Given the rapid ageing that Hungary is now faced with, and the need to maintain a health and pension system with some kind of minimum guarantees, then economic growth is essential, and the only way to get this economic growth is through the export sector, and this is now a hard fact of life. Indeed it is precisely because the structural commitments to current expenditure are so large in the Hungarian case, that the downturn in public sector construction has been so strong following the austerity package. The sooner everyone faces up to all of this the better.

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