Strong growth performances

From an economic perspective, Hungary has been performing well for a few years now. The year 2017 was no exception with a real GDP growth of 4%, which should be identical in 2018. The two main growth drivers are the absorption of European funds as well as the continuing decline in unemployment (3.7% in May 2018), leading to a significant increase in disposable income.

Nevertheless, there are some constraints to growth. Firstly, there is a strong shortage of skilled and unskilled labour in all sectors, especially in construction, where prices have sharply increased recently but remain below their 2008 level in relative terms. Labour shortages put upward pressure on wages and damage Hungary's competitiveness vis-à-vis neighbouring countries (Hungary notes the strongest wage increase in the region, see graph 1). Secondly, the risk of normalisation of the US monetary policy poses a risk to the Hungarian economy as the stock of portfolio investment liabilities (mainly owed by the general government) – even if they are on the decline since their peak reached in 2013 – still account for nearly 40% of GDP in 2017. In this context, a rise in the global interest rate would increase the costs of (re)financing and servicing the debt. Thirdly, strong growth in domestic demand combined with the expected depreciation of the Hungarian forint could push inflation above the Hungarian Central Bank’s (MNB) target of 2% to 4%. On the positive side, so far, inflation has remained in the target area of the MNB with 2.4% in 2017 and 3.1% in the second quarter of 2018. Finally, even if corporate debt is on a downward trend (cf. graph 2), the depreciation of the local currency would put companies under pressure because their debt would be more expensive to repay since more than one third of corporate debt is denominated in foreign currency.

Political tensions and trade war will probably affect the Hungarian economy

The international environment can also be a cause of economic slowdown. Indeed, the Hungarian economy is an open economy and very closely linked to the European supply chain, and more specifically to Germany. The latter is the largest importer of Hungarian goods but also the largest supplier in terms of imports into Hungary (27% of exports/imports in 2017, cf. graph 3). Far behind, Romania and Italy complete the podium of export markets for Hungarian goods. The US and China only rank 11th and 13th with export values accounting for only 2.8% and 2.3% of Hungarian exports, respectively. More broadly, exports to the European market account for 80% of Hungary's total goods exports.

Like many countries in the region, the three most important channels for goods exports are electrical machinery (20% of all goods exports), mechanical machinery (18%) and vehicle and car parts sectors (17%). These sectors are closely linked to the German economy, but this also goes for Slovakia, France and the Czech Republic. Even if Hungarian export sectors are more diversified than the Czech export sectors, they remain relatively concentrated in terms of products and geography. In the context of rising US protectionism, any attempt by US President Donald Trump to impose tariffs on the steel (25%) and aluminium (10%) sectors might affect the Hungarian economy. In particular, tariffs on European cars would damage the German vehicles industry and, indirectly, most of the Hungarian industry.

Finally, the political risk should not be ignored. The recent triggering of Article 7 (according to which the EU may decide among others to suspend the right to vote of an EU member) by the EU parliament is unlikely to lead to direct economic measures against Hungary. Still, the growing tension between the two parties could lead the European Union to significantly review its funds allocated to Hungary in the medium term (for the 2021-2027 budget). Moreover, tension between EU and Hungary may affect investor perception and thus weigh on the volume of FDI in the country.

In conclusion, Hungary, as an open and export-driven economy, benefits from the strong economic performance of its trade partners. Nonetheless, the economic slowdown of its main trade partners and/or rise in trade protectionism could have negative economic repercussions on the Hungarian economy. The most impacted sectors would be electrical and mechanical machinery sector as well as automotive and spare parts.

Analyst: Matthieu Depreter – m.depreter@credendo.com