Merry Xmas and A Happy New Year

Well, a Merry Xmas and a Happy New Year to all my readers. Thank you for taking the time and trouble to pass-by. This blog will now - failing major and surprising new developments in the global economy - be offline till the end of the first week in January, or till after the festival of Los Reyes Magos in Spain (for those of you who know what this is all about). Come to think of it, maybe this is just what our ever hopeful central bankers are in need of even as I write - some surprise presents from the three wise men - but I fear that this year if these worthy gentlemen do somehow show at the next G7 meet, the star in the east which draws them will not be the one described in the traditional texts, but in all likelihood the rising star of India.



Credit crunch, did someone use the expression credit crunch?

Russian Inflation November 2007

Russia's inflation rate rose to a two-year high in November as the prices of fruit, vegetables and other food prices surged. The rate rose to 11.5 percent, the highest since October 2005, up from 10.8 percent in October, according to data released todat by the Federal Statistics Service.



Economy Minister Elvira Nabiullina indicated that the Russian government anticipate that consumer prices will increase an annual 12 percent this year, compared with last year's 9 percent rate. The Russian government's ``massive additional spending'' before this years elections also helped push up inflation by stoking up additional demand the Organization for Economic Cooperation and Development said earlier this month in a report. Legislators approved additional budget outlays this year as the nation prepared to hold parliamentary elections on Dec. 2 and a presidential vote in March 2008.

For a full and extensive analysis of the dynamics of Russia's growing inflation problem see this post here.

Why Ukraine Needs to Run a Budget Surplus

Ukraine, whose economy will miss its central bank inflation target for a fourth consecutive year running in 2007, should adopt a budget surplus in 2008 to help curb consumer price growth, the International Monetary Fund said earlier this week in the concluding statement issued after its staff mission to the country.

"The Ukrainian economy has enormous long-term growth potential, as industrial efficiency continues to improve, financial markets deepen, and its structure of production evolves.

"However, there are near-term challenges. First, inflation is on the rise. While much of the increase in 2007 reflects food prices, strong domestic demand growth has intensified underlying inflationary pressure. Moreover, the current account position is eroding, and further deterioration in the years ahead—gas import prices may rise further and world steel prices may fall toward their long-term real average—could raise external financing risks. Finally, rapid credit growth points to rising risks in the financial sector.

Stability-oriented fiscal and monetary policies, a stronger monetary and financial sector policy framework, and progress on structural reform are needed to help Ukraine achieve high growth with low inflation and improve the living standards of all its citizens.

Does any of this sound familiar? It should do, at least to those of you with an interest in economics and what is going on at the moment in Central and Eastern Europe it should, since this profile is very typical of one we have seen extending itself right across the whole region in country after country over recent months. Claus Vistesen has already extensively covered (in this post) the issue of what is called "translation risk" (or what might get "lost in translation" if an effectively "dollarised" currency like the Ukranian Hryvnia is allowed to fall substantially at some point - to tackle, for example, the problem of the lack of export competitiveness which results from the combination of the rise value of the currency and the ongoing above-par inflation which is currently being sustained in many Eastern European countries).

GDP growth in the Ukraine has been "solid" but not "exaggerated" this year (think the Baltics or Bulgaria in comparison), and at this point been slowing slightly, running at a year-on-year rate of 7.2% from January to November.

The Ukraine government now forecasts inflation to stabilise at 9.6 percent next year, having missed its 7.5 percent target for this year. This view may be hopelessly over optimistic. Inflation ccelerated to 15.8 percent in November and will probably atttain 16 percent plus this month, according to a statement from President Viktor Yushchenko's office.




Inflation is the biggest of the "near-term challenges" according to the IMF. I would certainly agree, and while much of the increase we are seeing in 2007 reflects food price rises, strong domestic demand growth and a set of underlying structural demographics which also serve to intensify the inflationary pressure.

The Ukraine Cabinet announced on Nov. 21 that it now plans to run a budget deficit of 1.86 percent of gross domestic product next year, compared with the shortfall of 2.33 percent of GDP which was initially planned. The IMF argue for fiscal surpluses as a means of draining liquidity from domestic demand since, given the strong wave of inward capital flows that comparatively high growth countries like Ukraine are expeciencing, and the widespread availability of low interest non-local currency denominated loans.

The difficulty which comes into operation in a situation like that in Ukraine, where there is considerable dollarisation of the local economy, is that exchange rate and monetary policy become either effectively non-existent (in the former case) or impotent (in the latter) to correct growing competitiveness problems - since given the extent of dollarisation it is not practical to adjust the exchange rate downwards and increasing the interest rate only puts upward pressure on the currency, and encourages the contracting of non-Hryvnia denominated loans. The tightening of monetary policy also serves to attract additional funds in search of extra yield and these only serve to make the excess demand problem even worse.

Thus the only real arm left in the government policy arsenal is the fiscal policy one, whereby the government attempts, by running a fiscal surplus, to "drain domestic demand" from the system, and thus work to effect some form of price deflation (for a fuller discussion of this complex topic in the Latvian context see this post). And this, of course, is exactly the policy that the IMF economists tirelessly advocate that the Ukranian government practices.

But it is exactly here that we hit a problem, since far from running a fiscal surplus as the situation requires, the Ukrainian government has been running fiscal deficits, even if, up to the election year of 2007, these have been reducing.

One of the things we should now be learning from looking at what is happening across Eastern Europe is that in an environment where a number of underlying problems exist - ranging from a lingering and heavy state presence in the economy, a high public sector debt and deficit level, an absence of strong goods exports competitiveness, labour supply shortages due to migration and long term low fertility, and extensive euroization of the banking sector - heavy capital inflows can come to seriously strain the entire macroeconomic framework. This risk becomes even greater if measures are not taken to drain excess liquidity from the system (by running a fiscal surplus for example), to loosen labour supply constraints by facilitating inward migration of unskilled workers, and to accelerate the pace structural reforms - and particularly those which facilitate the development of "greenfield" investment sites which help channel capital flows towards productivity-enhancing uses and in so doing raise exports.

A Declining and Ageing Population

According to data from the Ukraine Statistics Office the national population fell by 232,485 people from January to October of 2007. This was a result of the fact that while there were 397,806 births (up from 383,384 during the comparable period for 2006) there were also 630,291 deaths (down slightly from 631,403 last year). What this means is that Ukraine's population is now falling at an annual rate of 0.675%. This is very fast, for population decline, and remember this is the natural decline, not counting out migration. As we can see in the chart below the Ukraine population peaked in 1993, and has been in some sort of free-fall ever since.

There are a number of factors which lie behind this dramatic decline in the Ukrainian population. One of these is fertility, which is currently in the 1.1 to 1.2 Tfr range. In fact Ukraine's fertility actually dropped below the 2.1 replacement level back in the 1980s.

A second factor which influences population size is life expectancy, and in the Ukraine case the recent evolution of life expectancy has been most preoccupying, since it has been falling rather than rising in recent years. In particular male life expectancy which is currently running at around 64. Apart from stating the obvious here, we should note that the deteriorating health outlook which this low level of life expectancy reflects places considerable constraints on the ability of a society like Ukraine to increase labour force participation rates in the older age groups, and this presents a big problem since increasing later life employment participation is normally though to be one of the princple ways in which a society can compensate for a shortage of people in the younger age groups.

The third factor influencing population dynamics is obviously migration. Ukranian out migration since the turn of the century has been distinguished by two factors, a reduced intensity when compared with the rather dramatic population movements which characterised the 1990s, and by a significant change in destinations. From migrating East the Ukranians are now moving West. Data on this latter movement has not been systematically collected but we have some national data on Ukranians in Portugal, Spain and Italy, and lots of anecdotal information about Ukranian migrant workers in Latvia, the Czech Republic, Poland and elsewhere in the EU 10.

According to information provided by Ukrainian diplomatic missions, 300,000 Ukrainian migrants may be working in Poland, 200,000 each in Italy and the Czech Republic, 150,000 in Portugal, 100,000 in Spain, 35,000 in Turkey, and another 20,000 in the US. According to official information based on the number of permits issued by the Russian Federal Migration Service, some 100,000 Ukrainian citizens currently work in Russia, although the real number of Ukrainians working there is often estimated to be more in the region of 1million.

With Fewer and Fewer People Avaialble For Work

This out migration is very significant from the economic point of view, since all those working abroad send money back (see chart below) while at the same time are not present in the country to offer themselves for the work which this extra money creates. So out migration and the accompanying remittances are one thing in a high fertility, growing population like that which is to be found in Ecuador or the Philipinnes, and quite another in the long term low fertility, declining population environment of Central and Eastern Europe. Hence all that demand driven wage inflation. As we can see from the data in the chart below (which the World Bank Economists themselves recognise if surely a substantial underestimation) the flow of remittances into Ukraine has increased steadily in recent years.

As a result unemployment has been falling steadily all year:


As salaries grow, of course, so do retail sales:

The Litmus Test?

In many ways Ukraine could be considered to be a rather important strategic unit in the whole Eastern labour supply and demographic puzzle, since many imagine that as labour supply runs out across the whole region, then countries as diverse as the Baltics, Poland, Hungary, the Czech Republic and Russia may all - and at one and the same time - be able to leverage Ukraine's population reserve to help them out of their own difficulties. In this sense many live in the hope that outward flows from Ukraine may serve to plug a lot of otherwise increasingly evident holes in the East European labour force. My feeling is that the people who make this kind of projection for the Ukraine tend to forget three things.

1) The corrosive effect that long term lowest-low fertility across all the East European and many of the CIS societies is already having on the numbers of people who are becoming available in the labour market of these countries.

2) That large migrant outflows from one society to help meet the domestic needs of the labour market in another (Poles and Latvians in the UK and Ireland or Romanians and Bulgarians in Spain) produce significant labour shortages in the home (sending) country, shortages which when combined with rapidly growing domestic demand (and especially for new housing) - domestic demand which is fueled by i) globally available non-local-currency denominated cheap credit and ii) a steady and growing return flow of remittances from those abroad, then this whole process only serves to push up sending country wages very dramatically indeed, and potentially feed through to a loss of competitiveness which can make the whole external position of the country concerned (and with this the local currency, and the sustainability of the non-local currency denominated mortgages) very vulnerable indeed. Let's call this whole process - with no perjorative intention whatsoever - the Baltic syndrome.

3) That these sending countries, and in particular as a result of the processes detailed in (1) and (2), themselves start to experience fairly high rates of economic growth, and as a result they themselves start to need migrants. Ukraine is now a classic case of this process at work. The only thing which remains to be seen here is how all this ends up in practice, since at this moment in time we are all basically off on a voyage into the unknown, since we have definitely never been here before.


A much fuller analysis of the underlying problem in the Ukraine economy can be found in this post here.

The Polish Economy: An Unlimited Need For People?

The gentleman in the photo is Konrad Jaskola, Chief Executive Officer of Polimex-Mostostal SA, Poland's biggest construction company, and according to this article in Bloomberg, he has just one message for us all: "I have an unlimited need for people".


The issue arising is that Joskola has plans to hire "several thousand" new workers next year to meet demand for new bridges and factories, but he has a problem, and the problem is that due to Poland's growing labour shortages he may have difficulty finding them. Poland's economy has been growing strongly in recent quarters, although not as strongly, it should be noted, in some of the more evidently "overheating" economies like the Baltics. Poland's economy expanded an annual 6.4 percent in the third quarter of 2007, following 6.7 percent growth in the second quarter and 6.8 percent in the first one, according to data released by the Warsaw-based Central Statistical Office at the end of November.







This strong growth rate is partly fueled by construction activity and partly by strong consumer demand for retail items like cars and washing machines. Construction in Poland rose 20 percent in the first nine months of 2007, and as can be seen in the chart below - which offers a breakdown of Polish GDP growth by components, construction has been playing a very important part in the process. The thing is, however, that construction activity is pretty labour intensive.





According to Joskola, Polimex needs to offer higher salaries across the board, to engineers and managers, and to on-the-ground site workers, as Poland's skilled workers steadily move abroad (like all that hedge fund money which is flowing in the opposite direction) in search of higher yield. As a result local competition for workers increases, and wages start strong upward climb. Polimex has raised wages by 11 percent over the last 12 months and plans to raise them them by a further 10 percent next year.


The company, which is a "recycled" formerly state-owned machinery supplier, established to drive Poland's post-World War II reconstruction effort, currently plans to spend as much as 200 million zloty on acquisitions next year, in order to add workers and production capacity. I imagine some, at least, of those acquisitions will have to be of workers coming from outside Poland.

Inflation On An Upward Path

Meantime Polish inflation accelerated to the upper end of central bank's target range in November on the back of higher food and oil prices, meaning policy makers at the central bank may be forced to raise interest rates again in the coming months, in so doing possibly pushing up the value of the zloty, and attracting even more funds in search of even more workers to put to work.

Polish inflation rate rose to 3.6 an annual percent in November from 3 percent in October, the Central Statistical Office reported today in Warsaw. Consumer prices gained a monthly 0.7 percent after rising 0.6 percent in the previous month. Food prices grew an annual 7.2 percent 1.3 percent from the previous month, while fuel prices soared 13.2 percent from November 2006 and 2.5 percent from last month




As Unemployment Continues To Fall

The unemployment rate fell for the ninth consecutive month in October to 11.3 percent from 11.6 percent in September, the office said in a separate report today. Earlier this month, the office said that average corporate wages advanced an annual 11 percent in October and employment grew a record 5 percent from the year before.



And Wages Continue To Rise



As I say, inflation in Poland is also being fed by a 10 percent average wage growth and record low unemployment this year. In fact Polish average corporate wages advanced in November at the fastest pace in more than seven years, suggesting that the very rapid economic growth and large scale out-migration of key age group workers may be squeezing the labour market more than people imagined, thus provoking the sharp rise in inflation. Wages rose at an annual 12 percent rate (and 4.8 percent from a month earlier) to 3,092.01 zloty, according to the Warsaw-based Central Statistical Office earlier this week.




While Remittances Continue to Flow in Strongly

Remittances from abroad, mostly by taking advantage of free movement of labor within the European Union, are currently estimated (by the Polish National Bank) to be worth almost 2.5% of the gross domestic product of 250 billion euros. Since the United Kingdom opened its labor market to Poles three years ago, at least half a million Poles have settled in Britain.

Marcin Korolec, under-secretary at Poland's ministry of economics is quoted as saying that "the statistics show that the transfer from Polish people working abroad is something like 6 billion euros a year....Obviously this is a huge amount of capital, a huge amount of flow. It has an impact on internal consumption and internal growth."




All of Which Produces A Rapid Rise in Sales

Polish October retail continued their rapid rate of annual increase adding to evidence that economic growth remains strong despite four interest rate increases from the Central Bank so far this year. Retail sales rose an inflation corrected 16.3% in October over October 2006, this was up from a 12.2% rise in September compared with 14.2 percent in September, according to the Warsaw-based statistics office today.





The growth which is driven by sales of vehicles (which rose 42% year on year) and sales furniture and household appliances (a 21.9% annual rate of increase) - confirms the impression that consumer demand is being bolstered by falling unemployment, which dipped to an 8 1/2-year low, higher wages, which last rose the most in seven years last month, and a steady and economically significant inward flow of remittances.


Monetary Policy in A Bind?


The central bank lifted the seven-day reference rate a quarter-point to 5 percent only last month, and this was the fourth increase since April, when the key rate was 4 percent. So as we can see, at this point of time , and against all traditional expectation, monetary tightening may actually be having the perverse effect of accelerating the economy.



At the same time the zloty continues its rise, trading at 3.58 to the euro after the release of this weeks wages data, holding near its highest in five and a half years.


So as the Monetary Council begins its 2 day meeting for December today, we can see that there are some difficult decisions to take. Members of the council have already made public some of their divergences, with policy maker Marian Noga having taken the view that "The sooner we have the hike, the better, as preventive action is cheaper than boosting rates to chase down inflation", while Council member Miroslaw Pietrewicz takes the view that Poland's central bank should delay raising the benchmark interest rate until policy makers have had time to assess whether the four increases already made so far this year have been sufficient to bring inflation into check in the mid term.

What this dispute is a reflection of are the serious issues which arise concerning the actual ability of conventional monetary policy to work in a situation like the one facing Poland, since raising interest rates may just as easily stoke up more inflation - as we have seen in Australia and New Zealand, and to some extent in China - by attracting more investment funds into the country. This issue became apparent when the zloty also gained after a central-bank policy maker Marian Noga said the interest rate may have to rise as much as three-quarters of a percentage point before the end of 2008 to ward off inflation. Normally, an impending rise in inflation and a monetary tightening process (which reduces growth) would be considered to weaken and not strengthen a currency. So what happens next? Well this is just what we don't know, since we have never been here before. Clearly these economies will continue accelerating till the day they can't. And after that, well we will have to wait till we get there to actually see. What is happening in Hungary may give us some clues, and what happens next in the Baltics will definitely provide another of the missing links. Meantime we are in "wait and see" mode I feel. And behind Poland, roaring down the track come Russia and Ukraine, remember.

Lithuania Unemployment Q3 2007, Running on Empty?

Lithuania's unemployment rate fell to record low in the third quarter, the statistics office reported today, following their quarterly labor-force survey.

Statistics Lithuania reports that, according to the labour force survey data, the number of the unemployed in the country in iii quarter 2007 was 63.5 thousand, i.e. The lowest over the recent 5 years. As compared to iii quarter 2006, the number of the unemployed decreased by 27.3 thousand persons, or by one-third. Over the year, the number of young unemployed persons (aged 15-24) decreased from 15.2 to 13.4 thousand.

The jobless rate dropped to 3.9 percent from 4.1 percent in the previous three-month period. The chart below shows the evolution in the Eurostat harmonised unemployment rate, which is calculated slightly differently, but the picture is broadly the same.




Lithuania's jobless rate has been falling since 2004. When the country joined the European Union the rate stood at 13 percent. Lack of available labor has forced employers to raise salaries, which accelerated an annual 18 percent in the third quarter. The unemployment rate has fallen steadily as people have emigrated to those European states that have opened their labor markets. Top destinations for Lithuania's migrants include the U.K., Ireland and the U.S., the statistics department said. Claus Vistesen has examined the Lituanian situation in some depth in "Lithuania Under the Loop" and "End of the Road in Lithuania". This twin pincer, of rapid economic growth plus large scale out migration is increasingly producing severe overheating, labour shortages and inflation all across the EU10 (with the honorable exception of Hungary which is spiraling downwards into recession). To the issue of migration must be added the long term presence of below replacement fertility, which means that new entrant cohorts are very small, and cannot compensate for the loss, and low male life expectancy, which means that poor health makes it very difficult to raise participation rates among older workers.

Bulgaria and Romania Inflation November 2007

Bulgarian inflation rose again last month, reaching 12.6 pct on an annual basis (as measured by the Bulgarian statistics office index of major groups), largely as a result of rising food prices. The index had fallen back (to 12.4%) in October on a year on year basis from September's high of 13.1%. The Bulgarian index rose by 1.6 pct in November from the figure for October the National Statistical Institute said in a statement. Here's a chart for the Bulgarian index and the EU harmonised index. The reason the HICP is consistently lower is largely a question of the differing weights attributed to food in the EU wide measure, but the local Bulgarian index may well be a much better reflection of the inflation situation on the ground in Bulgaria, since being a comparatively poor country food is a significant part of the household budget.



And in Romania


Well here is the Romania inflation chart, I wouldn't say the November figure was exactly good news, but a drop in inflation to an annual 6.67% from an annual 6.84% isn't bad news at any rate, unless you thought inflation was going to suddenly go away it isn't.



On one level you might have thought that the rot had been stopped, but it's not that simple. The month on month rate is 0,93, which is down from last months 0,97. But if we look at the components, then food rose 1,17% month on month, while services rose 1,21 month on month. In October food was up 1.3% over September, while services where only up 0,98. So food seems to be slowing, but price increases in services are accelerating (pass through) and this is not good news.

Migration and Labour Shortages?

Of course the big problem with all this inflation is the danger of a wage price spiral, given the constraints which have been placed on the local labour markets by low male life expectancy, declining populations, heavy out migration and years and years of very low fertility.

According to Romanian Labor Minister Paul Pacuraru, quoted in the newspaper Ziarul Financiar, Romania needs at least another 300,000 workers to meet current needs and will need more than 1 million within a decade.

The labor shortage, Pacuraru said, is caused partly by a migrating workforce and partly by a declining population, and is most acute in construction, and the textile, automobile and food processing industries.

Maybe he has been reading this blog (and here, and here).

Actually, according to the UK Daily Telegraph Romania's finance minister, Varujan Vosganian, aims even higher, saying Romania lacks half a million workers."We need more engineers, mechanics and bricklayers," he is quoted as saying "We have a labour deficit of 500,000 employees."


And he wasn't talking about the elites - doctors and IT programmers gone to make their fortune elsewhere, though that would be damaging enough. Romania needs its skilled labourers to return - the people who are going to build up the infrastructure that the country so severely lacks. But when we look at the wage differentials, this idea of a mass return would seem to be a forelorn hope to me, in Latvia, in Poland, in Ukraine or in Romania.

So the simple issue is, what is now the normal capacity neutral growth rate for Romania at this point (remember this will get less as the population continues to decline)? That is, what is the annual growth rate which Romania is capable of without seeting off the sort of inflation we are seeing at the moment? Noone really knows, but it is obviously well below the rate Romania is currently growing at.

Second question: when and how will the adjustment come?

Inflation and Monetary Policy Problems in the Czech Republic?

According to the Czech Statistics Office, the Czech consumer price increased by 0.9% in November as compared with October. The rapid rise in global food prices obviously had a strong upward effect on the consumer price level, but there may be more factors at work than meet the eye here. The year-on-year rise in consumer prices accelerated to 5.0% in November from 4.0% in October, and this is the highest year-on-year price growth experienced in the country since August 2001.




The 0.9% month-on-month increase in the consumer price level had a lot to do with the rise in the ‘food and non-alcoholic beverages‘ component, and the 4.0% increase here was the highest month-on-month price jump in this category since January 1993. This sort of price increase was recorded for majority of classes of food. The main upward pressure came from the rise in prices of bread and cereals (11.3%), and the prices of rolls and baguettes rose by 24.6% and prices of bread by 16.2%.

The prices of eggs, milk, cheese and other dairy products increased by 12.6%, 2.5%, 7.9% and 3.5%, respectively. while the prices of oils and fats rose by 9.4%, of which edible oils by 17.5%, vegetable fats by 9.7% and butter by 6.0%. Prices of vegetables grown for fruit were up by 6.7%. Prices of chocolate and chocolate-based products rose by 4.8%, confectionery without chocolate by 3.2% and confectionery products by 4.5%.

The price growth in the 'transport' component was also influenced by the increase in prices of automotive fuel by 2.9%, of which prices for diesel oil rose by 6.0% and liquefied petroleum gas by 6.2%. Oil prices hit a record high in November, above any level registered since the beginning of statistical price monitoring in 1969.

Monetary Policy In A Bind?

But moving on now beyond the details of these increases, this rise in inflation in the Czech Republic is significant since it means that the Czech central bank may need to continue raising interest rates, following a string of four increases already this year, and indeed central bank Deputy Governor Miroslav Singer has been hinting at just this possibility. The Ceska Narodni Banka's seven-member board last lifted the two- week repurchase rate by a quarter of a percentage point to 3.5% on November 29.



However, at the time of taking this decision policy makers - who target inflation at 3 percent plus or minus a percentage point - had been forecasting November inflation to come in at 3.9 percent. (The next meeting of the monetary policy board is scheduled for Dec. 19).

Singer is quoted as saying that the "sensitivities" in the bank forecast to the actual inflation registered and to the exchange rate "are more or less known, so the December debate will be substantive". ``What is evident is that the level of restriction will have to be higher, but it's not evident'' how the central bank will "achieve that'' objective using interest rates and the exchange rate.

This problem is no mean one, since it is not clear at this point whether additional increases in the interest rate will serve to slow inflation, or attract more funds which may even cause it to accelerate. A combination of rising rates and a rising koruna have made the Czech Republic an ideal "haven" for those playing the currency markets, and given the present rate raising process (and of course the new tendency on the part of the US Federal Reserve and othersto loosen interest rates) the koruna may be about to make the rapid turnaround from being a "carry" currency, to a carried one.

Indeed the koruna has been the world's best-performing currency in the second half 2007 and has risen by 10 percent against the euro since July. The currency could then keep on rising, with significant consequences from the Republic's trade balance in the medium term. Some signs that this "creeping" issue is now arriving are to be found in the October trade statistics, since the Czech trade surplus dropped to 8.6 billion koruna, compared with the 13.9 billion koruna surplus in September, but still up substantially on the 3.8 billion koruna surplus registered a year ago. The point is the rate of increase in the balance is slowing, and the balance could at some point turn negative. This is a very worrying prospect, since the Czech Republic had had the most solid looking economy in the whole EU10 group.

This issue also has broader importance, since the rise in the koruna must to some extent have limited price growth in the short term. That is without the appreciation in the koruna things would have been worse on the inflation front, and this must be taken into consideration when evaluating the consequences of any possible "unwind" at a later date. In the words of Miroslav Singer "the exchange rate is undoubtedly significantly stronger than foreseen by the October forecast, and is much higher than the koruna's trend appreciation".

Also according to Singer, the last central bank inflation report was "a signal that the level of restriction that we considered adequate" to tame prices may "prove to be insufficient" and "the resulting trajectory'' of interest rates "at this point is not clear'' In this inflation report the Czech national bank forecast that the inflation rate might rise to as much as 6 percent next year, fueled in part by one-time increases in indirect taxes. Also a growing shortage of labor may lead to demands for higher wages and prevent inflation slowing toward the bank's 3 percent target as the impact of the tax increases and rising food and oil prices wanes.

Now the Czech economy grew at an annual 6 % rate in Q3/07, with this growth being principally driven by increases in domestic demand and a continuing strong export performance. Household demand is estimated to be likely to grow at around 6% this year, and investment at around 19%, while government demand is only forecast to grow at around a 1% annual rate.

So if we look at the chart below (which was prepared by a staff economist at the Czech National Bank), we will find that according to central bank estimates Czech GDP is currently growing at roughly 1 % above its non-inflationary potential, while overall monetary conditions remain broadly neutral. That is to say, inflation is not exclusively a food and fuel price story.

What all this means is that the Czech economy is now moving into tricky territory, with what is known as the output gap - which is really a rule of thumb measure of how fast an economy can grow without producing inflation, since the "gap" in question is a general measure of spare capacity - having turned negative around the end of 2005. So basically the Czech economy is now dependent on inward flows to maintain stability, flows of both funds, in particular of FDI, to pay for the current account deficit, and inward migration flows of workers to meet the growing labour supply needs.



Labour Shortages?

The lowest unemployment rate for 10 years and a record number of vacant jobs, created by economic growth of more than 6 percent over nine quarters now, are increasing the chances that the growing demands for rising salaries will be met. Czech real wages rose at the same 5% pace in the third quarter as it had done over the preceding three months.

The average gross monthly annual growth, adjusted for inflation, rose 5 percent, while the average nominal wage grew 7.6 percent to 21,470 koruna, led by strong wages pressure in the private sector.



Among private businesses, the monthly salary grew be 7.6 percent, to 21,612 koruna, while salaries for state employee advanced 7.5 percent in the July- September period from a year earlier, to 20,952 koruna. That translates into a 4.9 percent real increase. The largest Czech trade union is now calling for an average 8 percent salary increase next year to cushion workers against measures in the pipeline like increases in value-added tax and cuts in social spending, which will are both likely to undermine purchasing power. The November inflation data will only add more grist to their mill.

Now all of this is still comparatively tame when we look at what is happening elsewhere in the EU10 (the Baltics, Bulgaria, Romania for example), but it is still important that the Czech central bank get this under control now, before things get really out of hand.

The relative position of labour has improved steadily as unemployment falls to decade lows month after month and businesses increasingly have difficulty finding people to hire. Indeed Czech Central Bank Governor Zdenek Tuma has been quite explicit in saying he expects a shortage of labor to fuel wage growth, and hence drive inflation up even more.

"The tension on the labor market is relatively significant'" and `"pressures on wage growth can be expected" told a conference in Prague back in October.




Czechia, however, has one big advantage over many of its East European neighbours in that it has had a positive policy of encouraging migrant workers in place for some time now, and the number of foreigners in the Czech Republic has been rising steadily. Indeed over 34,000 foreigners went to live in the Czech Republic in the first six months of this year, and this compares with 25,000 in the second half of 2006, according to data fromthe Czech Statistical Office.

Data from the Czech police indicate that there were a total of 356,014 foreigners living in the Czech Republic in the first half of this year, compared to 321,456 at the end of 2006. This means that about 34,600 foreigners have arrived in the Czech Republic to stay permanently or temporarily over the past six months. The number of non-nationals living and working in the Czech Republic is still very low when compared with Western European averages, but the figure is rising, and the change in the country's evolution in this sense is very significant. While at the end of 2005 foreigners accounted for 2.5 percent of the Czech Republic's population, by mid 2007 this share had risen to 3.5 percent.

The largest group of foreigners staying in the Czech Republic are Ukrainians. In the first half of 2007, there were 115,000 Ukrainians with permanent residence or temporary stay permits, while three years ago there were 70,500. Ukrainians are also the second largest group of employees who come from abroad, although the largest number are over-the-border workers from neighbouring Slovakia (100,000). In the first half of this year, almost 49,000 Ukrainians were working legally in the Czech Republic legally, but to this should be added many thousands more who are undoubtedly working in the country illegally. (Incidentally, it should be noted that this outflow of Ukrainians to countries across Eastern and Western Europe - and in particular of course to Russia - is now producing large pressure inside the Ukraine labour market, with unemployment dropping steadily, inflation hitting 15.4% in November, and wages and salaries rising at 20% plus a year. So there is not a bottomless pit here anywhere).

Ukrainians also form the biggest group of foreigners with residence permits in Slovakia but, compared to the Czech Republic, their number is low. In the first half of this year, only 630 Ukrainians received residence permits in Slovakia. Again this comparison gives us some idea of just how far out in from on the migrant labour flow question the Czech Republic actually is. All of these countries are suffering the corrosive effect of long run low fertility, and if they are to continue to grow at the rate they are doing they will need to find the labour supply from somewhere.

To give us some idea of just how complex all of this is, it is worth noting that the third largest group of non-nationals working in Czechia come from Poland (22,000) a country with its own labour supply problem (following the mass exodus to the UK and Ireland), where labour ministry officials recently visited India to scour the terrain for construction workers, and where as a short term "urgent" measure convicts have even been released from prison to help build the local highways.

And Poland is not the only EU10 country to start looking farther afield to meet the long term needs which arise from its population shortfall, Skoda has now begun to recruit workers from Vietnam for its factories in the Czech Republic as it struggles with the local labour shortage. Long queues outside the Czech consulate in Hanoi have now become an almost daily sight, provoking some controversy (and even allegations of corruption) both in Vietnam and in the Czech Republic.

This is not the first time that workers from Vietnam have moved to the Czech Republic. When the country was under communist rule as Czechoslovakia, Vietnam, also under communist control, and Cuba sent workers in return for arms and heavy engineering goods. Many of these Vietnamese stayed in Czechoslovakia after the overthrow of communism in 1989 and set up small businesses. Now the Vietnamese are the third-largest migrant worker group in the Czech Republic, behind Ukrainians and Slovaks.


Many Czech companies would now be unable to operate without the foreign labour force, according to HVB Bank analyst Pavel Sobisek. The share of foreign workers in the total labour force already exceeds four percent, and the share of value added created by them is around 3 percent, according to Sobisek. In some sectors, like construction and retail, the share is much higher.

Latvia GDP Q3 2007

Well, turning now to GDP, and as Latvian Abroad notes in a recent post, the Latvian Economy is slowing lost of signs of slowing. You can see it in the latest GDP numbers, for example.




As we can see, the high point was reached in Q1 2006, and since that time ever so surely and ever so steadily the Latvian enconomy has been slowing down. Compared to the corresponding period of previous year, in the 3rd quarter of this year Latvian GDP increased by 10.9%, according to data released by Latvijas Statistika last Friday. Interestingly one of the parts of the economy which has slowed most is manufacturing indutry, which actually decreased by 0.3% y-o-y in Q3, and mining and quarrying only managed a measly 2.4%. Construction managed a 13.2% y-o-y growth, but this is undeoubtedly due to large base effects earlier in the year, and the execution of previously signed contracts - as we are noting in the US, you need to wait nearly a year to see the full effects of a slowdown in requests for new buildings to execute.

Unfortunately Latvijas Statistika do not have the Q3 breakdon in their database yet, and they only give annualised data in the press release, when what is most interesting at this point are the quarter on quater changes. Still they do produce this reasonably informative chart about movements in some of the key expenditure components over the last year, and some things are reasonably clear (please click over image for better viewing).



As is obvious, final household demand peaked in the 4th quarter of 2006, and is now falling steadily. It is not clear when (ot whether) this component will ever recover to the extent of being able to drive growth, since we get into age related elements (which I know not many people agree with me on at this stage, but still) as Latvia's median age is climbing steadily, and calibrating all of this for Eastern Europe's comparatively low male life expectancy (ie calibrating how domestic constumption loses its relative strength as median age rises, in the way we have seen in Germany, Japan and Italy) is something noone has done at this point to my knowledge. In fact most people you talk to don't imagine that this is important, but then most of them didn't imagine that Hungary would fall into the hole it is currently falling into.



Now as we can see, these two countries (Latvia and Hungary) are pretty similar in the evolution of the relative population median ages. And if we come to male life expectancy, here is a comparison of Hungary, Latvia and Germany.



As we can see, male life expectancy is considerably lower in both Hungary and Latvia, than it is in Germany, and this must have consequences for economic behaviour and performance. Increasing the working life to 67 and beyond as they have in Germany is just not the same proposition at all in a lower life expectancy society like the other two, nor is the issue of getting employment participation rates among the over 60s comparable given the evident health problems of one part of the population.

So while we would not normally expect domestic consumption to run out of steam until the median age reaches 41/42 (this is the sort of lesson we can garner from Germany, Italy and Japan) there may be good reasons for imagining that this median age needs rounding down somewhat in the Latvian and Hungarian contexts. I will certainly stick my head out and say that this property boom, like the 1992 one in Japan, and the 1995 one in Germany is very likely to be the last of its kind we will see in Latvia, high median age societies just don't work like this. They do not ride on the backs of credit driven booms, and I would have thought that the reasons why would be obvious.

Just Why Is Hungary So Different From The Rest of the EU10?

According to the Hungarian Statistics Office (KSH) gross domestic product grew in Hungary by just 0.3% on a quarter by quarter basis from to July-September 2007. The KSH also took the opportunity to reduce their growth figure for the second quarter to zero, which was down from the previous 0.1% estimate.




On a year on year basis, economic growth in Q3 was just 0.9% according to unadjusted data or 1.0% if you prefer your figures to be adjusted for seasonal and calendar effects. In either case this is a very low reading end especially when you bear in mind the very rapid growth we are seeing in many other EU10 countries, and all the indications are that this figure is likely to drop further. Which raises three questions directly in our minds: a) why is Hungary so different from the rest of Eastern and Central Europe, b) where is Hungary headed, and c) what can we learn from Hungary about the future path of those EU10 economies who are now visibly overheating, after they have passed through their inevitable "correction" that is.

Looking at the evolution of Hungary's GDP on a year on year basis, the slowdown is evident. The first thing that strikes you when you look at the chart below is that annual growth rates seem to have peaked in 2004 (that is before the correction and fiscal adjustment of 2006), growth slowed entering 2005, and it was at this point that the expansion in the fiscal deficit became important, but it was a fiscal expansion to try to arrest a general downward tendency in the rate of output expansion(very reminiscent in its way of things we have seen in Japan and Italy if we work our way back through the data). And on a year on year basis Q3 2007 represents yet another step backwards, since the comparative figure for Q2 was 1.2%. And this process seems set to continue, and I would go so far as to say that no-one at this point has any idea where the bottom is on this one.



The engine behind what little growth Hungary is now getting continues to be industrial output which registered a 7.4% yr/yr growth in Q3, and this output was pulled along to a considerable extent by the 14.6% export growth which was registered.



The main drag on growth was, unsurprisingly, final household consumption, which declined by 2.0% yr/yr. Previously, the slowest pace of growth in recent memory was back in 1996 when the fiscal adjustment package of Economy Minister Lajos Bokros pushed growth to below 1% y-o-y.



If we now come to look at the evolution of GDP shares for some of the components, we will see, for example, that both agriculture and construction have been more or less stable in recent years (ie we have not had any sort of dramatic construction lead boom in recent years. On the other hand, if we look at manufacturing and real estate and financial services, we will see that the latter have clearly grown in importance in relation to the former, which is in many ways a pretty normal development.



On a quarterly basis, the largest growth was observed in industry (3.1%), followed by services (1.3%) and transport, storage and communications (0.9%). Consumption expenditure of households fell by 0.8% yr/yr and 0.2% q/q, while public consumption fell by 3.8% yr/yr and 3.2% on a quarterly basis.

Exports rose by 4% q/q (vs. 2.0% in Q2) and imports increased by 5.9% from the previous quarter, against a q/q decline of 0.3% in Q2. What this means is that while Hungary has now managed to achieve a small goods trade surplus:



The rise in imports pegs pretty closely on to the the coat-tails of the rise in exports, something for which the very strong value of the forint must undoubtedly bear some responsibility, since as the euro rises, and the forint clings on to par with the euro, the general tendency of opening the doors to products from China and other low-cost manufacturers (as well of course Japan, and a now much cheaper and more competitive United States) must have a reflection of the Hungarian import situation.



So it is really rather cold comfort that the 0.3% q/q growth obtained in Q3 is the largest so far this year, firstly because, as Portfolio Hungary indicate, it is disappointingly small and secondly, because it would really be very premature to start speaking of any kind of upswing even in the short term.

Hungarian central bank (NBH) Deputy Governor Ferenc Karvalits is quoted this morning as saying he believes the central question is not whether the growth rate of the Hungarian economy will start to increase but to what extent and up to which point. I think he is basically right, but he forgets one additional issue, when it will stop falling, and how much farther it still has to fall? Certainly if we look at the path of domestic retail sales, there is no sign at all that we are done yet.



And to this slowdown in private consumption we need to add future purchasing power, since real wages are also falling in Hungary. If we look at the chart below, the sharp improvement in the negative real wage tendency which we can observe in September 2007 is due to the base effect of the austerity package tax and social security measures introduced in September 2006 having moved out of the calculations (since these meant that between September 2006 and August 2007 net wages rose much more slowly than gross wages) and hence the change does not reflect any sudden spike in actual wages paid, and of course, inflation continues to be strong.



And when we come to think about public consumption it is important to bear in mind that the Hungarian government - according to its own latest Dec 1st estimates - is still running a fiscal deficit this year of 6.2% of GDP. The government are committed to reducing the deficit further next year, so this has naturally to be subtracted from GDP: that is we are going to face more fiscal tightening. In fact, what is incredible is that Hungary is currently only able to get 1% y-o-y GDP growth despite this whopping fiscal stimulus. Which is why a close examination is needed of just how Hungary got into this mess in the first place, and in that context why it is that Hungary is so apparently different from the rest of the EU10.

Obviously the presence of fiscal deficits has been one issue.



But again, and in the end, what is so striking is just how little "bang for the buck" (or forint) Hungary has been getting for all this fiscal stimulus. As I pointed out above, a lot of the sparkle had already been going out of Hungary's GDP growth some time before the fiscal correction came into force.

In addition monetary policy is likely to remain restrictive. The current Central Bank base rate of 7.5% is the highest in the European Union, and there is little room for any substantial reduction given the rate of domestic inflation - the government has just agreed to raise public sector wages by an average 5% in 2008, so it is hard to see inflation being anywhere near the "comfort zone" yet awhile.



Ideally, even considering the current inflation, given the state of domestic demand, you might have though that some element of monetary loosening would be desirable, especially since this would probably serve to weaken the currency, and this would help exports and in so doing increase that at present very minimal trade surplus. But it is just here that we hit one of Hungary's biggest headaches moving forward, the Swiss Franc Mortgages.

The use of non-local-currency denominated loans has become a widespread phenomenon in Eastern Europe in recent years. In Hungary the most common currency for such purposes is the Swiss Franc and around 80% of all new home loans and half of small business credits and personal loans taken out since early 2006 have been denominated in Swiss francs. A similar pattern of heavy dependence on foreign currency denominated loans is to be found in Croatia, Romania, Poland, Ukraine (US dollar) and the Baltic States, although the mix between francs, euros, the dollar and the yen varies from country to country.

First off, here's a chart showing the evolution of outstanding mortgages with terms over 5 years since the start of 2003. As we can see the outstanding debt is now over 5 time as big as it was then.



Now if we look at the growth of forint denominated mortgages over the same period, we can see that while they initially expanded very rapidly, they peaked around the start of 2005, and since that time they have tended to drift slightly downwards.



Then if we come to look at the growth of non-forint mortgages, we will see that since early 2005 the rate of contraction of such mortgages has increased steadily.




The Magyar Memzeti Bank (the Hungarian central bank) recently published the October edition of its bulletin on Household and non-financial corporate sector interest rates, interbank lending rates (careful PDF). This bulletin contains a lengthy summary of the state of play with non-forint denominated loans to individuals, and in particular a section on Swiss Franc loans in Hungary.

According to the Bank, following a moderation in the demand from Hungarian households for Swiss franc-denominated consumer loans, a sharp turnaround in demand occurred in October. The monthly volume of new mortgage loans for consumption purposes (ie not for buying homes, refis) leaped by 30% to reach an all-time high. It is also a noteworthy that even before the start of the real Christmas season the volume of new CHF-denominated consumer credit jumped by 25% from September, setting yet another historic high.



The amount of new mortgage loans rose to the previously unseen level of HUF 130 bn in October, and this increase is almost exclusively attributable to the increase in CHF-denominated loans (HUF 120 bn). Detailed data from the bank show that while the monthly amount of new CHF-denominated housing loans rose to the exceptional level of HUF 55-60 bn, mortgage loans for consumption purposes (ie "refis" or liquidity extraction, not to buy houses) became pretty fashionable, rising by 30% month on month to reach the level of HUF 62.5 bn.




Within these new mortgage loans, the ratio of foreign currency to total loans increased to 92.5%, setting yet another record. What all this suggests to me is that a lot of Hungarians are trying to maintain current consumption by borrowing forward in the hope and expectation of rising property values in the future. If this rise does not materialize, then the very least that can be said is that all of this will need, at some point, to be clawed back from current consumption. This whole process also represents a new form of moral hazard for the central bankers, since such borrowing in Swiss Francs is based on the assumption that with so many people doing this the Hungarian authorities will never dare to let the forint slide (you know, there's safety in numbers) or, pushing the buck back one stage further, the EU Commission and the ECB won't let it happen.

But this is very dangerous thinking, since in the first place there are a lot of people now out there riding around on the back of the same idea (think Italian government debt, for eg), and people may be seriously overestimating the ability of the political and monetary authorities to contain such a large and complex set of problems. It should not go un-noted that the whole weight of the ECB is currently not able to stop the spread of the growing credit crunch across the entire eurozone and beyond. Secondly, and just as importantly, all of this puts the Hungarian central bank in a real double-bind, since they cannot ease monetary policy at this point without precipitating a tremendous weakening in the forint, so interest rates stay high, and Hungarian domestic demand gradually gets strangled, while all the inflation puts a strong brake on export growth.




The translation problem that all these foreign currency loans may represent for Hungary, and some of the other EU10 economies where this kind of borrowing has become popular, are a matter which has been addressed by Claus Vistesen in this post. But what exactly is translation risk? Well let's take a standard type definition, such as this one from investopedia.com. Translation risk is "The exchange rate risk associated with companies that deal in foreign currencies or list foreign assets on their balance sheets. The greater the proportion of asset, liability and equity classes denominated in a foreign currency, the greater the translation risk".

Now as Claus points out much of the literature here refers to companies, and most of the words spent on the subject have been devoted to the description of companies' exchange rate risk when operating in foreign countries under insecure exchange rate systems and obviously subsequently how this risk can be hedged through the use of derivatives, or simply by adequately calibrating the denomination of the stock of liquid assets held on the balance sheets. But the issue in Eastern Europe is that the majority of this credit has been extended to households through loans intermediated by foreign financial institutions and thus it is unhedged, and even more to the point this borrowing is being facilitated either by bank flows or inward FDI which is what enables the current account at the end of the day to balance. The big problem will come if ever the direction of these capital flows reverses, and this is precisely why the Hungarian central bank is constrained in the way it can loosen monetary policy, since it simply cannot afford to either risk a reversal in the flow of funds, or a sharp rise in the cost of private debt servicing should the forint weaken significantly in value.

Those analysts who focus only on the secondary issue of steering inflation expectations are missing the bigger part of the problem here. As we are now seeing in the United States, and as we may well be about to see in an ECB context (indeed arguably we have already seen, since the inflation data treated alone may well have warrented an ECB raise this month) if expectations are your only problem, then the central bank can afford to be more flexible than many imagine.



It's the Demography?

So to return to where we started, just what is it that makes Hungary so different. The simple answer is that I don't know, but I know that it is, and that we need to keep digging. The philosopher Francis Bacon held that the important thing about doing science was to know how to put the right questions to nature, and the answers we get to some extent depend on the questions we ask. My intuitions tell me that Hungary's very special demography has something to do with it all, but others do not agree, and do not ask this type of question. But if we come to look at the demography, there are some things which we can hardly fail to notice. In the first place Hungary's population has been falling, and for many years now, in fact it peaked around the start of the 1980s.

Now something has to be said here. Noone knows what the long term consequences of having a declining (and ageing) population like this is going to be. We don't know, because quite simply we have never been here before. In previous periods, after a war or a plague, when population had fallen the Malthusian homeostatic mechanism of increasing wages lead to increased fertility, and this in and of itself corrected the problem. Indeed in some parts of Eastern Europe (though not Hungary) we are seeing a demographically driven form of wage inflation, but this is not leading to a homeostatically corrective rise in fertility because, quite simply, the old correlation between increasing wealth and increasing fertility has now been broken. More money today does not mean more children, indeed under certain circumstances it may mean less. So basically we don't know where we are going here, and my advice is don't let anyone convince you otherwise.

Having said all this, intuitively less people ought to constitute less domestic demand pressure, but this issue is undoubtedly more complex than this.

Turning now to fertility, it is worth noting that, apart from a brief episode in the late 1970s, Hungary has in fact been struggling with below replacement fertility since the early 1960s. The only real "novelty" about the 1990s is that Hungary transited from below replacement fertility, to lowest-low fertility (1.2/1.3 Tfr region).


Returning then, and in a demographic context to Deputy Central Bank Governor Ferenc Karvalits' question about how far and to what extent Hungarian growth will recover, as we have noted, domestic demand has been in virtual free-fall in recent quarters. What is not clear is when (ot whether) this component will ever recover to the extent of being able to drive growth, since now start to get into age-related elements (which I know not many people agree with me about at this stage, but still).

As a result of ongoing low fertility, and rising life expectancy, Hungary's median age is, of course, climbing steadily, and calibrating the macroeconomics of this ageing process in the context of Eastern Europe's comparatively low male life expectancy (ie calibrating how domestic consumption loses its relative strength as median age rises, in the way we have seen in Germany, Japan and Italy) is something noone has done at this point to my knowledge. In fact most people you talk to don't imagine that this is important, but then most of them didn't imagine that Hungary would fall into the hole it is currently falling into. As we can see below, Latvia and Hungary, despite having started the 1990s at not such a great distance from Germany, now have considerably lower median ages (please click on image for better viewing).



But this lower population median age is hardly a positive outcome, since it is not due to higher fertility or strong inward migration. Rather it is due to their much lower male life expectancy.



As we can see, male life expectancy is considerably lower in both Hungary and Latvia, than it is in Germany, and this must have consequences for economic behaviour and performance. Increasing the working life to 67 and beyond as they have in Germany is just not the same proposition at all in a lower life expectancy society like the other two, nor is the issue of getting employment participation rates among the over 60s comparable given the evident health problems of one part of the population.

So while we would not normally expect domestic consumption to run out of steam until the median age reaches 41/42 (this is the sort of lesson we can garner from Germany, Italy and Japan) there may be good reasons for imagining that this median age needs rounding down somewhat in the Latvian and Hungarian contexts. I will certainly stick my head out and say that the property boom which is now in the process of petering itself out in Latvia, like the 1992 one in Japan, and the 1995 one in Germany, is very likely to be the last of its kind we will see there, high median age societies just don't work like this. They do not ride on the backs of credit driven booms, and I would have thought that the reasons why would be obvious. Indeed, if we look at the proportion of construction in Hungarian GDP, this sort of confirms my suspicions, since in general terms this has not constituted a large share.



Indeed what we can note, as might be expected, is a very strong weather-driven annual cycle, and if there is any sort of trend discernible, it is ever so slightly downwards rather than upwards. This, again would fit in with a gradually ageing and declining population. The position is only confirmed if we come to look at the housing cost index.



So the first thing that strikes us is a local boom which we can see in the early months of this year, and which has since faded (and this is more than likely associated with a removal of public housing subsidies, a sharp rise in rents, and therefore a shift in the relative appeal of purchased property - always, of course, on low interest Swiss loans - and all of this at a time when internal demand is to all intent and purpose collapsing). Before this we can note the surge in prices in 2003/04. My guess is that this is/was Hungary's property boom, and that this phase has now come and gone. This also helps explain how the Hungarian fiscal side got into such a mess in 2005, as the government was increasingly having to shoulder the load against a faltering domestic demand. All of this is, as I say, very different from other parts of the EU10.

In conclusion then, we can assume that given sufficient determination by the central bank to hang on at all costs to the value of the forint, and absent a major external exodus from Hungary on the backs of a more general crisis, the systematic and sustained tightening on all fronts will eventually produce nominal as well as real wage deflation, especially if we sink into a deepish recession, which seems to look all but unavoidable when we come to think about the third factor - external conditions - which are almost certainly going to deteriorate over the next 6 to 9 months, as the powerhouse economies of the eurozone - Italy, Spain and Germany (France is the only semi-brightish star on the horizon) are all slowing mightily even as I write. So the message here is now twofold. Strap yourself in tight, since it is going to be a very bumpy ride, and secondly, Hungary is now about to join that honoured group, the export dependent economies. Of course, how rich she will ever get to be due to all the structural difficulties must remain a very open question.