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Tuesday, October 16, 2007

Magyar Nemzeti Bank in Pessimistic Mood

Unfortunately, for some reason the national bank seem to publish their quarterly report only in Hungarian, so I can only read this brief summary in Bloomberg:

Hungary's outlook for economic growth, the European Union's second slowest after Denmark in the second quarter, deteriorated as the effects of government austerity measures spread, the central bank said.

Growth in the second quarter was 1.2 percent as efforts to cut a record budget deficit, including higher taxes and energy prices, sapped consumer demand and curtailed government spending. The slowdown may be spreading beyond state-controlled industries, the bank said in its quarterly report today.

``Growth prospects changed negatively, despite the continuing favorable international environment,'' according to the report posted on the bank's Web site. ``The larger-than-expected slowdown may also be wider. The decline in construction output suggests a subdued investment outcome, which may risk the longer-term growth path of the economy.''

The current forecast from the Magyar Nemzeti Bank is for growth to be at 2 percent this year, while it expects next year's rate to 2.7 percent and the 2008 figure at 3.4 percent. These numbers seem way too high to me, especially given what is happening in the eurozone, and the risk of a generalized crisis in the EU 10 in the not too distant future. My feeling is that Hungary will have a brush with recession this winter and if the economy manages not to contract in 2008 then this will be a "good" result.

The central bank mentioned construction activity, and here is the latest data we have on that. I really need to do a more detailed analysis of the components of GDP growth to see where exactly we are here.

In the meantime, and on a slightly separate issue, I recently posted on the state of the CA balance (and here), and in particular I put up this chart here:

What we can see here is the importance of payments on equities in the Hungarian CA issue. This provoked Daniel Antal to make the following very interesting observation in comments:

I think you see the problem very clearly....... Your argument is very much valid I think.

However, I think you cannot do too much about it. Central Europe has a huge wealth problem: it always had very small per capita capital stocks compared to Western Europe. Privatization helped in the short-run, because made loss making ill-managed state-owned companies work again, thus giving the population income. However, the wealth problem was not solved: the new owners obviously made investments in order to make profit.

Personal incomes are flows and are much more easier to move up than capital stock. Central Europeans earned less than Western Europeans for centuries. Even if wages will converge in a few decades it takes at least a century for capital stocks to be comparable.

Ironically what makes some convergence possible is that European, especially Western Europeans have destroyed the majority of their inherited capital stocks in the World Wars. Since they had much more to loose, they have lost much more in those wars and Central Europe has only fifty years of very low income to make up.

Another interesting point: at the start of the transition Central Europe had abundant labor supplies and very little capital, so wages were relatively low and capital gains were very high. Foreign capitalists and those few who grabbed capital stocks in the early years made fortunes. Now there seems to be a sort of overshooting: in many countries labor is relatively more scarce than capital and wages are rising.

But if you think about the good old production function, these are just relative measures. We still have fewer labor and less capital than Western Europe.

I think Daniel also understands the situation pretty well. FDI to buy old state enterprises helps with the efficiency situation, but it doesn't resolve the wealth problem. It saves government debt in the short run by giving others a stake in the national wealth - in the absence of members of the nation themselves having this - but in the end, like any other debt it has to be paid back.

In the Western European countries FDI is not an issue, since the accumulated wealth issue means that the country has very similar stocks of external FDI to balance the inflows. But Hungary's problem is a bit like people in the US worry theirs could become in 10 or 20 years if they continue with the CA deficit and the Chinese and others start to buy-up US enterprises with the proceeds of the trade surplus China has with the US. This is a very real concern for the US in the future, since the accumulation of investment stocks would mean that at some point the outflows on income payments (dividends or interest) would exceed the annual inward stock flow. That is why the dollar is going down and the US is trying to correct. But Hungary seems to have already reached that point, and, quite frankly, I am not sure what to do about this. Here is a chart showing the relative stocks of inward and outward FDI as shares of GDP. One is clearly much bigger then the other.

True the proportions of the flows of FDI have changed rather in recent years, and there is more outbound FDI, but the inbound still exceeds the outbound, so the position in the longer run continues to deteriorate. Anyone have a plan 'B' to hand?

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