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Monday, February 4, 2008

GKI Economic Research, Getting Hungarian Economic Growth Wrong

The Hungarian economic expansion, which was the slowest in the European Union in the third quarter of 2007, will recover less than previously expected according to the Budapest-based GKI research institute today. The institute suggest that the Hungarian growth will accelerate to 3.2 percent from an estimated 1.5 percent last year. The institute prepares monthly forecasts in cooperation with Erste Bank AG. This is definitely the highest estimate I have seen of what we can expect in Hungary this year, and seems to put it mildly, wildly optimistic. Still, it is a movement back towards reality when compared with last month's forecast, which suggested we would see growth of 3.5 percent in 2008 and an estimated 1.7 percent in 2007.

The downward revision is due to a revevaluation of the potential for Hungarian export growth, the institute now estimate will slow to 13 percent this year, down from an estimated 16 percent increase in 2007. Previously the institute predicted the 16 percent rate would continue in 2008. But there are a number of reasons for thinking that increasing exports will prove to be a much harder task in 2008 than it was in 2007. One of these is the external environment which is darkening by the day. All the main global forecasting agencies - the IMF, the OECD, Consensus Forecasting - are lowering their estimates for global growth, and this is bound to have an impact on Hungary, which is now, remember, an export dependent economy, since both domestic private demand and government spending are likely to remain flat at best.

In addition, cost pressures in the Hungarian export sector are now likely to mount. As explained in this post, the export sector component in the PPI is now showing signs of trending upwards, as wage increases - which the GKI estimate as rising at a 7.5% rate in 2008. A rise of this order - which would no longer be simply wage "whitening" - will prove very hard to absorb in the much more competitive external environment of 2008, especially if the forint remains at the current comparatively high levels as the institute forcast.

Hungary's main destination countries for exports by order of importance are Germany (the leader by a long margin), Italy, France, Slovakia, Austria, Romania, United Kingdom, Poland, and the Czech Republic. Among the Western European countries here, only France looks like it is seriously resisting a growth slowdown. It is not apparent what is going to happen in Eastern Europe at this point, but the risk of a significant correction exists if the credit crunch continues to bite, and the strong level of interlocking and interdependence means that if one country falls the rest will more or less inevitably be affected.

All of the above suggests that extreme caution is called for when looking at export prospects in 2008, and any economy which needs to depend on exports will be vulnerable, even if it were solid enough in its own right, which Hungary manifestly isn't.

As regards other elements in the forecast, GKI have contruction pencilled in for an 8% rebound. This is also hard to regard as credible, although of course EU funds for civil engineering projects will make some difference. But residential construction is not likely to trend upwards in any way shape or form in 2008, given tightening credit conditions and general risk aversion. If we look at the most recent construction chart there is very little evidence of activity having bottomed out yet, and while it doubtless will do so at some point, we need to know when this happens and at what level of activity befoe we can start assessing realistic levels of construction output growth for 2008.

On retail sales GKI are estimating a 1.5% increase, but again there is no sign yet of the downward movement in retail sales has come to an end, even if the rate of contraction may have stabilised somewhat, so the same applies as in the case of construction:

As regards industrial output, GKI see this rising by 7.5% on the year, but again we need to ask what would be driving this? Clearly for GKI the driver would be exports - since it is very unlikely to be internal demand, and especially given the fact that the current forint value and the strong internal inflation make imports more and more attractive. Again looking at the monthly chart there is no real basis for the optimistic GKI forecast, since the rates of expansion have been - as one would expect - slowing since the summer.

When it comes to inflation, which during the course of last year accelerated to the fastest in six years in Hungary in part due to the price impact of the government measures, GKI seem much more realistic, and while they feel inflation will slow this year as the effects of administrative price rises work their way out of the system , they forecast that the average inflation rate will be 5.7 percent this year, down from last year's 8 percent. This number is higher than both the central bank's 5 percent forecast for inflation and the government's 4.8 percent estimate, and indeed is up from last months GKI estimate when they predicted 5 percent increase in consumer prices.

But they do not seem to draw the conclusions which flow from their own forecast here, since this inflation will continue to eat away at export competitiveness, and will effectively box-in the central bank when it comes to monetary easing, and both these factors are strong GDP growth negatives.

Actually I will say one thing for GKI research, they do keep their previous monthly reports online, so you can go back and compare. Thus I find that in February 2007 they were forecasting 2007 GDP growth at 3%, so in the sense they are over optimistic they are at least consistent.

As for my own case, personally I was estimating back in autumn 2006 (see comments) that Hungary would have a very significant slowdown in 2007 (and I think this has been borne out) and I am quite happy - at least until we see the results of Q4 2007 GDP (after which my best guess is that we may need downward revisions) - to stick with what I was saying at the start of January 2008:

My own view is much more nuanced. I think I am reasonably confident in holding to my recession forecast for 2008, although of course, "recession" does not mean negative growth for the whole year (technically it is simply 2 consecutive quarters of negative growth), so we might then go on to see what, between 0.5 and 1% growth over whole year 2008 (and the only really doubt is whether the contraction starts in Q4 2007, or in Q1 2008). But it is what happens in 2009 and 2010 that matters really, and at this point so many variables are in play (and interrelated ones to boot) that I can only say I envy those who have the courage - or the temerity - to stick their necks out). And of course, if we get a large correction in the value of the forint, then all those carefully weighed and weighted forecasts will, without a shadow of a doubt, go straight and directly off into the bin.

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