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Thursday, June 26, 2008

Hungary Retail Sales Recover Slightly In April

Hungarian retail sales rose by 0.4% month on month in April, following a 0.5% decline in March, according to data adjusted for calendar and seasonal effects. The Central Statistics Office (KSH) reported a 1.5% year on year fall in April, as compared with a 3.5% fall in March.

Despite the fact that the data was better than some expected the release still confirms the view that any recovery in domestic consumption is likely to be slow and drawn out affair this year following the austerity package-induced contraction in 2007.

As can be seen from the above chart, even though sales did improve slightly over March, they are still languishing down at a very low level.

This reading comes ohot on the heels of (and may partially help to explain) the surprising decision of Hungary's Central Bank Monetary Council to hold the benchmark rate on hold at 8.50% earlier this week. Market participants (as well as yours truly himself) had been more or less unanimous in expecting a 25-basis-point rate hike, especially after the last wages data. Of course, when you look at the sort of internal demand reading we see in retail sales it isn't hard to reach the conclusion that higher interest rates may well not be precisely what the Hungarian domestic economy needs right now, but then the central bank is in a very difficult position here, with domestic consumption needs to think about even as inflation continues to run well above target.

The structure of Hungarian growth has however changed enormously in recent years, and that I think is what many commentators are missing about the present conjuncture. In a pattern we have already seen in other ageing societies like Japan, Germany and Italy, private internal consumption seems to have already "maxed out" as a driver of headline GDP growth - according to my estimates in the second half of 2002 (see chart below, where the difference between "private" and "total" household consumption is simply that the latter includes government transfers, which have of course been affected by the adjustment programme hence the more rapid decline), but in any event well before the current austerity programme was introduced in the autumn of 2006.

It is my interpretation of the situation that the increase in government fiscal deficit in 2005 and 2006 was in fact a knock on consequence of this decline in private consumption as the goverment attempted to maintain momentum which was being lost (as we have also seen in other high govt debt to GDP countries with low private dmestc consumtion growth like Italy and Japan).

Investments in the Hungarian economy were down by 4.8% year on year in the first quarter of 2008. The volume of investment – according to seasonally adjusted indices – was 1% lower than in the previous quarter. Construction investments fell by 15.5%, while investments in machines and equipment were up by 8.4%.

After the impact of last years drought, the agricultural sector is now growing again (and in particular given the rapid rise in food prices).Since this sector is highly volatile it can have substantial impacts on short term GDP growth rates despite its small weight in the whole economy - last year it brought the headline data down and this year it may well pump it up. Most analysts expect a good harvest this year, but this is precisely why Q1 growth estimates are a little uncertain, since the real value of current operations will not be known before the middle of the year. For this reason, the current data may even be revised upward if crops prove to be as good as is being forecast this year.

So if there is a stable external environoment (in the eurozone) - something which is open to question - we could expect a slight pick-up in GDP growth during the year on the back of agricultural output and continuing exports, but it seems right now there is no spectacular change of pace in sight. Any economic recovery is going to be ``slow'' (especially given the inflation problem, and the very tight monetary policy being run by the NBH) and household consumption and investments are unlikely to improve dramtiaclly, and certainly cannot be expected to replace exports as the growth engine (as central bank President Andras Simor recently suggested) and investment will be very much driven by the export sector much as we have been seeing in Germany in recent years. The chart for total domestic use (which is the sum of private and public consumption demand and capital formation - or if you prefer investment) makes this abundantly clear. Without the improvement in the trade balance there is no growth whatsoever in Hungary at the present time. I think this is quite an important result, and one which people need to think about a lot, since if this is not understood none of the 1001 "remedies" are ever going to work. Hungary is an "elderly" society with a declining and ageing population, and the macroeconomic consequences of this need to be assimilated and understood.

Of course, we have strong downside risks on this scenario, since any deterioration in Germany, or increase in global risk aversion can unsettle a Hungarian economy which continues to remain precariously perched between heading up and heading down.

Essentially it seems to me that with the forint trading band now abolished the currency will be very likely to come under sharp attack if any indication is given of downward movements in interest rates (and this despite the recent record highs in the currency, which may well have been about taking the "ride up" on recent NBH decisions) and especially if Hungary's stagnant economy shows no signs of revival, and - with interest rates at the current level and fiscal policy tightening, and the eurozone slowing - it is hard to see just how it can rebound beyond a token surge in GDP growth (where would - apart from agriculture - the growth come from).

True, inflation remains stubbornly high:

but domestic demand is still declining. Retail sales, for example:

or construction:

and the rate of increase in industrial output has weakened considerably:

while GDP is now almost stationary:

Of course, any conjecture about the future path of the Hungarian economy evidently has strong downside risks attached to it, since any deterioration in Germany, or increase in global risk aversion can only further unsettle a Hungarian economy which continues to remain precariously perched between heading up and heading down.

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